One of the state's major education consulting firms has paid $3.4 million to settle a whistle-blower's lawsuit alleging that it routinely falsified claims to get more money from the state.

Rancho Cordova-based Mandated Cost Systems Inc., which works for hundreds of school districts across California, agreed to the settlement in a case that was kept under seal during an investigation by the state attorney general's office.

The company was investigated under the California False Claims Act, which seeks to protect taxpayers from fraud against the government. A former employee of Mandated Cost Systems filed the suit, which the attorney general's office joined after determining there was enough evidence to warrant it.

The whistle-blower, Chris Marquez, worked for the firm from 1995 to 1997. He received $884,000 of the settlement.

According to his lawsuit, managers at the firm routinely instructed employees to alter data received from districts, to double or triple amounts claimed, to vary numbers from one year to the next to avoid raising suspicions, and to create data when no backup documentation existed.

The lawsuit states that the falsified records then were submitted to the state through the mandate reimbursement process, which repays schools for the cost of providing programs or services required by the state. The suit suggests that the state paid school districts "millions of dollars' worth of claims based solely on the false claims and documents."

In the settlement agreement, filed in Sacramento Superior Court on April 2, the company denied it violated the False Claims Act. An attorney representing the firm told The Bee Tuesday that although employees made errors, which have since been resolved, the firm did not file fraudulent claims with the state.

However, Christopher Ames, senior assistant attorney general, said the settlement amount suggests otherwise.

"They paid $3.4 million," he said. "That speaks volumes."

Lawyer Malcolm Segal, who represented the company, said that in fact the firm agreed to the $3.4 million settlement to avoid a drawn-out court fight. "This was a little snapshot in time where a mistake was made and it has been rectified," he said.

Mandated Cost Systems prepares and files claims for districts across the state. The firm, founded in 1992 by Steve Smith, has consulting contracts with 675 of California's 1,000 school systems, including nearly 50 in the Sacramento region.

Through the mandate process, schools get reimbursed for tasks the state requires, such as notifying parents their children are truant, preparing for earthquakes and negotiating with unions.

A Bee investigation of the education mandate process, published last Sunday, found it has grown into a convoluted system that cost the state nearly $1 billion over the last five years. The Bee found that the mandate process has spurred a fiscal feeding frenzy among schools and their consultants, who claim every dollar they can, saying it is necessary because the state doesn't give them enough money.

One of the biggest players in the mandate process has been Smith and his firm, Mandated Cost Systems. Smith formerly worked as an auditor for the state controller's office, and over the years has touted that experience in notices to districts, saying he is an expert in getting the most money out of the mandate process. He referred all questions to Segal, his attorney.

During the last school year, Smith's firm brought in more than $730,000 from school systems in the four-county region, The Bee's review of mandate claims revealed. The contracts ranged from $3,800 for small districts to $83,800 for the largest. The districts, in turn, get reimbursed for those costs.

Marquez began preparing claims for Mandated Cost Systems in 1995. In an interview this week, he said he was criticized frequently by his bosses for failing to turn in high enough expenses for districts. He was terminated after two years, he said.

Segal said he could not discuss the termination.

After leaving the company, Marquez said, he brought his concerns about inflated claiming to the state controller's office, which handles the mandate claims and payments.

The controller demanded documentation from the districts and found enough evidence of inappropriately claimed money that the office took some of it back, said Richard Chivaro, the controller's chief counsel. Chivaro's office referred the matter to the attorney general's office in March 1998.

At the same time, Marquez filed his own lawsuit in Sacramento Superior Court in November 2000 -- a move necessary for him to retain his whistle-blower status and get a share of any settlement. He was represented by the law firm Stevens & O'Connell.

Under the state False Claims Act, such suits are kept under seal while the attorney general's office investigates. Ames, the senior assistant attorney general, said Marquez's complaint was one of the clearest and most detailed he had ever encountered.

Ames and his partner in the state investigation, Deputy Attorney General Melinda Vaughn, declined to discuss the evidence they found, but said their investigation substantiated major points in Marquez's lawsuit. They said they found no evidence to suggest school districts had intentionally done wrong.

"MCS supervisors instructed employees to alter original numbers received from the districts in order to increase amounts claimed as reimbursable," Vaughn said.

According to handwritten notes on internal company documents obtained by The Bee, employees of the firm, including Marquez, were instructed to alter data obtained from school districts and to create records when they did not exist. The instructions came in cases where districts did not have actual documentation to prove they spent staff time carrying out a mandate, or when they did not have enough documented bills to meet the $200 minimum filing amount in effect at the time.

In one example from 1997, Marquez was instructed by a supervisor to increase claims for interdistrict attendance permits and interdistrict transfer requests for the tiny Arcohe Union School District in south Sacramento County. Among the notes written on his review sheet: "Every claim that's $100 or higher I want bumped up regardless of $ amount. I want a claim every year for IAP. Increase time spent, counts, whatever. Get a claim."

Jack Hansen, superintendent of Arcohe, said he could not speak to the claims that year because he took charge of the district only this year. But Hansen said he plans to review the district's claiming process.

"It's something we definitely want to review to make sure we're legal," Hansen said.

In other instances, the internal company documents show employees being told to "bump up" figures, to "vary #s a little," and to "edit time" to highly specific numbers of hours such as 30.17 and 22.58.

Segal, the attorney for Mandated Cost Systems, declined to discuss any specific documents. In general, he said, the comments on the documents involved a few former employees who were not complying with the company's policies. He also said estimates are allowed in the mandate claiming process.

However, Chivaro, the state controller's chief counsel, said estimates are an ongoing point of contention between his office and consultants. For some mandates, estimates are allowed under certain circumstances. But mostly, Chivaro said, actual data are required to back up claims.

In recent weeks, Smith sold his company to his former chief executive officer, Jeff Williams, for an undisclosed amount. It now is called MCS Education Services.

Segal said the sale came about because Smith did not want to spend so much time dealing with business, personnel and legal issues. He continues to work for the company as director of governmental and client relations.

Marquez, who now works as an accountant for a private firm, said his life has been in turmoil as a result of the suit.

Ames and Vaughn praised Marquez for his courage in coming forward on behalf of taxpayers.

"Hopefully we sent a message that if this goes on, it can be costly to the perpetrator," Ames said.

"The other message," Vaughn added, "is to the insiders: That if you see abuse, you can come forward. These cases are filed under seal, and there are protections to employees."