United States District Court, Southern District of New York
August 19, 2003
UNITED STATES EX REL. MICHAEL R. LISSACK, PLAINTIFF,
SAKURA GLOBAL CAPITAL MARKETS, INC. AND MITSUI TAIYO KOBE GLOBAL CAPITAL, INC., DEFENDANTS
The opinion of the court was delivered by: Barbara Jones, District Judge
OPINION AND ORDER
Michael R. Lissack (the "Relator") brings this action to recover damages and civil penalties on behalf of the United States of America arising from allegedly false and fraudulent statements and claims made or caused to be made by Defendants, SMBC Capital Markets, Inc., successor by merger to Defendant Sakura Global Capital Markets, Inc. (formerly doing business as Mitsui Taiyo Kobe Global Capital, Inc.) (collectively "SGC"), in violation of the False Claims Act, 31 U.S.C. § 3729 et seq., as amended. The Relator's claims involve allegations of fraud in connection with certain municipal bond transactions. Relator originally filed a complaint against multiple defendants in the predecessor to this action in February `of 1995, but that initial complaint did not name Defendants SGC. The Government elected to intervene in these actions, and the parties subsequently entered [ Page 2]
into various settlement agreements resulting in the Government's recovery of over $200 million. Both the U.S. Attorney's Office and the Internal Revenue Service ("IRS") are parties to these agreements.
In May of 1996, Relator alleged for the first time that Defendants' conduct in its provision of ten forward supply agreements violated the False Claims Act. (See First Am. Compl., App. 2). On October 30, 2000, the Government declined to intervene in the Relator's action against SGC. (See Court Docket No. 82). Later, in March of 2001, Relator filed a Second Amended Complaint ("Compl.") against Defendants and listed five additional transactions in which Defendants allegedly engaged in fraud with respect to their provision of forward supply agreements.
Defendants seek the dismissal of Relator's Second Amended Complaint pursuant to Fed.R.Civ.P. 12(b)(1) for lack of subject matter jurisdiction. Alternatively, Defendants claim that the action should be dismissed for failure to state a claim upon which relief can be granted pursuant to Fed.R.Civ.P. 12(b)(6) and for failure to plead fraud with particularity pursuant to Fed.R.Civ.P. 9(b). [ Page 3]
I. The Transaction
Under § 103 of the Internal Revenue Code ("IRC"), interest on state and local bonds is excluded from taxable income, unless the bonds are private activity bonds, arbitrage bonds, or bonds not in registered form. 26 U.S.C. § 103. The alleged frauds at issue in this case stem from transactions in which municipalities refinanced outstanding, higher rate, tax exempt bond issues in advance of their first call dates with lower interest rate bonds. The bonds in such a refinancing are called "advance refunding bonds." To preserve the tax-exempt status of these bonds, municipalities must follow a set of rules established by the IRC and Treasury Regulations promulgated thereunder.
Under Treasury Regulations, a municipality must place all the proceeds from the sale of advance refunding bonds in an irrevocable "defeasance escrow" ("escrow"). 26 C.F.R. § 1.141-12(d)(1). This escrow is:
established to redeem bonds on their
earliest call date in an amount that,
together with investment earnings, is
sufficient to pay all the principal of,
and interest and call premium on, bonds
from the date the escrow is established
to the earliest call date.
26 C.F.R. § 1.141-12(d)(5). In other words, both interest and principal on the initially issued bonds are paid from the escrow account. To generate cash flow to pay this interest and principal through the call date, municipalities typically invest advance refunding escrows in Government securities for the entire [ Page 4]
defeasance period, selected on the basis of correspondence, at maturity, to the cash flow needed for debt service and, correspondence in maturity date, i.e.. Government securities are chosen that are scheduled to mature on a date as close as possible to the date debt service must be made. (Compl. ¶ 15). See generally 26 C.F.R. § 1.148-5. Under § 148(b) of the IRC, these escrow investments cannot yield more than the yield earned by the bondholders.*fn1 If the yield on the escrow exceeds the yield of the bonds, the bonds are considered arbitrage bonds and lose their tax-exempt status.*fn2 26 U.S.C. § 103, 148.
A component of the overall yield calculation is the yield that municipalities collect on forward supply agreements. In a typical forward supply agreement, the issuer, the provider and the escrow trustee execute an agreement that transfers to the provider the opportunity to earn the interest that the issuer would otherwise earn on the short-term investment opportunities arising in the escrow account. In exchange for this opportunity, the provider compensates the issuers, often in the form of a payment made at the time of the transaction's closing. (Compl. ¶ [ Page 5]
19). A municipality enters into a forward supply agreement with a provider, such as SGC, when there is a gap, or a "float period" between the time at which the Government securities mature and the time at which funds are needed to pay debt service. Forward supply agreements are generally entered into at the same time the escrow is established because the municipality knows in advance when the float periods will occur.
The purchase price received by the municipal issuer for a forward supply agreement is directly related to its yield. The more an issuer is paid for the forward supply agreement, the more its yield will increase. A municipality must be sure that its combined yield from the forward supply agreement and its yield from the escrow in general does not exceed the yield on the advance refunding bonds or those bonds will lose their tax exempt status. Since the tax exempt status of the bonds is inextricably related to the purchase price of the forward supply agreement, the Treasury Regulations establish a bidding process to secure a fair market value for the agreement. 26 C.F.R. § 1.148-5(d) ("The purchase price of a guaranteed investment contract and the purchase price of an investment purchased for a yield restricted defeasance escrow will be treated as the fair market value of the investment on the purchase date if [certain bidding conditions] . . . are satisfied").
If a municipality determines that the combined yield of the forward supply agreement and escrow account will exceed the yield [ Page 6]
of the bonds, it can avoid arbitrage and retain its tax-exempt status by investing in United States Treasury State and Local Government Series ("SLGS"), which are zero interest Treasury securities available only to local and state borrowers. (Compl. ¶¶ 27, 29). In order to retain tax-exempt status, municipal bond issuers "must, in good faith, certify the issuer's expectations as of the issue date" that the yield restrictions have been met. Additionally, the issuer must state the facts and estimates used to make this certification. Treas. Reg. § 1.148-2(b)(2)(i).
II. The Allegedly Fraudulent Forward Supply Agreement
Relator claims that SGC caused several municipalities to violate the yield restrictions by providing forward supply agreements to municipalities that were fraudulently priced.*fn3 The [ Page 7]
Relator alleges that SGC engaged in a sham bid process in contravention of Treasury Regulation § 1.148-5, in which SGC obtained non-bona fide bids to assure that SGC would be the "winning" bidder. The Relator asserts that "the non-bona fide bids were below fair market value, as were [SGC's] `high' bids." (Compl. ¶ 45). According to the Complaint, SGC:
corrupted, and conspired to corrupt, the
bid selection process by, inter
alia, selecting non-competitive bidders
to participate in the bid process;
communicating "not to exceed" bid
amounts to "losing" bidders; selecting
fewer than three disinterested bidders to
participate in the bid process; providing
false or misleading information in order
to cause legitimate bidders to submit
artificially low bids; diverting portions
of anticipated profits to pay off
co-conspirators that solicited
non-competitive bids or otherwise ensured
[SGC's] selection as forward supply
(Compl. ¶ 67) .*fn4
Relator further maintains that Defendants concealed the rigged bidding process that allowed SGC to provide an agreement [ Page 8]
below fair market value. Additionally, he contends that Defendants made false statements and misrepresentations in written documents to induce the issuers' and bond counsels to certify that the bonds "were priced consistent with federal law." (Compl. ¶ 52). Further, the Relator alleges that SGC paid undisclosed brokerage fees to co-conspirators that were responsible for the selection of SGC as the forward supply provider. The Relator asserts that, as a result of this fraud, Defendants caused the municipality to engage in bond arbitrage. He explains that because the forward supply agreement purchase price was fraudulently suppressed, the municipality reported an improperly low yield on its escrow. The result, the Relator contends, is that SGC "burned" excess yield earned by the escrows in violation of the IRC and that SGC's fraudulent profits equaled the dollar value of the yield it illegally burned.
If SGC had provided the fair market value, the combined yield would have exceeded the advance refunding bond yield.*fn5 Relator additionally alleges that to prevent losing their tax exempt status, the municipalities would have sought to keep their yield within the restrictions by investing in United States [ Page 9]
Treasury State and Local Government Series ("SLGS") securities, which are zero interest securities issued only to state and local borrowers. (Compl. ¶¶ 27, 29). Through the purchase of zero interest SLGS, the municipalities could ensure that "the federal Government (a) does not pay a higher overall yield on escrows than the municipality pays bondholders of the advance refunding bonds and (b) receives the positive arbitrage in open market escrows." (Compl. ¶ 30). The Relator claims that because the municipalities did not take this step, arbitrage occurred, and the Government was harmed in two related ways: the Government continued to pay the interest on the yield-bearing Treasury securities and it, correspondingly, lost the benefit of no cost borrowing "through which `positive arbitrage' — in the form of interest and principal paid on the escrow Treasury securities — is returned to the public [treasury]." (Compl. ¶¶ 31-32). The Relator claims that the U.S. Government is, thus, owed the arbitrage amount, as calculated either by the difference between the fair market value and the forward supply agreement purchase price or by the amount of interest that the Government should have saved through the issuance of SLGS.
III. Standard for Motion to Dismiss for Lack of Subject Matter Jurisdiction
On a motion to dismiss, the factual allegations of the complaint must be taken as true. Jaghory v. New York State Dep't [ Page 10]
of Educ., 131 F.3d 326, 329 (2d Cir. 1997). A court may not dismiss a complaint unless it appears beyond doubt that there are no set of facts the plaintiff can prove that would entitle him to relief. Still v. DeBuono, 101 F.3d 888, 891 (2d Cir. 1996). However, when a court considers a motion to dismiss pursuant to Fed.R.Civ.P. 12 (b)(1), it is appropriate to consider certain matters outside the pleadings, such as affidavits, documents and testimony. Phifer v. City of New York, 289 F.3d 49, 55 (2d Cir. 2002); Cargill Int'l S.A. v. M/T Pavel Dvbenko, 991 F.2d 1012, 1019 (2d Cir. 1993). Consequently, a court must "look to the substance of the allegations to determine jurisdiction." Cargill, 991 F.2d at 1019. The plaintiff bears the burden of proving that the court has jurisdiction. See Malik v. Meissner, 82 F.3d 560, 562 (2d Cir. 1996). Moreover, when considering whether subject matter jurisdiction exists, it is inappropriate to draw argumentative inferences in favor of the party asserting jurisdiction. Atlantic Mutual Ins. Co. v. Balfour MacLaine Int'l, 968 F.2d 196, 198 (2d Cir. 1992).
IV. The False Claims Act
"The False Claims Act, 31 U.S.C. § 3729 et seq., as amended in 1986, empowers the United States, or private citizens on behalf of the United States, to recover treble damages from those who knowingly make false claims for money or property upon the [ Page 11]
United States, or cause to be made, or who submit false information in support of such claims."*fn6 U.S. ex rel. Dick v. Long Island Lighting Co., 912 F.2d 13, 16 (2d Cir. 1990). The False Claims Act (the "FCA") is designed to ensure that the Federal Government recovers "losses sustained as a result of fraud," whether the fraud relates to Government payments or collections of debts owed. See S. Rep. No. 99-345, at 1 (1986) reprinted in 1986 U.S.C.C.A.N. at 5266. As the legislative history explains: [ Page 12]
The False Claims Act is intended to
reach all fraudulent attempts to cause
the Government to pay out sums of
money or to deliver property or services.
Accordingly, a false claim may take many
forms, the most common being a claim for
goods or services not provided, or provided
in violation of contract terms,
specification, statute, or regulation.
1986 U.S.C.C.A.N. at 9. The False Claims Act provides incentive to private citizens to bring suit on behalf of the Government for a fraud about which they had personal knowledge by rewarding them with a portion of the judgment should they recover on the Government's behalf. U.S. ex rel. Lamers v. City of Green Bay, 998 F. Supp. 971, 977 (E.D. Wis. 1998), aff'd, 168 F.3d 1013
(7th Cir. 1999).
In this case, a private citizen, the Relator, claims that Defendants caused municipalities to make false claims to the Federal Government in fifteen separate transactions with respect to the provision of forward supply agreements in connection with the "advance refunding" of certain federal tax-exempt bonds offered by state and local municipalities ("municipal entities").*fn7
In Count One of his Complaint, the Relator alleges that Defendants violated § 3729(a)(1) and (2) of the FCA, by knowingly making or causing to be made a false record or statement to be presented to the United States Government to induce the Government to pay false and fraudulent claims. In Count Two of the Complaint, the Relator alleges that Defendants violated § [ Page 13]
3729(a)(3) by conspiring with others to induce the Government to pay false and fraudulent claims. Count Three of the Complaint alleges that Defendants violated § 3729(a)(7) by knowingly making or causing to be made a false record or statement to conceal, avoid or decrease an obligation to pay money to the federal Government.
To support these claims, the Relator alleges that Defendants caused municipalities to make fraudulent statements and material omissions under the Internal Revenue Code and its accompanying Treasury Regulations. The Relator contends that SGC undervalued forward supply agreements and engaged in sham bidding processes, which caused two related harms to the Government. First, the Treasury was denied the benefit of significant zero-interest borrowing through the SLGS securities program. Second, the Treasury paid millions of dollars in excess interest and principal on escrows that included fraudulently priced FSAs.
B. The FCA Tax Bar
The FCA, however, does not allow private citizens to pursue all false claims made to the Government. At issue in this case is § 3729(e) of the FCA, which provides that "[the FCA] does not apply to claims, records, or statements made under the Internal Revenue Code of 1986." 31 U.S.C. § 3729(e).(the "FCA Tax Bar"). Defendants claim that based on this exclusion, the Court lacks subject matter jurisdiction to hear the Relator's claims as they [ Page 14]
are premised on Defendants' having caused the municipalities to violate the IRC and Treasury Regulations promulgated under the IRC. The Court agrees.
The FCA was amended to include the Tax Bar in 1986. In so doing, Congress codified existing case law that had held that the FCA did not support actions based on alleged violations of federal tax law. Prior to the amendment, courts consistently held that § 7401 of the IRC reserved sole enforcement over "the recovery of taxes, or any fine, penalty, or forfeiture" to the Secretary of the Treasury. 26 U.S.C. § 7401; see, e.g., United States ex rel. U.S. — Nambia Trade & Cultural Council, Inc. v. The Africa Fund, 588 F. Supp. 1350, 1351 (S.D.N.Y. 1984) (dismissing FCA action based on alleged false statement to obtain tax-exempt status); see also S. Rep. No. 99-345, at 18 (1986) (stating that "[t]he question of whether the False Claims Act covers situations where, by means of false financial statements or accounting reports, a person attempts to defeat or reduce the amount of a claim or potential claim by the United States against him, has been the subject of.differing judicial interpretations . . . [a]Ithough it is now apparent that the False Claims Act does not apply to income tax cases . . ."). Indeed, the FCA Tax Bar is designed to allow the Internal Revenue Service ("IRS") to enforce the IRC as it sees fit. See United States ex. rel Mikes v. Straus, 853 F. Supp. 115, 119 (S.D.N.Y. 1994) (holding that FCA did not permit subject matter jurisdiction over false tax claims [ Page 15]
and that such tax "matter [s] [should be] reported to the [IRS], to permit it to determine what inquiries, if any, may be called for under the circumstances.").
The Court is convinced that this case falls squarely within the language of the FCA Tax Bar. In his Complaint, the Relator relies exclusively on Defendants' violations of provisions of the IRC and the Treasury Regulations promulgated thereunder. At the heart of the allegedly fraudulent transactions in this case lies the municipalities' desire to protect their tax-exempt bond status, which is governed by §§ 103 and 148 of the IRC. If Defendants made or caused to be made statements to the Federal Government that jeopardized this status, such a determination would be made through application of these IRC sections to the facts of the case. Indeed, any finding of tax arbitrage would be based on the yield restrictions as set forth in § 148 of the IRC.*fn8
Specifically, the Court would rely on Treasury Regulation § 1.148-5(d)(6) in making a determination as to whether Defendants submitted a fraudulent bid in violation of the requirements for fair market value. The Court would also consider Treasury Regulation § 1.148-2 in determining whether Defendants caused a [ Page 16]
fraudulent certification to be made by the bond issuers to the federal Government with respect to the tax-exempt status. Finally, any false statements that might have been made with regard to the purchase of SLGS would be controlled by the yield restrictions promulgated under § 148 of the IRC. Thus, the relevant false claims in this case are "made under the [IRC]". 31 U.S.C. § 3729 (e).
If, as the Relator alleges, Defendants caused the municipality to commit arbitrage, the municipality would forfeit the tax-free status of its advance refunding bonds. Such a forfeiture would affect the income tax status of each bondholder. For example, in Harbor Bancorp & Subsidiaries v. Comm'r, 115 F.3d 722 (9th Cir. 1997), the Ninth Circuit affirmed the tax court's ruling that the IRS could hold each bondholder liable for taxes on the interest of formerly tax exempt bonds when the municipality had committed arbitrage. The Ninth Circuit held that the IRS was within its discretion to require such an income tax payment despite the fact that the municipality had not intentionally violated the yield restrictions. Harbor Bancorp, 115 F.3d at 732-33 (stating that "we believe the Commissioner and the Tax Court could properly interpret the Code as they have," further reasoning that "we are mindful that what is ultimately at stake is the exclusion of the interest on the bonds from [the bondholder's] gross income under § 103, which, like other exclusions, must be construed narrowly in favor of taxation.") [ Page 17]
(internal citations omitted); see also City of New Orleans v. Smith Barney, Inc., 98 Civ. 1767, 1999 U.S. Dist. LEXIS 6924, at *21-23 (E.D. La. May 7, 1999) (denying motion to dismiss declaratory judgment action seeking indemnification from defendant brokerage firms for any amount assessed by the IRS where defendants allegedly engaged in yield burning, and instead, staying proceedings pending determination by the IRS whether the bonds were in fact subject to tax); Internal Revenue Manual; Handbook 7.6.2. Exempt Organizations Examination Procedures, Ch. 5.6. (indicating that bondholders may be liable for failure to pay taxes on the interest from the bonds). Furthermore, although the financial reward may have come from yield burning, a necessary component of the scheme was the maintenance of the tax-exempt status of the bonds. While far more complex than most income tax schemes, at its heart, this alleged fraud was still focused on the wrongful preservation of a tax-free status.
As with all income tax recoveries, the Court must defer to the IRS's discretion as to how it should handle recovery of the taxes owed on the arbitrage bonds. See United States ex rel. U.S. — Nambia Trade & Cultural Council. Inc. v. The Africa Fund 588 F. Supp. 1350, 1351 (S.D.N.Y. 1984) ("If the Fund improperly obtained tax exempt status, the Government's recourse would be to revoke such status through administrative, action and then to proceed to make a tax liability assessment and to issue a Notice of Deficiency for taxes due.") (internal citations omitted). [ Page 18]
In fact, IRS discretion with regard to recovery appears imperative in a situation such as this. Certainly, the Government should not be able to recover taxes owed, the positive arbitrage, and the interest paid out on Treasury Securities. This would allow multiple recoveries for the same violation of the IRC.*fn9 The IRS, in its discretion, must consider which form of recovery is the most satisfactory option.
To the extent the Relator argues that the FCA only bars cases concerning income tax fraud, the Court disagrees. While as far as this Court is aware, the cases in which courts have found the Tax Bar to prohibit FCA claims have involved only income tax cases, these courts have never limited the Tax Bar to income tax cases. See, e.g., Almeida v. United Steelworkers of Am. Int'l Union, 50 F. Supp.2d 115, 126-27 (D.R.I. 1999); Hardin v. Dupont Scandinavia, 731 F. Supp. 1202, 1204 (S.D.N.Y. 1990). And, to do so would be a departure from the clear language of the statute. It refers only to "claims, records, or statements made under the [IRC]" and does not limit claims by the nature of the tax liability. 31 U.S.C. § 3729(e). Rather, the section focuses solely on whether or not a false claim is made "under the [IRC]". [ Page 19]
31 U.S.C. § 3729(e). In any event, as previously discussed, at bottom, this case does involve an income tax harm.
Further, the Court finds unpersuasive Relator's contention that two other courts have permitted actions to go forward in situations the Relator argues are similar to the instant one. In United States v. First Nat'l Bank of Cicero, 957 F.2d 1362 (7th Cir. 1992), the Relator alleged that false claims were made with respect to the Small Business Administration's guaranteed loan program. In that case, the defendant's loan application allegedly contained a variety of false statements, including a false tax return. First Nat'l Bank of Cicero, 957 F.2d at 1364. In United States v. Raymond & Whitcomb Co., 53 F. Supp.2d 436 (S.D.N.Y. 1999), the Relator alleged that the defendant travel agency misrepresented its eligibility under the Postal Service regulations to use non-profit mailing rates "causing the Postal Service to suffer a deficiency." . . . 53 F. Supp.2d at 439.*fn10 The Relator contends that the courts' holdings in both First Nat'l Bank of Cicero and Raymond & Whitcomb suggest that the FCA's Tax Bar does not apply, here because like there, false statements and records were used to effect a non-tax fraud on the [ Page 20]
federal Government. The Court disagrees. Those cases are easily distinguishable from the instant action in that the falsity of the statements in those cases neither depended on first establishing an IRC violation nor the procurement of a benefit under the IRC. In contrast, in this case, the falsity of the statements depends entirely on proving IRC violations. Additionally, the sole purpose of the allegedly false statements in this case was to gain the benefit of the IRC's tax-exempt bond provisions.*fn11
Finally, the Court is not convinced by the Relator's argument that the FCA Tax Bar is not applicable in this case because the IRS has no direct enforcement mechanism to recover the losses suffered by the Federal Treasury. The Relator concedes that SGC's alleged yield burning might create tax liability for the bondholders, but argues that the IRS does not have the ability to recover "actual damages" from SGC. (Opp. at p. 17). The mechanisms by which the Government may recover from SGC for its alleged profit at the Government's expense, however, are not proper considerations for the Court under the plain language of the FCA Tax Bar. It is not for this Court to establish new or additional ways for the Government to procure the equivalent money from Defendants as opposed to the [ Page 21]
bondholders. See, e.g., United States ex rel. Fallon v. Accudyne Corp., 880 F. Supp. 636, 639 (W.D. Wis. 1995) (stating that "[s]ince [income tax] fraud is directly addressed and remedied by the Internal Revenue Code it follows that Congress would not intend to duplicate those remedies with an FCA claim arising from the identical conduct . . . [and therefore] such claims are now expressly excluded from application of the FCA."). Moreover, the Defendants have appended news articles, which Relator does not dispute, demonstrating that, in fact, the Government has used securities and arbitrage laws to force parties that engaged in yield burning to settle with the IRS. (Joralemon Decl. Exs. 3, 4). Indeed, in this action, the IRS has been a party to twenty-seven settlement agreements entered into by other defendants alleged to have committed fraud in connection with the advance refunding of tax exempt municipal bonds. (See, e.g., Court Docket Nos. 33, 53, 63, 80).*fn12
In sum, the Court is convinced that the Relator's case is barred by the clear language of the FCA's Tax Bar. Because the Court lacks subject matter jurisdiction, this action is dismissed. [ Page 22]
V. The Public Disclosure Bar
As an alternative ground for dismissal, the Defendants contend that this Court lacks subject matter jurisdiction over certain of the Relator's claims because several of the allegations or transactions in the Relator's May 28, 1996 complaint have been publicly disclosed and the Relator does not qualify as an "original source" of that information pursuant to the FCA.*fn13 The Court agrees, and finds that the public disclosure of certain allegations or transactions in the Relator's Complaint is an independent, alternative basis for dismissal of the claims based on those allegations.
The FCA provides that "[n]o court shall have jurisdiction over an action under this section based upon the public disclosure of allegations or transactions in a criminal, civil, or administrative hearing, in a[n] . . . administrative . . . investigation, or from the news media, unless . . . the person bringing the action is an original source of the information." 31 U.S.C. § 3730 (e)(4)(A). An "original source" is defined as [ Page 23]
"an individual who has direct and independent knowledge of the information on which the allegations are based and has voluntarily provided the information to the Government before filing an action under this section which is based on the information." 31 U.S.C. § 3730 (e) (4)(B). The Second Circuit has stated that the public disclosure bar is intended to prevent "parasitic lawsuits" based on the public disclosure of information where relators "seek remuneration although they contributed nothing to the exposure of the fraud." United States ex rel. Kreindler & Kreindler v. United Technologies Corp., 985 F.2d 1148, 1157 (2d Cir. 1993) (citing United States ex rel. John Doe v. John Doe Corp., 960 F.2d 318, 319 (2d Cir. 1992).
Courts, however, are not in agreement with respect to precisely what is barred by the public disclosure bar. The D.C. Circuit has described the public disclosure bar as follows:
these jurisdictional provisions . . . have
led to extensive litigation and to
circuit splits concerning the meaning of
the words "based upon," "public
disclosure," "allegations or transactions,"
"original source," "direct and independent
knowledge" and "information." Virtually
every court of appeals that has considered
the public disclosure bar explicitly or
implicitly agrees on one thing, however:
the language of the statute is not so
plain as to clearly describe which cases
Congress intended to bar.
United States ex rel. Findley v. FPC-Boron Employees' Club, 105 F.3d 675, 681 (D.C. Cir. 1997).
Courts generally apply a two-part test to determine whether the public disclosure bar operates to divest it of subject matter [ Page 24]
jurisdiction. First, the court must determine whether the allegations or transactions in the qui tam complaint were publicly disclosed in one of the ways enumerated in the statute, that is, in a "criminal, civil, or administrative hearing, in a congressional, administrative, or Government Accounting Office report, hearing, audit or investigation, or from the news media." 31 U.S.C. § 3730(e)(4)(A); see United States ex rel. Doe, 960 F.2d at 323. If the allegations or transactions were "publicly disclosed," a court must next determine whether the relator qualifies as an "original source" of the information under the definition in the statute. Thus, a court must proceed to the second step only if the answer to the first question is affirmative. See United States ex rel. Mikes v. Straus, 931 F. Supp. 248, 253 (S.D.N.Y. 1996). Accordingly, this Court first considers whether the "allegations or transactions" were "publicly disclosed" prior to the filing of the qui tam complaint in which SGC is named as a defendant.
Prior to the filing of the Relator's First Amended Complaint on May 28, 1996, significant. information about the 1992 Oklahoma Turnpike Authority ("OTA") transaction and the Sisters of St. Mary's ("SSM") transactions had been "publicly disclosed" within the meaning of the statute.*fn14 The following information was [ Page 25]
disclosed in the news or publicly filed legal complaints prior to May 28, 1996: (1) that the SEC was investigating the $608 million refinancing of OTA bonds in 1992, and specifically that the allegations of wrongdoing centered around the underwriters on several cash management programs involving excess arbitrage profits*fn15; (2) that SGC, through its employee Steven Strauss, conspired with others, including Stifel, Nicolaus, & Co. ("Stifel"), who provided investment banking services to OTA in connection with the refinancing of OTA bonds, to rig the bidding process to ensure that SGC was the successful bidder in the OTA forward purchase agreement*fn16; (3) that SGC agreed to pay Stifel a fee if SGC was awarded the forward purchase agreement with respect to the OTA transaction*fn17; (4) that Stifel, SGC and Pacific Matrix, a broker of financial products, entered into and executed a scheme to control and compromise the bidding process, and "to insure that [SGC] would be the successful bidder and that [ Page 26]
Stifel would receive the secret payment"*fn18; (5) that Robert Cochran, the Executive Vice President of Stifel in Oklahoma City who supervised the Oklahoma City Municipal Bond Underwriting Department, "instructed Pacific Matrix, not to contact any major providers of forward supply contracts, effectively eliminating any legitimate competitive bids"*fn19; (6) that Cochran arranged for Stifel to receive the secret payment "in exchange for the acquisition of the bid through manipulation on the bid process"*fn20; (7) that Stifel, and in particular various Stifel employees in fact did receive an undisclosed payment of $6.5 million off the "forward purchase contract" awarded to SGC*fn21; (8) that SGC "demonstrated that it was willing to pay immediately in excess of $18.8 million for [the] Forward Purchase Agreement, [which] should have been paid in full to or for [the] benefit of OTA as [the] true price of [the] Forward Purchase Agreement"*fn22; (9) that the SEC was investigating political contributions and fees paid to underwriters, and specifically that the SEC was [ Page 27]
"seeking documents involving Sisters of St. Mary Health Care [bond offering]," and that "new subpoenas specifically ask for details about forward purchase contracts"*fn23; (10) and that with respect to the SSM transaction, the objective of the "scheme to defraud [was] to solicit a $100,000 secret payment from [SGC] to Stifel in exchange for acquisition of bid through manipulation of bidding process [for SSM forward purchase agreement]."*fn24
Comparing the above public information to the Relator's Complaint, it is clear that most of the "allegations or transactions" that were publicly disclosed are the same as the allegations in the Relator's Complaint with respect to the OTA transaction. In his Complaint, the Relator alleges that SGC "undervalued the forward supply agreements purchased in connection with advance refunding bonds in order to earn illegal positive arbitrage profits" with respect to, among others, the OTA transaction. (Compl. ¶ 40). Further, the Relator alleges that SGC engaged in noncompetitive bidding to ensure it would be awarded the forward supply agreement in connection with the OTA $608 advance refunding transaction in 1992. (Compl. ¶ 70). The Complaint also states that SGC made undisclosed payments to entities that administered selection of the forward supply [ Page 28]
provider in order that it be selected as the forward supply provider in the OTA transaction. (Compl. ¶¶ 66, 75). The Relator additionally contends that SGC "deceived issuers and caused them to believe that [SGC's] forward supply agreements were priced at fair market value". (Compl. ¶ 44).
Likewise, the allegations in the Relator's Complaint are the same as the allegations that were publicly disclosed with respect to the SSM transaction. Specifically, the Relator's Complaint alleges that SGC "conspired to circumvent bona fide bid procedures in connection with a refunding transaction by [SSM]". (Compl. ¶ 80). Additionally, with respect to the 1992 SSM transaction, the Relator contends that SGC "conspired to obtain bids from noncompetitive bidders to ensure that [SGC] would be selected as the forward supply provider" and "conspired to make  improper payments to entities that administered selection of forward supply provider. (Compl. ¶¶ 82, 66).
The Relator contends that although "information" regarding the allegations in his Complaint were public, his claims regarding the OTA and SSM transactions are not barred because the "information" did not rise to the level of "allegations" of fraud. The Court does not agree.
As stated by the Third Circuit, claims are barred under the FCA if "either the allegations of fraud or the elements of the underlying transaction" are publicly disclosed. United States ex rel. Dunleavy v. County of Delaware. 123 F.3d 734, 740 (3d Cir. [ Page 29]
1997). The D.C. Circuit has established an algebraic equation to aid courts in evaluating whether publicly disclosed information rises to the level of "allegations or transactions" so as to bar the FCA claims:
[I]f X Y = Z, Z represents the
allegation of fraud and X and Y
represent its essential elements. In
order to disclose the fraudulent
transaction publicly, the
combination of X and Y must be
revealed, from which readers or listeners
may infer Z, i.e., the conclusion that
fraud has been committed. The
language employed by 3730(e)(4)(A)
suggests that Congress sought to
prohibit qui tam actions only
when either the allegation of fraud
or the critical elements of the fraudulent
transaction themselves were in the public
United States ex rel. Springfield Terminal Ry. Co. v. Ouinn, 14 F.3d 645, 654 (D.C. Cir. 1994). This equation has been used by numerous courts in different circuits, including courts in this circuit. See, e.g., United States ex rel. Cosens v. Yale-New Haven Hospital. 233 F. Supp.2d 319, 328 (D. Conn. 2002); United States ex rel. Woods v. Empire Blue Cross and Blue Shield, No. 99 Civ. 4968, 2002 U.S. Dist. LEXIS 15251, at *16 (S.D.N.Y. Aug. 19, 2002); see also, United States ex rel. Found. Aiding The Elderly v. Horizon West. Inc., 265 F.3d 1011
, 1015 (9th Cir. 2001), cert, denied, 535 U.S. 1096, 122 S.Ct. 2292, 152 L.Ed.2d 1050 (2002).
Using this analysis, it is clear that in this case, the information that was publicly disclosed included the allegations of fraud or fraudulent transactions regarding OTA and SSM at issue in the Relator's Complaint. The publicly disclosed [ Page 30]
information included that SGC engaged in a sham bidding process with respect to the OTA and SSM transactions in which it undervalued the forward supply agreement and paid a secret fee to ensure it would be awarded the forward supply agreement. This is precisely the wrongful behavior the Relator alleges SGC engaged in, and which he contends caused the issuers of the bonds to make the false claims at issue in this litigation.
The Relator's reliance on United States ex rel. Mikes v. Straus, 931 F. Supp. 248 (S.D.N.Y. 1996), where the court held that although "information" regarding the allegations and transactions was publicly disclosed, the information did not rise to the level of "allegations or transactions," is misplaced. In Mikes, the relator's allegation that the Government was harmed when the defendants caused Medicare claims to be submitted to the United States for payment on unnecessary MRI tests was held not to be barred by the public disclosure of an unrelated contractual dispute between private parties for failure to pay fees for MRI referrals. See Mikes, 931 F. Supp. at 254-55. In contrast, in this action, the publicly disclosed information is precisely the same fraud occurring in the same transaction that the Relator identifies in his Complaint.
Additionally, the Relator contends that the allegations that were publicly disclosed are distinct from the "allegations or transactions" in his Complaint because no suggestion was made in the publicly disclosed information that the Federal Treasury was [ Page 31]
harmed by the fraud in connection with the OTA and SSM forward supply agreements and because there was no suggestion that false claims for payment were submitted to the Government in connection with the OTA and SSM forward supply agreements. The Court disagrees. The mere fact that the Relator alleges a different theory regarding how the Government is harmed by the fraud that has been publicly disclosed does not mean that the "allegations or transactions" were not disclosed. See United States ex rel. Whiddon v. Mylan Labs, Inc., Civ No. 99-2457, slip op. at 5-6 (D.D.C. Jan. 16, 2001) (holding that news articles that reported that the FTC was investigating a drug manufacturer and which reported that the drug manufacturer may have "cornered the market" on drugs through exclusive agreements with raw materials suppliers, thus injuring Medicaid and other Government programs, barred a qui tam despite the relator's claim that he identified a different rationale for the drug manufacturer's behavior than that which was publicly reported). Consequently, the Court finds that "allegations or transactions" in the Relator's Complaint were publicly disclosed under § 3730(e)(4)(A).
Having found that the allegations or transactions with respect to the OTA and SSM transactions in the Relator's Complaint were publicly disclosed, the Court must now consider whether the Relator qualifies as an "origirial source" of that information under FSA § 3730(e)(4) (B). See United States ex rel. Kreindler & Kreindler v. United Technologies Corp., [ Page 32]
985 F.2d 1148, 1158 (2d Cir. 1993) (stating that "public disclosure of the allegations divests district courts of jurisdiction over qui tam suits, regardless of where the relator obtained his information . . . unless [the relator] satisf[ies] the limited exception . . . provided . . . to an original source of the information.") (internal quotations and citation omitted).*fn25 For a relator to qualify as an original source, he must "(1) have direct and independent knowledge of the information on which the allegations are based, and; (2) have voluntarily provided such information to the government prior to filing suit;" and (3) "have directly or indirectly been a source to the entity that publicly disclosed the allegations on which a suit is based." United States ex rel. Kreindler & Kreindler, 985 F.2d at 1158-59. "The direct knowledge requirement was intended to avoid parasitic lawsuits by "disinterested outsider [s] who simply stumble across an interesting court file." United States ex rel. DeCarlo v. Kiewit/AFC Enterps., Inc., 937 F. Supp. 1039, 1048 (S.D.N.Y. 1996) (internal quotations and citations omitted).
According to the Relator, he satisfies all three prongs and [ Page 33]
thus qualifies as an "original source" of the information in his Complaint. First, the Relator contends that he had direct and independent knowledge of SGC's allegedly fraudulent conduct because as early as 1991 he personally observed, through his employment as a managing director of Smith Barney, SGC's improper manipulation of advance refunding FSAs and he personally discussed the improper manipulation of advance refunding FSAs with Steven Strauss of SGC. (Lissack Decl. ¶ 8).
Further, the Relator contends that he satisfies the second prong of the "original source" inquiry because from December 1993 through March 1994 he claims to have "had perhaps a dozen extensive conversations with the US Attorney's Office and the FBI" in which he "described in detail the mechanics of `yield burning'; how the federal Treasury, and in some instances the municipal agencies, are damaged; and which firms participated in the fraud." (Lissack Decl. ¶ 17.) The Relator additionally contends that he "identified refunding transactions done by Lazard and Merrill Lynch that were affected by yield burning, including refundings by the Oklahoma Turnpike Authority," specifically identifying SGC as among the forward supply agreement providers who were engaged in improper practices. (Lissack Decl. ¶¶ 20, 21.) These conversations all took place anonymously.
Finally, the Relator contends that he satisfies the third prong because he claims to have spoken "with the DOJ, SEC and FBI [ Page 34]
as well as state regulatory officials" beginning in February 1995. (Lissack Decl. ¶ 26).
In response, the Defendants contend that the Relator's "frugal" declaration is not specific enough to satisfy the "original source" inquiry. The Court agrees with the Defendants that the Relator fails to establish that he was an "original source" of the information in his Complaint.
With respect to prong two, the Relator contends that he disclosed to the FBI examples of "`bad' deals" including "refundings by the Oklahoma Turnpike Authority." (Lissack Decl. ¶¶ 19, 20). However, the Relator, fails to give any specific details about what in particular he told the Government with respect to the OTA. Moreover, the Relator fails to satisfy prong three because information regarding the OTA and SSM transactions was already in the public sphere before Relator even alleges that he began disclosing information to Government entities. Nor does the Relator allege that he was a source of the information to the news entities that first publicly disclosed the allegations of fraud with respect to the OTA and SSM transactions. United States of America ex rel. Kreindler & Kreindler, 985 F.2d at 1159 (stating that to qualify as an "'original source' . . . a plaintiff also must have directly or indirectly been a source to the entity that publicly disclosed the allegations on which a suit is based.") Because the Relator has not provided sufficient information to permit the Court to conclude that he was an [ Page 35]
"original source" of the allegations with respect to the OTA and SSM transactions in his Complaint, the Court finds that the claims in his Second Amended Complaint based on the OTA and SSM transactions are barred by § 3730(e)(4). Accordingly, the Defendants' alternative motion for dismissal pursuant to the public disclosure bar with respect to claims based on the OTA and SSM transactions would also warrant dismissal of those claims.
VI. Failure to Plead Fraud With Particularity
As an additional alternative ground for dismissal, the Defendants contend that the Second Amended Complaint fails to plead fraud with the particularity required by Fed.R.Civ.P. 9(b). The Court agrees with respect to the bond issuances that are merely appended to the Second Amended Complaint in list form.
Fed.R.Civ.P. 9(b) requires that "[i]n all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." The Second Circuit has stated that claims brought under the False Claims Act must satisfy Rule 9(b). See Gold. v. Morrison-Knudsen Co., 68 F.3d 1475, 1477 (2d Cir. 1995). Specifically, the complaint must "'(1) specify the statements that the plaintiff contends were fraudulent, (2) identify the speaker, (3) state where and when the statements were made, and (4) explain why statements were fraudulent." Shields v. Citytrust Bancorp, Inc., 25 F.3d 1124, 1128 (2d Cir. 1994) (quoting Mills v. Polar Molecular Corp., [ Page 36]
12 F.3d 1170, 1175 (2d Cir. 1993).
The Relator has attached to his Second Amended Complaint a list of what he claims "is a partial, nonexclusive list of transactions affected by [SGC's] fraudulent practices." (Compl. ¶ 63). However, merely providing a list of transactions without any further detail is insufficient to satisfy the pleading requirement of Fed.R. Civ. P. 9(b). See Shields, 25 F.3d at 1128. Accordingly, the claims with respect to those transactions merely listed on the attachment are dismissed with prejudice. The Relator has failed to meet the standard discussed above and it is clear that additional discovery would be necessary to provide any further details with respect to these transactions. (Oral Argument Tr. at 69); see United States ex rel. Barmak v. Sutter Corp., 95 CV 7637, 2002 U.S. Dist. LEXIS 8509, at *15 (S.D.N.Y. May 14, 2002) (dismissing qui tam complaint where the relator failed to provide the details of the alleged fraud with the requisite specificity).
However, the Court finds that three sets of bond issues that the Relator alleges involved.fraudulent mispricing by SGC as forward supply provider have been adequately pled. Specifically, the Relator has adequately pled that SGC engaged in fraud with respect to the 1991 Harris County bond issue, the 1992 New Jersey Highway Authority Garden State Parkway-Senior Parkway bond issue, [ Page 37]
and the 1993 MidBay Bridge Authority bond issue.*fn26 Consequently, these claims would be permitted to go forward had the Court not concluded that the entire action is tax-barred. [ Page 38]
Because the Court finds that it lacks subject matter jurisdiction under the FCA's Tax Bar, the motion to dismiss the Relator's Second Amended Complaint is granted. The Clerk of the Court is directed to close this case.