Contractor Argues U.S. Fraud Law Does Not Cover Iraqi Funds

Attorneys for a U.S.-based security company accused of setting up sham companies in a multimillion-dollar fraud scheme in Iraq are contending in court that the firm cannot be sued under a key federal anti-corruption law because the allegedly stolen money belonged to Iraqis, not Americans.

The potentially precedent-setting case could undercut fraud claims involving billions of dollars in reconstruction contracts that were issued by the U.S.-led Coalition Provisional Authority and paid for with money belonging to the Iraqi people.

Arguments broke out in federal court Friday over two fundamental questions: whether the CPA, which had ruled occupied Iraq, can be considered a U.S. agency, and whether fraud involving Iraqi money can be subject to suits under the False Claims Act, considered one of the federal government’s most important tools against fraud.

John Boese, an attorney for the security firm, Custer Battles, asked a judge to dismiss the case as “fatally defective.”

Boese argued that the act did not apply to his clients because the CPA, not the U.S. government, was the alleged victim.

“The funds that were used were Iraqi funds, not U.S. funds,” said Boese, adding later, “If there was any false claims here, the entity that was cheated was the Coalition Provisional Authority.”

Custer Battles has denied any fraud, attributing the allegations to disgruntled former employees who have since emerged as competitors to the firm.

Those employees are now suing Custer Battles under the False Claims Act, which allows citizens to sue U.S. contractors on behalf of the federal government to seek damages for fraud.

If successful, the citizens get a share of the money that the contractor is forced to pay back to the U.S. government. In effect, the act creates a potential army of informants among contractor employees with the incentive to report fraud.

In 2003, the act led to $2.1 billion in fraud recovery -- with $319 million going to the whistle-blowers, according to Department of Justice statistics.

Custer Battles was one of the first U.S. contractors on the ground in the chaotic days after the fall of President Saddam Hussein last year.

The company’s two founders, Scott Custer and Mike Battles, are former special operations forces soldiers who opened for business with almost no money and little experience.

Nonetheless, the company won at least four contracts in Iraq worth millions of dollars, including a deal to provide security at Baghdad’s international airport and another to help Iraqis swap their old currency for new dinars minted by the CPA.

Those contracts came under scrutiny after several former employees stepped forward and accused Custer Battles of creating a series of shell companies that were used to bilk the CPA out of millions of dollars.

Company officials are accused of submitting false invoices and billing for work done by other firms.

This year, the Defense Department suspended Custer Battles’ eligibility for future contracts with the U.S. government, believed to be the first time a company doing business in Iraq had faced such a judgment.

In addition, a criminal investigation of the company continues, an Air Force spokesman said.

Despite the criminal inquiry, the plaintiffs’ lawyer said it was important to allow the False Claims Act suit to proceed to avoid giving a green light to contractors in Iraq to commit fraud with Iraqi money.

The CPA issued as much as $20 billion in contracts paid for by the Development Fund for Iraq, which consisted of Iraqi oil revenue, seized assets and money and other valuables recovered from Hussein’s regime.

“It’s perfectly clear that if the judge dismisses [the case], then all fraud against the Coalition Provisional Authority will never be punished,” said attorney Alan Grayson, who represents former Custer Battles employees who have alleged fraud.

“They may not get away with murder. But they will get away with $50 million.”

Friday’s arguments offered a glimpse into the chaos surrounding the contracting process, which has come under fire from Congress, Pentagon auditors and United Nations investigators.

After the four-hour hearing, Judge T.S. Ellis III of the U.S. Eastern District in Virginia asked both attorneys to submit further information. Ellis found it intriguing that there were questions about whether the CPA was an arm of the U.S. government.

The judge’s decision on the CPA’s affiliation could potentially be applied to dozens of other U.S. laws, from federal tort claims to Freedom of Information Act requests, legal experts said.

“We need to probe more deeply into this,” Ellis said.

The Department of Justice declined to pursue recovery of money from Custer Battles, which is usually an indication that lawyers for the government believe the evidence of fraud is weak.

Grayson said that in this case, however, the government declined to become involved because the Justice Department had determined that no U.S. taxpayer money was at stake.

The Justice Department has declined to comment on the reasons it turned down the case.

In an unrelated case, the U.S. government has argued that the CPA was not a U.S. agency and thus U.S. laws pertaining to contracting did not apply -- the same position held by Custer Battles.

A court has yet to rule on the issue.

In the Custer Battles case, Ellis said he would consider whether to invite testimony from the U.S. government to clarify its position at a later hearing.