FCA Now

Over three years after the filing of the initial sealed complaint, a New York-based construction company and several affiliates—including its bonding company—have agreed to pay a combined $4.47 million to settle a False Claims Act case alleging a decade-long scheme to fraudulently obtain federal contracts set aside for Service-Disabled Veteran-Owned Small Business Concerns (“SDVOSBCs”) and small businesses operating in Historically Underutilized Business Zones (“HUBZones”). United States of America, ex rel. James Hagan v. Northland Associates, Inc., et al., No. 5:17-cv-00036-GTS-TWD (N.D.N.Y.). The Small Business Administration (“SBA”) maintains several programs that provide small and disadvantaged businesses exclusive opportunities to procure certain set-aside contracts with the federal government, i.e., contracts that non-eligible companies cannot compete for. These programs are governed by an extensive set of statutes, regulations, and rules. Under the Small Business Act, certain size standards apply when determining if a business qualifies as a “small business” for government contracting purposes. See 13 C.F.R. § 121.201. When assessing size, small businesses must consider whether any relationship rises to the level of “affiliation,” which exists when another business controls or has the power to control the small business. See 13 C.F.R. § 121.103. Control by an affiliate may arise in several ways, including through ownership, management, financial support, employee sharing, or other relationships or interactions between the parties. Id. Small business must meet additional standards set forth by the SBA to obtain more specialized SBA certifications. For instance, the SDVOSBC program requires a small business to be 51% owned and controlled by a military veteran injured in the line of duty. 15 U.S.C. § 632(q); 38 U.S.C. § 101(2), (16); 13 C.F.R. § 125.10; 38 C.F.R. § 74.4. Under the SBA’s separate HUBZone program—designed to encourage investment and employment in historically underutilized communities—a small business may obtain a HUBZone certification if it is located in a designated underutilized business zone. 13 C.F.R. § 126. In Northland Associates, two former-employee relators filed a complaint alleging that Northland Associates, Inc. (“Northland”) created a sham company—Diverse Construction Group, Inc. (“Diverse”)—to bid for and fraudulently obtain over $50 million in construction set-aside contracts for the SBA’s SDVOSBC and HUBZone programs. The complaint alleged that Northland and its owner, James Tyler, worked with a service-disabled veteran, the late Hunter Grimes, to establish and certify Diverse as a SDVOSBC. According to the complaint, the parties further certified Diverse as a HUBZone business by setting up an office for the company in Plessis, New York. The complaint, however, alleged Grimes lacked the experience or capabilities to run a construction company, and that he did not take part in the management of Diverse or any day-to-day decision-making. Instead, the complaint alleged Northland controlled Diverse at all relevant times—including the bid process and the performance of contracts awarded to Diverse—from Northland’s office in Liverpool, New York. Going beyond certification-related misrepresentations, the relators’ complaint alleged that Northland, Tyler, and Diverse took several affirmative actions to prevent discovery of their scheme. For instance, the complaint alleged that after a competitor initiated a bid protest involving Diverse in September 2009, the SBA conducted a size determination and concluded that Diverse did not qualify as a small business due to its affiliation with Northland. According to the complaint, Diverse successfully appealed the determination based upon declarations in which Tyler and Grimes allegedly misrepresented that: (1) Northland did not control Diverse, (2) Northland did not assist Diverse in the bid process; (3) Northland did not share employees, equipment, or facilities with Diverse; and (4) Northland did not financially assist Diverse or help it obtain bonding. The companies also allegedly attempted to hide their financial affiliation by transferring money through a Northland subsidiary, Maple Ridge Plateau, Inc., and using different bonding companies. The Department of Justice (“DOJ”) opted to intervene and simultaneously filed its settlement agreement with Northland, Defense, and Tyler. In the settlement agreement, Northland, Diverse, and Tyler admitted to their involvement in “a scheme devised and engaged in . . . to circumvent service-disabled veteran-owned small business and HUBZone contract requirements.” They further admitted to the undisclosed affiliation between Northland and Diverse—including employee-sharing, funneling of funds through a Northland subsidiary, Northland’s involvement in the bid process, and Northland’s performance under the Diverse contracts—and that the declarations submitted in response to the bid protest contained material misrepresentations. In addition, the DOJ filed a separate settlement agreement with Rose & Kiernan, the bonding company used by Northland and Diverse. Notably, Rose & Kiernan had not been named as a defendant in the complaint. In the settlement agreement, Rose & Kiernan admitted that it “knew or should have known . . . that Diverse and Northland were affiliated in violation of SBA regulations and that [Northland and Diverse] took steps to hide their affiliation from the government to obtain and receive payment on government set-aside contracts.” Rose & Kiernan further admitted that “[w]ithout the surety bonds that [Rose & Kiernan] helped Diverse procure . . . Diverse’s fraud would not have been possible.” Combined, the defendants and bonding company agreed to pay $4,470,000 to settle the allegations, although the bonding company’s share was only $120,000. The relators—two former Northland employees—will receive $1,000,000. This resolution provides three important reminders for all those who contract with the United States government. First, companies applying for any small or disadvantaged business certification must carefully and accurately assess their eligibility. This includes, importantly, assessing whether they have any affiliates and whether those affiliates affect eligibility. Second, bonding companies should look closely at the DOJ’s settlement agreement with Rose & Kiernan. Although FCA liability is most frequently applied to contractors who submit claims to the government, this settlement evidences an expansive reading of the FCA in which a bonding company knowledgeable of underlying fraud can be held liable under the FCA. Finally, the government eagerly and aggressively investigates fraud in its contracting programs—particularly where funds earmarked for veterans and small businesses are involved. As the DOJ reiterated in its press release, “those who contract with the United States government must do so fairly and honestly,” and “[p]roviding false information to gain access to SBA’s preferential contracting programs is fraught with peril and is especially egregious when it involves programs intended to benefit our nation’s service-disabled veterans.” Given the large number of set-aside contracts that have been awarded under tight deadlines in response to the current COVID-19 crisis, we are likely to see an increase in small business-related FCA investigations and prosecutions in the coming months and years.

On November 21, 2019, the Second Circuit held that allegedly fraudulent loan requests presented to one or more of the Federal Reserve System’s twelve Federal Reserve Banks are “claims” within the meaning of the FCA. The court clarified that while personnel of those Federal Reserve Banks are not officers or employees of the United States, the Federal Reserve Banks themselves are agents of the United States and fraudulent requests to them are subject to the FCA. In so holding, the court revived a long-running whistleblower case and rejected the arguments of the lower court, the U.S. Government, and the Federal Reserve Board of Governors. The lawsuit was first filed by plaintiffs in 2012. According to the complaint, two banks engaged in a massive fraud in the early to mid-2000s against the U.S. Department of the Treasury by representing to regional Federal Reserve Banks that they were in sound financial condition and thus eligible for desirable credit programs. The regional Federal Reserve Banks are subject to a Board of Governors, but their stock is held by private commercial banks. According to the federal government, the regional banks administer their money-lending activities for themselves. The regional banks’ loans are delivered in the form of credit to the borrowing bank, not lent out of federal money. The lower court—U.S. District Judge Brian M. Cogan for the Eastern District of New York—dismissed the fourth amended complaint in May of 2018. The lower court concluded that under the Federal Reserve Act, the 12 Federal Reserve Banks (one for each of the Federal Reserve’s 12 districts) are private corporations separate from the actual Federal Reserve System. Moreover, because the Federal Reserve Banks do not receive government money, the lower court concluded that defendants could not be properly accused of submitting false claims to the government by requesting loans from the regional banks. On appeal, the Second Circuit requested that the government weigh in on whether regional Federal Reserve Banks should be considered part of the government for FCA purposes. In August of 2019, the Federal Reserve Banks’ Board of Governors responded unequivocally that the regional banks should not be treated as part of the government due to their relative autonomy and lack of government appropriations. The Board of Governors likened the regional banks to other “federally chartered corporations” such as Amtrak, Fannie Mae, and Freddie Mac, entities that courts have treated as separate from the government for FCA claims. The Second Circuit disagreed. According to the appellate panel, the federal government created the regional banks to extend emergency credit to banks on the federal government’s behalf. Those regional banks must extend emergency credit in compliance with regulations from the Board of Governors—an independent agency within the executive branch. The appellate panel stated that the FCA does not require “agents” for purposes of the Act to be actual government agencies, but instead merely requires that those agents are empowered to act on behalf of the government. The Second Circuit’s opinion is a major win for qui tam relators. The Second Circuit affirmed that in enacting the FCA, “the objective of Congress was broadly to protect the funds and property of the Government from fraudulent claims, regardless of the particular form, or function, of the government instrumentality upon which such claims were made.” The case is U.S. ex rel. Kraus et al. v. Wells Fargo & Co. et al., Case Number 18-1746, in the U.S. Court of Appeals for the Second Circuit.

Seven years after filing their initial complaint, a Montana federal court ruled that plaintiffs’ FCA action—at least on some claims and against some defendants—may finally proceed. Cain v. Salish Kootenai Coll., Inc., No. CV-12-181-M-BMM, 2019 U.S. Dist. LEXIS 26955 (D. Mont. Feb. 20, 2019). In 2012, plaintiffs, as relators in a qui tam action, alleged that a tribal college, its board of directors, and various employees violated the FCA by submitting falsified student grades, retention data, and other records to the Department of Health and Human Services (“DHS”) and the Indian Health Service in order to receive federal education grants. The district court twice dismissed the FCA claims against Salish Kootenai College—before and after an appeal to the Ninth Circuit—finding that the tribal college was an extension of the sovereign tribe, and therefore not a “person” subject to the FCA. The court also dismissed plaintiffs’ claims against the individual defendants without prejudice, finding that plaintiffs had failed to satisfy Rule 9(b)’s heightened pleading requirements. Plaintiffs filed an amended complaint against the several defendants, which “repeat[ed] multiple paragraphs and insert[ed] a separate name into each allegation” to demonstrate each defendant’s alleged involvement with the false representations made to the DHS and Indian Health Service. Defendants again moved to dismiss, arguing that: (1) they could not be sued for conduct related to their official capacities; and (2) plaintiffs’ repetitive fraud allegations still failed to meet Rule 9(b)’s particularized pleading requirements with respect to each individual defendant. The court first concluded that, like federal employees sued in their personal capacities, tribal employees cannot hide behind the sovereign immunity of their employer to shield themselves from personal liability “for their alleged fraudulent conduct arising out of actions they took in their official capacities.” The court then held that plaintiffs’ repetitive, fill-in-the-defendant pleading style satisfied Rule 9(b) because: The crux of the Amended Complaint, and what likely saves it, is that Plaintiffs allege that Individual Defendants all acted in similar manners, all had similar involvements, and were all warned by Plaintiffs. The collective warning implies that the Individual Defendants’ [sic] possessed collective knowledge, collectively acted, and collectively omitted specific information in the applications submitted that gave rise to the alleged fraud against the United States Government. Combined with allegations that each defendant was involved in two different fraudulent schemes, details of which were described within the amended complaint to answer the who, what, when, where, and how of the scheme, the court found that the redundant pleading satisfied Rule 9(b)’s particularity requirements and denied the defendants’ motion to dismiss. The Montana federal court’s decision is notable for at least two reasons. First, it holds, under these particular alleged facts, that tribal employees can be sued in their individual capacities for violations of the FCA. Second, it permits repetitive, fill-in-the-defendant-style pleadings and allegations of “collective knowledge” to satisfy Rule 9(b)’s heightened pleading standard, even as to individual defendants sued in their personal capacities, where the allegations of the fraudulent schemes are sufficiently detailed. As the court recognized, “the practice does not constitute a failure per se,” so long as the allegations sufficiently state the “who, what, when, where, and how” to meet the particularized pleading requirements of Rule 9(b).