Prolific Tax Whistle-Blower Must Rethink Strategy

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By Michael J. Bologna

A Chicago lawyer regarded as the most prolific tax whistle-blower in the U.S. will have to reconsider his relentless litigation strategy in light of a state appeals court finding him ineligible for attorneys’ fees in false claims actions, tax practitioners told Bloomberg BNA.

Stephen B. Diamond, known as the “king of qui tam,” suffered the major legal setback June 15 when the Illinois Appellate Court found he couldn’t collect fees in an action under the Illinois False Claims Act (FCA) targeting the retailer My Pillow Inc. The ruling is precedent-setting for Illinois, focusing directly on the rewards available to whistle-blowers also serving as their own counsel ( Illinois ex rel. Schad, Diamond & Shedden P.C. v. My Pillow, Inc. , Ill. App. Ct., No. 152668, 6/15/17 ).

Tax attorneys representing defendants told Bloomberg BNA the My Pillow precedent could blow a hole in Diamond’s aggressive litigation model, which has involved the filing of almost 1,000 FCA actions against retailers around the globe over purported violations of Illinois’ sales and use tax code. The ruling preserves Diamond’s right to claim a bounty on dollars collected on behalf of Illinois, but rejects his demands for attorneys’ fees—a lucrative component of each lawsuit.

A Bloomberg BNA investigation last year revealed Diamond had racked up almost $12 million in proceeds from 371 settlements in FCA actions over 15 years. Of that total, $5.9 million was paid to Diamond in attorneys’ fees.

“We think it’s a big deal. Obviously, Steve is going to have to change the way he does business,” said Catherine A. Battin, a partner with McDermott Will & Emery LLP in Chicago and counsel to My Pillow. “Maybe there is a way to restructure, but I think this is the right result.”

David S. Ruskin, a partner in the Chicago office of Horwood Marcus & Berk Chartered who has represented dozens of defendants in FCA actions, applauded the court’s decision but cautioned that Diamond has been a resourceful and creative opponent. Ruskin said Diamond may seek an outside counsel in many of his cases to manage the My Pillow precedent.

“It certainly puts a dent in his plan, and it certainly will cause him to refocus how he does things, but it will not cause him to go away,” Ruskin said.

Manipulating FCA

Carol Portman, president of the Taxpayers’ Federation of Illinois, said she is pleased Illinois courts are finally taking Diamond to task for manipulating the intent of the FCA.

“The courts are finally seeing that these cases are not furthering the underlying goal of the statute,” Portman said. “That’s a wonderful development, but it’s hard for me to think there isn’t a workaround, or that this would be the death knell for these cases.”

Representatives of Diamond’s law firm, Stephen B. Diamond P.C., didn’t immediately respond to a request for comment. Battin and Ruskin both said they expect Diamond to appeal the ruling to the Illinois Supreme Court.

Diamond’s original action in 2012 challenged Chaska, Minn.-based My Pillow’s failure to collect and remit tax on remote sales to Illinois customers. During a bench trial in September 2014, Diamond successfully demonstrated My Pillow ignored its tax duties on sales from internet and telephone sales platforms. The court awarded $782,667 in the form of damages and penalties, and $600,960 in the form of attorneys’ fees.

Attorneys’ Fees Nixed

On appeal, the three-judge panel upheld the circuit court’s judgment with regard to the collection of taxes, but it reversed on Diamond’s eligibility for attorneys’ fees. The court found Diamond couldn’t achieve benefits in the litigation as both the whistle-blower, or relator, and the attorney for the whistle-blower.

Much of the court’s ruling relied on the Illinois Supreme Court’s 1989 decision in Hamer v. Lentz. The court held an attorney proceeding pro se in a claim under the Illinois Freedom of Information Act wasn’t entitled to fees, despite an attorneys'-fees provision in the act designed to ensure enforcement and minimize barriers to litigation.

Judge David Ellis, writing for the panel, said the high court’s reasoning was related to fears of “abusive fee generation if a lawyer were permitted to represent himself or herself pro se and then collect fees for the self-representation.”

Ellis pointed to these same policy considerations in the context of Diamond’s hundreds of lawsuits in circuit court. While agreeing that many of the actions “perform the valuable service of uncovering fraud against the state,” Ellis said Diamond has also “made a business” of filing FCA claims.

Ellis speculated that Diamond is likely more motivated by fees than the relator’s benefits under the FCA. The FCA rewards prevailing relators, granting bounties of between 15 percent and 30 percent of the proceeds of any successful lawsuits. He added that granting attorneys’ fees to a law firm that is also the relator “strikes us a double recovery.”

In the context of the My Pillow litigation, Ellis noted that Diamond’s bounty totaled $266,891, but fees and costs totaled $600,960. Ellis said the disparity between bounty and attorneys’ fees would be much larger in many of the hundreds of low-dollar cases filed by Diamond.

“It is hard to imagine, in other words, that the prospect of earning fees is not a significant driver in the decision to file these cases. It is presumably the reason why relator chooses to file these lawsuits in the name of the law firm and perform (or at least primarily perform) the legal work on the case, too—to obtain both the statutory percentage of recovery as well as attorney fees,” Ellis wrote.

Abusive Fee Generation

Battin said she was particularly encouraged by the court’s willingness to evaluate Diamond’s conduct in the context of broader policy considerations and the potential for abusive fee generation.

“That’s what we’ve seen in Illinois for all of these years,” she said. “The relator’s fee requests always seem very trumped up, particularly in the context of settlements where he has cookie cutter complaints and just swaps out the names and the products. And then he says there are huge attorney fees associated with drafting each complaint.”

Michael Wynne, a state and local tax partner with Jones Day in Chicago, said the ruling would force Diamond to focus his litigation strategy on large-dollar tax problems with potential for sizable bounties.

“The decision should limit the professional plaintiff—a lawyer who is bringing the case on behalf of his law firm as plaintiff—to large cases where the statutory share for success is sufficient reward without an additional award of attorneys fees,” Wynne said in an email.

If Diamond fails to get satisfaction from the Illinois Supreme Court, Ruskin predicted he would hire an outside counsel to represent him in future FCA litigation.

“He will use another law firm to do the legal work and enter into some agreement so that he still gets some of the benefits,” Ruskin said. “Or, he will set up his associates in a separate firm to represent them.”

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

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

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