Law Firm Nightmare: Clients Using Lawyer Services for Ponzi Schemes.

AuthorFucile, Mark J.

"'[The mastermind] was so charismatic and his Ponzi scheme so sophisticated that he duped everyone, including [the lawyers].'"

~Norton v. Graham and Dunn, P.C.,

2016 WL 1562541 at *11 (Wn. App. Apr. 18,

2016) (unpublished)

THERE are few risk management problems that law firms confront that are potentially more catastrophic than the discovery that a seemingly "good" client has used the firm's services for a Ponzi scheme or similar fraud. (1) Although circumstances vary, a classic scenario is the one illustrated by the opening quotation: an outwardly successful and celebrated business person has duped hundreds of investors--and the law firm. Once unmasked, the master-mind and any compatriots are almost inevitably on their way to jail, the business involved quickly spirals into bankruptcy, and angry litigants begin circling the professional firms that--presumably unknowingly--provided services to the business.

When a firm discovers that a client has used its services to further a fraud, three questions usually rush forward: (1) must or should the firm withdraw? (2) what can the firm disclose in its defense? and (3) what are the areas of potential exposure and what practical steps can a firm take in advance to better protect itself? This article surveys all three.

  1. Withdrawal

    Lawyers who knowingly participate in a fraud are usually on a short path to a new line of work and years of litigation. (2) In fact, ABA Model Rule 1.2(d) (3) expressly prohibits a lawyer from assisting a client "in conduct that the lawyer knows is criminal or fraudulent[.]" ABA Model Rule 8.4(c) similarly prohibits a lawyer from engaging in "conduct involving dishonesty, fraud, deceit or misrepresentation[.]" ABA Model Rule 1.16(a)(1), in turn, requires a lawyer to withdraw when "the representation will result in violation of the rules of professional conduct or other law[.]" Doing nothing once a client fraud is discovered is not an option.

    The wrongdoer is occasionally a "lone wolf in an otherwise upstanding company. In that circumstance, the law firm may be able to remain and assist the client in dealing with the fall-out. In most circumstances, however, four practical factors weigh against the law firm continuing to represent the client.

    First, the "lawyer-witness rule"--ABA Model Rule 3.7--may effectively disqualify the firm because the question of whether the firm knew about--or at least suspected-the wrongdoer's misconduct is often central to subsequent litigation. Under ABA Model Rule 3.7, a firm lawyer who will be a trial witness is personally disqualified from being an advocate at trial. That may not present a practical barrier to a firm continuing to represent the client if the lawyer who worked with the wrongdoer is a transactional attorney who would not be trying any resulting case anyway. But, if a firm lawyer's testimony will be averse to the firm's client, then ABA Model Rule 3.7 ripens into a rule of firm disqualification...

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