An important threshold question in qui tam cases under the False Claims Act is whether the relator-whistleblower is the original source of the information forming the basis for the claim. This is because qui tam actions under the False Claims Act are subject to a public disclosure bar, which provides that a court shall dismiss an action or claim if substantially the same allegations or transactions as alleged in the action or claim were publicly disclosed. Similarly stated, under the Act, an original source is one who has knowledge that is independent of and materially adds to the publicly disclosed allegations or transactions.
In a recently decided case, the Second Circuit Court of Appeals affirmed a District Court order dismissing a complaint that had been filed by CKD Project (“CKD”) as a whistleblower against Fresenius Medical Care Holdings and certain related companies (“Fresenius”) alleging that Fresenius purchased dialysis centers or interests in dialysis centers from physician-owners in violation of the federal Anti-Kickback Statute by paying in excess of fair market value for those centers — the overpayments allegedly serving to induce the physicians to refer patients to the newly acquired centers.
The case was dismissed pursuant to the public disclosure bar and it provides an excellent example of how that bar is analyzed and applied generally and, in particular, where the defendant has made disclosures in regulatory filings and the relator-whistleblower asserts it is supplementing those disclosures in material ways.
An illustration of the type of transaction that CKD alleged had occurred and violated the Anti-Kickback Statute was one in which Fresenius acquired a 75% interest in a dialysis facility and the original owners retained a 25% interest. According to CKD, the transaction agreements showed that nearly 90% of the purchase price was allocated to intangible assets, primarily consisting of goodwill, and that the price could be explained only by considering the revenue-generating value of the captive patient relationships. CKD stated that the transaction included non-compete agreements signed by physician-owners and seller representations and warranties regarding the target facilities. These contractual provisions allegedly served to “lock in the benefits” of existing patient relationships.
The Second Circuit’s Analysis
Following the filing by CKD of its lawsuit, Fresenius filed a motion to dismiss based on the public disclosure bar. The District Court granted the motion and CKD appealed. The Second Circuit affirmed the dismissal concluding that the public disclosure bar did apply.
In reaching its conclusion, the court explained that for the disclosure bar to apply, the public disclosures must have “exposed all the essential elements of the alleged fraud,” but that “it is not necessary that the alleged fraud, itself, have been disclosed as long as the material elements have been disclosed.” The court went on to state that in assessing whether the critical or material elements have been disclosed, a court may consider whether the disclosed transaction creates an inference of impropriety or whether the disclosure was sufficient to set the government squarely upon the trail of the alleged fraud.
As for the relator, the court explained that it must show that it had independent knowledge that materially adds to the public disclosures and that to have knowledge that materially adds to a public disclosure, a relator must “substantially or considerably add to information that is already public.” Providing detail or color to previously disclosed elements of an alleged scheme is not a material addition.
In moving to dismiss based on the public disclosure bar, Fresenius asserted that the material elements of the transactions at issue had been disclosed (as more fully described below) in regulatory filings with the SEC. CKD, on the other hand, argued that the regulatory filings did not disclose: (1) the use of certain shell entities in a complex transaction structure; (2) the use of contractual provisions such as non-compete agreements with physicians; (3) the use of contractual provisions such as seller representations and warranties about the state of the dialysis centers in transaction agreements; and (4) the alleged fact that Fresenius disguised overpayment by allocating most of the purchase price to intangible assets such as “goodwill.”
Applying the legal test described above, the court agreed with Fresenius and rejected CKD’s argument that the public disclosure bar should not apply because it was the original source of important information that was not disclosed in those filings. In dismissing CKD’s assertions, the court concluded that the critical or material elements of Fresenius’s joint venture acquisitions were publicly disclosed in its SEC filings and that CKD had merely supplied additional details. The court noted that the SEC filings disclosed:
- the New York regulatory regime that required complex joint venture transaction structures in which certain assets were transferred only after specific entities received the necessary state approvals;
- non-compete agreements with physicians when Fresenius acquired existing clinics;
- that when acquiring clinics, Fresenius entered into transaction agreements that customarily contained representations and warranties regarding the target clinics from the sellers; and
- that the growth of the business through acquisitions has created a significant amount of intangible assets, including goodwill, and a portion of the purchase price in such acquisitions was allocated to intangible assets.
Also, in those SEC filings, Fresenius disclosed the fact that a number of the dialysis centers and vascular access centers it operates are owned or managed by joint ventures in which it holds a controlling interest and one or more hospitals, physicians or physician practice groups hold a minority interest; that while it had “structured [its] joint ventures to comply with many of the criteria for safe harbor protection under the … Anti-Kickback Statute, [its] investments in these joint venture arrangements do not satisfy all elements of such safe harbor;” and that if these “joint ventures were found to be in violation of the Anti-Kickback Statute or the Stark Law, [Fresenius] could be required to restructure or terminate them [and face other penalties which] could have a material adverse effect on [Fresenius’s] business, financial condition and results of operations.”
In affirming the dismissal of CKD’s complaint, the court ultimately concluded that CKD had not shown that it had independent knowledge that materially adds to the public disclosures.
“CKD Project alleges that it acquired some of its information from an insider to one of the transactions [and] argues that this knowledge, including the details of the transaction, is independent of the public disclosures … For the reasons stated above, even if these details were independent of Fresenius’s public disclosures, the details do not ‘materially add’ to the publicly disclosed information.”
The public disclosure bar and the requirement that the relator be an original source has been and will continue to be a critically important threshold issue in qui tam cases and will often form the basis for a defendant to assert that the case against it should be dismissed at the start of the litigation.
The Fresenius case provides very useful guidance for parties in assessing when and whether regulatory filings made by a defendant in a qui tam case contain sufficient information concerning the transactions involved in the case:
- so as to constitute public disclosures that have exposed all the essential elements of the alleged fraud,
- recognizing that it is not necessary that the alleged fraud itself have been disclosed as long as the material elements have been disclosed, and
- that in assessing whether the material elements have been disclosed a court may consider whether the disclosed transaction creates an inference of impropriety or whether the disclosure was sufficient to set the government squarely upon the trail of the alleged fraud.
Of equal importance, the case provides guidance with respect to the question whether, notwithstanding the regulatory disclosures, a qui tam relator has provided independent knowledge that materially adds to the public disclosures.