The 1863 Law That's Haunting Business

To eye surgeon Paul Michelson, the evidence looked conclusive. Puzzled by what he believed to be unnecessary surgery done by a colleague at the Scripps Clinic & Research Foundation in La Jolla, Calif., Michelson started digging. He concluded the doctor billed medicare for a more costly glaucoma treatment than he had performed: Each time, the feds paid $1,000 for a service that costs under $400.

When Michelson's efforts to resolve the matter internally failed, he sued Scripps and the doctor under the False Claims Act. The 1863 law, stemming from Lincoln's efforts to stop Civil War profiteers, is aimed at fighting government-contract fraud. Although they didn't admit or deny wrongdoing, Michelson's colleague and employer settled the charges for $600,000 to $700,000. "In an ideal world, we wouldn't need anything like it," Michelson says of the law.

But the world of government contracting is not ideal. And the False Claims Act, bolstered by 1986 changes, offers tempting incentives to private citizens to dig up the dirt: The act now offers triple damages and 10% to 30% of the award as a bounty for winning plaintiffs. "Making every citizen a private prosecutor gives some muscle to the government," says Senator Charles E. Grassley (R-Iowa), who led the drive to beef up the law. But critics add it spurs frivolous suits by individuals with axes to grind.

Use of the law is spreading fast. Once focused on defense-contractor fraud, suits now also allege such things as falsification of medicare bills and environmental permits. GE, Northrop, and Prudential Insurance, among others, have fought suits. Some liken the law to the Racketeer-Influenced & Corrupt Organizations Act (RICO), the elastic antiracketeering law that has terrorized Wall Street. "It's sort of like the sword of Damocles" hanging over a company, says a big defense-contractor lawyer.

Not one case has yet gone to trial. But settlements since 1986 of so-called qui tam suits (from the Latin for: He who sues for the state and himself) have hit $70 million, with plaintiffs raking in $9 million. Among the larger payouts: $5.6 million paid by Miami's Cordis Corp. to settle charges it sold defective pacemakers to medicare patients, and $14.3 million paid by Industrial Tectonics Inc. of Dexter, Mich., to settle claims it sold the military faulty ball bearings. Cordis declined comment and Tectonics couldn't be reached. The penalties are making business take more notice of gripes. "Every case represents a management failure," in that the company didn't give enough credence to a worker's complaint, says Richard Sauber, a former Pentagon procurement-fraud chief who represents defense contractors.

BIG CASES. The bulging dollar signs also have lured high-powered law firms such as Washington's Patton, Boggs & Blow and New York's Paul, Weiss, Rifkind, Wharton & Garrison to the whistle-blowers' side, along with small firms like Los Angeles' Hall & Phillips, a pioneer in the law's use. Another ally is the Justice Dept. False Claims suits are sealed when they're filed, to let the agency review charges and decide whether to join them. While some lawmakers criticize Justice's lack of support, the agency has joined about a quarter of the 275 suits filed since 1986. "Cases have come in that we wouldn't have found out about," says Stuart M. Gerson, head of Justice's Civil Div. "Some of them are big."

In one, a former technical director for Litton Systems Inc. claims it bilked the Pentagon out of nearly $100 million by billing it for computer services given to private customers. A trial for Litton, which denies the charges, is set for next fall in California. Health & Human Services Dept. officials tell BUSINESS WEEK they are studying suits against health insurers, charging they billed medicare for claims they should have paid. HHS, which will soon advise Justice whether to join the cases, says such fraud costs taxpayers up to $1 billion a year.

Business isn't taking all this lying down. A coalition led by the defense industry has repeatedly challenged the constitutionality of the whistle-blower provisions, arguing that only the feds can bring enforcement cases. So far, the argument has lost in the lower courts, but lawyers on both sides expect it to reach the Supreme Court. Unless the high court decides otherwise, though, the False Claims Act could be to the 1990s what private securities cases were to the 1970s and RICO was to the 1980s.

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