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The “Government Knowledge Inference” Under the False Claims Act

By Joy Clairmont

Government knowledge no longer serves as an absolute bar to False Claims Act (“FCA”) actions as it did in the past.  Now, the focus is on the defendant’s state of mind.  Courts consider whether at the time of submitting the “false” claims to the government, the defendant fully cooperated and shared all information as to the claims, sufficient to show that the defendant did not intend to trick the government.  If the defendant did not fully communicate and cooperate with the government, then the defendant is not entitled to the “government knowledge inference” in refuting scienter (intent or knowledge of wrongdoing)

Fraud Went Unprosecuted Prior to the 1986 Amendments to the False Claims Act

Prior to the 1986 amendments to the FCA, most qui tam cases were dismissed based on a broadly-applied government knowledge bar.  As a result, fraud against the government skyrocketed and went unprosecuted.  With the 1986 amendments to the Act, Congress repealed the absolute government knowledge defense.  Since that time, courts have instead applied a much narrower government knowledge inference.

The Government Knowledge Inference Only Applies in the Rare Cases of Defendant’s Complete Communication and Cooperation with the Government

As seven different Circuit Courts have ruled, the government knowledge inference applies only in those rare cases where the defendant has completely communicated and cooperated with the government regarding its conduct and false claims.  See United States v. Bollinger, 775 F.3d 255, 264 (5th Cir. 2014), United States ex rel. A+ Homecare, Inc. v. Medshares Mgmt. Grp., Inc, 400 F.3d 428, 454 n.21 (6th Cir. 2005); United States ex rel. Becker v. Westinghouse Savannah River Co., 305 F.3d 284, 289 (4th Cir. 2002); Shaw v. AAA Eng’g. & Drafting, Inc. 213 F.3d 519, 534 (10th Cir. 2000); United States ex rel. Durcholz v. FKW Inc., 189 F.3d 542, 544-45 (7th Cir. 1999); United States ex rel. Kreindler & Kreindler v. United Techs. Corp., 985 F.2d 1148, 1157 (2d Cir. 1993); United States ex rel. Hagood v. Sonoma Cnty. Water Agency, 929 F.2d. 1416, 1421 (9th Cir. 1991).

Government Knowledge Inference Does Not Automatically Negate Scienter

Moreover, even in those unusual circumstances where there has been complete communication and cooperation from the defendant, the government knowledge inference functions not as an absolute defense, as during the pre-1986 Amendment time period, but rather as one of the ways in which a defendant may try to rebut scienter.  See Bollinger, 775 F.3d at 264 (holding that the government knowledge inference “serves simply as a factor weighing against the defendant’s knowledge, as opposed to a complete negation of the knowledge element.”).

A defendant is liable under the FCA if the defendant has knowledge (i.e., acts with deliberate ignorance or reckless disregard) that its claims are false.  In analyzing a defendant’s knowledge of the falsity of its claims, the Courts have looked to whether the defendant “completely cooperated and shared all information” with the government as to the facts underlying its false claims sufficient to show the defendant lacked the requisite intent to deceive.  Shaw, 213 F.3d at 534 (quoting United States ex rel. Butler v. Hughes Helicopters, Inc., 71 F.3d 321, 327 (9th Cir. 1995))).  The focus of the Court’s inquiry remains on the defendant’s knowledge and not on the government’s. See United States v. Incorporated Village of Island Park, 888 F. Supp. 419, 442 (E.D.N.Y.1995) (“[T]he government’s knowledge as to the falsity of a claim does not automatically bar the claim for a False Claim Act violation”).

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Are There “Special” Frauds Involving Specialty Drugs? Part II

By Susan Thomas

In Part I of this blog series, we defined the term “specialty drugs” and addressed whether fraud is common in the specialty drugs arena. In this blog post, we will examine how the federal Anti-Kickback Statute impacts specialty drug fraud, whether there are special frauds involving specialty drugs, and what to do if you suspect fraud is being committed.

Specialty Drugs and the Anti-Kickback Statute

Since there are often different pricing mechanisms or controls in place for specialty drugs, and because it’s not always clear whether a drug is properly characterized as a specialty drug, there is lots of room for bending the rules.  Additionally, some of the types of misconduct in the non-specialty field have spilled over to the specialty drug area, such as auto-refills, because specialty pharmacies are often mail order pharmacies; compounded drug frauds, since specialty drugs frequently require compounding; and manufacturer co-pay coupons. Because of the high prices of specialty drugs, they are often the types of drugs covered under manufacturer co-pay coupons.  While not generally illegal, the use of those coupons is not allowed for patients covered under federal healthcare programs, and the use of those coupons can be prosecuted as kickbacks under the Anti-Kickback Statute, 42 U.S.C. § 1370a-7b, and the False Claims Act. See generally United States Department of Justice Press Release, “Nashville Pharmacy Services Settles False Claims Act Lawsuit,”, January 5, 2016; United States Health and Human Services, Office of Inspector General, “Manufacturer Safeguards May Not Prevent Copayment Coupon Use for Part D Drugs”, September, 2014; United States Health and Human Services, Office of Inspector General Special Advisory Bulletin, Pharmaceutical Manufacturer Copayment Coupons, September, 2014.

Again, in part due to the high costs of these drugs, many common types of illegal conduct are also seen in the area of specialty drugs. In a whistleblower lawsuit filed against manufacturer Novartis and other parties, in which the government intervened, plaintiffs alleged that Novartis violated the FCA and the Anti-Kickback Statute through kickbacks to specialty pharmacies, as inducements for them to recommend Novartis’ Exjade, an iron chelation drug, and Myfortic, a drug used to fend off rejection for kidney transplant recipients. With respect to Exjade, the government also alleged that Novartis incentivized and pushed the specialty pharmacies to tout the benefits of Exjade and minimize the serious side effects, as compared to alternative drug choices. Novartis settled that case in November 2015 for $370 million. See United States Department of Justice Press Release, “Manhattan U.S. Attorney Announces $370 Million Civil Fraud Settlement Against Novartis Pharmaceuticals For Kickback Scheme Involving High-Priced Prescription Drugs, Along With $20 Million Forfeiture of Proceeds From The Scheme”, November 20, 2015; ExpressScripts had previously settled for its role in the kickback scheme, for $60 million. See Ed Silverman, “Express Scripts to Pay $60 M to Settle Novartis Kickback Scheme.”. The Wall Street Journal, May 1, 2015.

Are There Special Frauds Involving Specialty Drugs?

There are also certain characteristics of specialty drugs that seem to be leading to some “new” or “special” types of wrongdoing.  For example, with some drug therapies running into the tens or hundreds of thousands of dollars per course of treatment, it can be tempting for healthcare providers or pharmaceutical distributors to cheat in terms of adding just a few phantom patients to their claims submissions.  Many specialty drugs require some type of prior authorization, which can lead to shortcuts or outright fraud in order to allow a prescription to be processed and paid for.  See, e.g., United States Attorney’s Office, Eastern District of Tennessee Press Release, “Former Walgreens Clinical Pharmacy Manager Pleads Guilty to $4.4 Million TennCare Fraud Scheme”, October 25, 2016.  PBMs or other players can push certain drugs from a non-specialty to a specialty category in order to take advantage of favorable payment criteria.

Additionally, there have been concerns about kickbacks, again particularly driven by the very high cost of these drugs.  Given the large amount of money involved, even a few patients can generate large profits for pharmacies.  In one instance, a local pharmacy was considering imposing a fee for passing a customer needing a specialty drug to a particular specialty pharmacy.  When the local pharmacy sought an Advisory Opinion from HHS Office of Inspector General, the suggestion was frowned upon.  See, United States Department of Health and Human Services, Office of Inspector General, OIG Advisory Opinion No. 14-06, August 15, 2014.

What to Do If You Suspect Fraud

Frauds involving pharmaceuticals that end up being paid for by federal or state healthcare programs cost the healthcare programs huge sums of money and lead to severe pressures on these important programs.  In the specialty drug arena, the high cost of the drugs serves to magnify the incentives and the impact of those frauds.  Special conditions in terms of prescription access and reimbursement also provide opportunities for fraud.  Employees in the healthcare field provide the first and best line of defense against fraud committed on these critical government programs.  If you observe conduct that seems to violate the rules in the government healthcare programs, speak up!  Call us for a free and confidential consultation. You might both help keep the healthcare programs afloat and available, as well as be rewarded for your diligence.

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Are There “Special” Frauds Involving Specialty Drugs? Part I

By Susan Thomas

If you work in an industry involving pharmaceuticals, whether as a drug sales rep, a PBM employee or a direct healthcare provider, you’ve probably heard a lot about specialty drugs.  But what exactly are they?  Is fraud common in this area?  How do you know if your employer is playing by the rules with regard to these drugs?

What Are Specialty Drugs?

I was speaking at a seminar about two years ago, with experts in all different areas of pharmaceutical policy and pricing.  At a speakers’ dinner before the symposium, I innocently asked if someone could explain to me exactly what specialty drugs were.  To my surprise, everyone laughed – not unkindly, but with an understanding as to why someone might need to ask that question.

It turns out, there really isn’t a clear definition of what the term means, despite the fact that many contracts and various government regulations have separate provisions governing specialty drugs.  As stated in the March 2015 MedPAC Status Report on Part D, “[s]pecialty drugs are, by definition, high-cost drugs.” Medicare Payment Advisory Commission, Report to Congress – Medicare Payment Policy, March 2015, at p 370.

Somewhat more helpfully, the Report noted that while the industry does not have a consistent definition of specialty drugs, they “tend to be characterized as high cost … and are used to treat a rare condition, require special handling, use a limited distribution network, or require ongoing clinical assessment.”  Id. at n 17.  In other words, in some fashion or another, these drugs flow through the healthcare system in some way that varies from the norm of pharmaceutical manufacturer to wholesaler to pharmacy to patient, and these drugs quite likely have some atypical characteristics in terms of how they are prescribed or some special terms or conditions governing the usual money flow to pay for them.  Specialty drugs are often used to treat serious chronic illnesses, such as cancer, HIV/AIDS, multiple sclerosis, hepatitis C and hemophilia.

Is Fraud Common in the Area of Specialty Drugs?

Unfortunately, if you read the news, you’re aware that there is a lot of fraud involving pharmaceuticals overall.  Prices are manipulated and misreported, efforts are made to block generic versions of expensive brand drugs from coming to market, drugs can be over-prescribed to drive profits and drugs can be aggressively marketed for conditions they are not approved to treat.  Given the huge amount of government funding in the healthcare area, it is not surprising that many whistleblower cases include allegations of fraud on the government with regard to pharmaceutical products.

Is this happening especially in the area of specialty drugs? Again, given the enormous dollars that are spent on specialty drugs, it is hard to imagine that there has not been an increase in fraud in that segment of the market.  As everyone knows, it you want to find fraud, follow the money.  Where the government spends huge amounts of money through private entities, that’s where one will see attempts to cheat and defraud the government. In the 2015 MedPAC Report to Congress, it was estimated that 30% of all PBM dollars spent on drugs were for specialty drugs, and predictions were that the number would be as high as 50% by 2018.  Id. at p. 370.

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Third Circuit Decides Important Medical Necessity False Claims Act Case Brought By Qui Tam Whistleblower

By Daniel Miller

On May 1, 2017, the United States Court of Appeals for the Third Circuit decided U.S. ex rel. Petratos v. Genentech, Inc. et al., C.A. No. 15-3805 (3rd Cir. 2017), a qui tam lawsuit filed pursuant to the federal False Claims Act (“FCA”) and the False Claims Acts of the states of California, Colorado, Connecticut, Delaware, Florida, Georgia, Hawaii, Illinois, Indiana, Louisiana, Maryland, Massachusetts, Michigan, Minnesota, Montana, Nevada, New Hampshire, New Jersey, New Mexico, New York, North Carolina, Oklahoma, Rhode Island, Tennessee, Texas, Virginia, and the District of Columbia.[1]

The Allegations in Petratos

The Relator in Petratos “alleged that Genentech suppressed data that caused doctors to certify incorrectly that Avastin [an FDA-approved drug] was ‘reasonable and necessary’ for certain at-risk Medicare patients.”  Petratos, at 4.  In holding the relator’s allegations legally insufficient, the district court reasoned that “medically ‘reasonable and necessary’ is a determination made by the relevant [government] agency, not individual doctors.”  Id. at 6.

The Third Circuit Disagrees with the District Court’s Reasoning

The Third Circuit disagreed sharply with the district court, and held that the medical necessity of an FDA-approved product is a “process involving the FDA, CMS, and individual doctors.”  Id. at 9 (emphasis in original).  In reaching its holding, the Petratos Court noted the role of each entity involved in the process of determining medical necessity:

  • FDA –“One important factor considered by the Centers for Medicare and Medicaid Services (CMS) to determine whether a prescribed drug is ‘reasonable and necessary’ is whether it has received FDA approval.” at 8.

 

  • CMS – “[T]he ‘reasonable and necessary’ determination does not end with FDA approval. The claim at issue must also be ‘reasonable and necessary for [the] individual patient’ based on “accepted standards of medical practice and the medical circumstances of the individual case.” at 10 (emphasis in original) (citation omitted).

 

  • Individual Doctors – Ultimately, CMS relies on the medical judgment of individual physicians in deciding whether to pay claims. This reliance is reflected in the standard certifications physicians make to get paid: “[i]ndeed, physicians . . . must submit CMS Form 1500 along with a claim for reimbursement, wherein the doctor certifies that the drug was ‘medically necessary and personally furnished by me.’”   (citations omitted).

The Petratos Court noted the common sense inherent in this approach:  “[f]rom a practical perspective, this multi-step interpretation makes sense. CMS and the FDA are best positioned to make high-level policy decisions— such as issuing national coverage determinations and drug approvals. These general approvals demarcate what treatments can be considered ‘reasonable and necessary,’ and are thus a necessary condition for reimbursement. Meanwhile, the doctors are best suited to evaluate each patient and determine whether a treatment is ‘reasonable and necessary for [that] individual patient.’”  Id. at 12 (emphasis in original) (citation omitted).

The Petratos Court also reviewed the FCA’s materiality requirement.  In Petratos, the relator did not dispute that, had the government known of the defendant’s suppression of adverse event data, the government still would have paid the claims.  Petratos, at 14.  Consistent with the U.S. Supreme Court’s decision in Universal Health Services v. United States ex rel. Escobar, 136 S. Ct. 1989 (2016), the Petratos Court held that this concession was dispositive of the materiality analysis and that it doomed the relator’s claims.  Id.

In summary, although the Third Circuit dismissed the relator’s complaint in the Petratos decision, the opinion is very helpful to future whistleblowers who file qui tam lawsuits under the False Claims Act based on a lack of medical necessity.

[1] A copy of the decision is attached as Exhibit A.

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Misclassification of Employees May Form the Basis of an IRS Whistleblower Complaint, Part II

By Shauna Itri

In Part I of this blog series, we discussed which taxes employers must withhold from employees, as well as the Internal Revenue Code’s definition of “employee.” In this blog post, we will review the factors that determine whether an individual is an employee or independent contractor and discuss the consequences employers face if they misclassify these individuals.

Internal Revenue Service “Employee” Test

As an aid to determining whether an individual is an employee under the common law rules, the Internal Revenue Service has identified twenty factors or elements that indicate whether sufficient control is present to establish an employer-employee relationship.  See Rev. Rul. 87-41, 1987-1 C.B. 296, 298-299.  The Third Circuit has applied these factors in determining whether an employee-employer relationship exists for tax purposes. Greco v. United States, 380 F. Supp. 2d 598, 620 (M.D. Pa. 2005).   The twenty factors have been developed based on an examination of cases and rulings considering whether an individual is an employee. The degree of importance of each factor varies depending on the occupation and the factual context in which the services are performed. The twenty factors are designed only as guides for determining whether an individual is an employee; special scrutiny is required in applying the twenty factors to assure that formalistic aspects of an arrangement designed to achieve a particular status do not obscure the substance of the arrangement (that is, whether the person or persons for whom the services are performed exercise sufficient control over the individual for the individual to be classified as an employee). The twenty factors are described below:

Instructions. A worker who is required to comply with other persons’ instructions about when, where, and how he or she is to work is ordinarily an employee. This control factor is present if the person or persons for whom the services are performed have the right to require compliance with instructions. See, for example, Rev. Rul. 68-598, 1968-2 C.B. 464, and Rev. Rul. 66-381, 1966-2 C.B. 449.

Training. Training a worker by requiring an experienced employee to work with the worker, by corresponding with the worker, by requiring the worker to attend meetings, or by using other methods, indicates that the person or persons for whom the services are performed want the services performed in a particular method or manner. See Rev. Rul. 70-630, 1970-2 C.B. 229.

Integration. Integration of the worker’s services into the business operations generally shows that the worker is subject to direction and control. When the success or continuation of a business depends to an appreciable degree upon the performance of certain services, the workers who perform those services must necessarily be subject to a certain amount of control by the owner of the business. See United States v. Silk, 331 U.S. 704, 91 L. Ed. 1757, 67 S. Ct. 1463, 1947-2 C.B. 167 (1947), 1947-2 C.B. 167.

Services Rendered Personally. If the services must be rendered personally, presumably the person or persons for whom the services are performed are interested in the methods used to accomplish the work as well as in the results. See Rev. Rul. 55-695, 1955-2 C.B. 410.

Hiring, Supervising, and Paying Assistants. If the person or persons for whom the services are performed hire, supervise, and pay assistants, that factor generally shows control over the workers on the job. However, if one worker hires, supervises, and pays the other assistants pursuant to a contract under which the worker agrees to provide materials and labor and under which the worker is responsible only for the attainment of a result, this factor indicates an independent contractor status. Compare Rev. Rul. 63-115, 1963-1 C.B. 178, with Rev. Rul. 55-593, 1955-2 C.B. 610.

Continuing Relationship. A continuing relationship between the worker and the person or persons for whom the services are performed indicates that an employer-employee relationship exists. A continuing relationship may exist where work is performed at frequently recurring although irregular intervals. See United States v. Silk, 331 U.S. 704 (1947).

Set Hours of Work. The establishment of set hours of work by the person or persons for whom the services are performed is a factor indicating control. See Rev. Rul. 73-591, 1973-2 C.B. 337.

Full Time Required. If the worker must devote substantially full time to the business of the person or persons for whom the services are performed, such person or persons have control over the amount of time the worker spends working and impliedly restrict the worker from doing other gainful work. An independent contractor, on the other hand, is free to work when and for whom he or she chooses. See Rev. Rul. 56-694, 1956-2 C.B. 694.

Doing Work on Employer’s Premises. If the work is performed on the premises of the person or persons for whom the services are performed, that factor suggests control over the worker, especially if the work could be done elsewhere. Rev. Rul. 56-660, 1956-2 C.B. 693. Work done off the premises of the person or persons receiving the services, such as at the office of the worker, indicates some freedom from control. However, this fact by itself does not mean that the worker is not an employee. The importance of this factor depends on the nature of the service involved and the extent to which an employer generally would require that employees perform such services on the employer’s premises. Control over the place of work is indicated when the person or persons for whom the services are performed have the right to compel the worker to travel a designated route, to canvass a territory within a certain time, or to work at specific places as required. See Rev. Rul. 56-694.

Order or Sequence Set. If a worker must perform services in the order or sequence set by the person or persons for whom the services are performed, that factor shows that the worker is not free to follow the worker’s own pattern of work but must follow the established routines and schedules of the person or persons for whom the services are performed. Often, because of the nature of an occupation, the person or persons for whom the services are performed do not set the order of the services or set the order infrequently. It is sufficient to show control, however, if such person or persons retain the right to do so. See Rev. Rul. 56-694.

Oral or Written Reports. A requirement that the worker submit regular or written reports to the person or persons for whom the services are performed indicates a degree of control. See Rev. Rul. 70-309, 1970-1 C.B. 199, and Rev. Rul. 68-248, 1968-1 C.B. 431.

Payment by Hour, Week, Month. Payment by the hour, week, or month generally points to an employer-employee relationship, provided that this method of payment is not just a convenient way of paying a lump sum agreed upon as the cost of a job. Payment made by the job or on a straight commission generally indicates that the worker is an independent contractor. See Rev. Rul. 74-389, 1974-2 C.B. 330.

Payment of Business and/or Traveling Expenses. If the person or persons for whom the services are performed ordinarily pay the worker’s business and/or traveling expenses, the worker is ordinarily an employee. An employer, to be able to control expenses, generally retains the right to regulate and direct the worker’s business activities. See Rev. Rul. 55-144, 1955-1 C.B. 483.

Furnishing of Tools and Materials. The fact that the person or persons for whom the services are performed furnish significant tools, materials, and other equipment tends to show the existence of an employer-employee relationship. See Rev. Rul. 71-524, 1971-2 C.B. 346.

Significant Investment. If the worker invests in facilities that are used by the worker in performing services and are not typically maintained by employees (such as the maintenance of an office rented at fair value from an unrelated party), that factor tends to indicate that the worker is an independent contractor. On the other hand, lack of investment in facilities indicates dependence on the person or persons for whom the services are performed for such facilities and, accordingly, the existence of an employer-employee relationship. See Rev. Rul. 71-524. Special scrutiny is required with respect to certain types of facilities, such as home offices.

Realization of Profit or Loss. A worker who can realize a profit or suffer a loss as a result of the worker’s services (in addition to the profit or loss ordinarily realized by employees) is generally an independent contractor, but the worker who cannot is an employee. See Rev. Rul. 70-309. For example, if the worker is subject to a real risk of economic loss due to significant investments or a bona fide liability for expenses, such as salary payments to unrelated employees, that factor indicates that the worker is an independent contractor. The risk that a worker will not receive payment for his or her services, however, is common to both independent contractors and employees and thus does not constitute a sufficient economic risk to support treatment as an independent contractor.

Working for More Than One Firm at a Time. If a worker performs more than de minimis services for a multiple of unrelated persons or firms at the same time, that factor generally indicates that the worker is an independent contractor. See Rev. Rul. 70-572, 1970-2 C.B. 221. However, a worker who performs services for more than one person may be an employee of each of the persons, especially where such persons are part of the same service arrangement.

Making Service Available to General Public. The fact that a worker makes his or her services available to the general public on a regular and consistent basis indicates an independent contractor relationship. See Rev. Rul. 56-660.

Right to Discharge. The right to discharge a worker is a factor indicating that the worker is an employee and the person possessing the right is an employer. An employer exercises control through the threat of dismissal, which causes the worker to obey the employer’s instructions. An independent contractor, on the other hand, cannot be fired so long as the independent contractor produces a result that meets the contract specifications. Rev. Rul. 75-41, 1975-1 C.B. 323.

Right to Terminate. If the worker has the right to end his or her relationship with the person for whom the services are performed at any time he or she wishes without incurring liability, that factor indicates an employer-employee relationship. See Rev. Rul. 70-309.[1]

Consequences of Misclassifying Workers Under the Internal Revenue Code

The principal consequence of the reclassification of workers is to create, in the IRS’s determination, an obligation on the tax payer to have paid taxes on the workers’ wages under FUTA, 26 U.S.C. §§ 3301-3311, and FICA, 26 U.S.C. §§ 3101-3128; see 26 U.S.C. §§ 3301 (imposing FUTA tax), § 3111 (imposing FICA tax); to have withheld and remitted, or have paid, the workers’ FICA taxes, see 26 U.S.C. § 3102; and to have withheld and remitted specified amounts of the workers’ anticipated federal income taxes, see 26 U.S.C. § 3402.

[1] Section 530 of the Revenue Act of 1978 is a safe harbor provision that prevents the IRS from retroactively reclassifying “independent contractors” as employees and subjecting the principal to federal employment taxes, penalties and interest for such misclassification. In order for an employer to qualify for section 530 relief, it must have: (1) Consistently treated the workers (and similarly situated workers) as independent contractors; (2) Complied with the Form 1099 reporting requirements with respect to the compensation paid the workers for the tax years at issue; and (3) Had a reasonable basis for treating the workers as independent contractors.  There is no explicit definition of what constitutes a “reasonable basis” for purposes of section 530. There are four categories of authority that may be relied upon as a reasonable basis: (1) federal judicial precedents and administrative rulings; (2) a prior audit of the taxpayer; (3) industry custom; and (4) a catch-all “other” reasonable bases, such as reliance upon advice from an accountant or attorney.

Section 530 does not apply here because MJTP and the Josephs did not have a “reasonable basis” for treating workers as independent contractors, as there were no federal judicial precedents and administrative rulings; prior audits, industry customer any other reasonable bases.

 

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Misclassification of Employees May Form the Basis of an IRS Whistleblower Complaint, Part I

By Shauna Itri

Internal Revenue Code Generally: Withholding of Taxes

Under the Internal Revenue Code, employers must withhold federal income tax as well as social security tax from the wages they pay to employees. In addition, employers must pay social security and unemployment taxes on behalf of their employees.[1]  “These taxes are known collectively as ’employment taxes.'”  Greco v. IRS, 380 F. Supp. 2d 598, 613 (M.D. Pa. 2005).  Employers do not withhold and pay these employment taxes for independent contractors. See id. “In connection with payments to ‘independent contractors,’ employers only have to send annual information returns, on Form 1099 to the workers and on [a] Form[] 1099 to the IRS, indicating the income paid [to the independent contractor] during the year.” Id.[2]   “In light of these tax consequences, [the] proper characterization of the employment relationship is vital.” Halfhill v. United States IRS, 927 F. Supp. 171, 174-75 (W.D. Pa. 1996).  If an “employee” is “knowingly” misclassified, it could be the basis for an IRS Whistleblower Complaint or Form 211.

Internal Revenue Code Definition of “Employee”

Section 3121(d)(2) provides that for FICA tax purposes the term “employee” includes any individual who has the status of an employee under common law.[3] With certain exceptions not relevant here, the section 3121(d) definition of “employee” also applies for FUTA tax purposes. Sec. 3306(i). The IRS regulations state that the term “employee” includes “every individual performing services if the relationship between him and the person for whom he performs such services is the legal relationship of employer and employee.” Sec. 31.3401(c)-1(a), Employment Tax Regs. Guides for determining employment status are found in the following three substantially similar sections of the Employment Tax Regulations: sections 31.3121 (d)-1 (c); 31.3306 (i)-1; and 31.3401 (c)-1.  These sections provide that generally the relationship of employer and employee exists when the person or persons for whom the services are performed have the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but as to how it shall be done.   In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed; it is sufficient if the employer has the right to do so.

[1] Congress has imposed social security taxes on the employer and employee under the Federal Insurance Contribution Act (FICA), 26 U.S.C. § 3101, et seq., and unemployment insurance taxes on the employer under the Federal Unemployment Tax Act (FUTA). See 26 U.S.C. § 3301, et seq. See also Joseph M. Grey Pub. Accountant, P.C. v. Commissioner, 119 T.C. 121, 126 (2002), affd. 93 Fed. Appx. 473, 2004 U.S. App. LEXIS 6662 (3d Cir. 2004).

[2] Form 1099 is required when the “salaries, wages, commissions, fees, and other forms of compensation for services rendered aggregates $600 or more.” 26 C.F.R. § 1.6041-1(a)(1)(i).

[3]  Section 3121(d)(2) defines an employee as “any individual who, under the usual common law rules applicable in determining the employer-employee relationship, has the status of an employee.” See also sec. 3306(i).

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Tax Whistleblower Actions – How Do They Work?

By Arthur Stock

The Internal Revenue Service (“IRS”) has had a reward program for whistleblowers since 2006.   26 U.S.C 7623.   Several individuals have received rewards in the seven and eight digit range.  The process is simpler than filing a False Claims Act (“FCA”) complaint, and typically, very little is required from the whistleblower after the initial filing and interview.  However, the likelihood of recovery is very low—less than 1% of claims have led to a reward to date.

Underpayment of federal taxes can be committed by a corporation or individual, and the total amount of potential recovery—including interest and penalties—must be at least $2 million. In measuring potential damages for a long-running practice, keep in mind the applicable of statute of limitations for initiating an audit or enforcement action, which in most instances is three years.

Reporting a Tax Underpayment to the IRS

All that is required is filing a Form 211 with the IRS.  On this form, the whistleblower explains the tax underpayment and names the perpetrator.  Although many whistleblowers report tax frauds, the Form 211 needs to describe an underpayment, not a fraud.  There is no filing fee.  A Form 211 is confidential, and the IRS will not disclose the identity of a whistleblower until an award is made.

Since the goal of the Form 211 is to entice the IRS to take action, it is best to submit underlying documents demonstrating that a tax was underpaid.  For example, if the claim is that real estate was undervalued for purposes of estate tax calculation, the whistleblower might include an appraisal and/or other evidence of the correct value, such as documentation of the price of a recent sale of the property.  Many whistleblowers will not have access to relevant documents.  A former employee aware of a corporate fraud might have detailed knowledge of what occurred, but no documents at all.  Submission of documents is not required.  The IRS will always have access to tax returns, and it can receive additional documents through an audit or an administrative subpoena.

Whistleblower Interviews with the IRS

The IRS frequently interviews the whistleblower, often several months after the filing, but it is not required to do that.  Depending on the nature of the reported alleged fraud, the whistleblower may be interviewed more than once.  The whistleblower may even be asked to participate in an investigation, for example to explain the significance of documents that the IRS has obtained, but this is rare.  The IRS has complete discretion as to whether to initiate an audit or investigation, and whether to take any action on the basis of the investigation.

Whistleblower Rewards

If the IRS chooses to move forward and ultimately recovers money through either judgment or settlement, the whistleblower is entitled to receive a reward of fifteen to thirty percent of the amount recovered, including collection of any interest and penalties as well as the amount of the original underpayment.  If the IRS determines that the whistleblower’s contribution to the investigation was “less substantial,” the award may be lowered to 10%.

Because tax investigations are confidential, the IRS will not keep the whistleblower informed of developments in the case, and will not even confirm whether there is an ongoing investigation. Commonly, several years of complete silence go by before the IRS informs the whistleblower that there is – or much more frequently, there is not– an award.

BE CAREFUL:  The people most familiar with a corporate tax underpayment may be found by the IRS to have been participated in the fraudulent scheme.  There is no immunity for statements included in Form 211 or statements. One of the first large awards, of over $9 million, was awarded to a whistleblower who was incarcerated at the time of the award, following a conviction for participation in the  tax fraud he reported.  Consult your lawyer on the risks as well as the rewards of filing a Form 211 with the IRS.

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Violations of “Buy American” Laws Can Be Grounds for Lawsuits Under the False Claims Act

By Susan Thomas

In a two-part Executive Order (“EO”) issued earlier this month, the president took steps towards his campaign promise to promote “Buy American” and “Hire American” policies. This post focuses only on the “Buy” side of the EO.  Any tightening of Buy American policies at the federal procurement level raises the potential for violations that can be actionable under the False Claims Act (“FCA”).

Federal agencies have been directed to implement a tighter Buy American policy based on maximizing the use of American-made content in federal procurements and minimizing exemptions..

Statutory and Regulatory Background of Buy American Requirements

 By way of background, government contracts frequently include restrictions on the country of origin of the products that the government is purchasing. These are commonly referred to as “Buy American” requirements, although not all such requirements are created equal. The Buy American landscape is crowded and confusing, even to the point of having parallel statutes named the Buy American Act (41 U.S.C. §§ 8301-8305) and the Buy America Act (49 U.S.C. 5323(j) and 23 U.S.C. § 313) (which is different from the Buy American Act). Perhaps even more confusing, the Buy American Act does not actually force the government to buy American-made products, it only creates a preference. Thus even where the Buy American Act applies, the government can still purchase a foreign-made end product under various conditions, including disclosure by a vendor that it will be providing foreign products and price considerations.

The two main laws in this area are the 1933 Buy American Act (“BAA”), which requires the government to give preference to U.S.-made products in federal procurements whenever practicable, and the 1979 Trade Agreements Act (“TAA”), which largely supersedes the BAA by allowing items made in scores of designated countries with which the U.S. has certain trade agreements to be substituted for American products.  “Designated countries” are countries that U.S. trade policy chooses to favor — whether because the United States has entered into a free trade agreement (such as the North American Free Trade Agreement or the U.S.-Korea Free Trade Agreement) or because the country is small and still developing (as with Afghanistan or Haiti). FAR 25.003 lists these countries, and the list is updated regularly. Other pertinent statutes and regulations include the Berry Amendment, requiring the U.S. Department of Defense and Department of Homeland Security, to give preference to domestic food, textile and specialty metal sources and Defense Federal Acquisition Regulation Supplement 225.7017, singling out products such as photovoltaic devices to receive domestic manufacturing preferences. The country of origin restrictions typically apply also when Congress appropriates funds or grants to state and local governments. Additionally, many states may also impose separate “Buy American” or “Buy Local” requirements of their own.

Possible Tightening of Requirements and Enforcement

The tightening of the Buy American policies as announced by the current administration can potentially take many different directions.  For example, under the current regulatory interpretation used to fulfill the BAA’s “substantially all” requirement, the cost of U.S.-sourced components must make up more than 50 percent of the total cost of an end product for that product to be considered U.S-made, while a commercial off-the-shelf item is only required to be manufactured in the U.S., regardless of where its components come from.  There has already been some Congressional support to raise the sourcing requirement through the Buy American Improvement Act, introduced in February, but agencies could also simply decide to increase the percentage of required U.S.-sourced components or restrict the extent of leeway given on commercial off-the-shelf items.  Additionally, changes in trade agreements or types of trade agreements that qualify for exceptions under the TAA could substantially alter the Buy American standards.

The White House has also signaled that it might allow federal contracting officers to take into account the impact of unfair trade practices like “dumping” — the selling of items below cost to drive out competition — or other problematic assistance from foreign governments that arguably make American products less commercially competitive.  The U.S.-made components requirements could also be applied further down the manufacturing chain to subcomponents, making it harder for manufacturers to demonstrate that their products qualify for Buy American procurement.

FCA Lawsuits Stemming from Violations of Buy American Requirements

Presumably, any or all of these changes could lead to more regulatory or procurement violations, and thus be accompanied by opportunities to assert FCA violations in lawsuits filed by whistleblowers.  One possible violation would be companies that get bogged down in the specifics of different statutes and regulations and simply try to certify, on an across-the-board basis, that their products comply with Buy American regulations.  Such broad assertions may well constitute false certifications.  Similarly, falsely claiming that items were manufactured in designated countries would violate the laws.

As is true with most FCA lawsuits, however, the devil is in the details.  Precisely what laws or regulations are being violated?  Are the requirements clearly articulated?  Were the violations committed with knowledge, recklessness or deliberate indifference to the statutory or regulatory requirements? Are the violations material to the government’s decision to enter into the procurement order or contract, or to continue paying under that contract?  Experienced FCA counsel can help you assess whatever perceived violations you may have observed and determine whether there is an FCA case worth pursuing.

 

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Advice to a Potential Relator About Taking Documents from an Employer to Support a False Claims Act Lawsuit

By Sherrie Savett

Common Sense Advice Your Client Can Understand

It is important to advise your Relator client about the parameters of securing documents and information derived from an employer’s or former employer’s computer system.  Many clients still work at the company or have left and some have signed confidential agreements.  They are nervous about “stealing” information or breaching their agreement.

Lay language is needed to relax the client and have them understand they are not breaking the law, but instead are enforcing it.  Below is some useful language.

We believe that the law protects you when taking documents from your employer to support your allegations of fraud.  Because whistleblowers are encouraged to come forward, there is a policy to allow a relator to take evidence and documents from his or her employer so long as the documents are ones that the Relator would have seen during the scope of his or her regular employment.  While a relator is not allowed to root through the entire document database of a business to search for a fraud, we believe you are within the bounds of legal protection here.

Follow With a Sound Legal Analysis 

Advise your Relator client that he or she is permitted to take documents and information when obtaining the materials was reasonably necessary to pursue a qui tam action.  For example, in one recent case, a court noted both “a public policy exception to confidentiality agreements to protect whistleblowers who appropriate company documents” and an employer’s countervailing interest in “the enforcement of confidentiality agreements.”  Erhart v. BofI Holding, Inc., 2017 WL 588390, at *12 (S.D. Cal. Feb. 14, 2017).  Thus, the proper means to balance these competing interests is to ask whether “removal of documents was reasonably necessary to support [a relator’s] allegations of wrongdoing” Id. at *13 (internal quotation marks omitted).

Various courts across the county have reached similar rulings.  See e.g. Cafasso, U.S. ex rel. v. Gen. Dynamics C4 Sys., Inc., 637 F.3d 1047, 1062 (9th Cir. 2011) (explaining that if an employer asserts a counterclaim against a relator for breach of a confidentiality agreement, the relator “need[s] to justify why removal of the documents was reasonably necessary to pursue an FCA claim”); Shmushkovich v. Home Bound Healthcare, Inc., 2015 WL 3896947, at *2 (N.D. Ill. June 23, 2015) (“The protections afforded self-help discovery under the False Claims Act . . . have only extended to the collection of materials that are reasonably related to the formation of a case.”); U.S. ex rel. Notorfransesco v. Surgical Monitoring Assoc., Inc., 2014 WL 7008561, at *5 (E.D. Pa. Dec. 12, 2014) (distinguishing between “materials [that] are reasonably necessary to pursuing [a relator’s] FCA claim” and “information that is not related to proving [the] claim”) (internal quotation marks omitted); Walsh v. Amerisource Bergen Corp., No. CIV.A. 11-7584, 2014 WL 2738215, at *7 (E.D. Pa. June 17, 2014) (similar); U.S. ex rel. Ruhe v. Masimo Corp., 929 F. Supp. 2d 1033, 1039 (C.D. Cal. 2012) (denying a defendant’s motion to strike documents obtained by relators in alleged violation of a confidentiality agreement where the relators “limited their taking to documents relevant to the alleged fraud”).

Furthermore, the HIPAA statute specifically allows whistleblowers to disclose protected health information (PHI) to attorneys to determine how to proceed legally.  Below is the exact language of the statute:

45 CFR 164.502 – Uses and disclosures of protected health information: General rules.

(j)Standard: Disclosures by whistleblowers and workforce member crime victims –

(1)Disclosures by whistleblowers. A covered entity is not considered to have violated the requirements of this subpart if a member of its workforce or a business associate discloses protected health information, provided that:

(i) The workforce member or business associate believes in good faith that the covered entity has engaged in conduct that is unlawful or otherwise violates professional or clinical standards, or that the care, services, or conditions provided by the covered entity potentially endangers one or more patients, workers, or the public; and

(ii) The disclosure is to:

(A) A health oversight agency or public health authority authorized by law to investigate or otherwise oversee the relevant conduct or conditions of the covered entity or to an appropriate health care accreditation organization for the purpose of reporting the allegation of failure to meet professional standards or misconduct by the covered entity; or

(B) An attorney retained by or on behalf of the workforce member or business associate for the purpose of determining the legal options of the workforce member or business associate with regard to the conduct described in paragraph (j)(1)(i) of this section.

Conclusion

You will have an empowered client who understands what he or she can and cannot do.  That client is then better able to transmit valuable information to capable qui tam attorneys who then have better ammunition to use when writing the complaint.

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Another Appeals Court Limits One of the Barriers to a Whistleblower Lawsuit

By Susan Thomas

In United States ex rel. Hayes v. Allstate Ins. Co., et al., Case No. 16­705, 2017 WL 1228551 (2d Cir. Apr. 4, 2017), the Second Circuit addressed an objection that it lacked jurisdiction over a whistleblower’s qui tam suit pursuant to what is known as the “first-to-file” rule.   31 U.S.C. § 3730(b)(5). That provision of the False Claims Act (“FCA”) states that “[w]hen a person brings an action under [the FCA], no person other than the Government may . . . bring a related action based on the facts underlying the pending action.” 31 U.S.C. § 3730(b)(5).  Defendants argued that an earlier ­filed case deprived the court of jurisdiction pursuant to the first-to-file rule.  Before addressing a multitude of arguments on the merits, the Second Circuit joined the D.C. Circuit in holding that the FCA’s first-to-file rule is not jurisdictional.  2017 WL 1228551 at *3.  Accordingly, the court did not resolve the first-to-file challenge, since it chose instead to rule on other issues.

Importance of the Court’s Ruling

The court’s determination that a first-to-file issue is not jurisdictional is important for several reasons.  First, unlike jurisdictional issues, which a court must consider at any stage of the proceedings, non-jurisdictional challenges can be waived if not timely asserted.  Jurisdictional issues must even be considered sua sponte by a court at any stage of the proceedings. Second, challenges that are non-jurisdictional are more easily remedied by amendment, whereas jurisdictional challenges involve complicated analysis of whether or when an initial complaint can be amended.  The procedural process varies also, for example, in terms of burden of proof and ability to introduce evidence outside the complaint.  Finally, jurisdictional issues are not subject to equitable exceptions, which may apply to certain non-jurisdictional challenges.

Circuit Courts and the First-to-File Rule

As the court noted, there is a split among the circuit courts on the question whether first-to-file challenges are jurisdictional.   The Fourth, Fifth and Sixth Circuits have either held or just assumed that the issue is jurisdictional.  See U.S. ex rel. Carter v. Halliburton Co., 710 F.3d 171, 181 (4th Cir. 2013), aff’d in part, rev’d in part on other grounds sub nom. Kellogg Brown & Root, 11 135 S. Ct. 1979 (2015); U.S. ex rel. Branch Consultants v. Allstate Ins. Co., 560 F.3d 371, 376–77 (5th Cir. 2009); Walburn v. Lockheed Martin Corp., 431 F.3d 966, 970 (6th Cir. 2005).  On the other hand, in 2015, in U.S. ex rel. Heath v. AT&T, Inc., 791 F.3d 112 (D.C. Cir. 2015), the D.C. Circuit broke ranks with most other courts and concluded that the first-to-file rule was not jurisdictional. Id. at 120-21. As the D.C. Circuit observed, the statutory language states that no person other than the government can bring a (later) action, which “speaks only to who may bring a private action and when,” Id. at 120, but “does not speak in jurisdictional terms or refer in any way to the jurisdiction of the district courts.” Id. (quotation omitted).

In the Hayes decision, the Second Circuit noted that the Supreme Court has warned against careless use of the term jurisdiction, 2017 WL 1228551 at *2, citing Sebelius v. Auburn Regʹl Med. Ctr., 133 S. Ct. 817, 824 (2013). Thus, the Supreme Court has “adopted a ‘readily administrable bright line’ for determining whether to classify a statutory limitation as jurisdictional.”  2017 WL 1228551 at *2. A court should find that a provision is jurisdictional only if Congress has clearly stated the jurisdictional component and absent such a clear statement . . .  ‘courts should treat the restriction as non-jurisdictional in character.’” Id.  As the D.C. Circuit had held, the first‐to‐file rule provides that “no person other than the Government” may bring an FCA claim that is “related” to a claim already “pending, ” 31 U.S.C. § 3730(b)(5), which makes no reference to jurisdiction. Heath, 791 F.3d at 121.

The First-to-File Rule and Limitations on Jurisdiction

Both the D.C. Circuit and the Second Circuit contrasted the language of the first-to-file bar with other provisions in the FCA that clearly state limitations on jurisdiction.  For example, there is a clear statement that “[n]o court shall have jurisdiction over an action brought by a former or present member of the armed forces … against a member of the armed forces arising out of such person’s service ….”   31 U.S.C. § 3730(e)(1).  Similarly, the FCA provides that “[n]o court shall have jurisdiction over an action brought . . . against a [government] official if the action is based on evidence or information known to the Government when the action was brought.” 31 U.S.C. § 3730(e)(2)(A).

Interestingly, the simple test of whether the provision in question refers explicitly to the court’s jurisdiction has been the subject of discussion among courts dealing with challenges under the Public Disclosure Bar (“PDB”) of the FCA, where a statutory amendment enacted as part of the Patient Protection and Affordable Care Act deleted a prior reference to jurisdiction. See Patient Protection and Affordable Care Act, PL 111-148, March 23, 2010, 124 Stat 119 (amending 31 U.S.C. § 3730(e)(4) to change the language of the PDB from “[n]o court shall have jurisdiction” to “[t]he court shall dismiss”).   Most courts have concluded that the elimination of the term jurisdiction in the statutory provision resulted in the PDB no longer being considered to be jurisdictional. E.g., U.S. ex rel. Advocates for Basic Leg. Equal., Inc. v. U.S. Bank, N.A., 816 F.3d 428, 433 (6th Cir. 2016)(“ Congress removed the jurisdictional language, and the different language leads to a different meaning. The public disclosure bar is no longer jurisdictional”); U.S. ex rel. Moore & Co., P.A. v. Majestic Blue Fisheries, LLC, 812 F.3d 294, 300 (3d Cir. 2016)(“amended version does not set forth a jurisdictional bar”);  United States ex rel. Osheroff v. Humana, Inc., 2015 WL 223705 (11th Cir. Jan. 16, 2015)(amendments converted the public disclosure bar from a jurisdictional bar under Fed. R. Civ. P. 12(b)(1) into grounds for dismissal for failure to state a claim under Fed. R. Civ. P. 12(b)(6));  U.S. ex rel. May v. Purdue Pharma L.P., 737 F.3d 908, 916-17 (4th Cir. 2013)(after the 2010 amendments, “the public-disclosure bar is no longer a jurisdiction-removing provision.” ).

Conclusion

The Second Circuit’s common-sense interpretation of the first-to-file provision of the FCA will lessen the impact of the rule and potentially permit more whistleblower cases to move forward.

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