By Griff Witte
Washington Post Staff Writer
Friday, May 13, 2005; E03

A federal judge in Alexandria yesterday questioned opposing attorneys over two questions at the center of a whistle-blower suit that could set precedents for future cases involving allegations of fraud by contractors in Iraq:

Can a contractor that allegedly stole Iraqi money, not U.S. funds, be sued in U.S. court? And was the authority that ran Iraq for a year after the fall of Saddam Hussein part of the U.S. government?

In a two-hour hearing, attorneys for the whistle-blowers and the Justice Department squared off against lawyers for Fairfax security contractor Custer Battles LLC as U.S. District Judge Thomas Selby Ellis III presided.

Ellis said he hopes to decide soon whether the case -- the first of its kind to be made public -- will go forward.

Two men who worked for Custer Battles have charged that the firm defrauded the U.S.-led Coalition Provisional Authority of millions of dollars by using shell companies in the Cayman Islands and elsewhere to submit phony bills for work in Iraq. Custer Battles has denied the charges, and its attorneys have sought to dismiss the case because they say it doesn't belong in U.S. courts.

Custer Battles attorney John T. Boese argued yesterday that the money at stake in the case -- seized funds, donations and oil sales -- belonged to Iraq, not the United States. Thus, he said, the U.S. government could not have been a victim of fraud.

"If the government doesn't have any economic gain from obtaining the seized funds, it doesn't suffer an economic loss by losing the seized funds," Boese said.

"Does it have to be the government's money?" Ellis asked Justice Department attorney Michael F. Hertz in response.

Hertz said no.

U.S. anti-fraud law, he said, "protects not only the dollars that belong to the U.S., but also protects the integrity of the process for handing out funds."

Whistle-blower attorney Alan Grayson picked up on that point, noting that the United States may not have owned some of the Iraqi money but that it did control it and decide where to spend it. He said the CPA, which led Iraq's reconstruction until June of last year, was headed by Ambassador L. Paul Bremer, an American. He also said Custer Battles's contracts had been administered by U.S. Air Force and Army officials.

Boese countered that the CPA was a multinational institution with officials from numerous countries. He said the contracting officials with which Custer Battles worked insisted that the company's contracts were with the CPA, not the U.S. government.

Hertz said that for the purpose of this case, the CPA was a U.S. "instrumentality." He also raised the possibility of a legal vacuum developing if the Custer Battles case is not allowed to proceed because the CPA and its contractors were exempt from Iraqi law.

"Where does somebody go to seek redress if in fact the defendants committed fraud on those contracts?" he asked.

The Justice Department, which passed up a chance to join the plaintiffs' case last year, submitted two briefs this spring in which it argued that U.S. anti-fraud law should apply, even though the CPA was the apparent victim. The briefs came after multiple requests from Ellis, who chided the Justice Department yesterday for only reluctantly weighing in on the case. Ellis said it may be because the government doesn't want to expose itself to liability for the CPA's actions.

Hertz acknowledged that the government had written its briefs in the case "as narrowly as [it] could."