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Privatizing customs fraud enforcement under the False Claims Act

By Erika Kelton, Phillips & Cohen LLP
(Reprinted from BNA's International Trade Reporter, May 12, 1999, with permission)

A new era in customs fraud enforcement is emerging as a result of a Civil War-era law.

The law, known as the False Claims Act, is a powerful civil anti-fraud statute that allows anyone who knows of a fraud against the government to file a lawsuit and recover damages and fines on the government's behalf. The statute permits individuals to function as "private attorneys general" in enforcing government fraud claims.

As the False Claims Act becomes a better known vehicle for redressing customs frauds, the impact could be as profound - and as punitive - as any previous U.S. customs fraud enforcement effort.

The False Claims Act, 31 U.S.C. §3729, applies whenever a company or individual has falsely or fraudulently "concealed, avoided or decreased an obligation to pay or transmit money to the Government," according to the statute. Any company that has customs obligations to the federal government is covered by the law, and if liable, could be required to pay three times the government's losses and $5,000 to $10,000 for each false claim made. In instances where a company's improper import practices are longstanding, treble damages and fines for hundreds of false entries easily add up to many millions of dollars. With the law's 10-year statute of limitations, companies could be liable for avoiding duties as long ago as 1989.

Blowing the whistle on customs fraud
Companies that knowingly underpay or avoid their customs obligations run the risk that someone will blow the whistle on the practice and file a False Claims Act, or "qui tam," lawsuit. That person could be anyone - a customs broker, a manager, a secretary, a longshoreman or an accountant. Even a business competitor or an industry trade association may bring a suit. The whistleblower simply needs to know about the specific acts of fraud to file a lawsuit on behalf of the government.

The incentives to step forward and "blow the whistle" on customs fraud are substantial. The False Claims Act stipulates that whistleblowers will receive 15 percent to 25 percent of whatever money the government recovers as a result of their lawsuits if the government joins the case, and up to 30 percent of the recovery if the government does not.

As more people have learned about the False Claims Act's reward provisions, the number of whistleblower lawsuits filed annually has jumped from 33 in 1987 to more than 472 in fiscal 1998, according to the Department of Justice's civil division.

The U.S. Treasury has recovered nearly $2.5 billion as a result of whistleblower lawsuits under the False Claims Act between 1988 and 1998. And in just the past three years alone, more than $1 billion has been recovered under the Act's qui tam provisions. Based upon the probable outcome of pending cases, the U.S. government is likely to recover another $2 billion to $3 billion within the next two years.

Fight war profiteers
Congress passed the False Claims Act in 1863 because war profiteers were defrauding the Union Army through various schemes, including selling the Union Army bullets filled with sawdust. The law was weakened in 1943 and fell into disuse.

Widespread publicity about defense contractor fraud in the 1980s convinced Congress to revive the statute. It amended the False Claims Act in 1986 and made clear that the law should be used to uncover fraud in all areas where the government pays or receives money, either directly or indirectly. To make the statute more effective, Congress revised certain provisions to stipulate harsher penalties for wrongdoers and greater rewards for whistleblowers.

The False Claims Act has been enormously successful in pursuing fraud against the government in the defense and health care industries. The most recent example of the law's clout is the federal government's investigation of the world's largest health care provider, Columbia/HCA Healthcare Corp., for Medicare fraud. Analysts estimate Columbia's liability could exceed $1.5 billion as a result of whistleblower lawsuits.

The law also has been effective in recovering damages due to fraudulent practices in other areas, including federal construction projects, agricultural subsidies and municipal bond transactions.

Some whistleblowers choose to file False Claims Act lawsuits because it offers private parties "hands on" involvement in prosecuting customs frauds against the government and forces the government to investigate. Whistleblower cases are filed under seal and are not available to the defendant or to the public while the government investigates to decide whether the allegations have merit and whether it will join the lawsuit. If the government joins the case, the Justice Department has primary responsibility for its prosecution. Whistleblowers and their counsel work alongside the Justice Department as co-prosecutors, providing information and assistance that might help the case. If the Justice Department declines to join, then the whistleblowers and their counsel may continue the lawsuit on their own in the government's stead.

The Department of Justice made clear in court filings in October 1998 that the False Claims Act is an appropriate enforcement tool for recovering unpaid customs duties, tariffs and user fees. Lawsuits thus could be brought against companies for numerous different customs frauds, including practices such as:

- misclassifying products to avoid, or decrease, import duties;
- falsely undervaluing imported products;
- misrepresenting antidumping duty obligations;
- misstating country of origin to avoid anti-dumping duties, or to gain preferential duty status in programs such as the Caribbean Basin Initiative; and
- misdesignating country of origin to avoid apparel quotas thereby causing an underpayment of tariffs.

Popular with prosecutors
The False Claims Act is a popular anti-fraud enforcement tool for both government and private prosecutors. The statute provides that the plaintiff only need prove that the improper acts were done with "reckless disregard" or "deliberate indifference" of the truth. This low threshold of culpability makes it irrelevant whether a company intended to commit a customs fraud, unlike in criminal cases where that intent must be proved.

Companies also are not insulated from liability if they caused an innocent third party to finalize the fraud. If misrepresentations or false customs records are passed through many others, liability still will attach as if that conduct was done directly.

Congress supported broad and nonrestrictive applications of the False Claims Act when the law was amended in 1986. It explicitly endorsed the Supreme Court's refusal in United States v. Neifert-White Co., 390 U.S. 228, 232 (1968), "to accept a rigid, restrictive reading [of the statute]." As the Court held in Neifert-White, "[the Act] was intended to reach all types of fraud, without qualification, that might result in financial loss to the Government."

Scope in customs fraud
Congress intended that the False Claims Act be applied sweepingly. But customs fines or duties that are not noncontingent, fixed obligations may not always be the basis of legal liability. For example, mandatory 10 percent ad valorem mismarking duties assessed under 19 U.S.C. §1304(f) may fall outside the law's scope. This was the Southern District of Ohio's conclusion in United States ex rel. ATMI v. The Limited, 1997 LEXIS 18142 (S.D. Ohio Nov. 13 1997). The court acknowledged that it was a "close question" since the 10 percent mismarking duty was fixed. It nevertheless concluded that the obligation was contingent, since there is no obligation to pay the additional ad valorem duty if the goods are exported, destroyed or properly marked. The district court's decision is on appeal, and reliance on contrary related precedent may be the basis for reversal.

The Ohio court, however, distinguished the ATMI case from cases in which companies might misrepresent the country of origin to avoid a higher duty. In this instance, liability was proper since, the court said, "there is clearly an existing obligation to pay the correct duty and, if not paid, the government has been deprived of duties to which it is entitled." Thus, if the transshipment of quota-restricted items of apparel results in the underpayment of existing, noncontingent duties, False Claims Act liability is appropriate.

Jurisdictional questions resolved
Defendants in early False Claims Act cases involving customs frauds argued for dismissal on grounds that the lawsuits could not be brought in district court and were within the Court of International Trade's exclusive jurisdiction. Title 28 U.S.C. Section 1582 provides that the Court of International Trade "shall have exclusive jurisdiction of any civil action which arises out of an import transaction and which is commenced by the United States." If another court has not been granted exclusive jurisdiction, 28 U.S.C. Section 1331 gives district courts "original jurisdiction of all civil actions arising under the Constitution, laws, or treaties of the United States."

Defendant companies contended that whistleblower suits are "commenced by the United States" because they are brought on behalf of the government, and are thus within the CIT's exclusive jurisdiction. Courts on all levels - including the CIT, Federal Circuit Court and Federal District Court - have rejected the notion that a False Claims Act custom fraud lawsuit may not be litigated in federal district court. (United States ex rel Felton v. Allflex USA, Inc., 989 F. Supp. 259 (Ct. Int'l Trade 1997); United States ex rel Felton v. Allflex USA, Inc., 155 F.3d 570 (Fed. Cir. 1998); United States ex rel Vallejo v. Investronica, Inc., 2 F. Supp.2d 330 (W.D.N.Y. 1998).

The courts agree that the "mere fact that the United States is the real party in interest does not necessarily lead to the conclusion that the action was 'commenced by the United States' for purposes of 28 U.S.C. §1582." It is the private party who commences a False Claims Act action for himself and on the government's behalf. As the CIT observed, the government was simply a party "who may join and assume responsibility for the suit at a later time."

With the jurisdictional questions answered, a significant issue for the False Claims Act's application to customs fraud has been surmounted.

Not preempted by customs laws
Federal courts have likewise consistently rejected arguments that the False Claims Act is preempted by other statutes and/or regulations. Thus, defendants in customs fraud cases would likely be unsuccessful in arguing that the customs laws provide exclusive redress for customs frauds. (See e.g., United States v. Double Day Office Services, 121 F.3d 531 (9th Cir. 1997) (False Claims Act action not barred by the Service Contract Act); United States v. General Dynamics Corp., 19 F.3d 770 (2d Cir. 1994) (False Claims Act not preempted even where allegations constitute violations of the Anti Kickback Act); United States v. Rule Industries, Inc., 878 F.2d 535 (1st Cir. 1989) (False Claims Act not preempted by the Buy America Act).

It is similarly well-established that wrongful conduct may violate multiple statutes, and that legal action may be pursued under any - or all - of the statutory options available. In all the cases cited above, the courts concluded that False Claims Act enforcement was appropriate even though other statutory alternatives were available.

This substantial precedent, along with the legislative history's insistence that the False Claims Act be applied against all frauds that damage the Treasury, make is extremely unlikely that customs laws will be applied to preempt the False Claims Act.

New enforcement tool
As the False Claims Act becomes better known, more companies are seeing it as an alternative means to redress competitors' unfair business practices. Anger over the flood of cheap Japanese, Russian and Korean steel, coupled with a perception of government inaction, could well lead a domestic company to file suit if, for example, it has information that the government lost antidumping or other duties because of the misdesignation or misclassification of steel imports.

U.S. companies that have information about competitors' improper import practices may decide to file a False Claims Act lawsuit rather than complain to the Commerce and Treasury departments. In the case of anti-dumping duties in particular, many will find that a whistleblower lawsuit is an appealing alternative to the petition process.

The False Claims Act also has a deterrent effect. An economic analysis of the law found the deterrence value to the U. S. Treasury of the qui tam provisions to be well in excess of $100 billion since the 1986 amendments were adopted. Media reports bolster that analysis. Health care executives recently were quoted in the media as saying the federal investigation of Columbia/HCA Healthcare Corp. - touched off by two qui tam cases - has encouraged greater compliance with Medicare billing regulations.

As this powerful anti-fraud remedy is more fully utilized in the trade area, it can be expected to have a similar impact on customs fraud enforcement. The False Claims Act's financial incentives and action-forcing mechanisms combine to create substantial risks for those who evade their U.S. customs obligations.

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