The False Claims Act and Securities Fraud: Overlapping Remedies

The False Claims Act and Securities Fraud: Overlapping Remedies

The False Claims Act (FCA) is a federal law that imposes liability on persons and companies who defraud governmental programs. The FCA allows the federal government to recover treble damages and penalties from those who knowingly submit or cause the submission of false or fraudulent claims for payment to the federal government.

The FCA also contains a “qui tam” provision that allows private parties, known as “relators,” to bring suit on behalf of the government against those who have violated the FCA. If the government intervenes and prevails, the relator can receive up to 30 percent of the recovery. Even if the government does not intervene, the relator can still pursue the action and recover up to 25 percent of the proceeds.

So how does this overlap with securities fraud? The FCA imposes liability in connection with government contracts and programs like Medicare and Medicaid. If a company makes misrepresentations to investors in the sale of securities, that would potentially constitute securities fraud under federal securities laws. But that securities fraud could also give rise to FCA liability if government money is involved in the securities transaction.

FCA Background and Purpose

The FCA was originally enacted during the Civil War to combat fraud by defense contractors against the Union Army. The law imposed civil liability and penalties for the submission of false claims. The law also contained a qui tam provision allowing private citizens to bring suit on behalf of the government and share in any recovery.

Over time, the FCA fell into disuse. But amendments in 1986 modernized the law and strengthened the ability of relators to pursue qui tam cases. As a result, FCA litigation increased dramatically, recovering over $2.8 billion in 2018. The FCA has become the government’s primary tool to combat fraud by healthcare companies, defense contractors, and any entity doing business with the federal government.

FCA Elements and Damages

To establish a claim under the FCA, the relator must show:

• A false or fraudulent claim
• The defendant knew the claim was false
• The false claim was material
• The false claim caused the government to pay out money

If these elements are met, the defendant is liable for:

• Treble (triple) damages
• Civil penalties up to $23,331 per false claim

The damages and penalties can quickly escalate into massive sums. As a result, FCA cases represent substantial risk to healthcare companies, contractors, and any entity doing business with or receiving payments from the federal government.

Application to Securities Fraud

Securities fraud under federal securities laws like Section 10(b) of the Securities Exchange Act occurs when a company or individual makes material misstatements or omissions in connection with the purchase or sale of securities. Common examples include overstating financial performance or failing to disclose regulatory compliance issues.

But FCA liability can attach even if the securities fraud does not directly involve government funds. For example, Medicare and Medicaid providers often access capital markets to finance expansions and operations. Likewise, companies in aerospace, defense, and other industries may commit securities fraud while also doing substantial business with the government.

If the securities fraud causes increased payments or avoids obligations owed to the government, FCA liability may attach. For instance, a healthcare company that overstates earnings or regulatory compliance to obtain better terms in a stock or bond offering could face FCA liability down the road if the misconduct impacted billing or services to Medicare patients.

Pharmaceutical Company Example

Take the example of a pharmaceutical company that is heavily reliant on revenue from Medicare and Medicaid drug reimbursements. If the company commits accounting fraud or fails to disclose serious regulatory violations to investors, that could constitute securities fraud.

But if the misconduct also resulted in over-billing federal healthcare programs, it could trigger FCA liability. In this case, the company could face SEC penalties for securities fraud violations as well as treble damages and per claim penalties under the FCA.

Defense Contractor Example

As another example, consider a defense contractor that obtains an equity investment to finance expansion of manufacturing operations for a fighter jet program. If the company misrepresented cost overruns or manufacturing delays to the investors, that could be securities fraud.

But if the misconduct also impacted billing under the fighter jet development contracts with the Department of Defense, it could lead to FCA violations as well. So the company might face SEC action over the securities violations together with FCA liability for false claims submitted to the government under those contracts.

Pros and Cons of FCA/Securities Overlap

Allowing FCA liability to attach to securities fraud, even when government funds are not directly involved, remains controversial. Proponents argue it provides another tool to combat fraud and abuse by companies doing substantial business with the federal government. But critics argue it leads to overreach and penalties disconnected from actual damages to government programs. There are good arguments on both sides.

Pros

• Powerful deterrent effect against fraud by government contractors
• Treble damages and per claim penalties incentivize whistleblowers
• Relators can uncover fraud that regulatory agencies miss
• Punishes and deters indirect harm to government programs

Cons

• Risk of over-deterrence that stifles innovation and growth
• Severely penalizes misconduct indirectly tied to government funds
• Diverts enforcement resources away from direct government fraud/abuse
• Incentivizes speculative or frivolous whistleblower complaints

Key Defenses

Despite the power of the FCA, targets can raise several defenses to reduce or defeat liability:

No knowledge

If the target can show that management was unaware the claims were false or fraudulent when submitted, this can rebut the “knowing” intent requirement.

Minor or insubstantial violations

Courts have held that minor recordkeeping discrepancies or technical regulatory violations may not give rise to FCA liability.

Government knowledge

If the government knew about the alleged falsity when the claims were submitted but still paid, courts may decline to impose FCA liability.

Statutory bar

The FCA has a first-to-file bar stopping later whistleblowers from pursuing claims already under investigation. Companies can argue a relator’s suit is precluded under this bar.

Companies dealing with overlapping FCA and securities fraud allegations need experienced counsel to navigate these issues. An effective defense requires a nuanced understanding of complex rules governing federal healthcare programs, government contracting, federal securities laws, and the FCA statute itself.