IRAQ: Whistle-Blower Suit in U.S. Court May Set Course on Iraq Fraud Cases

To its accusers, the security company Custer Battles exemplifies corporate profiteering in post invasion Iraq, when officials were pumping out hastily written contracts for everything from air conditioners to armed guards.

In a lawsuit now in federal court, two former associates of the company say it bilked the American-led coalition out of millions, turning in hugely inflated invoices from phantom supplier companies among other misdeeds. If successful, the suit, brought under the False Claims Act, could recover triple damages for the government and handsome rewards for the whistle-blowers.

Custer Battles has denied wrongdoing and the accusation remains to be proved. But before a trial can proceed at all - before any company can be sued for fraud in the chaos of occupied Iraq - a federal judge in Virginia must issue another, more basic ruling that is now anxiously awaited by the company, its accusers and the Justice Department.

Lawyers for Custer Battles argue that the False Claims Act - the prime legal tool against contractor fraud - does not apply because the company signed contracts with the Coalition Provisional Authority, not the American government, and was mainly paid with Iraqi money seized or managed by the United States, rather than with money appropriated by Congress.

Lawyers for the whistle-blowers and the Justice Department argue that the law does apply. All sides agree that the case will set a precedent and that the stakes are high, and not only for Custer Battles.

"This is an important case because there are a lot of companies over there with poorly constructed contracts and little oversight," said Steven L. Schooner, an expert on procurement at the George Washington University Law School. "The potential for chicanery is great and the potential universe of whistle-blowers is mind-boggling."

In a court hearing on the issue on May 12, a senior Justice Department official warned that if companies could not be held accountable under the False Claims Act, they might not be accountable to anyone.

The Coalition Provisional Authority disappeared in mid-2004, after decreeing that contractors could not be held liable by Iraqi courts. So if the United States cannot bring suit against fraudulent contractors, "who could do that?" asked the official, Michael F. Hertz of the Justice Department's Civil Division.

Judge T. S. Ellis III of the Federal District Court in Alexandria, Va., said at the May 12 hearing that he would rule soon on the prior issue.

In September 2004 the Pentagon, citing evidence of fraud and a continuing criminal investigation of Custer Battles, barred the company from receiving more federal contracts, halting what had been the company's explosive growth. The company was founded in 2001 by two veterans with more ambition than assets, and by mid-2004 it had $100 million in Iraq contracts.

The company's critics say its owners, Scott Custer and Mike Battles, benefited from the frantic awarding of contracts in 2003 and the constant turnover of monitors.

The whistle-blower suit accuses the company of defrauding the government through actions as large as the creation of shell companies to pose as suppliers and increase billable costs and as small as the repainting of Iraqi Airways forklifts, then claiming to have leased the machines for thousands of dollars per month.

The company says it performed admirably and honestly in Iraq, starting with its initial contract, which was for $16.8 million to provide security at the Baghdad airport.

In June 2003, seeking to open the airport quickly, coalition authority officials put out a request for immediate proposals to provide security, including control of vehicles and enforcement of weapons-free zones.

Several established companies called the proposed timetable unrealistic, but Mr. Custer and Mr. Battles promised to have a security team in place within two weeks and they won the bidding. To make the proposal credible, Mr. Custer and Mr. Battles had hastily lined up subcontractors with relevant experience. But at least two crucial partners left the project within months, citing disputes over company practices.

That autumn, an inspector from the United States Army lambasted the company's airport security procedures.

"What we saw horrified us," Col. Richard Ballard wrote in a memo on Nov. 28, 2003. Beyond undisciplined and poorly trained guards, he wrote, cargo trucks were often waved through without a search, and Custer Battles refused to cooperate with his review.

In a memo dated Nov. 21, 2003, a senior American adviser in the Iraqi Transportation Ministry, Charles E. McVaney, described Custer Battles as "incompetent" and "deceitful."

A coalition contract officer sent the company a warning letter detailing 13 areas of concern. In a long reply, the company said any disputes reflected the lack of clarity in their assignment. Custer Battles finished out the initial year of the airport contract but it was not renewed.

In the meantime, from its base in the airport, Custer Battles swiftly won several other security and logistical contracts worth $100 million. At the center of many fraud charges is a 2003 contract to provide logistical support for the urgent program to replace Iraq's currency.

To increase billing and profits, former associates have said in court documents, Mr. Custer, Mr. Battles and their partners formed several shell companies, some registered in the Cayman Islands. These were listed as suppliers of millions of dollars worth of equipment, at inflated prices and using false invoices, witnesses allege.

One of the most striking pieces of evidence, critics say, is a company spreadsheet that Mr. Battles accidentally left on the table after a meeting in Baghdad. The spreadsheet was retrieved by coalition authority officials and is part of the lawsuit record.

Item by item, it lists the company's actual expenditures and the far higher costs reported to the coalition authority for reimbursement, claims far exceeding the 25 percent markup allowed. The spreadsheet shows that the company spent $240,000 for 12 trucks, to give one of dozens of examples, but told the authority it spent $600,000, for a gain on this item of $360,000, or 150 percent.

Judge Ellis's decision on the prior question, the applicability of the False Claims Act, is likely to be appealed by the losing party. Still, a decision that the act applies, together with the Justice Department's supporting stance, will be widely seen as a green light to whistle-blowers, said Mr. Schooner, the legal expert.

"There is every reason to believe that a significant number of attorneys around the country are preparing False Claims Act cases," he said.

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