Attorneys and Whistleblowing

The defendants in Quest moved to dismiss the qui tam action, claiming that state ethics rules prohibited a former in-house counsel's participation as a relator as well as his disclosure of confidential information. Judge Robert P. Patterson agreed and granted the motion. In so doing, he disqualified plaintiffs, including former in-house counsel, and their attorneys from serving as relators in a qui tam action.

Plaintiff Fair Laboratory Practices Associates (FLPA) had commenced the $1 billion qui tam suit in June 2005, alleging that Quest Diagnostics Incorporated (Quest) and Unilab Corporation (Unilab) violated the Federal Anti-Kickback Act by engaging in a so-called pull-through scheme in which they charged customers below-cost rates in exchange for referrals of Medicare and Medicaid reimbursable lab tests. Former Unilab employees Andrew Baker (CEO), Richard Michaelson (CFO) and Mark Bibi (General Counsel) formed FLPA to bring the qui tam action. During his employment at Unilab, from 1993 until Spring 2000, Bibi was the only lawyer that Unilab employed.

From about 1997 until 1999 ' when Kelso & Co. acquired Unilab through a leveraged buyout for $5.85 per share ' Unilab was raising its below-cost prices nearer to cost. Yet, Kelso's newly installed CEO allegedly lowered prices and reinstituted Unilab's former pull-through scheme. Also around this time, the Office of the Inspector General of the Department of Health and Human Services (OIG) issued an advisory opinion, which posited that the OIG would infer that companies such as Unilab that offered prices below cost engaged in an illegal pull-through scheme. Bibi apparently investigated this letter, but was later “frozen out” from giving advice on compliance matters to Unilab. He left the company shortly thereafter.

A few years later, Kelso sold Unilab to Quest for about $26.50 per share, a more than $20 increase since Kelso's 1999 acquisition. Intrigued by the increase, Baker made various inquiries and eventually learned that the new CEO had increased profits by reinstituting the pull-through scheme. Baker and Bibi further confirmed with other sources that Quest and Unilab intended to continue their pull-through schemes.

Certain that Unilab and Quest were defrauding the federal gvernment, Baker asked Michaelson and Bibi to join him as relators. 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.

The Court's Analysis

In deciding the Defendants' motion to dismiss, Judge Patterson noted that the FCA did not preempt state ethics rules, and held that former in-house counsel's prior representation of one defendant barred his participation in the action.

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.” Opposing the defendants' motion to dismiss, FLPA contended that a Quest-only action would not violate DR 5-108(A) because Bibi's client had been Quest's subsidiary, Unilab. FLPA further argued that the rule did not even apply to Bibi, because he was a mere relator and not counsel of record. Finding neither argument compelling, Judge Patterson 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.

Considering FLPA's position that Bibi 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 United States government. The court reasoned that because Bibi could not serve as counsel of record in the qui tam action under DR 5-108, he could not then act as a relator on the government's behalf. A contrary holding, according to the court, “would allow counsel to skirt the protections afforded to clients under DR 5-108.”

Regarding Bibi's disclosure of Unilab's confidential information, the FLPA contended that the “intention to commit a crime” exception to maintaining client confidences contained in DR 4-101(c)(3) justified such disclosure. That rule permitted, without requiring, an attorney to reveal
“[t]he intention of a client to commit a crime and the information necessary to prevent the crime' .” Although, according to the court, Bibi could reasonably have believed that Quest and Unilab intended to commit a crime in 2005, when FLPA instigated the action, disclosure of client confidences learned prior to that time were not necessary to prevent the crime in 2005. As DR 4-101 applied only to future crimes, an attorney could not act as a whistleblower ' and reap a financial reward ' for a client's past crimes. Thus, even if DR 5-108 did not bar Bibi's participation as relator, Judge Patterson held that dismissal was warranted because his disclosures of client confidences were improper.

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.” Indeed, FLPA stood to profit by as much as $300 million, or 30% of the $1 billion alleged damages. Disqualification of FLPA's counsel was further necessary to shield Quest and Unilab from the improper use of their confidential information.

Attorneys Need Not Apply?

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, 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.” The judge identified two federal interests: encouraging qui tam actions and the government's interest in preserving the attorney-client privilege. 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.

The new regulations under the Dodd-Frank Act, finalized on May 25, 2011, appear not to reflect the same level of deference to state rules governing client confidentiality. Under Rule 240.21F-4(b), attorneys who learn of a client's violations during the course of the representation will not be permitted to whistleblow, unless either the applicable state rules or 17 C.F.R. ' 205.3(d)(2) permit disclosure. Similarly excluded from the Rule is information obtained “through a communication that was subject to the attorney-client privilege,” except when state rules or 17 C.F.R. ' 205.3(d)(2) allow. But it is well known that the cross-referenced Sarbanes-Oxley (SOX) rules contemplate a conflict between state ethics rules and SOX, and resolve any such conflict in favor of the SEC rule permitting disclosure: “Where the standards of a state or other United States jurisdiction where an attorney is admitted to practice conflict with [SEC standards of professional conduct], this part shall govern.” 17 C.F.R. ' 205.1.

In issuing the final rules, the SEC noted that “[their] intention [is] that all attorneys ' whether specifically retained or working in-house ' are eligible for awards” so long as their disclosures “are consistent with their ethical obligations and our Rule 205.3.” Release No. 34 64545 at 60 (May 25, 2011). But the question remains whether the SEC's preemption clause in 17 C.F.R. ' 205.1 would be held by a court to overcome any conflict with state ethical obligations so as to protect the whistleblower attorney from a state disciplinary proceeding. And that issue may only be presented to a court after a state disciplinary body asserts its authority despite the SEC's preemption rule. In other words, a whistleblower attorney seeking financial reward has to be willing to stick her neck out.

Conclusion

As the Quest case suggests, and the new SEC regulations further support, attorneys seeking financial reward in exchange for disclosing client confidences should seriously consider both the possibility of success and the possibility of professional discipline. If nothing else, the enhanced size of a potential whistleblower award increases the odds that the preemption issue will soon be litigated.

Howard W. Goldstein ([email protected]), a member of this newsletter's Board of Editors, is a partner at Fried, Frank, Harris, Shriver & Jacobson LLP in New York. An earlier version of this article appeared in the New York Law Journal, an ALM sister publication of this newsletter. Kathleen R. Fitzpatrick, an associate at the firm, assisted in the preparation of this article.

The False Claims Act (FCA), enacted shortly after the Civil War, allows private parties, known as relators, to bring qui tam actions on behalf of the United States government for violating the Act, and awards those parties up to 30% of all monies recovered. See 31 U.S.C. ' 3730(d). Similarly, under the new Dodd-Frank Act regulations, whistleblowers may reap up to 30% of the damages over $1 million. But for lawyers, there's more to the calculus than just the potential payouts. Disclosing client confidences is fraught with difficult legal and ethical issues that are only further complicated when financial incentive drives disclosure.

While the FCA does not expressly prohibit an attorney-relator, a recent opinion from the Southern District of New York, United States ex rel. Fair Lab. Practices Assocs. v. Quest Diagnostics Inc., 05-Civ-5393, 2011 WL 1330542 (S.D.N.Y. Apr. 4, 2011), indicates that lawyers will typically be prohibited from bringing qui tam actions against their former clients. And the new Dodd-Frank regulations expressly limit when an attorney can reap a whistleblower reward.

The Quest Case

The defendants in Quest moved to dismiss the qui tam action, claiming that state ethics rules prohibited a former in-house counsel's participation as a relator as well as his disclosure of confidential information. Judge Robert P. Patterson agreed and granted the motion. In so doing, he disqualified plaintiffs, including former in-house counsel, and their attorneys from serving as relators in a qui tam action.

Plaintiff Fair Laboratory Practices Associates (FLPA) had commenced the $1 billion qui tam suit in June 2005, alleging that Quest Diagnostics Incorporated (Quest) and Unilab Corporation (Unilab) violated the Federal Anti-Kickback Act by engaging in a so-called pull-through scheme in which they charged customers below-cost rates in exchange for referrals of Medicare and Medicaid reimbursable lab tests. Former Unilab employees Andrew Baker (CEO), Richard Michaelson (CFO) and Mark Bibi (General Counsel) formed FLPA to bring the qui tam action. During his employment at Unilab, from 1993 until Spring 2000, Bibi was the only lawyer that Unilab employed.

From about 1997 until 1999 ' when Kelso & Co. acquired Unilab through a leveraged buyout for $5.85 per share ' Unilab was raising its below-cost prices nearer to cost. Yet, Kelso's newly installed CEO allegedly lowered prices and reinstituted Unilab's former pull-through scheme. Also around this time, the Office of the Inspector General of the Department of Health and Human Services (OIG) issued an advisory opinion, which posited that the OIG would infer that companies such as Unilab that offered prices below cost engaged in an illegal pull-through scheme. Bibi apparently investigated this letter, but was later “frozen out” from giving advice on compliance matters to Unilab. He left the company shortly thereafter.

A few years later, Kelso sold Unilab to Quest for about $26.50 per share, a more than $20 increase since Kelso's 1999 acquisition. Intrigued by the increase, Baker made various inquiries and eventually learned that the new CEO had increased profits by reinstituting the pull-through scheme. Baker and Bibi further confirmed with other sources that Quest and Unilab intended to continue their pull-through schemes.

Certain that Unilab and Quest were defrauding the federal gvernment, Baker asked Michaelson and Bibi to join him as relators. 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.

The Court's Analysis

In deciding the Defendants' motion to dismiss, Judge Patterson noted that the FCA did not preempt state ethics rules, and held that former in-house counsel's prior representation of one defendant barred his participation in the action.

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.” Opposing the defendants' motion to dismiss, FLPA contended that a Quest-only action would not violate DR 5-108(A) because Bibi's client had been Quest's subsidiary, Unilab. FLPA further argued that the rule did not even apply to Bibi, because he was a mere relator and not counsel of record. Finding neither argument compelling, Judge Patterson 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.

Considering FLPA's position that Bibi 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 United States government. The court reasoned that because Bibi could not serve as counsel of record in the qui tam action under DR 5-108, he could not then act as a relator on the government's behalf. A contrary holding, according to the court, “would allow counsel to skirt the protections afforded to clients under DR 5-108.”

Regarding Bibi's disclosure of Unilab's confidential information, the FLPA contended that the “intention to commit a crime” exception to maintaining client confidences contained in DR 4-101(c)(3) justified such disclosure. That rule permitted, without requiring, an attorney to reveal
“[t]he intention of a client to commit a crime and the information necessary to prevent the crime' .” Although, according to the court, Bibi could reasonably have believed that Quest and Unilab intended to commit a crime in 2005, when FLPA instigated the action, disclosure of client confidences learned prior to that time were not necessary to prevent the crime in 2005. As DR 4-101 applied only to future crimes, an attorney could not act as a whistleblower ' and reap a financial reward ' for a client's past crimes. Thus, even if DR 5-108 did not bar Bibi's participation as relator, Judge Patterson held that dismissal was warranted because his disclosures of client confidences were improper.

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.” Indeed, FLPA stood to profit by as much as $300 million, or 30% of the $1 billion alleged damages. Disqualification of FLPA's counsel was further necessary to shield Quest and Unilab from the improper use of their confidential information.

Attorneys Need Not Apply?

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, 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.” The judge identified two federal interests: encouraging qui tam actions and the government's interest in preserving the attorney-client privilege. 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.

The new regulations under the Dodd-Frank Act, finalized on May 25, 2011, appear not to reflect the same level of deference to state rules governing client confidentiality. Under Rule 240.21F-4(b), attorneys who learn of a client's violations during the course of the representation will not be permitted to whistleblow, unless either the applicable state rules or 17 C.F.R. ' 205.3(d)(2) permit disclosure. Similarly excluded from the Rule is information obtained “through a communication that was subject to the attorney-client privilege,” except when state rules or 17 C.F.R. ' 205.3(d)(2) allow. But it is well known that the cross-referenced Sarbanes-Oxley (SOX) rules contemplate a conflict between state ethics rules and SOX, and resolve any such conflict in favor of the SEC rule permitting disclosure: “Where the standards of a state or other United States jurisdiction where an attorney is admitted to practice conflict with [SEC standards of professional conduct], this part shall govern.” 17 C.F.R. ' 205.1.

In issuing the final rules, the SEC noted that “[their] intention [is] that all attorneys ' whether specifically retained or working in-house ' are eligible for awards” so long as their disclosures “are consistent with their ethical obligations and our Rule 205.3.” Release No. 34 64545 at 60 (May 25, 2011). But the question remains whether the SEC's preemption clause in 17 C.F.R. ' 205.1 would be held by a court to overcome any conflict with state ethical obligations so as to protect the whistleblower attorney from a state disciplinary proceeding. And that issue may only be presented to a court after a state disciplinary body asserts its authority despite the SEC's preemption rule. In other words, a whistleblower attorney seeking financial reward has to be willing to stick her neck out.

Conclusion

As the Quest case suggests, and the new SEC regulations further support, attorneys seeking financial reward in exchange for disclosing client confidences should seriously consider both the possibility of success and the possibility of professional discipline. If nothing else, the enhanced size of a potential whistleblower award increases the odds that the preemption issue will soon be litigated.

Howard W. Goldstein ([email protected]), a member of this newsletter's Board of Editors, is a partner at Fried, Frank, Harris, Shriver & Jacobson LLP in New York. An earlier version of this article appeared in the New York Law Journal, an ALM sister publication of this newsletter. Kathleen R. Fitzpatrick, an associate at the firm, assisted in the preparation of this article.