Whistleblower Rejects Allegations of Abusive Fee Generation

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By Michael J. Bologna

A tax whistleblower beat back suggestions that his 1,000 false claims lawsuits constitute “abusive fee generation,” telling the Illinois Supreme Court his conduct is grounded in state statute and supervised by the attorney general.

During May 22 oral argument before the high court, Stephen B. Diamond, the most prolific tax whistleblower in the country, argued the Illinois Appellate Court wrongly stripped him of more than $600,000 in attorney fees in a case he won against the retailer My Pillow Inc.

The appeals court ruled Diamond couldn’t collect both a bounty under the Illinois False Claims Act (FCA) as the relator in a qui tam action, and attorney fees as counsel for the relator. The appeals ruling, released in June 2017, focused on public policy concerns of “abusive fee generation if a lawyer were permitted to represent himself or herself pro se and then collect fees for the self-representation.”

High court justices peppered Diamond with questions about the appeals finding of abusive fee generation and My Pillow’s assertion that his 17-year pattern of lawsuits in Cook County Circuit Court was driven by an opportunistic fervor to generate fees against out-of-state retailers accused of sales and use tax code violations. Diamond stressed that the Legislature intended for the FCA to provide not only bounties for funds recovered when relators successfully demonstrate frauds against the state, but also reasonable attorneys’ fees to support their courthouse campaigns.

More importantly, Diamond said attorney fees realized as part of his litigation couldn’t be characterized as abusive because relators are closely supervised by the Illinois Attorney General. The attorney general retains control over critical features of each case, holding primary authority to investigate, intervene, settle, and dismiss actions brought by relators. In the context of his own FCA litigation, Diamond noted that the attorney general had executed this “gatekeeper” function, dismissing hundreds of cases and settling others against his instincts.

“Every case the relator has brought, and there have been several hundred, the attorney general has authorized the relator to continue with the case after conducting an investigation,” Diamond told the court. “So the idea that there is some abuse here is controverted by the fact that the attorney general has authorized every case that we’ve filed.”

Abusive Fee Generation

But the counsel for My Pillow had little patience for an attorney known to some as the “king of qui tam,” calling his business model the very definition of abusive fee generation.

“This case provides a prime example of some of the abuses that can and do occur in these False Claims Act cases brought by this relator,” said Catherine A. Battin, a partner with McDermott Will & Emery in Chicago and counsel to My Pillow. “It violates the purpose of the act and the public policy of this state to award attorneys’ fees, where the potential for abusive fee generation or actual abusive fee generation occurs.”

Diamond’s original 2012 action in circuit court challenged Chaska, Minn.-based My Pillow’s failure to collect and remit tax on millions of dollars of remote sales to Illinois customers. During a trial in September 2014, Diamond demonstrated that My Pillow ignored its tax duties on sales from internet and telephone sales platforms. The court awarded $782,667 in damages and penalties, with $266,891 reserved for Diamond. The court also awarded $600,960 to Diamond in attorney fees.

Eligibility for Fees?

On appeal, a three judge panel upheld the circuit court’s judgment with regard to damages and penalties, but reversed on Diamond’s eligibility for attorney fees.

Much of the appeals court’s ruling relied on the Illinois Supreme Court’s 1989 decision in Hamer v. Lentz. The court in Hamer held that an attorney proceeding pro se in a claim under the Illinois Freedom of Information Act (FOIA) wasn’t entitled to fees based on concerns of abusive fee generation, despite a fee-shifting provision in the act. The appeals court pointed to these same policy considerations in the context of Diamond’s pattern of lawsuits, noting that Diamond has “made a business” of filing FCA claims.

High court justices asked Diamond why the public policy concerns grounded in Hamer didn’t apply to his conduct in My Pillow.

Diamond said the concerns expressed in Hamer don’t apply because unlike the FOIA, the FCA grants a gatekeeper authority to the attorney general and limits opportunities for abuse by relators and lawyers for relators.

Diamond pointed to the Illinois Supreme Court’s decision in Scachitti v. UBS Financial Services, which held both the state and the relator are real parties in interest in an FCA action, and that the state attorney general’s control diffuses any potential for abusive fee generation.

“Here, as Scachitti pointed out, the attorney general is the independent counsel that Hamer wanted,” Diamond said.

Attorney General’s Control

Diamond added that Scachitti recognized that the attorney general’s control is rooted in statutory provisions granting the state authority to intervene, settle, and dismiss FCA cases.

In the context of My Pillow, Diamond noted that the Special Litigation Bureau of the office of the attorney general was actively involved, eliminating opportunities for abuse. He noted bureau attorneys investigated the claim, authorized the claim to proceed, reviewed all pleadings and orders of the court, attended depositions, attended the trial, and assisted in the determination of damages.

Though not mentioned in court, Illinois Attorney General Lisa Madigan filed a friend-of-the-court brief supporting the appeals precedent in My Pillow. 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.”

Diamond used a portion of his time to stress that his lawsuits shouldn’t be characterized as abusive because he has uncovered significant tax frauds against the state, pointing to recoveries of approximately $25 million. Moreover, Diamond said his cases have had a “prophylactic effect” on retailers, causing them to collect and remit taxes to the state. He noted initial cases against Target Corp. and Walmart Inc. caused the retailers to comply with the state tax code.

“The fact that our lawsuits precipitated settlements with Target and Walmart, the largest retailers in the state, who then started collecting tax on their internet sales, shows the statute has worked exactly as it was intended to work,” he said.

Significant Potential for Abuse

Battin objected on multiple fronts, telling the high court the potential for abusive fee generation is significant in scenarios where fees are routinely provided to a law firm that is both a relator and counsel for the relator.

In the context of My Pillow, Battin noted Diamond initially billed more than 2,000 hours in the case and nearly three times the attorney fees billed by the defense counsel. In addition, Diamond abused the process by billing for time acting as both attorney and client, and even billed My Pillow for time spent testifying at trial as a witness.

More importantly, Battin said attorney fees would be inappropriate because Diamond’s business model doesn’t feature the type of independent legal representation envisioned by the state Supreme Court in Hamer.

“Relator lacks sufficient independent and objective detachment from its member lawyers to justify eligibility of an award for fees in this case,” she told the court. “These are the very same reasons that this court held the pro se litigant in Hamer wasn’t entitled to attorneys’ fees and the very considerations that have uniformly and repeatedly applied in the Illinois appellate courts, including the first district in this case.”

The case is Illinois ex rel. Schad, Diamond & Shedden PC v. My Pillow, Inc. , Ill., No. 122487, oral argument 5/22/18 .

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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