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The Unwritten Nexus Requirement: Requiring a Connection Between Federal Funds and False Claims Under the False Claims Act

By Jonathan DeSantis

The federal government provides funding to an incredible number of non-government entities through direct spending and grants.  The False Claims Act (“FCA”) provides that anyone who presents “false or fraudulent claims” or who commits other similar offenses is subject to substantial penalties. “Claim” is defined as including any request for payment where the federal government provided “any portion” of the requested funds, meaning many false claims presented to non-government entities will be subject to FCA liability.[1]  Indeed, under one reading of the “any portion” language of the FCA, any false claim presented to a non-government entity that receives any federal funding may be subject to FCA liability. As discussed below, courts have largely rejected this reading and instead require that there be a nexus (aka connection) between the federal funding provided to the non-government entity and the false claim.

The FCA Covers False Claims Made to Non-Government Entities for Government Funds

Prior to 1986, the FCA did not define “claim.”  In response to a concern that courts were improperly limiting the scope of FCA liability, Congress added a definition of “claim” to expressly provide that FCA liability existed when false claims were made for government funds even if such claims were made to non-government entities.  “Claim” was defined as:

[A]ny request or demand, whether under a contract or otherwise, 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.[2]

However, the FCA still only imposed liability for persons who “knowingly presents, or causes to be presented, to an officer or employee of the United States Government . . .  a false or fraudulent claim for payment or approval.” [3] The interplay of these definitions created a seeming ambiguity: the definition of “claim” contemplated claims made to non-government entities using government money while the liability provision required that the claim be made “to an officer or employee of the United States Government.”   Courts interpreted the FCA as only creating liability where a claim was presented to the Government, i.e. that liability did not exist in situations where claims were presented to recipients of government funds, even where government funds were used to pay the false claims.[4]

In 2009, Congress reconciled this ambiguity by enacting more amendments to the FCA.  Specifically, Congress eliminated the language “to an officer or employee of the United States” from the substantive liability provision of the FCA such that it now provides that anyone who “knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval” is subject to liability.  It is now clear that false claims presented to recipients of government funds are actionable under the FCA.  As one court explained, “[t]he new language underscored Congress’s intent that FCA liability attach to any false claim made to an entity implementing a program with government funds, regardless of whether that entity was public or private.”[5]

Courts Interpret the FCA to Require a Nexus Between False Claims and Federal Funds

As described above, “claim” includes any request for payment where the federal government provides “any portion” of the requested money.   This creates potentially vast liability under the FCA given that the federal government provides funding to a wide variety of institutions and programs.  For example, school districts in the United States are largely funded through state and local funding, although the federal government still provides a substantial amount of funding.   One reports estimates that schools receive about 90% of their funding through state and local sources with the remaining 10% coming from the federal government.[6]  Applying the “any portion” language of the FCA, any and all false claims presented to school districts are potentially subject to liability given that the federal government provides every school with some funding.

Courts have largely rejected relators’ attempts to contend that the “any portion” language of the statutory definition of “claim” means that a false claim presented to an entity is automatically actionable under the FCA so long as the entity receives any federal funding irrespective of whether the claim itself involves any federal funds.   Put differently, courts have generally held that there must be some nexus between an entity’s receipt of federal funding and the false claims.

For example, in Garg v. Covanta Holding Corp., 478 F. App’x 736 (3d Cir. 2012), the Third Circuit held that the “FCA requires that there be some greater nexus between the alleged fraud and the government funds.”  In another recent case, a court similarly held that the FCA “requires a connection between government funds and the funds used to pay a false claim.” United States ex rel. Todd v. Fid. Nat’l Fin., Inc., 2014 WL 4636394, at * 10 (D. Colo. Sept. 16, 2014).  Other courts have reached similar conclusions. See United States v. McMahon, 2016 WL 5404598, at *12 (N.D. Ill. Sept. 28, 2016) (“Although under the amended FCA, Relators are not required to show that any false statement or claim was presented directly to the federal government, Relators are still required to sufficiently allege a nexus to federal funds.”).


While courts have generally construed the “any portion” language to require a nexus between the false claims at issue, it is important to carefully evaluate each individual case under the specific facts and circumstances.  This is particularly true given that there is not a wide body of law on this issue, and it is possible that interpretations of the “any portion” language could change and evolve in the coming years.

[1] 31 U.S.C. § 3729(b)(2).

[2] 31 U.S.C. § 3729(c) (1986).

[3] 31 U.S.C. 3729(a)(1) (1994) (emphasis added).

[4] See e.g. U.S. ex rel. Totten v. Bombardier Corporation, 380 F.3d 488 (D.C. Cir. 2004).

[5] United States ex rel. Garbe v. Kmart Corp., 824 F.3d 632, 638 (7th Cir. 2016).

[6]U.S. Dep’t of Education, Revenues and Expenditures for Public Elementary and Secondary School Districts: School Year 2011–12 (Fiscal Year 2012) (Jan. 2015), available at

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Fraud in Connection With Contract Preferences or Set-Asides for Small Businesses or Businesses Owned by Veterans, Service-Disabled Veterans, Women or Disadvantaged Minorities, Part II

By Susan Schneider Thomas

In Part I of this blog series, we identified various government programs that are often the target of fraud. In this blog post, we will examine the types of fraud that are committed against these programs, as well as recent case examples of fraud.

Types of Fraud

Cases alleging violations of the various preference or set-aside programs generally involve misrepresentations about a business’ eligibility to participate in the program.  This can involve false certifications about the actual ownership or affiliates of the company or false representations about the amount of work that the small or minority business will perform on a given contract or project.

Fraudulently Formed Businesses

Sometimes companies are fraudulently formed specifically to take advantage of set-aside or preference programs, and other times there was at least a semblance of eligibility but it wasn’t maintained over time. Misrepresentations regarding average annual gross revenue, number of employees, ownership, or other qualifying characteristics to obtain a set-aside contract or preference is subject to a fine up to $500,000, imprisonment up to 10 years, penalties under the Program Fraud Civil Remedies Act of 1986, ineligibility to participate in any program or activity under the Small Business Act for up to three years – and potential liability under the False Claims Act, with its possibility of treble damages and very substantial penalties per false claim or statement.

Large Businesses Fraudulently Aligning With Small Businesses

Also, since there are circumstances in which large and small companies can work together as joint venturers, especially through the SBA Mentor-Protégé project, there are temptations for large businesses to fraudulently align themselves with small qualified entities in order to get those contracts.

Since set percentages of work must actually be done by the small business, the large business is not permitted to usurp the contract and take all of the federal funding. Basically, pursuant to rules promulgated by the SBA, funding must be split according to the percent of work performed, which has to include a set percent done by the qualified entity.

Misrepresenting the Allocation of Work or Profits

Misrepresentations about the allocation of work or profits is a frequent form of fraud in these instances.  Just this week, a bill was introduced on the floor of the House, with bipartisan sponsorship, to address this issue concerning the passing-through of contract work to ineligible companies by abusing a program intended to aid veteran-owned small businesses. H.R. 2749, the Protecting Business Opportunities for Veterans Act, would require participants in the VA’s Vets First Contracting Program to certify they are performing the requisite minimum amount of work. The VA would have the ability to refer suspected violators to its Office of Inspector General.

Additionally, false or fraudulent statements or schemes that do not pertain specifically to the special eligibility qualifications of the company can lead to FCA actions, such as misrepresentations about the ability of the company to perform the tasks, tainted bids or falsified billing.

Recent Allegations of Fraud in the Specially-Qualified Arena

In December 2016, Rhode Island-based Rosciti Construction Corporation and Wallace Construction Corporation, and several of the companies’ current and former owners, paid $1 million dollars for FCA violations involving the submission of claims for reimbursement for funding earmarked for minority, women-owned, or small businesses that they were not entitled to receive.  The contracts were issued by the Environmental Protection Agency, the United States Department of Education, and the United States Department of Transportation. Each of the contracts contained requirements that subcontractors on these projects must include disadvantaged business enterprises, specifically minority-owned, women-owned, or small businesses.  Rosciti Construction was the prime contractor for the projects and joined with subcontractor Wallace Construction, which misrepresented itself as a disadvantaged business enterprise.

Another FCA example involved Hayner Hoyt Corporation, a Syracuse, New York based contractor that agreed to pay more than $5 million to resolve allegations that it intentionally exploited the Service-Disabled Veteran-Owned Small Business (SDVOSB) Program for contracting opportunities.

The government alleged that Hayner Holt officials placed a service-disabled veteran figurehead at the head of the operation, while in fact the responsibilities of the service-disabled veteran were limited to tool inventory and snow removal tasks.  The true control and management was handled by non-veteran employees of Hayner Hoyt.

The scheme was allegedly carried out through a front company known as 229 Constructors, which was created and controlled by and subcontracted for Hayner Hoyt and its affiliates.  A Hayner Hoyt executive established an email account in the figurehead president’s name and set it up so that all emails received by the veteran were automatically forwarded to him.

In addition to the fact that control and management was by non-veterans, Hayner Hoyt also provided substantial resources to 229 Constructors, giving it a competitive advantage over legitimate service-disabled veteran-owned small businesses that are often small, not well-funded entities.

2017 Fraud Allegations

Two examples from 2017 involve non-FCA cases, but the substance of the frauds was the same.  A federal jury in Boston convicted a Chelmsford, Massachusetts man who won over $100 million in federal contracts that gave preference to disabled veteran-owned companies, finding that he lied when he represented that the companies were owned by disabled vets.  The government contended that David Gorski recruited two veterans to stand in as the majority owners and top executives of his construction firm so it could win those federal contracts.  Gorski was sentenced to 30 months in prison and fined $1 million by the federal court.

A Kansas City veteran and the owner of a construction company were indicted by a federal grand jury in January 2017 for their roles in a “rent-a-vet” scheme to fraudulently obtain more than $13.8 million in federal contracts.

Patriot Company was a pass-through or front company that was allegedly set up using Paul Salavitch’s veteran and service-disabled veteran status in a “rent-a-vet” scheme to bid on at least 20 government contracts and receive approximately $13.8 million to which Patriot Company would not have otherwise been entitled. Although Salavitch is legitimately a service-disabled veteran, he worked full-time as a federal employee with the Department of Defense in Leavenworth, Kansas, and did not work full time for Patriot Company.  Jeffrey Wilson, who is not a service-disabled veteran, set Salavitch up as a front man so that Wilson’s non-qualified company could compete for the contracts.

The scheme allegedly included decorating the office rented for the front company with some personal items reflecting Salavitch’s military service.  The fraud allegedly involves 20 contracts with the U.S. Department of Veterans Affairs and the U.S. Army.


Be on the lookout for these types of frauds, which seem to be increasing and which funnel money away from the people and enterprises that the government is trying to encourage.

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Fraud in Connection With Contract Preferences or Set-Asides for Small Businesses or Businesses Owned by Veterans, Service-Disabled Veterans, Women or Disadvantaged Minorities, Part I

By Susan Schneider Thomas

For decades now, the federal government has had various programs in place to provide preferences to businesses owned by groups to which the government wants to provide special opportunities. We wrote about this in a previous post and write now to expand on and update that post. In Part I of this blog series, we identify some of these government programs, and in an upcoming Part II, we will discuss some of the types of fraud that are prevalent in this area, as well as some recent cases.

Section 8(a) of the Small Business Act

The Section 8(a) business development program, named after Section 8(a) of the Small Business Act (“SBA”), is intended to foster business ownership by individuals who are both economically and socially disadvantaged.  The goal is to give these individuals the opportunity to participate fully in the free enterprise system, through a variety of measures, including loans, training, assistance with marketing, executive development and counseling. The most common assistance for 8(a) participants is given through sole source and set-aside contracts. The qualifications for the 8(a) program are essentially the same as those for a Small Disadvantaged Business except: (1) to meet the economic disadvantage test, all owners must have a net worth below $250,000 (excluding the business and personal residence) and (2) the business must have been operating for at least two years (with possible exceptions if the socially and economically disadvantaged owners demonstrate substantial technical and business management experience).

Disadvantaged Business Enterprise Program

A program very similar to SBA’s 8(a) program is the Department of Transportation (DOT) Disadvantaged Business Enterprise (DBE) Program. The DBE program provides contracting opportunities in the transportation industry for small businesses owned and controlled by socially and economically disadvantaged individuals for projects through the Federal Highway Administration, the Federal Transit Administration, and the Federal Aviation Administration.  Other programs of this ilk include the HUBZone Program, for Historically Underutilized Business Zones. The focus there is small businesses operating in economically distressed communities. A HUBZone is an area of high unemployment or low income. The businesses eligible for assistance must be small, 51% owned and controlled by U.S. citizens, have the primary office in a HUBZone, and have at least 35% of its employees reside in that zone.

Small Business Innovation Research Program

Three other programs are worth mentioning. The Small Business Innovation Research (SBIR) Program focuses on channeling funds from federal agencies with significant research and development budgets to small businesses. In effect, the SBIR program is a research and development small business set-aside.  As explained on its website, “Through a competitive awards-based program, SBIR enables small businesses to explore their technological potential and provides the incentive to profit from its commercialization. By including qualified small businesses in the nation’s R&D arena, high-tech innovation is stimulated and the United States gains entrepreneurial spirit as it meets its specific research and development needs.”

Vets First Contracting Program

Under the Vets First Contracting Program, competing VA contractors must certify that they are eligible for Service-Disabled Veteran-Owned Small Business (SDVOSB) or Veteran-Owned Small Business (VOSB) status, allowing them to participate in both VA small-business set-aside contracts and small-business subcontracts with large VA prime contractors. The Department of Veterans Affairs estimates that this market involves more than $3 billion in contracts each year.  Under those contracts, SDVOSBs and VOSBs may subcontract some work but must conduct a certain percentage of the contracted work themselves.

Women-Owned Small Businesses Federal Contracting Program

Finally, in 2011, Congress implemented the Women-Owned Small Businesses (WOSB) Federal Contracting Program, with the goal of expanding the number of industries where WOSBs can compete for business from the federal government.  It allows set-asides for WOSBs in industries where women-owned small businesses are substantially underrepresented. There are also special considerations for Economically Disadvantaged WOSBs in certain industries.


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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 Schneider 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 Schneider 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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How to Report Tax Fraud

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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