Fraud Investigation Forces Law Firm to Pay $23.7M

The Pennsylvania law firm of K&L Gates has reached a settlement for allegations that their fraud investigation work performed on the now defunct LeNature failed to uncover wrongdoing.   In 2003, three board members of LeNature suspected that the founder (Gregory Podlucky) was stealing money from the company.  The board members decided to hire K&L Gates to investigate whether this was true.  Sanford Ferguson led the investigation at K&L and issued a report that no fraud was suspected.

In 2006, LeNature filed for bankruptcy and Podlucky pleaded guilty to defrauding LeNature through the use of two sets of accounting books.  LeNature also tried to IPO in 2006, but it was prevented from doing so by the bankruptcy.  Sanford Ferguson was hired at the beginning of 2006 to assist LeNature and Podlucky in the IPO.

The settlement K&L Gates agreed to does not admit any wrongdoing.  The backruptcy trustee who brought the claim against K&L said that Ferguson lacked the experience necessary to adequately determine whether fraud had taken place.  The trustee also stated that much of the work was performed by junior lawyers.  This alledgedly caused Ferguson to overlook evidence that fraud had taken place and that three years worth of additional theft could have been prevented had he investigated properly.

Disciplinary actions could also face K&L Gates and Fergesun individually.  Now that the civil trial is concluded, the administrative and regulatory bodies will review the facts and decide if a disciplinary proceeding is warranted.

This case highlights a number of risk management issues law firms face today.

The first is to review the relative expertise of a firm to perform the duties they are engaged to do.  The trustee alleged that the lawyer assigned to the LeNature investigation lacked the necessary knowledge to effectively conduct a fraud investigation.  It is important that all firms engage with clients on services that the firm has expertise and confidence on.  If the firm lacks the necessary knowledge; contacting an outside firm, engaging an of counsel, or declining to perform the service are the best routes.

Secondly, proper oversight of junior staff is paramount.  If K&L allowed Ferguson to use junior lawyers to perform much of the work, and if Ferguson lacked the ability to provide proper oversight to the work, this may also have led to important facts going unnoticed.  Law firms should ensure that all work product of junior staff is reviewed and confirmed to avoid mistakes from surfacing or impacting the end result.

Finally, lawyers professional liability claims have deep impact.  K&L now faces a potential regulatory action.  To practice law means the potential for lawsuits – this much is obvious.  What is less obvious is that the impact of these lawsuits are more than just money from the firm’s pocket.  K&L wasted time, resources and money on this trial.  That is time and resources that could have been used to bring in new clients.  Now that the claim is completed, a possible disciplinary action could further hamper the firm’s future.  It is important for firms to consider the implications of a lawsuit on their time, reputation and even their ability to practice law in the future.

To discuss ways to protect your firm or to learn more about transferring some of this risk to lawyers malpractice insurance, contact us today.