By Neil V. Getnick and James P. Schratz. Mr. Schratz, formerly Vice-President at Fireman’s Fund, is now president of Jim Schratz & Associates, a consulting firm in Santa Rosa, California. Mr. Getnick, the managing partner of Getnick & Getnick LLP, a Manhattan law firm, was counsel to the litigation team that undertook the successful civil prosecution of “the Alliance”.
Published in Civil Prosecution News, Vol. 1 No. 2, Winter 1994.
The group of California attorneys known as “the Alliance” got away with insurance fraud for years. They may have gotten clean away, were it not for the fact that one of the defrauded companies, Fireman’s Fund Insurance Company, responded to the news of a possible billing scheme not by following the traditionally risk-averse practices of the insurance industry and paying up, but by adopting a get-tough attitude and launching an intensive investigation based on the civil prosecution methodology.
That investigation, aggressively pursued first by Fireman’s Fund and then concurrently by the federal government, uncovered an attorney-generated scam that had cost the insurance industry in excess of $200 million, and resulted in multiple criminal convictions for mail fraud, perjury and violations of the RICO statute, together with a civil RICO settlement in favor of the defrauded companies.
The unraveling of the Alliance scheme commenced in 1986 when a claims adjustor in San Diego noticed that claims for legal costs in his area were running in excess of five times the normal rate. In the most recent chapter of this saga in June, 1994, the Ninth Circuit Court of Appeals affirmed the RICO and mail fraud convictions of the attorneys who formed the Alliance, ruling that the sending of legal pleadings via the mails can form the basis of a mail fraud predicate under RICO. (U.S. v. Mason No. 91-50690 (9th Cir. June 15, 1994). (See Recent Developments, this issue.) Multiple counts of mail fraud were also the predicates in the civil RICO action, which had earlier been settled in favor of the defrauded companies.
The Alliance case is a study in the aggressive use of proactive investigative techniques and the multidisciplinary investigative team approach by a defrauded corporation in co-operation with law enforcement authorities, directed towards the building of successful civil and criminal RICO prosecutions. The result was the cessation of the fraud, the recovery of insurance company losses, and the conviction of the perpetrators.
Background to the Alliance: How was the scam possible?
In 1984 the California Court of Appeals ruled that in certain circumstances insurance companies no longer had the right to select counsel for the insured. Insured individuals and entities were thus authorized to select their own attorneys, who came to be known as “Cumis” counsel (from the name of the case, San Deigo Navy Federal Credit Union v. Cumis Insurance Society, Inc. 162 Cal. App. 3d 359 (1984)). The insurance companies were still obliged to pay the Cumis counsel’s fees even though they had no control over the attorneys’ conduct of the case; indeed (under the system devised by the Alliance) carriers could be sued for “bad faith” by the Cumis counsel if they were too strident in demanding an explanation for the size of a Cumis counsel’s bill.
The modus operandi
The Alliance capitalized on the Cumis decision. The organizer of the Alliance, Lynn Boyd Stites, established a network of attorneys (all of them sole practitioners or members of small law firms in the Los Angeles area) administrative personnel, clients and potential clients over whom he exercised control.
The objective of the Alliance was to infiltrate existing lawsuits and create new lawsuits in order to establish Alliance attorneys as Cumis counsel. The attorneys were then in a position to engage in a variety of fraudulent billing practices against insurance companies that had not retained them and yet were obliged to fund them. Through Stites, the Alliance attorneys were assigned to represent both sides in the insurance litigation, allowing them to prolong the lawsuits and resist settlement.
Clients to be represented by Alliance members were recruited by Alliance members, who paid them kickbacks in return for their acquiescence in the plan. Clients were also paid kickbacks to recruit other clients to the scheme.
Lawsuits involving Alliance members were characterized by an array of amended complaints, cross-complaints, demurrers, motions and the taking of numerous and unnecessary depositions that generated huge bills. Administrative and paralegal staff were also co-opted into the scheme.
On one occasion, for example, paralegals were told to change all the pronouns in depositions back to proper names, generating a bill of $186,000.
Stites had three rules that Alliance members had to follow: (1) They were not to talk about the cases to anyone; (2) they were not to cooperate with insurance companies in any way; and (3) they were not to settle a lawsuit without Stites’ authorization.
In many cases, the legal fees generated by Alliance attorneys far exceeded the amount in dispute. And yet the insurance companies kept paying the bills – indeed, the Alliance counted on the fact that the insurance companies were less inclined to risk the cost of a Cumis attorney countersuit for “bad faith” by probing too deeply into suspected fee inflation, than they were to continue to pay the cost of a suspected fraud.
The unraveling of the scheme: Fireman’s Fund investigates
That is, until Jim Schratz, then an assistant vice-president for major claims of Fireman’s Fund, was alerted by the San Deigo claims adjustor to the excessive billing in his area in 1986.
Schratz’s first case for investigation was one in which investors had lost around $4 million in a real estate investment. By the time Schratz became involved, the legal bills had grown to $10 million. Schratz personally met with the plaintiff’s attorney, a member of the Alliance, who demanded $1.8 million to settle, which Schratz accepted. The attorney called back two days later and said he meant $4.3 million. Three days later, it was up to $7.1 million.
Schratz went to the top executives of Fireman’s Fund. They agreed that the short term cost of a full-scale investigation was money well spent in the interests of uncovering and putting a stop to the fraud Schratz suspected was underway. Fireman’s Fund assembled its private economic crime unit – or civil prosecution team – of investigators, auditors and attorneys. Ultimately, the Fireman’s Fund team consisted of private investigators, a legal auditing firm, the law firm of McNitt, Edwards & Schraner in San Diego, and Getnick & Getnick LLP in New York, together with Notre Dame law professor G. Robert Blakey, specializing in civil RICO and the civil prosecution of business crime.
Following the civil prosecution methodology, Fireman’s Fund devised an investigation/litigation plan that directed itself at all stages to identifying and pursuing the following goals: investigating the activity; stopping the fraud; initiating legal action; encouraging parallel criminal prosecution; tracing funds and locating assets for recovery of losses; and obtaining judgment and effecting recovery. The contemplated legal action underlying the pursuit of these goals was a civil RICO action with its advantages of treble damages and attorney fees and the potential for parallel criminal prosecution. Laying the predicate for a criminal action and the development of a working relationship with law enforcement authorities was an important element of the overall team effort. From the outset, the team’s efforts, under counsel’s guidance, were geared toward assembling the evidence that would make for a successful lawsuit. Each member of the team was integral to that effort.
Seasoned investigators were hired to go out into the field and gather facts from all possible (legal) sources, including interviews with former law-office staff, public record searches and surveillance.
The Alliance attorneys refused to allow Fireman’s Fund auditors access to their offices to conduct on-site audits of files and to interview attorneys, paralegals and law clerks who had billed time to cases. Nonetheless, the auditors (consisting of both experienced attorneys and certified public accountants) were able, with the aid of sophisticated computer programs, to “unscramble” the fraudulent bills submitted by the Alliance attorneys, exposing double billing and other fee inflations.
Information was managed using litigation support software, and by maintaining fully indexed files of hard copy, so that information and documents to support every step in the anticipated litigation, from the preparation of the complaint to document discovery to the conduct of depositions, could be dealt with in a timely and efficient manner.
Thus equipped, the legal oversight and planning of the investigation was expertly informed not only of the relevant law but of the full factual context in which the fraud was perpetrated. Perhaps more importantly, the legal co-ordination of the investigation was undertaken with an attitude and an approach that was bold and assertive. Too often, lawyers follow instincts that tell them to look for reasons why things cannot be done, rather than to pursue creatively and aggressively all appropriate legal avenues in representing their clients’ interests. The need for “can do” lawyering is particularly crucial in the area of civil RICO. This is because the same fact pattern can be viewed as producing any of a number of target defendants, enterprises and patterns of racketeering activity.
Parallel civil and criminal prosecutions
A cornerstone of the civil prosecution approach is parallel prosecution. Fireman’s Fund alerted the U.S. Attorney’s Office in San Diego to the suspected fraud early in its investigation. In November, 1988, a federal grand jury investigation commenced in the Southern District of California, targeting the Alliance members for possible violations of RICO, mail fraud and other federal criminal statutes.
By the time the civil RICO lawsuit was filed in March, 1990, seven Alliance members had pled guilty to mail fraud and two of its members had been indicted for perjury before the grand jury. The guilty pleas by those members, who were also defendants in the civil suit, not only collaterally estopped those defendants from denying the RICO predicates underlying the case, but made them ready candidates for a swift civil settlement. Their co-operation with prosecutors and information they provided against other defendants who had not pled guilty shored up the civil case against those remaining defendants when the criminal RICO indictments and convictions were later obtained. Stites was convicted of RICO violations and sentenced to 12 years imprisonment.
The civil RICO action was based on multiple counts of mail fraud, consisting of mailings made by the attorneys in the course of litigating the fraudulent lawsuits. Twenty-seven defendants were named as an association-in-fact RICO Enterprise, directed by Stites and consisting of fifteen Cumis attorneys, five administrative personnel, four controlled plaintiff attorneys and three “cappers” (clients who were paid to induce other clients to join the Alliance). The complaint in the action identified six “infiltrated lawsuits” and sought $6 million in identified damages together with equitable relief.
The civil RICO case was settled before trial with recoveries in the millions of dollars to Fireman’s Fund, Allstate Insurance Company, and State Farm Insurance Insurance Company. Allstate and State Farm also were defrauded by the Alliance and joined Fireman’s Fund in the action. In addition, Fireman’s Fund recovered $4 million in fraudulently billed legal fees, on which payment had been withheld when the attorneys refused to allow Fireman’s Fund to conduct on-site audits.
Parallel prosecution: Why corporations should take the lead
Why was the expense and trauma of the investigation and civil action undertaken by Fireman’s Fund necessary if the criminal convictions put a stop to the activity and were accompanied by adequate orders for restitution? Why should corporations take matters into their own hands when they suspect they are the victims of fraud, rather than rely on public authorities to protect them? There are several reasons.
One is that without the fruits of the investigation conducted by Fireman’s Fund when it uncovered the tip of the Alliance iceberg, there would most likely have been insufficient evidence of criminal activity to interest or even justify an investigation by the government to begin with. The Alliance scheme wasn’t born fully developed, but rather it evolved through three phases. The first phase was characterized by a churning of lawsuits and by paying kickbacks to clients. In the second phase, the Alliance found plaintiff’s attorneys who were willing to act as directed by the defense attorneys. In the third phase, kickbacks were actually paid to plaintiffs’ attorneys and complete control was exercised. Without the phase 3 kickbacks, the case may not have been criminally indictable. It certainly would have been much more difficult to prove – possibly too difficult to be a reasonable or feasible undertaking for an overburdened U.S. Attorney’s office. Until that kind of “smoking gun” evidence was developed by Fireman’s Fund, the case might have been viewed by the U.S. Attorney’s office as a billing dispute between the defendants and the insurance companies.
Another reason is that prosecutors’ objectives are often served by securing a single high profile conviction and jail sentence. The deterrent impact of such a conviction can, from the viewpoint of the prosecutor, be a significant and sufficient contribution in the war against business crime. An isolated case, however, will not adequately address the needs of a corporation seeking compensation for and a cessation of systemic business fraud or fraud occurring in a variety ways.
The corporation’s responsibility to police itself
Another reason is that government policies are increasingly assigning responsibility to corporations to police themselves. Corporations seeking redress for business crimes via the civil prosecution methodology and in particular parallel prosecution should be aware that cooperation between the government and private parties in the fight against business fraud is not only permitted by judicial and legislative authority, but is increasingly encouraged by government programs and policies and by the policies underlying legislative initiatives like the federal corporate Sentencing Guidelines. The RICO statute itself was provided with a dual enforcement mechanism, civil and criminal. Civil RICO was designed to supplement the government’s limited resources.
The Sentencing Guidelines (28 USC § 996), which became law on November 1, 1991, are designed to ensure that corporate sanctions are not only just, but provide incentives for corporations to maintain self-policing mechanisms and to co-operate with the government in the event that such mechanisms disclose illegal activities. The Guidelines assign to corporations primary responsibility for the prevention, detection and reporting of criminal conduct within their ranks and for fully co-operating with and assisting law enforcement authorities. In so doing, they mandate a “partnership” between the government and the corporation in the investigation of corporate criminal conduct.
Cooperation between corporate victims and law enforcement is also in accord with federal law enforcement guidelines. For example, the Attorney-General’s Guidelines for undercover operations authorize the FBI to participate in joint undercover operations with “any suitable informant, confidential source or other cooperating private individual,” and to use a corporation or other business entity as a “front” for the conduct of an undercover operation. These guidelines state that the use of “undercover employees … is a lawful and essential technique in the detection and investigation of white collar crime.” (Department of Justice Manual, 1-2.303C)
The right of crime victims to assist and take an advisory role in investigations is, furthermore, asserted and protected by federal legislation. Under the Victims’ Rights and Restitution Act of 1990, victims’ rights include the right to confer with the attorney for the government and the right to restitution. Investigators and prosecutors must make their best efforts to see that victims of crime are accorded those rights (42 USC § 10606). Investigators and prosecutors are required to provide timely status reports to victims (42 USC § 10607). Similarly, the Victim and Witness Protection Act of 1982 (18 USC §§ 1501, et seq.) encourages cooperation with the government by victims and witnesses and protects them from intimidation.
As a Ninth Circuit court observed recently in IBM v. Brown, 857 F.Supp 1384 (C.D. Cal.1994):
“It is often difficult and virtually impossible for large corporate victims to secure prosecution of crimes committed against them, especially if they are unwilling or unable to make a significant contribution to the criminal investigation at their own expense. The result had been that crimes against large corporations may be committed with criminal impunity, subject only to the risk of civil recovery. This virtual lack of criminal exposure for white collar crime against large corporations may be partly responsible for a dramatic increase in business crimes over recent years. The effects of such an increase may be such ills as higher prices and loss of jobs.”
In the case of the fraud perpetrated by the Alliance, the result was almost certainly higher premiums to policy holders over the period during which the fraud was perpetrated and the loss of business as a consequence. The Alliance fraud may never have been uncovered had Fireman’s Fund not embraced a corporate culture that promoted a long term view of fighting fraud and an aggressive pro-active stand. The civil prosecution approach to uncovering and seeking redress for the fraud provided Fireman’s Fund with an effective and targeted weapon for translating that corporate philosophy into action.
“The Alliance case is a study in the aggressive use of proactive investigative techniques and the multidisciplinary investigative team approach by a defrauded corporation in co-operation with law enforcement authorities, directed towards the building of successful civil and criminal RICO prosecutions.”
“Fireman’s Fund assembled its civil prosecution team of investigators, auditors and attorneys … From the outset, the team’s efforts, under counsel’s guidance, were geared toward assembling the evidence that would make for a successful lawsuit. Each member of the team was integral to that effort.”
“The civil RICO case was settled before trial with recoveries in the millions of dollars to Fireman’s Fund … In addition, Fireman’s Fund recovered $4 million in fraudulent billed legal fees.”
“Cooperation between the government and private parties in the fight against business fraud is not only permitted by judicial and legislative authority, but is increasingly encouraged by government programs and policies and by the policies underlying legislative initiatives like the federal corporate Sentencing Guidelines.”