‘King of Qui Tam’ Runs Into Appeals Court Buzzsaw

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By Michael J. Bologna

A prolific tax whistleblower is having a tougher time making a living after his pattern of litigation under the Illinois False Claims Act hit a dry spell and a state appeals court cut off his ability to earn fees, data obtained by Bloomberg Tax reveals.

Chicago attorney Stephen B. Diamond, known to some as the “king of qui tam,” has seen a precipitous drop in his volume of false claims settlements over the past few years. Data provided by Illinois Attorney General Lisa Madigan shows that Diamond scored 13 settlements in 2016, four in 2017 and just two this year. Those numbers compare to 124 settlements in 2012, 36 in 2013, 54 in 2014, and 102 in 2015.

The data, provided by Madigan’s office after a Freedom of Information Act request by Bloomberg Tax, shows a corresponding drop in the dollar value of those settlements. Diamond’s personal share from settlements for 2012 through 2015 totaled more than $3.3 million, but that number dropped to about $1.4 million for the following two and a half years.

In a further indication of Diamond’s receding influence, his portfolio of active cases in Cook County Circuit Court has declined. Diamond has filed approximately 1,000 FCA actions over the last 17 years, and he frequently litigates hundreds of cases at the same time. A review of court records, however, reveals 68 active cases. The vast majority of Diamond’s cases allege violations of the sales and use tax code by out-of-state sellers.

Significantly, the settlement data reveals judges have generally denied attorney’s fees to Diamond over the last 12 months. While Diamond racked up attorney’s fees of more than $1 million per year for 2012 through 2015, his paychecks for legal work done on settlements in 2017 was less than $30,000 and zero in 2018.

This dramatic decline in attorney’s fees—a key driver in Diamond’s relentless litigation strategy—is attributable largely to the landmark My Pillow ruling, rendered by an Illinois appeals court panel in June 2017. The ruling, which found Diamond ineligible for attorney’s fees, is on appeal to the Illinois Supreme Court with oral arguments scheduled for May 22.

Petering Out

Paul Bogdanski, a state and local tax director with Grant Thornton LLP and a former general counsel for the Illinois Department of Revenue, said Diamond’s false claims blitz may be petering out.

“It’s obvious there has been a significant drop off. In 2017, there was $27,000 in attorney’s fees and so far this year, nothing. That’s telling,” Bogdanski said. “It’s trending in the wrong direction for him. This has been running for nearly 18 years, and maybe it has just run its course.”

But some suggest Diamond’s business model has merely entered a moment of transition.

“I think this is mostly a story where they’ve exhausted the low-hanging fruit. The recent cases have been too few and not as lucrative. The attorney’s fees issue is going to hit them potentially hard right now, until the model shifts,” said David Gamage, a professor of tax law at Indiana University’s Maurer School of Law.

Through his counsel Tony Kim, Diamond declined an opportunity to discuss the latest settlement data collected by Bloomberg Tax.

However, in a brief filed with the state Supreme Court seeking reversal in the My Pillow case, Diamond touted his lawsuits as a public service. He pointed to the recovery of unpaid taxes and penalties on behalf of the state through nearly 400 separate settlements. Any Supreme Court decision in My Pillow barring an attorney/whistleblower from recovering fees “threatens Relator’s ability to perform that valuable service,” Diamond told the court.

Fraud Against State

Actions under the False Claims Act (FCA) permit whistleblowers, or relators, to step into the shoes of the attorney general to sue persons who knowingly perpetrate frauds against the state. The FCA encourages relators to come forward, permitting them to share in any proceeds resulting from their lawsuits. Relators can generally claim attorney’s fees and court costs in claims that settle or succeed during a trial.

Critics, including retailers and taxpayer organizations, argue that Diamond isn’t a classic tax whistleblower—a corporate insider holding specific knowledge of misconduct. They accuse Diamond of establishing a litigation “cottage industry” that trolls the internet for remote retailers making minor mistakes under the tax code. In many cases, these critics contend, Diamond focuses on narrow issues that wouldn’t be flagged in an audit by the state revenue department.

In October 2016, Bloomberg Tax conducted a comprehensive analysis of 911 qui tam actions filed by Diamond during the previous 15 years. More than 500 actions were dismissed during that period, but Diamond also achieved 371 settlements, triggering payments of nearly $30 million from the defendants. While a large portion of the funds were transferred to Illinois, Diamond banked $5.7 million in settlement proceeds and another $5.9 million in attorney’s fees.

Settlement Trends

Several key findings emerged from the most recent batch of settlement documents obtained by Bloomberg Tax for 2016, 2017, and 2018.

Total settlement proceeds from Diamond’s cases have been slipping, peaking at $7.3 million in 2016. This high figure was due primarily to a single $6.27 million settlement involving computer retailer Gateway Inc. and subsidiary Cowabunga Enterprises Inc. after 13 years of litigation. This is the largest single settlement ever won by Diamond.

Total settlements dropped to $428,224 in 2017 and $112,422 in 2018. By way of comparison, Diamond scored total settlements of $4.7 million in 2012, $2.4 million in 2013, $2.7 million in 2014, and $1.4 million in 2015.

Diamond’s personal bounties, which are generally between 25 percent and 30 percent of settlement proceeds, totaled $1.25 million in 2016 (the year of the Cowabunga case), $124,018 in 2017, and $31,116 in 2018. Those numbers compare to bounties of $1.4 million in 2012, nearly $700,000 in 2013, $789,118 in 2014, and $435,258 in 2015.

Outside of the 2016 Cowabunga settlement, critics deride much of this activity as “nuisance settlements.” Ten of the recent checks cashed by Diamond were for amounts between $80 and $2,000. Most of these small settlements came from out-of-state wineries that failed to properly account for Illinois’ use tax on shipping and handling charges.

But the loss of attorney’s fees registers as the most striking data point from the most-recent wave of settlement documents. Diamond earned almost $5 million in attorney’s fees between 2012 and 2015, but only $487,531 in 2016, $27,100 in 2017 and nothing for the current year. Judges in at least four cases have denied or stayed attorney’s fees to Diamond, citing My Pillow.

‘Existential Threat’

Dennis Ventry, a professor of tax policy at the University of California Davis School of Law, pointed to several factors chipping away at Diamond’s false claims business model, including greater willingness by Madigan to intervene in these matters, higher degrees of judicial skepticism leading to hundreds of dismissed cases, retailers implementing meaningful tax compliance protocols, and national media attention aimed at Diamond’s practice.

While those factors should be concerning to Diamond, Ventry said the My Pillow case represents a bigger threat.

“There is an existential threat facing this guy, and maybe it’s not even an existential threat, maybe it’s the reality,” Ventry told Bloomberg Tax. “There are all these cases where he’s been stripped of fees. This one high profile case is on appeal, but it appears courts are willing to use the reasoning of My Pillow to strip fees in other cases.”

Under My Pillow, the appeals court agreed that Diamond had successfully demonstrated that the seller of high-end pillows had failed to collect and remit tax on merchandise sold to Illinois customers from internet and telephone sales platforms. The court affirmed a trial court’s award of $782,667 in damages and penalties, with $266,891 reserved for Diamond as a bounty.

However, the court also stripped Diamond of $600,960 in attorney’s fees, previously awarded by the trial court. The appeals panel held Diamond couldn’t achieve benefits as both relator and attorney for the relator.

‘Abusive Fee Generation’

The court expressed concerns about any litigation strategy by which attorneys might engage in “abusive fee generation.” The court cast a skeptical eye on Diamond specifically, noting that while some of his cases have uncovered substantial frauds, it is also clear that he had “made a business” of filing FCA claims. The court further speculated that Diamond was primarily motivated by fees rather than the relator’s benefits under the FCA, a scenario that “strikes us as a double recovery.”

Ventry said the latest batch of data obtained by Bloomberg Tax validates some of the court’s fears regarding abusive fee generation, with Diamond frequently earning more from fees than bounties.

For example, in 2013 Diamond’s share of 36 settlements was almost $700,000, but he won more than $1.1 million in attorney’s fees. In 2014, Diamond won about $790,000 from 54 settlements, but more than $1.5 million in fees. And, in 2015, Diamond won $435,258 from 102 settlements, but just more than $1 million in fees.

‘Parasitic or Non-Meritorious Lawsuits’

Madigan has also signaled frustration with Diamond’s aggressive demands for attorney’s fees.

In March, Madigan filed a friend-of-the-court brief with the Supreme Court in support of the My Pillow ruling. Only in “rare circumstances,” Madigan wrote, should judges permit relators to act as their own counsel and collect both attorneys’ fees and bounties. Doing otherwise risks distorting the “golden mean” between fair incentives for whistleblowers and patterns of “parasitic or non-meritorious lawsuits.”

A spokesperson for Madigan said the state would continue to monitor Diamond’s fee requests for indications of abusive fee generation.

“Generally in false claims cases, attorneys’ fees and costs are best resolved between the relator and defendant,” Madigan’s press secretary Annie Thompson told Bloomberg Tax. “In some cases, however, the request for fees are not fully consistent with the ruling in My Pillow, so we are monitoring and reviewing these requests. We will consider filing briefs with the Court as we have done previously.”

Diamond Strikes Back

But no one is expecting Diamond to go away quietly.

In a brief filed with the Supreme Court last December, Diamond said the My Pillow ruling endangers important features of the FCA. He stressed that relators bring incidents of fraud to the attention of the attorney general, capture revenue lost to the state due to fraud, and remedy fraudulent conduct on a going-forward basis.

In the context of his own litigation, Diamond said he had “recovered more than $25 million for State coffers and, more significantly, produced a continuing revenue stream from hundreds of violators who agreed to start collecting taxes when they settled a case against them.”

Diamond is also doing his part to rebuild his caseload, filing dozens of lawsuits primarily against bespoke tailors based in Hong Kong and the United Kingdom.

Diamond objects to a business model in which foreign and out-of-state tailors convene trunk shows and fitting meetings with Illinois customers at hotels in the Chicago area. Tailors working in remote locations sew the garments and ship them directly to Illinois customers.

Diamond contends the defendants create tax nexus with Illinois during these fitting sessions and are obligated to collect and remit taxes to the state. Diamond has said in court he intends to file as many as 85 lawsuits against custom tailors.

Plausible Tax Problems

Bogdanski and Gamage said the tax problems underpinning the tailor cases are plausible and deserve further examination in court.

“It is an interesting legal question,” Bogdanski said. “These companies definitely create a presence here. Whether it’s enough for nexus or not remains to be seen. But if they are doing this regularly and systematically, there might be some issues.”

In addition, Diamond is adapting his business strategy to deal with any post- My Pillow world where relator-attorneys are ineligible for attorney’s fees. Several new cases show Diamond is represented by a law firm called Kim & Burns LLP. The firm was recently formed by two of Diamond’s associates, Tony Kim and Matthew Burns. Judges have granted attorney’s fees to Kim & Burns.

On Feb. 1, Circuit Court Judge James Snyder denied Diamond’s request for $98,714 for legal work in a case against menswear retailer Knot Standard LLC. Snyder, however, granted Kim & Burns $5,896 for work done on behalf of Diamond. The case settled earlier for $72,146, with Diamond earning a bounty of $19,840.

Similarly, in litigation targeting CBS Interactive Inc. the court stayed Diamond’s petition for $43,415 pursuant to My Pillow, but awarded $16,171 to Kim & Burns. The case settled in January for $40,276, with Diamond earning $11,276.

Waiting on Supreme Court

Of course, the need for a Kim & Burns strategy will depend on the Supreme Court’s ruling in My Pillow. An opinion overturning the appellate court would sweep away Diamond’s necessity for separate counsel. But an opinion upholding the appellate court would likely cause Diamond to double down on Kim & Burns.

If the Supreme Court upholds My Pillow, Gamage predicted that Diamond would construct a litigation strategy featuring two separate operating structures.

“I would expect them to separate into a research organization and a legal organization that are sufficiently separate to satisfy whatever legal standard is established,” Gamage said. “I would not expect that to be a massive bar to what they are doing.”

Diamond’s Alter Ego

But Ventry expressed doubts about any legal representation scheme that might function as “Diamond’s alter ego.” He also warned that the high court may craft its opinion to demand a high degree of independence between a relator and counsel for a relator before courts could grant attorney’s fees.

At first blush, the Kim & Burns strategy doesn’t reflect the kind of independence that the court might require, Ventry said.

“If he called Sidley Austin to take care of this, maybe it would be different,” Ventry said. “But if you peel back the onion a little bit and look at the lawyers in this separate law firm and it turns out these are two folks he groomed, well that’s just a distinction without a difference. And My Pillow should apply.”

David S. Ruskin, a partner in the Chicago office of Horwood Marcus & Berk Chartered and counsel for dozens of companies sued by Diamond, predicted continuing litigation over attorney’s fees -- even if the high court expresses complete support for the appeals court’s opinion in My Pillow.

“Unless and until there is a challenge to the actual relationship between K&B and Diamond and someone can ‘follow the money’ to expose the lack of objective independence, their workaround should continue along with the abusive fee generation,” he said.

To contact the reporter on this story: Michael J. Bologna in Chicago at mbologna@bloomberglaw.com

To contact the editor responsible for this story: Ryan C. Tuck at rtuck@bloombergtax.com

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