On August 24, 2018, the Ninth Circuit addressed the Supreme Court’s decision in Universal Health Services, Inc. v. U.S. ex rel. Escobar, holding that Escobar sets forth the exclusive test for establishing FCA liability under the theory of implied false certification.  In that case, U.S. ex rel. Rose v. Stephens Institute, the Ninth Circuit also grappled with Escobar’s materiality requirement, providing further guidance on how the past government action factor of the materiality analysis should be applied.

Federally Funded College Accused of Providing Incentives to Employees Based on Enrollment

The defendant Stephens Institute is an art college in California that receives federal funding in the form of financial aid to students under Title IV of the Higher Education Act.  The relators are former school admissions employees who alleged that the school violated statutory, regulatory and contractual requirements that prohibit schools receiving Title IV funding from tying incentive payments for admissions employees to the number of students enrolled.  Specifically, the relators alleged that Stephens Institute improperly set targets for admissions employees and offered salary increases up to $30,000 and an expenses-paid trip to Hawaii to employees who hit their targets.

At the close of discovery, Stephens Institute moved for summary judgment.  Evidence showed that during the relevant time period, the government had identified 32 violations of the incentive compensation ban at other schools.  Stephens Institute argued that such evidence showed that the alleged violation was not material under Escobar because the government had not limited, suspended or terminated any of those schools’ access to financial aid after discovering the violations.  The U.S. District Court for the Northern District of California denied Stephens Institute’s motion, but certified the issue for interlocutory appeal.

Ninth Circuit Adopted Two-Part Test for Asserting Implied False Certification Claim

On appeal, the Ninth Circuit panel first addressed the proper test for establishing an implied false certification claim.  Prior to Escobar, the Ninth Circuit had adopted a broad view of implied-certification liability, holding that an implied-certification claim could be asserted where the defendant explicitly undertook to comply with a requirement and then later submitted claims in violation of that requirement.  See U.S. ex rel. Ebeid v. Lungwitz, 616 F.3d 993 (9th Cir. 2010).  In Escobar, however, the Supreme Court appeared to construe the theory more narrowly, holding that the implied certification theory can be a basis for FCA liability “at least where two conditions are satisfied: first, the claim does not merely request payment, but also makes specific representations about the goods or services provided; and second, the defendant’s failure to disclose noncompliance with material statutory, regulatory, or contractual requirements makes those representations misleading half-truths.” 136 S. Ct. at 2001 (emphasis added).

The question for the Ninth Circuit panel in Rose was whether Ebeid remained good law.  Arguably, Escobar did not rule out other methods for establishing an implied false certification claim.  And indeed, the panel reasoned that if it were ruling on a blank slate, it doubted that Escobar would have required the panel to overrule Ebeid.  The panel noted, however, that two earlier post-Escobar Ninth Circuit opinions applied only Escobar’s narrower test when addressing implied false certification.  Although neither opinion explicitly addressed the scope of implied false certification liability after Escobar, the Rose panel felt bound by the prior panels’ reasoning, and therefore held that after Escobar, the only way to establish an implied false certification claim in the Ninth Circuit is to satisfy the two conditions described in Escobar.  On the facts, the panel had no trouble finding those requirements met in Rose.  Going forward, the court’s narrow interpretation of implied false certification liability should limit the scope of FCA liability in the Ninth Circuit.

Evidence of Materiality Found by Majority of Ninth Circuit Panel

Although the panel was unanimous in addressing the scope of implied certification liability, the judges split 2-1 on the issue of materiality.  The majority found that materiality was a triable issue and that the incentive compensation ban was “triple conditioned”—it was an express condition of payment in an applicable statute and regulation, as well as in the school’s agreement with the government.  That was not dispositive, the majority reasoned, “but it is certainly probative evidence of materiality.”

The majority also noted that Stephens Institute did not violate the incentive compensation ban in a small way, such as by offering admissions employees cups of coffee or $10 gift cards.  Moreover, the majority was persuaded by evidence that the government took corrective action in 25 of 32 cases in which other schools violated the incentive compensation ban, including by requiring schools to cease providing incentives.  Evidence also showed the government required two schools to pay a penalty, and recouped payments from one school.  The majority deemed that to be sufficient evidence that the government “care[d] about violations of the incentive compensation ban.”

The majority’s reasoning begs the question whether it is sufficient to establish materiality that the government “cares about” a violation.  Justice Thomas wrote that it is evidence of materiality that “the Government consistently refuses to pay claims in the mine run of cases based on noncompliance.”  He also stressed that “materiality looks to the effect on the likely or actual behavior of the” government.   If the government chose not to impose fines or seek repayment in the mine run of incentive ban violations, it is fair to ask whether relators should be permitted to impose “essentially punitive” FCA liability on Stephens Institute for its violation.  Put differently, the majority’s reasoning risks allowing private individuals to impose a much harsher punishment on Stephens Institute than evidence suggests the government would have.

Picking up on these issues, the dissent in Rose argued that to faithfully apply the “rigorous” and “demanding” materiality standard set forth in Escobar, evidence of past government action must relate to how the government would respond to the specific violation alleged.  The dissent noted that the evidence presented related only to the government’s general enforcement of the incentive compensation ban.  The dissent reasoned “the Majority is correct that this evidence demonstrates that the Government cares in a broad sense.  But, caring is not enough to make it material under the Escobar standard.  Whether aggregate data demonstrates that the Government cares is not evidence that, in this case, the Government would find these alleged misrepresentations material.”  The dissent would have returned the case to the district court for further discovery into how the government would have responded to the specific, alleged violations.

For more information about the Rose case or courts’ applications of the Supreme Court’s Escobar decision, don’t hesitate to contact the author and/or subscribe to this blog for updates.