Law Firm Nightmare: Clients Using Lawyer Services for Ponzi Schemes

By Fucile, Mark J. | Defense Counsel Journal, January 2018 | Go to article overview

Law Firm Nightmare: Clients Using Lawyer Services for Ponzi Schemes


Fucile, Mark J., Defense Counsel Journal


"'[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2016) (unpublished)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.

I. 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 because the firm would have a non-waivable conflict. (4)

Second, the "crime-fraud" exception to the attorney-client privilege may put the firm's work on public display in subsequent litigation. (5) Although formulations vary, the exception is generally invoked when a client (or a client representative) consults with or uses a lawyer's advice in furthering a crime or fraud. (6) The lawyer consulted need not know of the client's purpose for the exception to apply. (7) Although framed as an exception to the attorney-client privilege, some courts have extended the logic to the work product and lawyer confidentiality generally. (8)

Third, the mastermind may contend that the law firm was representing him or her as an individual in addition to the corporate client involved in an effort to create a disqualifying conflict or to exclude evidence allegedly subject to a personal attorney-client privilege. (9) ABA Model Rule 1. …

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