IN THE UNITED STATES DISTRICT COURT FOR THE NORTHERN DISTRICT OF CALIFORNIA
October 5, 2005
UNITED STATES OF AMERICA, EX REL. MOUNTHASONE BOTT AND SUSAN NEWMAN, PLAINTIFFS,
SILICON VALLEY COLLEGES, ET AL., DEFENDANTS.
The opinion of the court was delivered by: Claudia Wilken United States District Judge
ORDER GRANTING DEFENDANTS' MOTIONS TO DISMISS
Defendants U.S. Education Corporation (USEC), Silicon Valley Colleges and Western Career Colleges (the Colleges), and Greg Nathanson, Ellis C. Gedney and Darryl Lindsey (collectively, USEC Defendants) move pursuant to Federal Rules of Civil Procedure 12(b)(6) and 9(b) to dismiss the second amended complaint (SAC) of Relators Mounthasone Bott and Susan Newman (collectively, Relators). Defendant Almich & Associates (Almich) separately moves to dismiss the SAC on the same grounds. Relators oppose the motions. The matters were heard on September 16, 2005.
Having considered all of the papers filed by the parties and oral argument on the motions, the Court grants the motions to dismiss.
Relators bring this qui tam action under the False Claims Act (FCA), 31 U.S.C. § 3729 et seq, against all Defendants on behalf of the United States to recover all federal educational grants, including Pell Grants, and all payments on federally insured educational loans used to fund students at the Colleges. The parties and claims are described in the Court's July 13, 2005 Order Granting Defendants' Motions to Dismiss.
As explained in that order, the Colleges must enter into a Program Participation Agreement (PPA) with the Secretary of Education in order to be eligible to participate in grant and loan programs authorized by Title IV of the Higher Education Act (HEA), 20 U.S.C. § 1070 et seq. 20 U.S.C. § 1094(a). The PPA conditions the Colleges' eligibility upon compliance with certain requirements, among others, The institution will not provide any commission, bonus, or other incentive payment based directly or indirectly on success in securing enrollments or financial aid to any persons or entities engaged in any student recruiting or admission activities or in making decisions regarding the award of student financial assistance . . . .
Id. § 1094(a)(20). The Department of Education (ED) has promulgated "safe harbor" regulations, which clarify that institutions may provide their admissions representatives with fixed compensation, such as a fixed annual salary or a fixed hourly wage, as long as that compensation is not adjusted up or down more than twice during any twelve month period, and any adjustment is not based solely on the number of students recruited, admitted, enrolled, or awarded financial aid. For this purpose, an increase in fixed compensation resulting from a cost of living increase that is paid to all or substantially all full-time employees is not considered an adjustment.
34 C.F.R. § 668.14(b)(22)(ii)(A). Nothing in the statute or the regulations addresses the conditions under which an institution may terminate its admissions representatives. In addition to the PPA, HEA requires that participating institutions submit to the ED the results of annual audits. 20 U.S.C. § 1094(c)(1)(A)(i).
In both the first amended complaint (FAC) and the SAC, Relators allege that Defendants falsely certified that the Colleges were in compliance with applicable federal law prohibiting incentive payments to admissions representatives. In the FAC, Relators alleged that they and other recruiters were paid a "so-called 'salary' . . . that was directly tied to an enrollment quota for that recruiter." FAC ¶ 47. Pursuant to this arrangement, recruiters who failed to enroll their minimum quota were terminated, while those who exceeded the minimum quota were retained and given raises. In addition, admissions representatives who failed to "convert" a minimum percentage of leads into enrollments were also terminated. Relators also alleged in the FAC that Almich and another accounting firm, Weworski & Associates,*fn1 falsely certified in connection with annual audits that the Colleges were in compliance with federal eligibility requirements.
In its July 13, 2005 order, the Court dismissed the FAC pursuant to Rule 12(b)(6) for failure to state a claim and for failure to comply with Rule 9(b)'s requirement that the FCA allegations of fraud be plead with particularity.
The Court found that the FAC failed to state an FCA claim because the USEC Defendants' alleged system of recruitment quotas, in which employees who fail to meet the minimum enrollment quotas are fired and those who exceed the minimum are retained and given raises, fell within the safe harbor provisions of the ED's regulations. The Court reasoned that, although pay adjustments could not be based "solely" on the number of students recruited, the safe harbor provision reflected the ED's understanding that institutions could base salaries or salary increases on merit. The Court found that the regulations did not otherwise address the hiring and firing of admissions representatives or an institution's ability to set mandatory recruitment quotas. The Court found that, in fact, Relators have not alleged any conduct that falls outside the safe harbor regulations. For example, they have not alleged that the Colleges provide more than two salary adjustments in a year not related to cost-of-living, or adjustments based "solely on the number of students" recruited.
July 13 Order at 10. Because the practices alleged were protected by the regulations, the Court concluded that Defendants could not be held liable for fraud under the FCA, even if the ED regulations were inconsistent with the HEA.
In the SAC, Relators allege generally and repeatedly that the Colleges "were paying commissions and other incentive compensation to recruiters based solely on their success at securing enrollments." SAC ¶ 13; see also id. ¶ 17 ("recruiters at SVC were paid substantial raises based solely on their success at securing enrollments"), ¶ 19 ("All Sales Representatives at [SVC] were paid solely based on the number of students they enrolled. . . . The salary of each sales representative was based solely on their enrollments."), ¶ 20 ("the enrollment quotas are assigned to the individual Sales Persons on the basis of the salaries they receive"), ¶ 21 (alleging that Mr. Nathanson informed Ms. Bott that "recruiters were rewarded according to success at securing enrollments") and ¶ 27 (recruiters "were promised they would receive raises based solely on their success in securing enrollments beyond their minimum enrollment quotas . . . All recruiters who failed to meet their minimum enrollment quotas were terminated").
More specifically, Ms. Bott alleges that she had a minimum enrollment quota of approximately twelve students per month, and that she was fired after three months "solely because she failed to meet her enrollment quota." Id. ¶ 18. Relators allege that sales representative Indy De Croos was paid a starting salary of $40,000, and "received a $10,000 raise after his third month of employment solely based on the number of students he recruited. Indy received a second $10,000 raise later in the year based solely on his continued success as [sic] securing enrollments for the company." Id. ¶ 19. Relators also allege that other sales representatives were paid salaries varying between $50,000 and $90,000, but do not allege any additional details suggesting a specific relationship between those salaries and the number of students enrolled. Similarly, Ms. Newman alleges that, after enrolling eight students in her first two weeks of employment, she was told she "would receive a raise based solely on her ability to continue enrolling students" at that rate. Id. ¶ 24. One month later, she was "given a letter . . . stating that she was being terminated solely for failing to meet her enrollment quota." Id. ¶ 25. Relators also allege that USEC Defendants closely monitored sales representatives' enrollment figures, and that those who failed "to 'convert' a minimum percentage of leads into enrollments were also terminated." Id. ¶ 39.
The FAC alleged no details with respect to its claims against the individual Defendants or Almich. The Court therefore found that Relators failed to allege with the requisite particularity their claims of fraud against those Defendants. In the SAC, Relators allege that individual Defendants Nathanson, Gedney and Lindsey "directed, authorized, ratified, and/or acted with knowledge or reckless indifference to the wrongful conduct described" in the SAC. Id. ¶¶ 5-7. Relators also allege that the recruiter compensation strategies described in the SAC were "conceived, designed, and implemented by the officers and shareholders Defendants Gedney, Lindsey, and Nathanson." Id. ¶ 78. Nathanson in particular is alleged to have "executed the Program Participation Agreements with the U.S. Department of Education on behalf of SVC and WCC." Id. ¶ 5. The SAC also states that Almich conducted compliance examinations of SVC for fiscal years 1997, 1998, 1999 and 2000; audited SVC's financial statements for fiscal years 1997, 1998, 1999, 2000, 2001 and 2002; and performed both the compliance examinations and the financial audits for WCC for fiscal years 1997, 1998, 1999, 2000, 2001 and 2002. Id. ¶ 8.
"In all averments of fraud or mistake, the circumstances constituting fraud or mistake shall be stated with particularity." Fed. R. Civ. P. 9(b). The allegations must be "specific enough to give defendants notice of the particular misconduct which is alleged to constitute the fraud charged so that they can defend against the charge and not just deny that they have done anything wrong." Semegen v. Weidner, 780 F.2d 727, 731 (9th Cir. 1985). Statements of the time, place and nature of the alleged fraudulent activities are sufficient, Wool v. Tandem Computers, Inc., 818 F.2d 1433, 1439 (9th Cir. 1987), provided the plaintiff sets forth "what is false or misleading about a statement, and why it is false." In re GlenFed, Inc., Sec. Litig., 42 F.3d 1541, 1548 (9th Cir. 1994). Scienter may be averred generally, simply by saying that it existed. See id. at 1547; see Fed. R. Civ. P. 9(b) ("Malice, intent, knowledge, and other condition of mind of a person may be averred generally"). As to matters peculiarly within the opposing party's knowledge, pleadings based on information and belief may satisfy Rule 9(b) if they also state the facts on which the belief is founded. Wool, 818 F.2d at 1439.
I. Failure to Plead Fraudulent Statements with Specificity
Defendants move for dismissal on grounds, among others, that the SAC's allegations of conduct outside the protection of the ED's safe harbor regulations are not stated with the specificity required by Rule 9(b).
According to the SAC, Ms. Bott and Ms. Newman were fired "solely" for failing to meet their minimum enrollment quotas, and Mr. De Croos received one $10,000 raise "solely" based on the number of students he recruited and a second $10,000 raise in the same year based "solely on his continued success" at recruiting. Other than the insertion of the word "solely," the allegations do not differ substantially from the quota system described in the FAC, which the Court found fell within the safe harbor provision.
As the Court noted in its prior order, the ED's regulations were promulgated based on the assumption that the HEA does not prohibit institutions from basing "salaries or salary increases on merit," Dep't of Ed., Federal Student Aid Programs, 67 Fed. Reg. 67,048, 67,053 (Nov. 1, 2002), and neither the HEA nor the regulations otherwise addresses the hiring and firing of admissions representatives or quotas. The firing of Ms. Bott and Ms. Newman for failing to meet a mandatory quota does not constitute a "commission, bonus, or other incentive payment" prohibited by the HEA, and Relators in their opposition do not argue otherwise.
For admissions representatives responsible for increasing enrollment of students, there is necessarily a fine distinction between a permissible salary increase "based on merit" and an impermissible salary increase "based solely on the number of students enrolled." In order to state their fraud claim, Relators must allege with specificity a direct relationship between the raises given and the number of students enrolled. Other than frequently using the word "solely," the SAC does not do so. For instance, Relators do not provide any information demonstrating with specificity that there was a direct relationship between the number of students enrolled by Mr. De Croos and his two $10,000 raises. To the contrary, the specific facts alleged are equally susceptible to Defendants' interpretation, that fulfillment of quotas merely rendered Mr. De Croos eligible for two raises and thus fell within the safe harbor regulations. Without more detailed allegations showing the relationship between pay raises and the specific number of students actually enrolled by Mr. De Croos or other admissions representatives, the Court finds that Relators have not described with particularity a pay structure that falls outside the safe harbor regulations.
As the Court explained in its previous order, such a pay structure would be necessary in order to maintain Relators' FCA action. See July 13, 2005 Order at 9-11. This reasoning applies as well to to the FCA claim against Almich, because Relators' fraud claim against it rests entirely on Almich's alleged ratification of the Colleges' alleged incentive payments. For these reasons, the Court finds that the SAC fails to meet Rule 9(b)'s requirement that the false or fraudulent statements by Defendants be alleged with particularity.
II. Failure to Plead Fraud with Respect to Specific Defendants
A. Individual USEC Defendants
USEC Defendants move for dismissal of the complaint on the grounds that the allegations against the three individual USEC Defendants, Nathanson, Gedney and Lindsey, fail to meet the requirements of Rule 9(b). As USEC Defendants note, the allegations against the individuals are for the most part so vague and conclusory that they do not allow each to know how he, in particular, is alleged to have participated in the Colleges' conduct. Relators do specify that Nathanson executed the PPAs. However, they do not identify the time, place and date of the alleged fraudulent or false statements for either Gedney or Lindsey. The only other allegations of wrong-doing against the individual Defendants are collective accusations that attribute every act of the Colleges to each individual. Therefore, the Court finds that the SAC fails to meet Rule 9(b)'s particularity requirement with respect to the allegations against Defendants Gedney or Lindsey.
Almich also moves for dismissal pursuant to Rule 9(b) on grounds, among others, that it did not provide services for the Colleges during the times of specifically alleged fraud, if any.
In the SAC, Relators specify the years in which Almich conducted compliance examinations or financial statement audits; the last fiscal year for which Almich is alleged to have provided its services to the Colleges is 2002. The SAC makes clear that Almich's liability is premised on the Colleges' alleged failure to comply with federal law governing recruiter compensation. SAC ¶ 44. However, all of the SAC's specific, dated allegations of conduct in violation of the HEA refer to 2003 or later. Therefore, even if those allegations had met the requirements of Rule 9(b) with respect to the USEC Defendants, they would be insufficient to state with particularity circumstances for which Almich could be held liable for false or fraudulent statements.
For the foregoing reasons, USEC Defendants and Almich's motions to dismiss Relators' complaint (Docket Nos. 87 and 8, respectively) are GRANTED. Because counsel stated at oral argument that Relators did not seek leave to amend to remedy the deficiencies identified by the Court, the dismissal is with prejudice.
USEC Defendants' request for judicial notice (Docket No. 26) is DENIED as moot. Judgment shall be entered in Defendants' favor; each side shall bear its own costs. The Clerk shall close the case file.
IT IS SO ORDERED.