Second Circuit: in-house counsel may not seek to profit as whistleblowers against former employers

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The United States Court of Appeals for the Second Circuit has issued an important ruling restricting in-house counsel from acting as whistleblowers in litigation against their current or former employers.

In United States ex. rel. Fair Laboratory Practices Associates v. Quest Diagnostics Inc., et al., the Second Circuit upheld a Southern District of New York ruling dismissing the action and disqualifying the former General Counsel of Defendant Unilab Corporation, a wholly-owned subsidiary of Defendant Quest Diagnostics Inc., as well as his co-relators, the former Chairman and Chief Executive Officer and former Chief Financial Officer of Unilab, and their outside counsel, from bringing any subsequent related qui tam action, on the basis that “such measures were necessary to prevent the use of [the former general counsel’s] unethical disclosures against defendants.” 

The decision, handed down on October 25, held that state statutes and rules regulating an attorney’s disclosure of client confidences were not preempted by the False Claims Act and that the former general counsel’s decision to “spill his guts and freely disclose Unilab’s confidential information” went well beyond anything that was authorized under the crime/fraud exception of the New York Rules of Professional Conduct, making it “virtually impossible to identify and distinguish each improper disclosure.”

The decision comes at a time of increased concern that lawyers serving as in-house counsel or compliance officers may “switch sides” and act as whistleblowers against their employers.i  Plaintiff’s counsel have also expanded the theories under which they seek recovery on behalf of whistleblowers.  Among these are the Dodd-Frank Act and the retaliatory discharge provisions of the Sarbanes-Oxley Act.  As the “relator’s share” awarded to whistleblowers continues to grow and be increasingly well publicized, and the statutes both encouraging reporting and providing for recovery to those who report grow, almost any company must navigate a difficult landscape in which to buy insurance and factor employee liability.  This ruling should provide some comfort to public companies and entities receiving government funds who fear that in-house counsel and compliance officers hired to identify and remediate risk may instead exploit it for personal monetary gain.

The relators in Fair Laboratory Practices were three former executives including the Chairman and Chief Executive Officer, the Chief Financial Officer, and the General Counsel of Unilab.  Mark Bibi, the former General Counsel, acted as Unilab’s sole in-house lawyer from 1993 to 2000, where he was responsible for all of the company’s legal and compliance affairs.  Years after their employment with Unilab ended, the three former executives (at least one of whom was in a tax dispute with the company and “felt shortchanged” after Unilab’s stock price rose) formed the entity known as Fair Laboratory Practices Associates (FLPA) for the express purpose of acting as a relator in a qui tam action against Unilab and its parent Quest.

The case itself focused on a health care industry statute.  FLPA alleged that, from at least 1996 through 2005, Unilab violated the Anti-Kickback Statute by operating a “pull-through” scheme in which they charged private managed care organizations and independent practice associations commercially unreasonable discounted prices on non-federal business in order to induce those entities to refer Medicare and Medicaid business to Unilab, which was then billed to the government at significantly higher prices than those charged to the private entities.  During his tenure as General Counsel, Bibi allegedly advised Unilab that its pricing practices violated the Anti-Kickback Statute, and obtained an opinion letter from an outside law firm concerning the practices at issue.  Bibi alleged that, as a result of his concerns, he was frozen out by management and eventually replaced as General Counsel.

After discovery on the issue of whether Bibi and FLPA had used or disclosed Unilab’s confidential information in their lawsuit, defendants filed a motion to dismiss, arguing that Bibi had violated the New York Rules of Professional Conduct governing the conduct of New York-licensed attorneys, including rules associated with (1) the use of confidential information to the disadvantage of a former client, and (2) representing a client with adverse interests to a former client in “the same or a substantially related matter.”  The District Court granted dismissal over FLPA’s objection that its disclosures were permitted under New York’s version of the crime/fraud exception.  This so-called exception to the attorney-client privilege is well known and recognized when the disclosure of confidential information is reasonably necessary to prevent the commission of an ongoing or imminent crime.  The crime/fraud exception has traditionally been applied where (1) the attorney’s advice was sought in furtherance of a knowingly unlawful end and (2) the unlawful end was a crime or civil fraud of moral turpitude.ii  The expansion of this “exception” in the context of regulatory violations, particularly when the attorney’s work was not used in furtherance of the same, is still very much in dispute.

The Second Circuit upheld the District Court decision, holding that “[n]othing in the False Claims Act evinces a clear legislative intent to preempt state statutes and rules that regulate an attorney’s disclosure of client confidences.”iii  The Second Circuit recognized that the broad disclosures made by FLPA went well beyond what was reasonably necessary to prevent any alleged ongoing crime in 2005 when the lawsuit was filed.  Indeed, the court noted that FLPA had divulged confidential information dating as far back as 1996 and had “pursued this litigation on the basis that Bibi could ‘spill his guts’ and freely disclose Unilab’s confidential information,” including the existence and content of the outside counsel’s opinion letter.

The Second Circuit further noted that while Bibi had consulted the New York Professional rules, as well as the American Bar Association’s Model Rules of Professional Conduct, he “did not feel it was necessary” to consult with the New York State Bar to verify his understanding of the rules prior to filing the lawsuit and making subsequent disclosures.  Citing Bibi’s unrestricted sharing of confidential information with his co-relators and the likelihood that such information was also shared with FLPA’s outside counsel, the complete dismissal of the action and disqualification of the FLPA relators and their outside counsel from filing any subsequent related qui tam action was also upheld.  The court noted that FLPA’s outside counsel argued they had not personally committed the ethical violations. But the court found the risk that Unilab’s confidential information had been shared with outside counsel was too great and that “[d]isqualification is not a sanction but a remedy that seeks to avoid the prejudice to the party whose confidences have been revealed and, in so doing, promote the integrity of our justice system.”iv

In sum, this case provides federal appellate support for the notion that employees (particularly in-house counsel) who come into possession of attorney-client privileged information, as well as their outside counsel hired to pursue whistleblower claims on their behalf, are taking on cases that will be at high risk for dismissal and perhaps for sanctions.  We suspect other courts will arrive at the same conclusion as the Second Circuit: the sanctity of the attorney-client relationship trumps allegations of regulatory violations (characterized by plaintiffs as the “crime” allowing the “exception” to be invoked).  It is apparent in the FLPA case that monetary gain was a driving force in bringing the claims – the individual relators created an entity for that very purpose.  In this regard, the Second Circuit found the dynamics of the case unacceptable for waiver of client confidences despite the possibility that the underlying claims may have had merit.