Lawyers as Whistleblowers

Lawyers as Whistleblowers
The New York Law Journal by Howard W. Goldstein  -  May 5, 2011

Last month, the Internal Revenue Service made the first whistleblower payment in the four-year history of its whistleblower program. 1 While word of the $4.5 million payout spread like wildfire, whistleblower rewards are hardly new. Nearly 150 years ago, Congress enacted the False Claims Act (FCA), in part to incentivize private parties to bring qui tam suits on behalf of the U.S. government for violating the Act. The incentive to those parties, known as relators, was the ability to reap a payment of one half of all monies recovered,2 an award reduced to a 30 percent maximum (plus reasonable costs and fees) under the 1986 FCA amendments.3  Similarly, under the proposed Dodd-Frank Act regulations, whistleblowers will reap up to 30 percent of the damages. But lawyers beware: a recent decision in the Southern District of New York, United States ex rel. Fair Laboratory Practices Associates v. Quest Diagnostics Incorporated,4 makes clear that lawyers, while not specifically barred from being relators, will typically be prohibited from bringing qui tam actions against their former clients.

The Facts

Relator Fair Laboratory Practices Associates (FLPA) commenced a $1 billion qui tam suit in the Southern District in June 2005, alleging that Quest Diagnostics Incorporated and Unilab Corporation violated the Federal Anti-Kickback Act by engaging in a so-called pull-through scheme whereby they charged customers below cost rates in exchange for referrals of Medicare and Medicaid reimbursable lab tests.5 Andrew Baker, Richard Michaelson and Mark Bibi, all former employees of Unilab, formed FLPA to bring the qui tam action. Baker served as CEO of Unilab from 1993 through 1996; Michaelson was CFO from 1993 to 1996, and then director until 1997; Bibi was Unilab's general counsel from 1993 until Spring 2000 and the only lawyer that Unilab employed.6  Around 1997, Unilab raised its below-cost prices nearer to cost, which negatively impacted not only Unilab's customer base and profits, but, ultimately, Baker's tenure as CEO. Nonetheless, Baker's successor continued to raise prices.7  In 1999, Kelso & Co. acquired Unilab through a leveraged buyout for $5.85 per share and installed yet another CEO. The new CEO allegedly reinstituted Unilab's former pull-through scheme.8 lso around this time, the Office of the Inspector General of the Department of Health and Human Services (OIG), issued Advisory Opinion 99-13, which stated that, when companies such as Unilab offered prices below cost, the OIG would infer the existence of a pull-through scheme.9 Bibi apparently investigated this letter, but was later "frozen out" from giving advice on compliance matters to Unilab. Bibi left Unilab in March 2000 and joined Baker and Michaelson at Life Sciences Research, Incorporated.10  In 2003, Kelso sold Unilab to Quest for about $26.50 per share, an over $20 increase since Kelso's 1999 acquisition. The surge in stock price intrigued Baker. In response to his inquiries, he learned that the new CEO had reinstituted the pull-through scheme, which increased profits. Baker and Bibi further confirmed Quest and Unilab's intentions to continue their pull-through schemes with other sources.11  Armed with the belief that Unilab and Quest were defrauding the government, Baker asked Michaelson and Bibi to join him as relators.12 Bibi reviewed the then governing New York Code of Professional Conduct and the American Bar Association (ABA) Model Rules of Professional Conduct and concluded that he could act as a relator in the action against his former client and disclose information learned while he was general counsel of Unilab.13

The Court's Opinion

Quest and Unilab moved to dismiss the action, claiming that state ethics rules prohibited both Bibi's participation as a relator and his disclosure of confidential information. The court granted the motion, noting that the FCA did not preempt state ethics rules and holding that Bibi's prior representation of Unilab barred his participation in the qui tam action.14  New York Code of Professional Responsibility DR 5-108(A) prohibited an attorney from representing "another person in the same or substantially related matter in which that person's interests are materially adverse to the interests of the [attorney's] former client," and from using "any confidences of the former client except as permitted by DR 4-101."15 In response to the motion to dismiss, FLPA argued that Bibi's client had been Quest's subsidiary, Unilab, and action against Quest alone would not violate DR 5-108(A). Going further, it argued that the rule did not even apply to Bibi, because he was merely a relator and not counsel of record.  The court found neither argument persuasive. Judge Robert P. Patterson dealt with the corporate family conflict issue in a footnote and in a paragraph discussing the remedy. He concluded that a Quest-only action would be materially adverse to Unilab, since monetary damages against Quest would harm Unilab, Quest's wholly-owned subsidiary.16  Regarding FLPA's argument that it was not representing another party (and thus did not trigger DR 5-108), the court found that DR 5-108 applied and that a plaintiff in a qui tam action represents the U.S. government. Because DR 5-108 clearly prevented Bibi from serving as counsel of record in the qui tam action, the rule likewise barred him from participating as a relator on behalf of the government.  Judge Patterson noted that a contrary holding "would allow counsel to skirt the protections afforded to clients under DR 5-108 by simply hiring outside counsel to represent them in any action substantially related and materially adverse to a former representation."17  The court then addressed Bibi's use of Unilab's confidential information, which the relators justified under the intention to commit a crime exception to maintaining client confidences contained in DR 4-101(c)(3).  That rule permitted (but did not require) an attorney to reveal "[t]he intention of a client to commit a crime and the information necessary to prevent the crime. . . ."18 The court found that Bibi could have reasonably believed Quest and Unilab intended to commit a crime in 2005, when FLPA instigated the action. But disclosure of client confidences learned prior to that time, going back to 1996, were not necessary to prevent the crime in 2005.  Because DR 4-101 applied only to future crimes, it did not allow an attorney to act as a whistleblower for a client's past crimes. Judge Patterson therefore concluded that even if DR 5-108 did not bar Bibi's participation as relator, dismissal was warranted because his disclosures of client confidences were improper.19  Finally, Judge Patterson concluded that disqualification of Bibi alone could not guarantee that the remaining relators would not use the wrongly disclosed information in their suit, and that allowing the case to proceed "would allow Baker and Michaelson to profit from Bibi's breaches of Unilab's disclosures."20  Indeed, FLPA stood to profit as much as $300 million, or 30 percent of the $1 billion alleged damages.21 Disqualification of FLPA's counsel was further necessary to shield Quest and Unilab from the improper use of their confidential information.22

Preemption?

The first legal question faced by Judge Patterson was whether the FCA's interest in encouraging whistleblowers preempted state ethics rules governing attorneys. Relying on Second Circuit precedent,23 Judge Patterson noted that when interpretation of a state ethics rule conflicts with federal interests, "a federal court interpreting that rule must do so in a way that balances the varying federal interests at stake."24  Judge Patterson identified two federal interests: encouraging qui tam actions and "the government's interest in preserving the attorney-client privilege."25 He held that neither interest warranted a finding that the state ethics rules governing an attorney's obligation to preserve client confidences were inapplicable, and therefore applied the applicable state rules.  Interestingly, the Securities and Exchange Commission's (SEC) proposed regulations under the Dodd-Frank Act appear to reflect the same deference to the rules governing client confidentiality. Under the SEC's proposed regulations, to avoid conflict between incentivized whistleblowing and the protections for confidential communications, attorneys who learn of a client's violations will not be permitted to bring a private action to avenge the client's wrongdoing,26 unless the applicable state rules permit disclosure.27  This is a markedly different approach to confidentiality than the approach of the SEC's 2003 rules implementing Sarbanes-Oxley, which specifically permitted disclosure of confidential information to the SEC without regard to state ethics rules: "Where the standards of a state or other United States jurisdiction where an attorney is admitted or practices conflict with [SEC standards of professional conduct], this part shall govern."28

Corporate Family Adversity

Judge Patterson concluded that Bibi, the former general counsel to Unilab, had a disabling conflict because a possible adverse verdict against Quest would have a materially adverse economic impact on Unilab. While this conclusion is not necessarily incorrect, relegation of this issue to a footnote understates the complexity of determining whether adversity to one member of a corporate family creates adversity to other family members.29  According to the ABA, "the Model Rules of Professional Conduct do not prohibit a lawyer from representing a party adverse to a particular corporation merely because the lawyer . . . represents, in an unrelated matter, another corporation that . . . is owned by it. . . ."30   Not one year ago, in GSI Commerce Solutions, Inc. v. BabyCenter, L.L.C., the Second Circuit, deciding a similar issue of first impression, noted: "we agree with the ABA that [corporate] affiliates should not be considered a single entity for conflicts purposes based solely on the fact that one entity is a wholly owned subsidiary of the other. . . ."  In GSI, the Second Circuit considered the degree of the subsidiary's reliance on the parent corporation for administrative matters, the sharing of an in-house legal department, the overlap in management control between the two affiliates, and the financial interdependence of the parent and subsidiary. Based on these facts, the court concluded in that case that a law firm, representing a parent corporation in another matter, could not be counsel in a law suit against its subsidiary.31  In a 2007 ethics opinion, the New York City Bar Association (City Bar) determined that a "nuanced and fact-specific approach to corporate-family conflicts is necessary." Such approach includes consideration of whether the affiliate is a de facto current client, the risk of the responsibilities to one client materially limiting the representation of the other, and knowledge of client confidences that might preclude representation. The city bar identified adverse economic impact as just one of many concerns. Like GSI, the opinion suggested factors such as sharing of corporate personnel or offices, noting that finding an adverse relationship will depend on how closely the corporate affiliates are intertwined.32 The record in Quest reveals no examination of operational commonality, administrative matters or any other non-financial factors. Moreover, the financial interdependence between Quest and Unilab seems to have been assumed. At oral argument, relator's counsel contended that Quest and Unilab had "not put in a shred of factual information to support" their claim that a substantial monetary judgment against Quest would adversely affect Unilab.33 If that in fact was the case, and if the other factors indicated a fair degree of subsidiary independence, the conflict of Bibi pursuing a Quest-only case is not self-evident.

Conclusion

As the Quest case suggests, attorneys contemplating disclosure of client confidences should think long and hard about the consequences. While sunlight is generally the best disinfectant, it also burns from time to time. The New York Rules of Professional Conduct are particularly protective of client confidences,34 and those lawyers practicing in New York should therefore take extra care when deciding whether to disclose, let alone attempt to collect on, client misconduct. .

Howard W. Goldstein is a partner at Fried, Frank, Harris, Shriver & Jacobson. Kathleen R. Fitzpatrick, an associate at the firm, assisted in the preparation of this article.

Endnotes:

1. Ashby Jones, "After Four Years, the IRS (Finally!) Makes a Whistleblower Payment, WALL STREET J. L. BLOG, April 8, 2011, http://blogs.wsj.com/law/2011/04/08/after-four-years-the-irs-finally-makes-a-whistleblower-payment; Daily Mail Reporter, "Encourage Others to Squeal': IRS awards $4.5m to accountant after tip off in first ever whistleblower award, DAILY MAIL ONLINE, April 8, 2011, www.dailymail.co.uk/news/article-1374938/IRS-gives-4-5m-accountant-tip-whistleblower-award.html.
2. S. Rep. 99-345, at 8, 10 (1986), reprinted in 1986 U.S.C.C.A.N. 5266, 5273, 5275; see 31 U.S.C. § 3730.
3. See 31 U.S.C. § 3730(d).
4. United States ex rel. Fair Lab. Practices Assocs. v. Quest Diagnostics Inc., 05-Civ-5393, 2011 WL 1330542 (S.D.N.Y. Apr. 5, 2011).
5. Id., at *1-*2; see Amended Complaint, Quest, 05-Civ-5393, ¶ 147 (S.D.N.Y. Nov. 18, 2009). The Second Amended Complaint (SAC), which is the subject of Quest and Unilab's motion to dismiss is currently filed under seal, as are the parties' moving papers
6. Quest, 2011 WL 1330542, at *1.
7. Id. at *2.
8. Id.
9. Id. at *3; see also Letter from OIG to [Redacted], dated Nov. 30, 1999, regarding "OIG Advisory Opinion No. 99-13," available at http://oig.hhs.gov/fraud/docs/advisoryopinions/1999/ao99_13.htm.
10. See Quest, 2011 WL 1330542, at *3. Because part of the opinion is redacted, Bibi's exact actions are unknown.
11. Id. at *3-*4.
12. Id. at *4.
13. See id.
14. Id. at *5-*7
15. N.Y. Code of Prof'l Responsibility 5-108(A) (2007). The Court, in its opinion, relies on the former New York Code of Professional Responsibility, which was in place when FLPA brought the action and Bibi revealed the confidential information in question. Analysis under the New York Rules of Professional Conduct, enacted April 1, 2009 and amended January 28, 2011, would likely yield similar results. Compare N.Y. Code of Prof'l Responsibility DR 4-101, 5-108 (2007) with N.Y. R. Prof'l Conduct 1.6, 1.9 (2011).
16. Quest, 2011 WL 1330542, at *5-*7, *6 n.13.
17. Id. *7-*8
18. N.Y. Code of Prof'l Responsibility 4-101(B)(3).
19. Quest, 2011 WL 1330542, at *9-*10.
20. Id. at *12, *14.
21. See 31 U.S.C. § 3730(d)(1), (2).
22. Quest, 2011 WL 1330542, at *13
23. See Grievance Comm. For the S.D.N.Y. v. Simels, 48 F.3d 640 (2d. Cir. 1995).
24. Quest, 2011 WL 1330542, at *6 (quoting Simels, 48 F.3d 640, 646 (2d. Cir. 1995)).
25. Id. at *6.
26. See Securities & Exchange Commission, Proposed Rules for Implementing the Whistleblower Provisions of Section 21F of the Securities Exchange Act of 1934, 20 (November 3, 2010), available at http://www.sec.gov/rules/proposed/2010/34-63237.pdf ("Compliance with the federal securities laws is promoted when individuals, corporate officers, and others consult with counsel about potential violations, and the attorney-client privilege furthers such consultation. This important benefit could be undermined if the whistleblower award program created monetary incentives for counsel to disclose information about potential securities violations that they learned of through privileged communications.").
27. Id. The SEC carves out an exception to this rule, "where the attorney is permitted to disclose the substance of a communication that would be otherwise privileged." Id.
28. 17 C.F.R. § 205.1; see 17 C.F.R. § 205.3(b); (d)(2).
29. See, e.g., GSI Commerce Solutions Inc. v. BabyCenter, L.L.C., 618 F.3d 204 (2d Cir. 2010); Discotrade v. Wyeth-Ayerst Int'l, Inc., 200 F. Supp. 2d 355 (S.D.N.Y. 2002); Ass'n of the Bar of the City of New York Comm. on Prof'l & Judicial Ethics (City Bar), Formal Op. 2007-3 (2007); ABA Comm. on Ethics & Prof'l Responsibility, Formal Op. 95-390 (1995).
30. ABA Comm. on Ethics & Prof'l Responsibility, Formal Op. 95-390 (1995).
31. GSI Commerce Solutions, Inc., 618 F.3d at 210-12.
32. City Bar, Formal Op. 2007-3.
33. Transcript, Quest, 05-Civ-5393, 86:16-20 (S.D.N.Y. Dec. 15, 2010).
34. See, e.g., N.Y. R. Prof'l Conduct 1.13(c).