Two years ago, the U.S. Department of Justice announced a focus on enforcing the False Claims Act against private equity firms based on their portfolio companies’ conduct.[1] That government focus remains strong: Private equity firms, and particularly those invested in health care and pharmaceutical businesses, continue to face exposure simply for knowing about — or recklessly disregarding — their portfolio company’s potential False Claims Act violations. Three recent cases illustrate the risks to private equity firms and demonstrate why they should engage in careful diligence — both at the time of acquisition and afterward — of any portfolio companies that do business with the government.

The False Claims Act

The False Claims Act is a civil statute that imposes liability for knowingly or recklessly submitting, or causing or conspiring in the submission of, materially false claims for payment, or making false statements material to a false claim. See 31 U.S.C. § 3729(a)(1). Claims for payment can be made directly to the federal government or its agents, or to entities that receive federal funds, such as states. Many states also have their own false claims statutes.

False Claims Act suits can be brought by the government directly or, more commonly, by whistleblowers, called “relators,” on behalf of the government, in what are called “qui tam” cases. These qui tam cases are filed under seal, often unbeknownst to the defendant for years, while the government investigates whether any wrongdoing occurred. After its investigation, the government can intervene and take over the case or leave it to the relator to litigate with private counsel in exchange for a share of any judgment. If either the government or the relator prevails, the defendants face liability up to treble the government’s actual damages, plus penalties for each claim submitted and attorney’s fees. And in some cases, the defendant may be barred from doing further business with the government.

False Claims Act cases can be extremely costly for defendants. We know from previous analyses that more than 75% of cases brought directly by the government (or where it intervenes) end in a settlement or judgment. And while most cases that settle do so for under $5 million, settlements regularly reach into the hundreds of millions or even billions of dollars. Further, even if the defendant prevails, the legal fees to defend the government’s investigation and subsequent litigation can be significant, with most cases lasting at least a couple of years and some far longer.

Recent Cases Against Private Equity Firms

One recent case involved whistleblower allegations that a former Johnson & Johnson subsidiary, Therakos, promoted unapproved uses for its cancer treatments.[2] The whistleblower also sued private equity firm The Gores Group, which acquired Therakos from the Johnson & Johnson subsidiary in January 2013 and sold it to Mallinckrodt Inc. a few years later. The claims against The Gores Group rested on two core allegations: (i) that the improper promotion continued while The Gores Group owned Therakos and (ii) that The Gores Group hired as its CEO a former Therakos employee. The case settled in November 2020, eight years after the whistleblower first filed the case. Therakos paid $10 million, and The Gores Group paid $1.5 million.

A second set of cases likewise stems from alleged conduct that started before the private equity firm’s investment and continued after the investment. In those cases,[3] the government alleged that medical testing company Alliance Family of Companies LLC ran a scheme involving kickbacks and fraudulent billings. The government also sued private equity firm Ancor Holdings LP — a minority shareholder of Alliance that held two seats on Alliance’s board and received monthly fees from Alliance under a management services agreement. The government alleged that, during pre‑investment due diligence, Ancor had discovered Alliance’s illegal scheme but acquired Alliance anyway. The government contended that Ancor caused false claims when it allowed Alliance’s conduct to continue. Last summer, Alliance and Ancor settled these claims with the government for $13.5 million and $1.8 million, respectively.[4]

A final case is similar. Last October, private equity firms H.I.G. Growth Partners and H.I.G. Capital (collectively, H.I.G.) paid almost $20 million to settle a case based on alleged failure to stop pre-investment misconduct after investing.[5] In that case, a private whistleblower alleged that South Bay Mental Health Center had fraudulently billed federal and Massachusetts health care programs for services by employees whose qualifications and supervision did not comply with federal and state requirements.[6] The whistleblower also sued H.I.G. — the majority shareholder of an entity (known as C.I.S.) formed to acquire South Bay. The whistleblower alleged that, during the pre‑investment due diligence process, H.I.G. learned of South Bay’s misconduct and knew (or should have known) that the conduct continued after the acquisition. The commonwealth of Massachusetts joined the suit to pursue parallel claims under the Massachusetts False Claims Act.

H.I.G.’s settlement of the federal and state claims followed its failure to shake the case at the motion‑to‑dismiss and summary‑judgment stages. When declining to dismiss the case, the district cited two key sets of allegations: first, that “H.I.G. members and principals formed a majority of the C.I.S. and South Bay Boards, and were directly involved in the operations of South Bay”;[7] and second, that the relator and others had “expressly informed the CEO and Boards of C.I.S. and South Bay” about the regulatory violations and had suggested ways “to fix the problem” but “that the recommendation was rejected.”[8] Because “[a] parent may be liable for the submission of false claims by a subsidiary where the parent had direct involvement in the claims process,” the district court concluded, those allegations were enough to overcome a motion to dismiss.[9]

When denying summary judgment, the district court held that there was sufficient evidence showing H.I.G.’s “direct involvement in the claims process” or its “knowing ratification” of South Bay’s “prior policy of submitting false claims.”[10] In particular, the court cited evidence that two H.I.G. employees sitting on the C.I.S. board had received reports showing that a South Bay working group’s two‑year‑old recommendations for addressing the regulatory violations were not implemented. That evidence, the court concluded, suggested that “H.I.G. had the power to fix the regulatory violations which caused the presentation of false claims but failed to do so.”[11]

Takeaways

These cases demonstrate that private equity firms remain tempting targets for both whistleblowers and government agencies seeking to expand the scope of potential False Claims Act liability. Accordingly, private equity firms must consider potential False Claims Act risk at every stage of their involvement with government contractors or government-regulated businesses. Private equity firms should scrutinize a prospective investment for potential government regulatory and reimbursement concerns during the diligence process, including by engaging regulatory and False Claims Act counsel if appropriate. They should examine their existing portfolio companies’ operations and policies for possible compliance failures. They should review their portfolio companies’ compliance programs, ensuring that internal reporting systems, audit practices and investigative abilities are robust and follow best practices. And firms that identify compliance issues should ensure that the portfolio company documents its investigation and remediation, and assess whether the portfolio company has mandatory reporting obligations.

These and other protective measures can help private equity firms improve their odds of avoiding and (if necessary) defeating a False Claims Act suit.