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Pharmaceutical Regulation in the United States: A Confluence of Influences

Background

Pharmaceuticals, like other consumer products distributed in the United States, are subject to regulation and scrutiny from multiple sources. Legislative oversight and statutory pronouncement, regulatory mandate and oversight, judicial review, and non-governmental organization (NGO) and media oversight directly and/or indirectly impact the conduct of pharmaceutical manufacturers. In addition, stakeholders including pharmaceutical company shareholders, employees of pharmaceutical companies, and those entities that ultimately bear the costs of paying for drugs – known as third-party payors –also influence the conduct of drug manufacturers.

For example, the securities markets that price stock rely, in part, on representations that drug companies make about the integrity of their products. Public misrepresentations to regulatory bodies and/or consumers also play out indirectly as misrepresentations to shareholders resulting in additional liability for companies and those individuals who run them. Accordingly, shareholders – the owners of the pharmaceutical companies – have an interest in ensuring not only the integrity of products sold to consumers, but the integrity of public statements about their products.

Through their retirement plans, Pharmaceutical Regulation in the United States: A Confluence of Influences1 pharmaceutical company employees invest in their employer and, to some degree, stand in the same shoes as shareholders except that they have rights of redress under United States Pension laws. Product recalls result in diminished stock value and lost savings for employees who invest in their companies.

Third-party payors, including labor union health and welfare funds, State Medicaid and employee health and welfare funds, and the federal Medicare system, have also had an immense impact with regard to the conduct of the pharmaceutical industry.

To say that any one of these influences is the real source of regulation would paint an incomplete picture. It is the totality of these influences, and their interplay with each other, that either impact or have the potential to impact manufacturer conduct.

Read the full article . . .

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Corporate Integrity Agreements: Asking the Companies to Police Themselves, Please

I. Introduction

The use of a corporate integrity agreements (“CIA”) in resolving the prosecution of pharmaceutical and medical companies is commonplace. As part of a deferred prosecution agreement, the U.S. Department of Justice, or the U.S. Department of Health and Human Services, Office of Inspector General, will ask the defendant corporation to enter into a CIA to police its behavior and, in part, ensure compliance with the terms of the settlement.

II. Background on Corporate Integrity Agreements

Since the mid-1990s, CIAs have accompanied the federal government’s enforcement efforts in the field of health care regulations, and to recover funds lost to fraud and abuse. The Health Insurance Portability and Accountability Act of 1996 (“HIPAA”) significantly enhanced the resources and capabilities of federal agencies involved in these efforts, including the OIG.

For example, the website of the HHS states: “The Office of Inspector General (OIG) often negotiates compliance obligations with health care providers and other entities as part of the settlement of Federal health care program investigations arising under a variety of civil false claims statutes. A provider or entity consents to these obligations as part of the civil settlement and in exchange for the OIG’s agreement not to seek an exclusion of that health care provider or entity from participation in Medicare, Medicaid and other Federal health care programs.” (FN 2)

In the years that followed the mid-1990s, OIG has entered into more than one thousand CIAs and similar agreements, including many with pharmaceutical and drug companies. (FN 3) CIAs were originally structured around the core elements of the Federal Sentencing Guidelines of 1995. After an early period of taking a rigid approach to the agreements, OIG began recognizing over time that there was a need for greater awareness about compliance and sanctions, as well to encourage self-regulation through the adoption of ongoing compliance programs. OIG also sought to create an atmosphere conducive to self-disclosure by offering concessions to those who came forward.

In 1997, OIG announced that in determining the level of sanctions, penalties and exclusions, it would take into account any reasonable efforts made by a company’s management to avoid and detect any misbehavior within their operations. In 1998, it published a detailed self-disclosure protocol. By 2000, seven segment-specific compliance program guidance documents were issued, providing suggestions on how providers could design internal controls to monitor adherence to applicable statutes, regulations and program requirements. OIG also began issuing fraud alerts, advisory opinions, advisory bulletins and work plans to make its concerns and expectations more transparent.

III. Structural Limits of the Corporate Integrity Agreements

A. Purposes of the CIA

The CIA details the duties of various compliance positions within the corporation; requires the adoption of certain written standards, including a code of conduct, and policies and procedures related to compliance topics; and implements a minimum number of hours of employee training in compliance. (FN 4) The company’s compliance officer might be assigned to uphold the CIA, or sales representatives are sometimes tasked with reporting violations.

However, too often the CIA assumes the corporation’s internal compliance officer, or sales representatives, who are assigned a role in the CIA, will prove as objective as a third-party might, or as effective as the law requires. The fines for violation of the CIA may pale in comparison to the business pressures to engage in a banned practice, and may not deter the corporation in the future from a repeat of the wrongdoing that initiated the CIA.

B. Pfizer CIA for Illegal Promotion of Drugs

A review of the Pfizer deferred prosecution is illustrative. On September 9, 2009, the U.S. Department of Justice announced that Pfizer, Inc., and a subsidiary, agreed to pay $2.3 billion to settle the largest health care fraud case in the history of the Department of Justice, to resolve criminal and civil liability arising from the illegal promotion of certain pharmaceutical drugs.

According to the press release, a Pfizer subsidiary pled guilty to a felony for its promotion of Bextra, and settled civil charges, as follows: “In addition, Pfizer has agreed to pay $1 billion to resolve allegations under the civil False Claims Act that the company illegally promoted four drugs – Bextra; Geodon, an anti-psychotic drug; Zyvox, an antibiotic; and Lyrica, an anti-epileptic drug – and caused false claims to be submitted to government health care programs for uses that were not medically accepted indications and therefore not covered by those programs. The civil settlement also resolves allegations that Pfizer paid kickbacks to health care providers to induce them to prescribe these, as well as other, drugs.” (FN 5)

The settlement implemented a CIA, and monitoring program to be run by the company’s internal compliance officer. The press release states: “As part of the settlement, Pfizer also has agreed to enter into an expansive corporate integrity agreement with the Office of Inspector General of the Department of Health and Human Services. That agreement provides for procedures and reviews to be put in place to avoid and promptly detect conduct similar to that which gave rise to this matter.” (FN 6)

Nowhere in Pfizer’s CIA, or any document accompanying the CIA, is disclosure made of the breadth and depth of the allegations surrounding Pfizer’s alleged marketing violations, notwithstanding that 11 drugs were encompassed by whistleblower complaints, including Geodon, which was allegedly marketed to children. Likewise, there was no complete disclosure to the medical community about what misrepresentations were made concerning the safety and efficacy of these drugs.

C. CIAs Rely on Internal Monitoring by the Company

An analysis of several CIAs reveals four obvious problems in their structure and allocation of responsibility. First, the agreements give credit for the company having a voluntary compliance program, designed to ensure compliance with the law. Second, the company appoints its own compliance officer and review committee. Third, as discussed, the agreements leave the corporate integrity obligations to the defendant company’s compliance officer, who reports to an internal compliance committee. Finally, the penalties set forth in the CIA are modest, typically $2,500 per day for a violation, but some violations are as low as $1,000.

As shown in Table 1, below, the company compliance officer is placed in charge of CIA compliance, among other examples of internal monitoring, in each of the nine CIAs analyzed, dating from 2003 to 2010, specifically: (1) SmithKline, (2) Medtronic, (3) Aventis, (4) Merck & Co., (5) Eli Lilly, (6) Pfizer, (7) Biovail, (8) Boston Scientific, and (9) AstraZeneca.

IV. Conclusion

A review of CIAs indicate that they do not address the actual evidence uncovered during lengthy investigations of fraud. The following points are noteworthy:

  1. the CIAs do not address bonus plans which compensate sales representatives for off-label promotion;
  2. the CIAs do not categorically proscribe the role of marketing personnel in the selection of outside speakers;
  3. the CIAs do not require companies to disclose, for the period of alleged wrongdoing, alleged kickbacks paid to doctors or speakers at promotional conferences;
  4. the CIAs do not provide for an independent monitor to investigate the claims of whisteblowers;
  5. in some cases, CIAs actually allow for marketing personnel to play a role in compliance monitoring;
  6. the CIAs, in some cases, make ensuring compliance with the underlying settlement agreement the responsibility of the company’s internal compliance officer; and
  7. finally, the CIAs do not require release of information maintained at the FDA which would provide the medical community with the transparency of information needed to protect patient safety.

Table 1. Corporate Integrity Agreements with Selected Pharma / Medical Companies, 2003-2010: Compliance Responsibility Assigned to Company
Sorted by date…

# Date Company Requirements
1 2003 SmithKline 1. Gives credit for simply complying with the law. “Prior to the Effective Date, SKB voluntarily established a comprehensive Compliance Program.” CIA, Sect. I, at 1.2. SKB appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 5.3. Leaves corporate integrity obligations to SKB compliance officer. “The compliance officer is, and shall continue to be, responsible for overseeing the development of and coordinating the implementation of policies, procedures, practices designed to ensure compliance with the requirements set forth in this CIA and with federal health care program requirements for US pharma.” CIA, at 3.4. Penalty for non-compliance $2,500 per day. CIA, at 23.
2 7/4/06 Medtronic, Inc. 1. Gives credit for simply complying with the law. “Medtronic represented to the OIG that, prior to the effective date of this CIA, Medtronic established a voluntary compliance program.” CIA, Sect. I, at 1.2. Medtronic appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 3-6.3. Leaves corporate integrity obligations to Medtronic compliance officer. “To the extent not already accomplished, within 120 days after the Effective Date, the Medtronic Compliance Officer shall be responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA.” CIA, Sect. III(A)(1)(a), at 4.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(1)-(5); $1,000 – $5,000 per day penalties for other violations. CIA, Sect. X(A)(6)-(8), at 30-31.
3 8/30/07 Aventis, Inc. 1. Gives credit for simply complying with the law. “Prior to the Effective Date, API established a voluntary compliance program applicable to its United States operations.” CIA, Sect. I, at 1.2. Aventis appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 4.3. Leaves corporate integrity obligations to Aventis compliance officer. “The U.S. Corporate Compliance Officer shall be responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA and with Federal health care program requirements.” CIA, Sect. III(A)(1), at 4.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(2)-(4); $1,000 – $5,000 per day penalties for other violations. CIA, X(A)(5)-(7), at 28-29.
4 2/5/08 Merck & Co., Inc. 1. Gives credit for simply complying with the law. “Prior to the Effective Date, Merck voluntarily established a comprehensive Compliance Program.” CIA, Sect. I, at 1.2. Merck appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 5.3. Leaves corporate integrity obligations to Merck compliance officer. “The Compliance Officer is responsible and shall continue to be responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA and with Federal health care program requirements.” CIA, Sect. III(A)(2), at 5.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(1)-(4); $1,000 – $5,000 per day penalties for other violations. CIA, X(A)(5)-(7), at 28-30.
5 1/14/09 Eli Lilly 1. Gives credit for simply complying with the law. “Prior to the Effective Date of this CIA[], Lilly established a voluntary compliance program applicable to all Lilly employees.” CIA, Sect. I, at 1.2. Eli Lilly appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 5.3. Leaves corporate integrity obligations to Eli Lilly compliance officer. “The Chief Compliance Officer shall be responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA and with Federal health care program requirements and FDA requirements.” CIA, Sect. III(A)(1), at 4.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(1)-(4); $1,000 – $5,000 per day penalties for other violations. CIA, Sect. X(A)(5)-(7), at 40-42.
6 8/31/09 Pfizer, Inc. 1. Gives credit for simply complying with the law. “Prior to the Effective Date, Pfizer established a compliance program and initiated certain voluntary compliance measures.” CIA, Sect. I, at 1.2. Pfizer appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 4.3. Leaves corporate integrity obligations to Pfizer compliance officer. “The Chief Compliance Officer shall be responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA and with Federal health care program requirements and FDA requirements.” CIA, Sect. III(A)(1), at 4.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(1)-(4); $1,000 – $5,000 per day penalties for other violations. CIA, Sect. X(A)(5)-(7), at 52-53.
7 9/11/09 Biovail 1. Gives credit for simply complying with the law. “Prior to the Effective Date, Biovail initiated certain voluntary compliance measures and established a voluntary compliance program designed to address its U.S. operations and compliance with Federal health care program and FDA requirements.” CIA, Sect. I, at 1.2. Biovail appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 5.3. Leaves corporate integrity obligations to Biovail compliance officer. “The Chief Compliance Officer shall be primarily responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA and with Federal health care program and FDA requirements.” CIA, Sect. III(A)(1), at 4.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(1)-(4); $1,000 – $5,000 per day penalties for other violations. CIA, X(A)(5)-(7), at 28-29
8 12/22/09 Boston Scientific 1. Gives credit for simply complying with the law. “Prior to the effective date of this CIA Boston Scientific established a voluntary compliance program.” CIA, Sect. I, at 1.2. Boston Scientific appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 5.3. Leaves corporate integrity obligations to Boston Scientific compliance officer. “The Chief Compliance Officer shall be primarily responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA and with Federal health care program requirements.” CIA, Sect. III(A)(1), at 5.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(1)-(4); $1,000 – $5,000 per day penalties for other violations. CIA, X(A)(5)-(7), at 35-36.
9 4/27/10 AstraZeneca, L.P., and AstraZeneca Pharmaceuticals, L.P. 1. Gives credit for simply complying with the law. “Prior to the Effective Date, AstraZeneca initiated certain voluntary compliance measures and established a voluntary compliance program designed to address its U.S. operations and compliance with Federal health care program and FDA requirements.” CIA, Sect. I, at 1.2. AstraZeneca appoints its own compliance officer and review committee. CIA, Sect. III(A)(1), (2), at 5.3. Leaves corporate integrity obligations to AstraZeneca compliance officer. “The Compliance Officer shall be responsible for developing and implementing policies, procedures, and practices designed to ensure compliance with the requirements set forth in this CIA and with Federal health care program requirements.” CIA, Sect. III(A)(2), at 5.4. Penalty for non-compliance $2,500 per day. CIA, Sect. X(A)(1)-(4); $1,000 – $5,000 per day penalties for other violations. CIA, X(A)(5)-(7), at 52-53.

Footnotes:

1. Reuben A. Guttman is a founding partner at Guttman, Buschner and Brooks PLLC in Washington, DC.
2. Department of Health and Human Services, Office of Inspector General Web site (http://oig.hhs.gov/fraud/ cias.asp).
3. See, e.g., U.S. Dept. of Health and Human Services, Office of Inspector General, “Corporate Integrity Agreements Document List” (http://oig.hhs.gov/fraud/cia/cia_list.asp).
4. E. Basile et al., “Boston Scientific Corporate Integrity Agreement,” FDA and Life Sciences Client Alert, King & Spalding, Jan. 8, 2010, at 1.
5.  Press release, “Justice Department Announces Largest Health Care Fraud Settlement in Its History,” U.S. Dept. of Justice, Sept. 2, 2009.
6. Id.

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Blowing the Whistle on Securities Fraud Means Money for Whistleblowers

The Dodd- Frank Wall Street Reform and Consumer Protection Act: The SEC Whistleblower Provision

On July 15, 2010 the Senate voted 60-to-39 to adopt the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). President Obama signed the bill into law on July 21, 2010.

Under the new legislation, the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.) is amended by inserting a new Section 21F, which includes provisions dealing with whistleblower incentives and protection.

Under Section 21F the voluntary submission of “original information” relating to a violation of the securities laws to the Securities and Exchange Commission (“SEC”) that leads to the successful enforcement of a judicial or administrative action, and that results in monetary sanctions exceeding $1,000,000, will entitle the whistleblower to an award equal to not less than 10 percent, but not more than 30 percent, of the total amount of the monetary sanctions collected from the action.1 In contrast with the provision included in the False Claims Act (“FCA”), the whistleblower may not bring an action before the Court pursuant to Section 21F of the Act in the event that the SEC decides not to pursue judicial or administrative action.

The term “whistleblower” includes any individual who provides, or two or more individuals who jointly provide, information relating to a violation of the securities laws to the SEC, in a manner established by rule or regulation by the SEC. The SEC has 270 days after the date of enactment of the Act to issue final regulations implementing section 21F of the Securities Exchange Act of 1934.2

Of particular interest is the broad definition of “original information” that may be presented by the whistleblower. Public information may be included, provided that the information leading to the SEC action is derived from the independent analysis of the whistleblower. The original information cannot be exclusively derived from an allegation made in a judicial or administrative hearing, in a governmental report, hearing, audit, or investigation, or from the news media, unless the whistleblower is a source of the information. Likewise, the information is not “original information” as defined by the Act if it is known to the SEC from any other source, unless the whistleblower is the original source of the information.

While the Act provides whistleblower protection against retaliation, the information may be offered anonymously if the whistleblower is represented by counsel. The identity of the whistleblower will be disclosed to the SEC prior to the payment of the award.

All information provided by the whistleblower, unless and until required to be disclosed to a defendant in connection with a proceeding instituted by the SEC or by certain entities specifically identified,3 shall remain confidential and privileged and shall not be subject to civil discovery, or other legal process, and shall not be subject to disclosure under the Freedom of Information Act.

The award is not limited to the information submitted after the enactment of this Act. Rather, if the violations of securities laws have been reported by the whistleblower prior to the enactment of the Act, the whistleblower has a right to collect the award if the monetary sanctions are collected by the SEC after the date of enactment of the Act or if related to a violation for which an award under this section could have been paid at the time the information was provided by the whistleblower.

[1] The final determination of the amount of the award is in the discretion of the SEC, but among the criteria to be evaluated in determining the amount weigh is given to the degree of assistance provided by the whistleblower and any legal representative of the whistleblower, thus granting significance to the expertise and ability of whistleblower’s counsel. Additional criteria in the determination of the amount of the reward are the significance of the information provided by the whistleblower to the success of the covered judicial or administrative action, the programmatic interest of the SEC in deterring violations of the securities laws by making awards to the whistleblowers, and additional relevant factors as the SEC may establish by rule or regulation. The determination is discretional, but it may be appealed, except the determination of an award, if the award was made in accordance with subsection (b), which provides for a bounty of not less than 10, but not more than 30, percent of the total amount of the monetary sanctions that are recovered.

[2] The Act does not provide that loss causation is a required element of the action and does not specify how the SEC will calculate the monetary sanctions. The SEC final regulations implementing section 21F of the Securities Exchange Act of 1934, however, may contain provisions on those issues.

[3] The SEC in its discretion may determine if the information may be disclosed to certain entities, if necessary to accomplish the purpose of the Act and protect the investors. The information, which will not lose its confidential and privileged status, may be made available to: (i) the Attorney General of the United States; (ii) an appropriate regulatory authority; (iii) a self-regulatory organization; (iv) a State attorney general in connection with any criminal investigation; (iv) a State attorney general in connection with any criminal investigation; (v) any appropriate State regulatory authority; (vi) the Public Company Accounting Oversight Board; (vii) a foreign security authority; and (viii) a foreign law enforcement authority. With respect to foreign authorities, the information shall be maintained “in accordance with assurance of confidentiality” as the SEC determines appropriate.

Reuben Guttman is a founder partner in Guttman, Buschner and Brooks PLLC. in Washington, D.C.

Changes to the False Claims Act in Senate Bill 386

Introduction

Under new legislation, the federal False Claims Act (FCA),[1] will take an even more prominent role in protecting from fraud the increase of federal spending to meet the nation’s financial crisis.  With federal funds going to a range of projects– from state infrastructure “shovel ready” road building to Internet connectivity, green energy innovation and high-tech transportation solutions”there are simply more federal expenditures in the pipeline for the FCA to cover.

On May 20, 2009, President Obama signed into law Senate Bill 386, the Fraud Enforcement and Recovery Act (FERA),[2] which makes important amendments to the FCA.  Under the new law, bailout-fund recipients’ potential liability under the FCA is increased.  The President stressed the importance of protecting taxpayer dollars needed for economic recovery under the Troubled Asset Relief Plan (TARP), run by the U.S. Treasury to shore up financial institutions, and other stimulus programs.

A key amendment in S. 386 is to delete the requirement for a “claim” in 31 U.S.C. § 3729(c), and expand the definition of claim in a new section.[3]  The problem the drafters of S. 386 had to overcome was that a claim, as included in § 3729(c), was deemed by some courts as bound by “the rule that a claim requires a request or demand for payment from government funds.”[4]  In response, S. 386 excises § 3729(c) and instead defines “claim” to include “any request or demand for money, whether or not the government has title to that money or property, and including situations where the defendant submits the request or demand either directly to the government or to a contractor, grantee, or any other recipient of government funds used to advance a government program.”[5]

As enacted, S. 386 broadens the coverage of current laws against financial crimes, including fraud affecting mortgages, securities, and federal assistance and relief programs.[6]  Mortgage lending now unquestionably falls within the purview of the FCA, on the basis of the large federal role in propping up the sub-prime lenders during the current financial crisis.

The bill also addresses recent court decisions, including the 2008 U.S. Supreme Court decision in Allison Engine Co. v. U.S.,[7] which narrowly interpreted the scope of the FCA to potentially exclude subcontractors and non-governmental entities from coverage.  Importantly, S. 386 revises the liability provisions of the FCA to clarify and reaffirm that whistleblowers’ suits for anti-fraud civil liability reach federal funds spent by non-governmental entities.  The common theme in these legislative changes is that the jurisdiction of the FCA is co-extensive with the federal dollars spent to support industries, as through TARP, or by private contractors paid by the Government to run facilities or programs.

Legislative History of S. 386

The legislation moved through Congress on a fast-track, reflecting the importance of the FCA to the Obama administration.  Although various iterations of the bill were introduced during the Bush administration, the most recent version of the bill was introduced February 5, 2009, by Senator Patrick Leahy (D-Vermont), Senator Charles Grassley (R-Iowa), and Senator Ted Kaufman (D-Delaware), and referred to the Senate Judiciary Committee.[8]  The bill was reported, as amended, by that committee on March 5, 2009, by a voice vote, and subsequently placed on the Senate calendar.  On April 28, 2009, the Senate passed the bill by a vote of 92 to 4, showing bi-partisan support.  On May 18, 2009, the House amended and passed S. 386 by a count of 338 to 52.  The Senate then agreed to the House amendments with one change, to which the House concurred.[9]  On May 19, 2009, the bill was presented to the President, and he signed it the following day.[10]

Effect of S. 386 on Mortgage Lending Industry

The nation’s editorial pages have reflected a palpable sense of frustration that such a large financial collapse as occasioned by sub-prime lending would result in few criminal indictments, while bad actors seemingly went untouched by law enforcement and industry regulators.[11]  In strengthening the ability of private attorneys general to enforce anti-fraud laws, in S. 386 the FCA was squarely extended to interstate mortgage lenders and other recipients of TARP and economic stimulus funds.

The problem of the doctoring of loan documents was widely noted in the press.  Unwitting consumers declared that if they did not qualify for a home loan based on the legitimate credit analysis, the mortgage broker would help fill out the paperwork to make it pass.[12]  As stated in a recent U.S. Senate report, shadowy financiers adopted practices that resulted in pushing mortgages on to consumers who could not afford them, so that short term speculators could generate profits by packaging the mortgages into securities sold on Wall Street.  As residential home prices dipped, collateralized securities lost value, leading to a spiral of fraud and injury to investors.[13]  Accordingly, S. 386 now defines a “false statement” to include mortgage application statements by mortgage brokers, as defined in 18 USC § 1014.

A White House press release explained that S. 386 corrects the problem that many mortgage lenders fell outside existing protections, as follows: “Over 50% of sub-prime mortgages issued as recently as 2005 involved private mortgage institutions and similar entities not currently covered under federal bank fraud criminal statutes.  FERA amends the definition of a ‘financial institution’ in the criminal code (18 U.S.C. § 20).  This will extend Federal laws to private mortgage brokers and companies that are not directly regulated or insured by the Federal Government.” [14]

In S. 386, the definition of “financial institution” in 18 USC § 20, para. 10, was amended to include banks and mortgage lenders making “a federally related mortgage loan as defined in section 3 of the Real Estate Settlement Procedures Act of 1974.”[15]

Finally, Section 5 of S. 386 creates a Financial Crisis Inquiry Commission, whose mandate is to investigate the causes of the financial crisis, including the worst practices of the mortgage industry.  The Commission will examine the “lending practices and securitization, including the originate-to-distribute model for extending credit and transferring risk,” and will submit a report on its findings by December 15, 2010.[16]

The bill appropriates to the Attorney General the sum of  $265 million, “which would go to hire about 160 more FBI agents and 200 more Justice Department prosecutors to work on mortgage fraud cases.” [17]

Effect of S. 386 on TARP Spending

In remarks made May 20, 2009, at the signing of S. 386, President Obama said that the law: “allows DOJ to prosecute anyone who fraudulently obtains Recovery Act or TARP funds — precious taxpayer dollars we’ve carefully invested in order to turn this crisis around.” [18]

TARP was created to purchase and insure up to $700 billion of troubled assets held by banks and other financial institutions in an effort to stabilize and otherwise bail out the financial markets.  On June 22, 2009, The Office of Management and Budget (OMB) released a memorandum giving guidance on reporting requirements included in Section 1512 of the Recovery Act.[19]  Stimulus recipients and subrecipients must report a series of data, including, “names and compensation of the five highest paid employees.”  According to the OMB memorandum: “Section 1512 of the Recovery Act requires that prime recipients and delegated sub-recipients submit quarterly reports on their use of the funds not later than the 10th day following the end of each quarter beginning on October 10, 2009, and will be cumulative since enactment, or February 17, 2009.”[20]  Reports are entered at the www.FederalReporting.gov website and published at www.Recovery.gov within 30 days of filing.

The Emergency Economic Stabilization Act of 2008, which authorized TARP, established under Section 121 the Office of the Special Inspector General for TARP, which is commonly referred to as SIGTARP.  On December 15, 2008, Neil Barofsky was appointed the inspector general, with the authority to “conduct, supervise, and coordinate audits and investigations of the purchase, management and sale of assets” under TARP.[21]

In the initial report to Congress of February 9, 2009, and a letter of January 7, 2008, Barofsky urged the Treasury to include language in all TARP contracts entered into after that date that requires the bank to, at the minimum, account for the use of TARP funds, provide internal controls to ensure compliance with the remainder of the TARP contract, and have a senior officer certify the accuracy of the information provided.[22]

One element of the government’s response to the financial crisis is the Term Asset-backed Securities Loan Facility (TALF) program, in which the Federal Reserve will give non-recourse loans totaling up to $20 billion upon the posting of collateral in the form of newly issued asset-backed securities.  Barofsky has stated the need to extend the FCA to the program.[23]

In addition to recipients of government funds facing potential increased FCA liability, private sector contractors and agents providing services to the Treasury in connection with TARP may face increased potential liability under the FCA in connection with new conflict of interest and mandatory disclosure requirements under an interim rule issued by the Treasury.[24]  False responses to these inquiries could subject TARP recipients to potential liability under the FCA.

Since the inception of TARP in October 2008, there has been a push for oversight over the use of the funds by recipients.  On November 17, 2008, Sen. Grassley suggested that those found to be using TARP funds under false pretenses should be subject to liability under the FCA.[25]  The applicability of the FCA to pre-SIGTARP recipients is less certain than to those recipients certifying under SIGTARP requirements to the funds use prior to receiving the funds.[26]

One may assert that false certifications in response to the SIGTARP’s request should not be considered “claims”[27] under the FCA because the TARP funds that are the subject of the certifications were distributed before requirements as to their use were imposed.  But one could argue in reply that funds already distributed are subject to the FCA if there was: (1) an express or implied condition on the recipient to use the funds for a specific purpose; and (2) an express or implied obligation to return the funds if the condition of use was violated.

The case for FCA liability with respect to new TARP distributions is considerably stronger as the funds are typically not distributed by the government until after the letter of intent is submitted.  Recipients should expect that the U.S. Department of Justice and/or private whistleblowers will argue that the false certification was material to the payment decision to release the funds, subjecting the entire amount to trebling of the government’s loss, plus penalties.

S. 386 More Clearly Extends FCA to Government Contractors and Subs

The effect of S. 386 on the mortgage industry and TARP spending are weighty enough. But S. 386 also resolves problems in three of four recent cases under debate.

The key change in Section 4 of S. 386 is to the definition of “claim.”  The Senate Report explains the significance of the change, as follows:

By removing the offending language from section 3729(a)(1), which requires a false claim be presented to ‘an officer or employee of the Government, or to a member of the Armed Forces,’ the bill clarifies that direct presentment is not required for liability to attach. This is consistent with the intent of Congress in amending the definition of ‘claim’ in the 1986 amendments to include ‘any request or demand * * * for money or property which is made to a contractor, grantee, or other recipient if the United States Government provides any portion of the money or property which is requested or demanded, or if the Government will reimburse such contractor, grantee, or other recipient for any portion of the money or property which is requested or demanded.’ 31 U.S.C. Sec. 3729(c) (2000).[28]

Further, the change to the definition of claim makes clear the FCA extends to funds administered by the United States, as follows:

False claims made against Government-administered funds harm the ultimate goals and U.S. interests and reflect negatively on the United States. The FCA should extend to these administered funds to ensure that the bad acts of contractors do not harm the foreign policy goals or other objectives of the Government. Accordingly, this bill includes a clarification to the definition of the term ‘claim’ in new Section 3729(b)(2)(A) and attaches FCA liability to knowingly false requests or demands for money and property from the U.S. Government, without regard to whether the United States holds title to the funds under its administration.[29]

The statute removed the FCA’s “by the Government” limitation and the “to get” verbiage in section 3729(a)(2).  The same amendments are made to parallel language in sections 3729(a)(3) and (a)(7).  The excised, narrow terms are replaced in the statute with “material,” in a new Section 3729(a)(1)(B), which now imposes liability for knowingly making or using a false record or statement material to a false or fraudulent claim.  The definition of “material” is amended to mean “having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property.”[30]

These changes solve the narrow interpretations of the FCA presented in the three cases discussed next.[31]  The fourth case at issue addressed the public disclosure bar.  A companion bill, H.B. 1788, limited to the Department of Justice the ability to invoke the public disclosure bar, an idea to remove a perceived disincentive for relators to report fraud and abuse.[32]   That provision was not included in S. 386.

In a floor statement, Senator Grassley noted that the legislation would close a loophole in the law as a result of the decision in Allison Engine Co. v. U.S. ex rel. Sanders, 123 S. Ct. 2128 (2008).[33]  In Allison Engine, the Supreme Court limited liability to fraudulent statements that were specifically connected to government funds and designed “to get” false claims paid or approved by the government.  For example, as opined by Justice Alito, the sub-contractor’s false invoice was passed up the chain by the prime contractor to justify a payment by the government, the FCA applied.  If, instead, the prime contractor, or sub-contractor above a lower sub-contractor, had a fixed amount of money, and paid the false claim from that pool of funds, the FCA would not apply.

The amendment to the provision in the bill that corresponds to section 3729(a)(2) would specifically apply retroactively to all claims pending as of June 7, 2008,[34] which is the date of decision of Allison Engine.

The question may arise: is there a sufficient nexus between federal funds and private industry to apply the FCA?  For example, the federal government has ploughed billions into General Motors, and so litigation may assert that the FCA applies to that company.  Section 4 of S. 386 limits liability to the funds provided by the government “to be spent or used on the Government’s behalf or to advance a Government program or interest.”[35]

In a letter of April 21, 2009, from the U.S. Chamber of Commerce and allied business groups, to the U.S. Senate, the argument was advanced that S. 386 was unnecessary due to recent appellate reversals of two of the cases of concern.  The business groups wrote: “More fundamentally, we believe that recent court decisions have also eliminated the need for any changes to the Act.  The two key precedents that Section 4 of the legislation was designed to overturn ” Custer Battles and Totten ” have been reversed.  Specifically, the 4th Circuit recently reversed the Custer Battles decision, and the Supreme Court’s Allison Engine decision overturned the ‘presentment’ requirement identified in the [U.S. ex rel. Totten v. Bombardier Corp.] case.”[36]

On April 10, 2009, in U.S. ex rel. DRC, Inc. v. Custer Battles, LLC,[37] the Fourth Circuit reversed the district court’s interpretation of “claim.”  In that case, a relator alleged that a contractor submitted false claims to the Coalition Provisional Authority (CPA) in Iraq.  The District Court for the Eastern District of Virginia, in U.S. ex rel. DRC, Inc. v. Custer Battles, LLC,[38] dismissed the claims, reasoning that the CPA was a private contractor and the nexus to the federal government too tenuous.

Reversing on this point of law, on appeal the Fourth Circuit held that the contractor’s fraudulent demand for payment from CPA was a claim within the meaning of the FCA.  The court wrote: “Section 3729(c) does not define a ‘claim’ in relation to the obligation of the United States government but rather to the provision of United States funds.”[39]

In the earlier case, U.S. ex rel. Totten v. Bombardier Corp.,[40] a relator brought a qui tam action against contractor under the FCA for allegedly submitting false claims to the National Railroad Passenger Corporation (Amtrak) to obtain payment for allegedly defective railroad cars.  The trial court dismissed the case.  In an opinion by circuit Judge John Roberts, now Chief Justice of the U.S. Supreme Court, the U.S. Court of Appeals for the District of Columbia affirmed the lower court’s dismissal.  Under the FCA, Amtrak is not a governmental entity, so the presentation of false claim to Amtrak was not a presentation to the federal government, the appeals court ruled.  The U.S. Supreme Court in Allison Engine rejected the direct presentment requirement, and so Totten is not considered good law.  Nevertheless, Congress felt it sufficiently important to clarify in S. 386 the language of the statute that the provenance of government funds, not the status of private contractor, is the key to the scope of the FCA.

Regarding the public disclosure bar, H.B. 1788, a parallel bill to S. 386, had sought to undo the ruling in U.S. ex rel. Stone v. Rockwell Int’l Corp..[41]  In Rockwell Int’l, the Supreme Court held that the qui tam whistleblower was barred from receiving a share of any money recovered because under the “public disclosure bar” the whistleblower was not an original source with “independent knowledge of the information on which the allegations are based.”[42]  Senator Grassley noted that Rockwell provides a disincentive for a whistleblower to bring a case, even if the Justice Department is overloaded or does not chose to bring the case.[43]  The proposed language in H.B. 1788, which was not included in S. 386, would have eliminated the procedural uncertainties by requiring the Justice Department to file a timely motion to dismiss claims that violate the “public disclosure bar.”[44]

Finally, S. 386 also carves out an exception to the seal provision to allow sharing of evidence with state and local government law enforcement authorities.  Section 4(e) of S. 386 amends 31 USC § 3730(h), to permit the sharing of sealed case files to enable state or local government officials to evaluate taking co-plaintiff status as intervenors.  Obviously, the change is important for projects in which federal funding is intermingled with state and local funds, as is the case in many of the new stimulus spending activities.

Conclusion

The provisions of S. 386 make important changes to the FCA that expand its powers to new arenas of interstate mortgage lending and TARP spending, and clarify jurisdictional questions raised by Allison Engine and related cases.  The rapid adoption of the bill shows the appetite in Congress for protecting the large federal stimulus expenditures from fraud and abuse.  With adoption of S. 386, the role of relators, as private attorney generals, is more important than ever.  From false statements on mortgage applications, to fraud in TARP-funded programs, the FCA is front and center in providing effective incentives for whistleblowers to come forward and explore the merits of potential litigation.

__________________________
* Mr. Guttman is a founding partner with the law firm of Guttman, Buschner and Brooks PLLC, a leading litigation boutique located in Washington, D.C., representing whistleblowers in False Claims Act cases, and shareholders in securities litigation and corporate governance matters nationally.

[1]  31 U.S.C. § 3729 et seq.

[2] Public Law No. 111-021.

[3] S. 386, § 4(a)(2), deleting 31 USC § 3729(c), and substituting § 3729(b)(2)(A).

[4] FCA Liability Only Attaches to U.S. Government Funds, discussing U.S. ex rel. DRC, Inc. v. Custer Battles, LLC, 376 F. Supp. 2d 617 (E.D. Va. July 8, 2005), TAF Quarterly Review, v. 39 (Oct. 2005), at 11 (While the court recognized that the definition in § 3729(c) is not exclusive, the court warned that the expanded definition outlined in Section 3729(c) ‘does not explicitly overturn the rule that a claim requires a request or demand for payment from government funds.’  Thus, the district court held that a ‘claim’ requires a request or payment for government property plainly survives the 1986 FCA amendment.) (available at http://www.taf.org/publications/ PDF/TAF_QR_v39.pdf).

[5] Ronald A. Sarachan, Dee Spagnuolo & Tejal K. Mehta, Expansion of False Claims Act liability signed into law by the President, May 22, 2009, Ballard Spahr Andrews & Ingersoll, LLP (available at http://www.ballardspahr.com/press/article.asp?ID=2529).

[6] Marcia Coyle, “Fears rise over new fraud law, Changes to False Claims Act adds muscle to whistleblower suits,” Nat’l Law Journal, May 25, 2009 (The law expands the potential liability of companies and institutions receiving federal funds, extending the act’s reach to subcontractors and subgrantees and enhancing the Justice Department’s investigative tools, among other provisions.)(available at http://www.law.com/jsp/nlj/PubArticleNLJ.jsp?id= 1202430941952&Fears_rise_over_new_fraud_law_&slreturn=1).

[7] 123 S. Ct. 2128 (2008).

[8] Many of the ideas in S. 386 had appeared in a bill in the previous Congress that had not reached a vote.  See S. 386 report, U.S. Senate Republican Policy Committee Legislative Notice, no. 9, Apr. 20, 2009, at 3 (Section 4 of S. 386 incorporates a number of very similar provisions to S. 2041 from the 110th Congress. That bill was introduced on September 12, 2007, referred to the Committee on the Judiciary, and subsequently reported, as amended, by the committee to the full Senate. No further action was taken on the bill.) (available at  http://rpc.senate.gov/public/_files/L9S386FraudEnforcementandRecovery042009.pdf).

[9] Roll Call #268 (Suspend Rules and Agree to S Adt to House Adts – Fraud Enforcement and Recovery Act). 111th United States Congress, 1st Session. Clerk of the U.S. House of Representatives (available at http://clerk.house.gov/evs/2009/roll268.xml); also see, History of S. 386, GPO Access (available at http://frwebgate6.access.gpo.gov/cgi-in/TEXTgate.cgi?WAISdocID=472376472841 +0+1+0&WAISaction=retrieve); and see, Sen. Res. S. 386 EAS, May 14, 2009 (available at http://thomas.loc.gov/cgi-bin/query/D?c111:5:./temp/~c111VytoFn::).

[10] John T. Boese, “The False Claims Act is amended for the first time in more than twenty years as the President signs the Fraud Enforcement and Recovery Act of 2009,” FraudMail Alert, No. 09-05-21, May 21, 2009, Fried, Frank, Harris, Shriver & Jacobson LLP (available at http://www.ffhsj.com/siteFiles/Publications/ 96C624E1C1C818605ABF4C050E2677B9.pdf).

[11] Editorial, “Wall Street follies,” L.A. Times, Jan. 4, 2009 (Lenders should be deterred from giving money to people with no reasonable ability to repay it, even if they plan to sell the loans to Wall Street as soon as the borrowers’ signatures are dry.) (available at http://www.latimes.com/news/opinion/ editorials/la-ed-wallstreet4-2009jan04%2C0%2C7346014.story).

[12] See, e.g., Lisa Scherzer, “Subprime blame game,” SmartMoney, Nov. 1, 2007 (available at http://www.smartmoney.com/investing/economy/subprime-blame-game-22074/).

[13] See Senate Report 111-001, Joint Economic Report, Jan. 9, 2009, at 180-181 (available at http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_reports&docid=f:sr001.111.pdf).

[14] Press release, President Obama Signs the Helping Families Save Their Homes Act and the Fraud Enforcement and Recovery Act, May 20, 2009, White House archives (available at http://www.whitehouse.gov/the_press_office/ Reforms-for-American-Homeowners-and-Consumers-President-Obama-Signs-the-Helping-Families-Save-their-Homes-Act-and-the-Fraud-Enforcement-and-Recovery-Act/).

[15] S. 386, § 2(a)(3).

[16] S. 386, § 5(c)(1)(I).

[17] Foon Rhee, “Obama signs mortgage bills,” Boston Globe, May 20, 2009 (available at http://www.boston.com/ news/politics/politicalintelligence/2009/05/ obama_back_on_e.html); and see Ronald D. Orol, “Obama to sign $490 million mortgage fraud bill into law,” MarketWatch.com, May 20, 2009 (The House voted Monday night, 338-52, to approve bipartisan legislation that would authorize $490 million over two years to hire fraud prosecutors, increase enforcement actions and add funds to the Secret Service and Housing and Urban Development Inspector General.) (available at http://www.marketwatch.com/story/obama-to-sign-490-million-mortgage-fraud-bill).

[18] Remarks of Pres. Obama, May 20, 2009, White House archives (available at http://www.whitehouse.gov/ the_press_office/Remarks-by-the-President-at-Signing-of-the-Helping-Families-Save-Their-Homes-Act-and-the-Fraud-Enforcement-and-Recovery-Act/).

[19] M-09-21, Implementing Guidance for the Reports on Use of Funds Pursuant to the American Recovery and Reinvestment Act of 2009, OMB website, June 22, 2009 (available at http://www.whitehouse.gov/omb/ memoranda_default/).

[20] Id., para. 3.2, at 16.

[21] Emergency Economic Stabilization Act of 2008, Pub.L. 110-185, 122 Stat. 613, enacted Feb. 13, 2008, at 63.

[22] See Jan. 7, 2009, letter of Neal Barofsky’s to the U.S. Senate Committee on Finance (available at http://finance.senate.gov/press/Bpress/2009press/prb010709.pdf).  Barofsky has written to the previous stimulus recipients to ask for a certification of information provided to the government.  See Jan. 22, 2009, letter from Neal Barofsky to the U.S. Senate Committee on Finance (available at http://finance.senate.gov/press/Gpress/2009/ prg012209.pdf).

[23] SIGTARP, Initial Report to Congress, Feb. 6, 2009, at 100-101 (Fraud vulnerabilities in the Term Asset-backed Securities Loan Facility (‘TALF’) should be addressed before the program is initiated.) (available at http://www.sigtarp.gov/reports/congress/2009/SIGTARP_Initial_Report_to_the_Congress.pdf).

[24] See Dep’t of the Treasury, TARP Conflicts of Interest Interim Rule, 74 Fed. Reg. 3431 (Jan. 21, 2009) (to be codified at 31 C.F.R. pt. 31) (available at http://edocket.access.gpo.gov/2009/pdf/E9-1179.pdf).

[25] See Nov. 17, 2008, letter from Sen. Grassley to Treasury Secretary Paulson and Attorney General Mukasey (available at http://grassley.senate.gov/news/Article.cfm?customel_dataPageID_1502=18128).

[26] Newsletter, “SIGTARP: The most important acronym to come along in years,” Feb. 12, 2009, McDermott Will & Emery  (available at http://www.mwe.com/index.cfm/fuseaction/publications.nldetail/object_id/aabeddb9-ab15-4ff1-b46d-0c5b759bcdb4.cfm).

[27] 31 U.S.C. § 3729(c).

[28] Senate Report No. 111-010, Fraud Enforcement and Recovery Act of 2009, n. 4, citing S. Rpt. No. 99-345, at 5282-5301 (providing section-by-section analysis explaining that a false claim includes claims submitted to grantees and contractors if the payment ultimately results in a loss to the Government) (available at http://thomas.loc.gov/cgi-bin/cpquery/R?cp111:FLD010:@1(sr010):).

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