Defense Counsel Journal: The Department of Justice’s Cyber-Fraud Initiative and Its Impact on the False Claims Act
By Peter Pizzi, Kimberly Bessiere Martin
On October 6, 2021, The Department of Justice (“DOJ”) announced the launch of the Civil Cyber-Fraud Initiative (the “CCFI”), which is designed to combat emerging cyber threats to the security of sensitive information through the use of civil fraud enforcement tools. This initiative proposes to use civil enforcement tools to pursue government contractors who receive federal funds in the event that those contractors fail to meet required cybersecurity standards. The DOJ developed the CCFI as a result of its review of cyber threats with a focus on developing recommendations to combat those threats. At the time of its announcement, Deputy Attorney General Lisa O. Monaco stated that the use of civil enforcement tools was intended to “ensure that taxpayer dollars are used appropriately,” as well as to combat the “mistaken belief that it is less risky to hide a breach than to bring it forward and to report it. . . .”1
The Initiative relies on the False Claims Act (“FCA”)2 to pursue cybersecurity-related fraud by government contractors, grant recipients, and other entities which rely upon federal funding. The FCA, addressed in more detail below, is the main vehicle by which the government addresses false claims for federal funds. In its launch of the CCFI, the DOJ highlighted the FCA’s whistleblower provisions, which allow for a private party who successfully brings forward instances of fraudulent conduct to share in any recovery by the government. The DOJ anticipates that the Initiative will “hold accountable entities or individuals that put U.S. information or systems at risk by knowingly providing deficient cybersecurity products or services, knowingly misrepresenting their cybersecurity practices or protocols, or knowingly violating obligations to monitor and report cybersecurity incidents and breaches.” The DOJ’s use of the FCA as a part of its initiative to combat cyber-threats adds another layer of complexity to an already challenging landscape for companies navigating cybersecurity issues. This article provides an overview of the FCA and discusses recent use in the context of cybersecurity issues.
I. The False Claims Act
The FCA imposes treble damages and a civil penalty from $12,537 to $25,076 per claim3 on anyone who knowingly submits or causes the submission of a false or fraudulent claim payable by the United States government or related entities.4 In particular, the government has a civil cause of action against any person or entity who:
knowingly presents, or causes to be presented, a false or fraudulent claim for payment or approval;5
knowingly makes, uses, or causes to be made or used, a false record or statement material to a false or fraudulent claim;6
has possession, custody, or control of property or money used, or to be used, by the Government and knowingly delivers, or
causes to be delivered, less than all of that money or property;7
knowingly makes, uses, or causes to be made or used, a false record or statement material to an obligation to pay or transmit money or property to the Government, or knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the Government[;]8 or
conspires to commit [one of these violations].9
Claims for violation of the FCA can be brought by the government or as qui tam actions on the government’s behalf by a private individual, known as a relator.10 Suits brought by relators are often called “whistleblower” suits, and provisions applying to whistleblowers will be discussed in more detail below.
To state a claim under the FCA, the government generally must make at least four showings by a preponderance of the evidence.11 First, the government must establish the existence of a claim actionable under the FCA. Second, the government must establish that the claim was false, either factually or legally. Third, the government must demonstrate that the falsity was material to the payment of the claim. Finally, the government must establish that the defendant acted with knowledge of the falsity. The following sections provide a brief overview of each requirement for FCA liability.
The submission of a claim is “the sine qua non of a False Claims Act violation.”12 The FCA broadly defines “claim” as “any request or demand . . . for money or property whether or not the United States has title to the money or property” either (a) “presented to an officer, employee or agent of the United States” or (b) “made to a contractor, grantee or other recipient, if the money or property is to be spent or used on the Government’s behalf or to advance a Government program or interest” and the government has provided or will reimburse for any portion of the money or property requested.13 Entities that routinely receive payment through government programs or contracts—namely government contractors, health care suppliers and providers and financial services companies—are the most likely to find themselves targets of an FCA claim or investigation.
To establish a violation of the FCA, the government must show the existence of a “false or fraudulent claim.”14 A claim may be considered false under the FCA if it is factually or legally false.15 The factually false claim is one “in which a contractor or other claimant submits information that is untrue on its face.”16 A factually false claim generally involves “an incorrect description of goods or services provided or a request for reimbursement for goods or services never provided.”17
In contrast, a legally false claim or certification is one that is “predicated upon a false representation of compliance with a federal statute or regulation or a prescribed contractual term.”18 Courts further divide legally false claims into those claims made legally false by an “express certification” and those claims made legally false by an “implied certification.”19 In an express false certification claim, the claim “falsely certifies compliance with a particular statute, regulation or contractual term, where compliance is a prerequisite to payment.”20 False certification claims based on broad and vague certifications of compliance with law may be found insufficient to give rise to FCA liability.21
An implied false certification claim “is based on the notion that the act of submitting a claim for reimbursement itself implies compliance with governing federal rules that are a precondition to payment.”22 The United States Supreme Court clarified this theory of FCA liability in 2016 in Universal Health Services v. United States ex rel. Escobar.23 In Escobar, the Court held that the “implied certification theory can, at least in some circumstances, provide a basis for liability . . .” and did not require that the government “expressly designated” compliance as a condition for payment.24 The circumstances under which this theory may apply, however, were limited by the Court to circumstances where two conditions are satisfied.25 First, a claim must make specific representations about a good or service (as opposed to merely requesting payment). Second, the defendant’s failure to disclose noncompliance with the material statutory, regulatory or contractual requirements makes those specific representations “misleading half-truths.”26
The FCA also requires that false statements be “material” to a false claim. Since the 2009 amendments, materiality has been defined as “having a natural tendency to influence, or be capable of influencing, the payment or receipt of money or property.”27 The Supreme Court also addressed the materiality requirement of the FCA in Escobar by defining it as “demanding.”28 The Court stated that the materiality standard turns on the “likely or actual behavior of the recipient of the alleged misrepresentation.”29 It is not enough for the government or relators to show that “[g]overnment would be entitled to refuse payment were it aware of the violation.”30 The Court did not find that an express designation as a condition of payment was required to state a claim but found this to be relevant to the materiality inquiry.31 The government’s past practices in paying such claims are relevant to the determination.32
While the government and relators may argue that the “materiality” analysis was unaffected by the Escobar decision, many post-Escobar decisions have applied a heightened materiality standard. This heightened scrutiny is resulting in courts requiring more facts supporting materiality to be pled and a closer examination of the government’s actions.33
Since this decision, appeals of adverse verdicts based on Escobar materiality grounds have had success. For example, the Fifth Circuit reversed a $663 million jury verdict in a suit alleging that the defendant had submitted false claims to the government by not disclosing changes to highway guardrails.34 In reaching this result, the court concluded that “continued payment by the federal government after it learn[ed] of the alleged fraud substantially increase[ed] the burden on the relator in establishing materiality.”35 The Escobar materiality requirement is also being raised at the pleading stage under Rule 9(b), with some courts requiring additional facts to be pled on the materiality element or dismissing complaints.36
To establish a FCA violation, the government must show that the defendant acted “knowingly.” To act “knowingly,” the individual may, but need not, have actual knowledge of the claim’s falsity or have a specific intent to defraud the government.37 Rather, the individual need only “act in deliberate ignorance”38 or “in reckless disregard of the truth or falsity of the information.”39 The statute expressly provides that the government is not required to prove that a defendant specifically intended to defraud.40 While Federal Rule of Civil Procedure 9(b) allows knowledge to be alleged “generally,” relators must still plead facts under Rule 8 to support a plausible inference that the Defendants knowingly submitted a false claim.41 General and con-clusory allegations that a defendant “knowingly” submitted false claims, without supporting facts, do not suffice under Rule 8.42
Reckless disregard under the FCA is “an extension of gross negligence or an extreme version of ordinary negligence.”43 As the Supreme Court explained in an analogous context, to show recklessness the government must show that the party’s conduct entailed “an unjustifiably high risk of harm that [was] either known or so obvious that it should [have] be[en] known.”44 The Supreme Court has before it in the 2022-2023 Term a case which involves the application of the reckless disregard standard, which lower courts have said could suffice for FCA liability.45 The law on this precise point could change in the coming months.
Determining whether conduct raises an “unjustifiably high risk” of violating the law depends on a variety of factors. Relevant factors cited by various courts include:
- the personal knowledge of the defendants and their familiarity with governing legal rules and obligations;46
- the clarity of existing statutory, regulatory, and contractual guidance addressing the conduct at issue;47
- the defendant’s justifiable reliance on experts, attorneys, or other entities in making the challenged statements;48
- the defendant’s compliance with industry practice in taking the challenged actions;49 and
- the government’s knowledge of or acquiescence towards the challenged conduct.50
b. Whistleblower Provisions
A private individual, known as a relator, may bring a qui tam action and enforce the FCA on the government’s behalf.51 The relator may be anyone with knowledge of the allegations—such as a current or former employee, a competitor, a customer, or a consultant. When brought by a relator, a complaint is filed under seal and remains unserved on the defendant until the presiding federal court orders otherwise.52 While the complaint is under seal, the government may investigate the relator’s claims and decide whether it will elect to intervene and take responsibility for prosecuting the action or decline to intervene, leaving the relator to litigate his or her complaint.53 The FCA incentivizes private relators to bring claims by providing them with a share of any proceeds of the action or settlement—15% to 25% if the government intervenes and 25% to 30% if the government does not intervene.54
The government may settle an action brought by a relator, notwithstanding any objection by the relator, “if the court determines, after a hearing, that the proposed settlement is fair, adequate, and reasonable under all the circumstances.”55 The Supreme Court has before it in the 2022-2023 Term the issue whether the government can move to dismiss a FCA action in which it has not intervened and the procedural steps in order for the government to do so.56 The law on this precise point also could change in the coming months.
II. Application of the FCA to Cybersecurity Issues
Since the start of the CCFI, there have been two reported FCA cyber-fraud settlements. The first occurred in March 2022 and involved the resolution of two whistleblower actions pending in the Eastern District of New York against Comprehensive Health Services LLC (“CHS”).57 CHS is contracted to provide medical support services at government-run facilities in Iraq and Afghanistan. The government asserted that, under one of the contracts, CHS submitted claims to the State Department for the cost of a secure electronic medical record (EMR) system to store all patients’ medical records. The DOJ alleged that, between 2012 and 2019, CHS billed the State Department $485,866 for storing medical records in a secure system, even though some of the medical records were saved on an internal network drive that was accessible to non-clinical staff. This was asserted to be a direct violation of government contractual requirements. The DOJ alleged that CHS did not take adequate steps to store information exclusively on the EMR system, even after concerns were raised about the privacy of protected information. CHS resolved claims relating to these allegations, and allegations that it falsely represented certain medical supplies as being approved by the FDA or EMA, for $930,000.58
On July 8, 2022, the DOJ reported another settlement involving alleged cybersecurity violations by defense contractor Aerojet Rocketdyne Holdings and Aerojet Rocketdyne Inc. (collectively “Aerojet”), who allegedly failed to comply with requirements in certain federal government contracts.59 The case was watched closely by practitioners in this area. The claim was originally filed by former Aerojet employee Brian Markus – the former senior director of Cybersecurity, Compliance & Controls. Markus alleged that Aerojet knew its cybersecurity programs fell short of Department of Defense and NASA acquisition regulations, which were part of contracts between Aerojet and the agencies.
Despite declining to intervene in the Aerojet case in June 2018, the government filed a statement of interest two weeks after it announced the Civil Cyber-Fraud Initiative, assailing Aerojet’s arguments that it was entitled to summary judgement.60 Notably, the government argued that Aerojet’s contractual deficiencies were a source of damages even if Aerojet otherwise complied with the contracts because “the government did not just contract for rocket engines, but also contracted with [Aerojet] to store the government’s technical data on a computer system that met certain cybersecurity requirements.” The government also argued that assertions that the entire defense industry is not compliant with cybersecurity requirements has no bearing on whether such compliance is material to the government’s payment decision in any particular case.
On February 1, 2022, the United States District Court for the Eastern District of California ruled that the case against Aerojet could proceed on triable issues of fact as to whether noncompliance with government cybersecurity requirements are material to the government’s decisions to approve contracts. The federal court denied Aerojet’s motion for summary judgment and issued the first major ruling in an FCA case testing the Department of Justice’s new CCFI.
The court commented that the relevant regulations required government contractors to implement specific safeguards to protect unclassified technical information from cybersecurity threats. A key component of Aerojet’s argument was that it had disclosed to the government areas in which it did not meet the cybersecurity requirements of the contract. While the court acknowledged that Aerojet may have disclosed its cybersecurity shortcomings to the government, the court questioned whether Aerojet failed to disclose key events and the results of audits showing gaps in Aerojet’s cybersecurity. The court also expressed concern as to whether Aerojet knowingly misrepresented their intention to comply with the cybersecurity provisions of their contracts in the first place. These issues presented a question of fact for trial.
Following the ruling of the district court, the case proceeded to trial, which commenced on April 26, 2022. On the second day of trial, the parties reported that the matter had been settled. On July 8, 2022, the DOJ issued a press release detailing the terms of the settlement.61
The DOJ’s CCFI highlights for companies the need to understand and comply with the cybersecurity requirements contained in federal contracts. The initiative is well-staffed and encourages whistleblowers to bring forward instances of violations. Companies should expect increased action by the DOJ with regard to alleged violations.
Federal contractors should implement processes for identifying the cybersecurity requirements in their contracts and assessing compliance with them. These processes should include collaboration and coordination between the IT, legal, and compliance functions. In some instances, third-party vendors maintain information that may be implicated by a company’s cybersecurity obligations. The FCA exposure applies particularly in the healthcare field, where third-party vendors often maintain protected healthcare information. A vendor management review conducted on a regular basis – at least annually – is an important tool to ensure that vendors are meeting cybersecurity obligations. To the extent that such a review identifies deficiencies either internally or with vendors, companies should develop a process for escalating and responding to these deficiencies. This process may include disclosure to the government.