Plaintiff Fails to Show Fraudulent Results of Software Audit Induced Agency Into Signing New License Agreement; U.S. District Court for the District of Columbia No. 13-cv-00907 (APM), Paul A. Cimino v. International Business Machines Corporation

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A district court granted IBM’s motion to dismiss a False Claims Act case alleging the company concocted fraudulent audit findings to induce the Internal Revenue Service into purchasing software licenses it did not need. The court found the plaintiff plausibly alleged that IBM falsified the results of an audit of IRS’ usage of its software, but failed to connect those findings to IRS’ agreement to enter into a new contract for the licenses. The court also noted IRS continued to pay under the contract long after the allegations came to light and therefore the plaintiff had not demonstrated materiality.

International Business Machines Corporation moved to dismiss a False Claims Act action filed by a former employee, who alleged IBM fabricated audit findings to coerce the Internal Revenue Services into extending a software license worth $265 million.

Paul Cimino alleged IBM and Deloitte LLP falsified information about IRS’s software usage, and then used the findings to convince the agency to renew its enterprise software license. According to Cimino, IRS renewed the license under the threat of a $91 million penalty, which was supported by the audit.

During his employment, Cimino was a senior sale representative for IBM’s Rational software. According to Cimino, when IBM learned that IRS was considering not exercising an option year to continue a lucrative package of software licenses, the company offered to conduct an audit of IRS’s usage to determine which software it actually utilized and to use the results to craft a new license agreement that would provide cost savings. In reality, IBM expected that the compliance audit would reveal that the IRS had overutilized software and therefore would be subject to steep compliance charges allowed under the initial license.

IBM also believed that once IRS declined to exercise the option year on its current agreement, it would be compelled to enter into a large new contract that included products it did not need, due to the press of the approaching tax season and threat of stiff overage fees. Cimino cited several internal communications suggesting IBM would have more leverage to negotiate a new deal if IRS declined the option year.

IRS agreed to the audit and declined to exercise the option year in favor of a three-month bridge contract. IBM engaged Deloitte, which found only $500,000 in possible compliance charges, which the company considered low. Cimino alleged IBM suppressed these findings and never released them to the agency. Instead, Cimino alleged IBM asked Deloitte to manipulate the audit by basing it on assumptions that were either without basis or impossible in order to create leverage over IRS. For example, IBM urged Deloitte to redo the audit on the assumption that licenses deployed on discontinued servers, and thus never used, were in constant use. By September 2012, the changes to Deloitte’s audit assumptions resulted in approximately $18.9 million in overage fees.

IRS rejected the charges because IBM could not substantiate them. In November 2012, IBM changed the audit assumptions yet again—this time, resulting in $292,000,000 in overage fees, which were again presented to the agency. IBM also created an internal audit team to validate Deloitte’s findings, which included the relator. In one area, the audit team found $3 million of over-deployment of the software, compared to Deloitte’s finding of $27 million in the same area. Unsatisfied, IBM management directed the team to employ different assumptions, which the relator alleged were impossible. For example, although technically impossible, Somerville instructed the team to assume that numerous IRS employees were using certain Rational brand “floating user” licenses concurrently—including employees who did not develop software and had no need to use the Rational brand. When the team’s findings remained too low, IBM suppressed these results as well.

IBM presented $91 million in compliance charges, which IRS again rejected. However, when IRS’ contact person was away from the office, IBM presented its findings to his superior and stated that the company would agree to waive the payment if IRS entered into a new contract. Concerned about the possible penalty payment, IRS signed a five-year, $265 million license with IBM in late December 2012. However, according to the relator, IBM broke its promise to forgo the overage fees and secretly included at least $86.9 million in such fees in the new license under the guise of costs for prospective licenses and technical support. In support of this allegation, the relator noted that IBM included the exact same number of purportedly over-deployed Rational floating user licenses—2,353, to be precise—as prospective licenses for first year of the new license. By contrast, for each subsequent option year, the IRS purchased only 25 such licenses. The relator alleged IBM never provided IRS with the additional 2,353 licenses.

Cimino filed a qui tam action alleging fraud-in-the-inducement in the formation of the contract and the presentation of a false claim in the guise of the overage fees presented as the cost of new licenses. After a multi-year investigation, the United States declined to intervene, but Cimino proceeded with his action. IBM moved to dismiss.

The court dismissed the case. While finding the complaint well-pleaded facts, the court found the case fell short on causation and materiality.

A plaintiff alleging fraud in the inducement must plead not only that the omitted information was material but also that the government was induced by, or relied on, the fraudulent statement or omission. The parties disagreed as to what the verb “induce” meant in this context. Cimino argued that the complaint need only plead facts showing that the false audit findings were a “substantial factor” in the agency’s decision to renew the licensing agreement. In response, IBM argued for a stricter “but for” standard, meaning the relator must show that absent IBM’s presentment of the false audit findings, the IRS would not have entered into a new agreement.

The court explained that the element of causation for an FCA claim requires a showing that the alleged false statement is not only the actual, or but for, cause of the government harm, but also the legal, or proximate, cause for the loss. The court cited the Supreme Court’s decision in Escobar, in which it explained that Congress intended to import common law concepts into the FCA. Proximate cause is the usual common law understanding of causation in fraud cases.

The court held that for purposes of causation under the FCA, an allegation such as this—that a false statement is merely a “substantial factor” in causing loss—is not enough to give rise to FCA liability. Instead, the relator must plausibly allege facts establishing but-for causation. The court found the relator did not show that had IRS known of the audit findings, it would have declined to enter into the contract, and therefore did not satisfy the FCA’s restrictive causation standard. The conclusory allegation that Deloitte’s findings were a mere “substantial factor” in the decision to renew the licensing agreement was by itself fatal.

The court also found the factual allegations deficient. The court found it implausible to accept that IRS would enter into a $265 million contract during the brief period a key employee connected to the contract was on vacation. The court also noted that the relator did not show that the audit findings were a factor in the agreement. At most, the relator established a timeline showing IRS management authorized the new contract after IBM presented the false audit findings. That was not enough. The court also held that IRS’ purported concern about the audit findings was insufficient to show causation.

Next, the court held the relator failed to establish materiality. The court found strong evidence IRS did not consider the audit findings to be material. The relator filed his suit only six months after IRS signed the contract, yet IRS paid all or a substantial portion of the $265 million license fee after the case was filed. It also agreed to add six months to the agreement for an additional cost of $16,147,772. The court found it implausible that IRS sat on its hands upon learning that IBM had tricked it into signing a contract for $265 million for software that it did not need, and in fact, agreed to pay more later. The government’s decision not to intervene was also a factor. While not dispositive, the court explained that decision is entitled to some respect, especially in light of a four-year investigation.

Next, the court considered the relator’s allegation that IBM reneged on its promise to waive overuse penalties by hiding them in the agreement in the form of 2,300 additional licenses IRS did not need. The court again found no evidence IRS relied on the false audit findings or IBM’s promise not to assess penalties when it entered into the new agreement. The court also found the complaint failed on materiality grounds, as IRS continued to pay after the allegations came to light and took no corrective actions. The court found it implausible that IRS would not have attempted to recover $90 million in fees for software that was not provided or used.

Finally, the court considered the relator’s allegation that IBM presented a false claim for payment regarding the alleged hidden overuse fees. Again, the court cited IRS’ knowledge of the allegations and its failure to take any action against IBM in relation to the alleged fraud. The court found it implausible to believe IRS would not have noticed IBM failed to deliver on one-third of the value of its new agreement.

FCA Cimino v IBM