A Powerful Tool To Effectively Fight Fraud

Katz, Marshall & Banks senior associate Alexis Ronickher and partner Debra Katz published an article in Law360 on September 17, 2013, entitled "A Powerful Tool To Effectively Fight Fraud."  The article discussed one of the central issues in combatting financial fraud: creating real penalties that will actually work to disincentivize wrongdoing.

Read the article below, or click here to view the article in PDF format.

Law360, New York (September 17, 2013, 7:27 PM ET) -- In 2011, DHB Industries settled with the U.S. government for a paltry $1 million for knowingly manufacturing and selling defective bulletproof vests to U.S. military and law enforcement. On Aug. 15, 2013, David H. Brooks, the company’s former CEO was sentenced to 17 years in prison and ordered to pay $8.7 million in fines and to forfeit approximately $65 million in illegally gained profits to the United States.

Brooks faces jail time and massive fines, although not for defrauding the U.S. government and jeopardizing the lives of U.S. soldiers and law enforcement but for engaging in other crimes including insider trading, securities violations and tax fraud.

Despite his stiff prison sentence and fines, Brooks’ conviction serves not as a warning to other top executives to quash fraud at their companies but as a reminder that the lion’s share of corporate executives never face personal repercussions for their role in defrauding the U.S. government.

Although the Obama administration’s recently stepped-up anti-fraud efforts have resulted in companies being forced to pay hundreds of millions of dollars back to the United States, companies continue to openly and aggressively engage in practices that constitute fraud. The reason why is clear: The financial and criminal penalties are not high enough to counteract the immense amount of money made by engaging in fraud.

A recent client, who was unlawfully terminated by a major pharmaceutical company for reporting fraudulent off-label marketing practices, told a story that illustrates why civil penalties alone will not solve the problem.

Despite having paid hundreds of millions of dollars for engaging in unlawful off-label marketing and being subject to a five-year corporate integrity agreement that created further monetary penalties of future violations, his employer continued to have a culture of aggressive unlawful off-label marketing.

The joke around the water cooler was if you could get $100,000 from robbing a bank, and the only penalty for being caught was paying back $2,000, who wouldn’t rob the bank?

Even with higher penalties, fraud against the government will not stop until the people in charge have a personal incentive to tamp down on those practices. Currently, incentives for executives foster these fraudulent practices.

Executives face sales and profit goals that are unattainable if their company does not engage in fraud, especially in industries like the pharmaceutical industry where exponential growth is considered the norm. Few executives are willing to crack down on fraud when the most foreseeable effect is losing their lucrative bonus for meeting sales and growth goals or even possibly facing termination, like my client.

These executives also do not face a financial penalty for not stopping the fraudulent practices. It is standard practice for companies to indemnify their executives, meaning that the burden of any penalties, and even the legal fees from fighting them, falls on the company.

Some tools exist to curb this abuse, however. One powerful tool that the U.S. Department of Justice has started to use to achieve this goal is the responsible corporate officer (RCO) doctrine, although it is only available for violations of the federal Food, Drug and Cosmetics Act and certain federal environmental statutes. Under this doctrine, a corporate executive is held criminally accountable for failing to exercise his or her authority and supervisory responsibility to prevent the fraud.

This tool is so powerful because it means top executives, who otherwise have little incentive to disrupt the culture of fraud in their companies, finally have real skin in the game. Critically, the executive personally is held criminally liable, not just the company. There is also no requirement that the executive personally engage in the fraud; rather, the executive is criminally penalized for abdicating his or her responsibility to prevent the fraud.

While the executives only face a misdemeanor that carries a relatively modest fine, or at most, short jail time, the violation goes on their criminal record, meaning they cannot avoid taking personal responsibility.

Perhaps more importantly, the U.S. government can bar a convicted executive from participating in federal programs based on this violation. An executive faced with the prospect of a criminal conviction and being barred from working in his or her field for at least three years is likely to rethink not taking the necessary actions to stop fraud at his or her company.

The Justice Department’s use of the RCO doctrine is a promising start, but infrequent prosecutions are insufficient. The Justice Department can send this message by aggressively prosecuting pharmaceutical executives who turn a blind eye to rampant fraud, coupled with the U.S. Department of Health and Human Services barring all executive convicted under this doctrine for at least the three-year baseline.

Additionally, Congress should expand the availability of the RCO doctrine to all areas of fraud against the government, so that executives who defraud the U.S. government are not able to escape unscathed.

Expanding the availability of the RCO doctrine to all violations of the False Claims Act would provide law enforcement with further ammunition to combat fraud against the federal government outside the pharmaceutical industry.

--By Alexis Ronickher and Debra S. Katz, Katz Marshall & Banks LLP

Alexis Ronickher is a senior associate and Debra Katz is a partner with the whistleblower and employment law firm of Katz Marshall & Banks in Washington, D.C. They specialize in the representation of whistleblowers before the U.S. Securities and Exchange Commission and Internal Revenue Service, in qui tam actions under the False Claims Act and in retaliation lawsuits arising under the Sarbanes-Oxley Act and other federal and state laws.

The opinions expressed are those of the author(s) and do not necessarily reflect the views of the firm, its clients, or Portfolio Media Inc., or any of its or their respective affiliates. This article is for general information purposes and is not intended to be and should not be taken as legal advice.