FCA Alert : Lawyers & Attorneys for Whistleblower, False Claims Act & Qui Tam Defense : Kelley Drye & Warren LLP

The Facts

In 2007, the United States intervened in a qui tam suit against Lockheed Martin Corporation ("Lockheed") and Tools & Metal, Inc. (“TMI”). The government alleged that TMI, a perishable tool supplier, engaged in an illegal pricing scheme and submitted inflated subcontractor invoices to general contractor Lockheed Martin, which in turn, submitted the invoices to the United States for payment pursuant to a government contract. In late 2005, TMI filed for bankruptcy and TMI’s CEO Todd Loftis pled guilty to conspiracy to defraud the United States based on his role in submitting inflated subcontractor invoices to Lockheed.

In its civil complaint against Lockheed, the government alleged that Lockheed received “credible evidence” of TMI’s fraud in 2000. In May 2000, the qui tam relator, a former TMI national account executive, sent a short email to a procurement manager at Lockheed Martin warning about allegedly excessive prices charged by TMI. The government alleged that Lockheed ignored this warning and continued to submit TMI’s inflated costs to the United States and, despite Lockheed’s allegedly broad contractual audit rights, did not conduct a “proper” audit of TMI until late 2004 after Lockheed learned that a federal prosecutor was investigating TMI. The government claimed that Lockheed’s lack of oversight of TMI demonstrates that Lockheed knowingly created false records and presented false claims to the United States for payment or approval and sought to hold Lockheed liable for claims submitted from October 2000 to May 2006.

The Motion to Compel

Lockheed moved to compel the government to provide factual information regarding its criminal investigation of TMI and Loftis. Lockheed asserted that it needed the information to show Lockheed’s absence of scienter. The government opposed the motion to compel, arguing that the investigative material sought by Lockheed was irrelevant to Lockheed’s defense and, in any event, was protected from disclosure by the investigatory law enforcement and work product privileges.

Holding #1:  An FCA defendant may use circumstantial evidence to establish lack of scienter.

According to Lockheed, the government’s central allegation in the lawsuit is that Lockheed should have investigated TMI and learned of the illegal pricing scheme shortly after receiving a “tip” from the relator in May 2000 regarding possible fraud. Lockheed contended that it could not have been aware of TMI’s fraud as quickly as the government alleges because it took the government several years to substantiate the relator’s allegations of fraud even though the government had at its disposal broad investigatory powers not available to a private corporation.

The government argued that information concerning its investigation was irrelevant to the issue of scienter because the only facts that could establish scienter (or its absence) are those that were known to Lockheed during the time of the government’s investigation. The government further argued that events outside of Lockheed’s knowledge could not be relevant to the question of Lockheed’s scienter.

The court disagreed with the government’s assertion that only “direct” evidence of Lockheed’s state of mind is relevant and held that circumstantial evidence has a place in establishing an actor’s scienter in a civil FCA action:

Establishing a requisite state of mind in any case, such as the scienter at issue here, necessarily involves an analysis and consideration of at least some circumstantial evidence….If discovery pertaining to the government’s criminal investigation of Loftis can reveal facts about Lockheed Martin’s dealings with TMI that were unknown to Lockheed Martin at the time and could not reasonably have been known to Lockheed Martin, the court is at a loss to see why those facts would not constitute relevant circumstantial evidence as to Lockheed Martin’s absence of scienter.

The court therefore held that Lockheed's discovery requests seeking facts concerning the government's investigation of TMI and Loftis were relevant for discovery purposes.

Holding #2.  The investigatory law enforcement privilege does not apply to a closed criminal investigation.

After determining that Lockheed's discovery requests were relevant, the court considered whether the requested information was shielded from discovery by the investigatory law enforcement privilege. In its opposition to Lockheed’s motion to compel, the government asserted an extremely broad interpretation of the investigatory law enforcement privilege. Specifically, the government claimed that the privilege protects not just criminal investigations but also investigative files prepared for civil law enforcement purposes; and that the privilege should extend beyond Loftis’s criminal prosecution because the civil case is simply a continuation of the criminal case.

The district court disagreed with the government’s assertion that a sweeping investigatory law enforcement privilege exists in the Fifth Circuit. Rather, the district court noted that the Fifth Circuit recognizes a qualified law enforcement privilege that protects only government files related to an “ongoing criminal investigation”:

The Fifth Circuit Court of Appeals has made clear that “the law enforcement privilege is bounded by relevance and time constraints.”…In this case, it is clear that the information Lockheed Martin seeks in discovery pertains to the criminal investigation of Loftis, who, in light of his December 2005 conviction, is no longer under investigation. Moreover, despite the government’s attempt to eliminate a distinction between civil cases and criminal cases with respect to the application of the investigatory law enforcement privilege, the court declines to adopt the government’s sweeping view. The Fifth Circuit has made no statement that suggests that this privilege was intended to protect government files for any purpose other than insofar as they relate to an ongoing and criminal investigation.

Accordingly, the district court held that the investigatory law enforcement privilege no longer affords protection to government information related to its criminal investigation of Loftis.

Holding #3.  The work product doctrine does not apply because Lockheed sought only the facts obtained from the government’s investigation.

The government argued that its criminal investigation was work product because it constitutes notes and memoranda that contain attorneys’ mental impressions. Lockheed contended that the work product doctrine does not shield the government from Lockheed’s discovery requests because Lockheed seeks only the facts related to the criminal investigation of Loftis.

The court was not persuaded by the government’s assertion that such facts were inseparable from mental impressions, and directed the government to provide the facts sought from its criminal investigation “stated as answers to interrogatories, requests for admission, and depositions of witnesses,” as requested by Lockheed.
 

Since the claims at issue accrued prior to Congress’ amendment of the FCA under the Fraud Enforcement and Recovery Act (FERA) on May 20, 2009, the pre-FERA version of the federal FCA applied, which attaches liability under Section 3729(a)(7) when a person “knowingly makes, uses, or causes to be made or used, a false record or statement to conceal, avoid or decrease an obligation to pay or transmit money or property to the [federal] Government.”

Because the alleged false statements were premised on Caremark’s denial of coverage rather than on the submission of any claim for reimbursement, the Fifth Circuit viewed the conduct in question as a “reverse” false claim. Moreover, because the alleged false statements were not made directly to the federal government but rather to state Medicaid agencies, the court characterized this as an “indirect” reverse false claim.  The Fifth Circuit then held that if the government is able to prove that Caremark knowingly made false statements to the states knowing that these statements could cause the states to impair their obligation to the federal government, Caremark will be liable under Section 3729(a)(7).  The Fifth Circuit's decision reversed the district court's holding that Caremark did not have any obligation to the federal government for denials of reimbursement requests that Caremark submitted to state Medicaid agencies. 

At issue in the Steury case was whether the knowing delivery of defective products to the government violated the FCA.  Leslie Steury, the relator in the action, worked for Alaris Medical Systems as an account consultant.  As an account consultant, Steury marketed medical devices, including Signature Edition Infusion Pumps to hospitals, including children’s hospitals and hospitals operated by the Veteran’s Administration, from March 1996 until her termination in late September 2001.  The infusion pumps were electrical devices designed to regulate the rate at which intravenous fluids flow into patients.  Alaris started selling the infusion pumps nationwide in 1996 but stopped doing so in August 2006 after 1,300 of the products were seized by the FDA for an unrelated problem.  In her FCA complaint, Steury alleged that the infusion pumps had a dangerous defect that could cause air bubbles to accumulate and release into a patient’s intravenous line, potentially causing serious injury or death.  She alleged that she first became aware of this defect in October 2000 when a pediatric anesthesiologist at a children’s hospital in Akron informed another Alaris employee that an infusion pump had injected air into his patient’s intravenous line and that a similar problem had been reported at a children’s hospital in Philadelphia.  Seven months later, in May 2001, Steury allegedly met with Alaris’s area manager and nurses from the Akron children’s hospital to discuss concerns about the infusion pumps.  During this meeting, Alaris’s area manager allegedly discredited a nurse’s report of an infant mortality related to an intravenous air bubble.  One month later, in June 2001, Alaris’s area manager informed Steury that Alaris had temporarily suspended shipments of the infusion pumps while it reviewed the air bubble defect, but nonetheless directed Steury to continue marketing the infusion pumps.  Steury was terminated in September 2001 before she received an answer about the company’s review of the alleged defect.

Almost six years later, in May 2007, Steury filed a qui tam complaint under seal against Cardinal Health (Alaris’s successor) alleging violations of the federal FCA and a number of state FCAs.  In January 2008, the United States filed a notice that it declined to intervene in the suit (which is typically a sign that the government believes the merits of the case are weak, the damages are small, or both). 

In the Fifth Circuit, to state a claim under the FCA, a plaintiff must allege: (1) a false statement or fraudulent course of conduct; (2) made or carried out with the requisite scienter; (3) that was material; and (4) that is presented to the Government.  Two key allegations in Steury’s complaint attempt to establish FCA liability.  First, she alleged that a “claimant submits a false or fraudulent claim within the meaning of the FCA when he submits a claim for payment for the Government for products that contain defective parts.”  (Am. Compl. ¶ 51).  Second, she alleged that by “accepting payment from the federal Government or one of its agencies for the SE infusion pumps, Cardinal Health knowingly misrepresented that the SE infusion pumps were safe, reliable and quality-assured.” (Am. Compl. ¶ 52).

Cardinal Health moved to dismiss the complaint pursuant to Rules 9(b) and 12(b)(6).   The district court agreed and dismissed the case, and for reasons unclear from the opinion, declined to give Steury an opportunity to amend the complaint to try to cure the pleading defects. 

In an effort to “streamline” the appeal, Steury pressed only one substantive contention: that Cardinal Health made a false certification (i.e., a false statement) to the Veteran’s Administration that the infusion pumps complied with the warranty of merchantability.  Steury did not assert that Cardinal Health actually made this certification.  Rather, Steury alleged that Cardinal Health, impliedly, and falsely, certified compliance with the warranty of merchantability simply by requesting payment for the infusion pumps.

A plaintiff may establish a false statement under the FCA (element #1) by alleging that when the government expressly conditions payment of a claim upon a claimant’s certification of compliance with a statute or regulation, a claimant submits a false claim when he falsely certifies compliance with that statute or regulation. This is known as “express certification” and is recognized in many Circuits.  Fewer Circuits (specifically, the Second, Sixth, Ninth, Tenth, and Eleventh Circuits) also recognize something called “implied certification” as a basis for establishing a false statement under the FCA.  The implied certification theory of liability “is based on the notion that the act of submitting a claim for reimbursement itself implies compliance with governing federal rules that are a precondition to payment.”  Mikes v. Straus, 272 F.3d 687, 699 (2d Cir. 2001).

In Steury’s case, the Fifth Circuit observed that it had not yet recognized the implied certification theory, but did not yet have to resolve the issue because the allegations in Steury’s complaint provided no basis for implying a false certification.  The court observed that “a false certification of compliance, without more, does not give rise to a false claim for payment unless payment is conditioned on compliance.”  Applying this principle to Steury’s case, the court found “no indication that the Government conditioned payment for the Signature pumps on a certification that the Signature pumps complied with the warranty of merchantability.”

While the court closed one door on Steury, it opened another when it stated later in the opinion:

We do not suggest, however that a knowing delivery of defective goods to the Government will never implicate the FCA.  Particular government contracts may specifically condition payment on a certification of compliance with the warranty of merchantability.  Other courts have suggested that the knowing provision of ‘worthless’ goods or services to the Government may violate the FCA.  Steury has not yet pursued or briefed these theories, however, so we need not address them here.  Finally, although we have held that a knowing attempt to deceive the Government about the nature of commercial items may violate the FCA, the district court was correct in concluding that Steury has so far failed to allege this type of claim with particularity. 

The Fifth Circuit then remanded the case to the district court with instructions to permit Steury to amend her complaint as “we cannot say that the defects in Steury’s complaint are necessarily ‘incurable’ or that amendment would be futile.”

It will be interesting to see if Steury can follow the Fifth Circuit’s guidance and file an amended complaint that can withstand dismissal under Rules 9(b) and 12(b)(6).  A copy of the amended complaint that was dismissed can be found here.

In 2007, Denenea represented homeowner Robert Weiss in a breach of contract action against Allstate Insurance Company. In that action, Weiss alleged that Allstate did not pay enough to cover the damage his home sustained during Hurricane Katrina. Prior to trial, Weiss received $350,000 in federal flood insurance and an additional $50,000 from Allstate for wind damage to his home. At trial, the question of liability hinged on whether the damage to Weiss’s home was due to wind damage (an event which was covered by Weiss’s homeowners insurance policy) or a storm surge (which was not covered). On April 16, 2007, the jury issued a verdict finding that Allstate did not pay Weiss enough to cover the wind damage to his home and awarded him $2.8 million in damages, including a $1.5 million penalty for Allstate’s failure to pay the claim quickly enough.

Two weeks later, on May 4, 2007, Denenea filed a federal whistleblower complaint under seal against Allstate, naming himself as the relator. According to Denenea’s 9-page complaint (which is pretty short by qui tam standards), Allstate entered into an agreement with the federal government pursuant to which Allstate agreed to sell and administer federal flood insurance policies on the federal government’s behalf.  Claims under the federal flood insurance policies sold by Allstate were paid with federal funds whereas claims under homeowners insurance policies sold by Allstate were paid with Allstate’s own funds. The complaint goes on to allege that Hurricane Katrina caused catastrophic wind and flood damage to thousands of properties situated along the Gulf Coast insured by both federal flood insurance policies and homeowners insurance policies sold by Allstate, including insured properties owned by Weiss and several other of Denenea’s clients. The crux of Denenea’s FCA claim is his allegation that Allstate fabricated and falsified documents associated with claims for property damage arising from Katrina in an effort to inflate the amount of damage attributable to flooding and deflate the amount attributable to winds, thereby increasing the federal government’s liability on the claims while minimizing Allstate’s. (Complaint, ¶ 14.)

On September 17, 2010, the United States filed a consent motion to lift the seal and notified the Court that it did not intend to intervene at this time. On September 21, 2010, the Court granted the motion and unsealed the complaint. Allstate was served with the complaint on September 24, 2010 and currently has until October 14, 2010 to move to dismiss or answer the complaint. Given the lack of specificity in Denenea’s complaint, including the failure to provide any detail about the allegedly falsified documents or identify any specific false claims submitted to the government, we are curious to see whether the complaint can withstand dismissal under Rule 9(b). Another interesting question that may be addressed during the motion to dismiss stage is whether Denenea is a proper relator. Unlike the typical qui tam relator who is a company insider with first-hand knowledge of the fraudulent activity, Denenea’s complaint alleges that his knowledge comes from his representation of Weiss and other homeowners in civil claims against Allstate. (Complaint ¶ 18.) Although the Fifth Circuit has not yet addressed the issue, the Second and Third Circuits have both held that information produced in discovery in a lawsuit is “publicly disclosed” for the purposes of the FCA’s public disclosure/original source bar, and that an attorney who learns of the information through his participation in the lawsuit cannot be an “original source.”  We will report back once Allstate’s motion to dismiss is filed.     

The relators filed their original complaint in 2003, and the case remained under seal until December 2009. During the seal period, the documents at issue were produced by the defendant to the State of Texas and the Commonwealth of Virginia pursuant to a series of civil investigative demands. Texas and Virginia subsequently shared the documents with the relators. The complaint was unsealed, and the defendants brought a motion to dismiss for failure to plead fraud with particularity under Rule 9(b). The court denied defendant’s motion to dismiss and granted relators leave to amend their complaint in order to plead the alleged fraud with particularity. The relators then sought leave of court to use the documents obtained by Texas and Virginia while the case was under seal in order “to streamline the complaint and ensure that the necessary factual details are provided to survive a Rule 9(b) challenge.” The defendant argued that the use of the subpoenaed documents was not authorized under Virginia or Texas statutes and that the relators offered no other authority permitting the use of the documents.  

The court held that relators could amend their complaint using the subpoenaed documents, finding that the respective state statutes govern only the conduct of state attorneys general and not relators. The court further held that Fifth Circuit precedent “almost necessitates that relators be allowed to use the subpoenaed documents that were shared by the states.” This holding has particular significance to False Claims Act cases with prolonged sealed periods, as relators may be allowed to supplement their claims with facts and information obtained by state or federal entities to cure an otherwise defective complaint.  While relators are permitted the benefit of discovery taken while the case is under seal, defendants have no reciprocal ability to take discovery of the relators or the government.