O'Melveny law firm faces feds' legal suit: court clears the way for professional-breaches charges.

O'Melveny & Myers can be sued by Federal Deposit Insurance Corp., which has charged the law firm with professional breaches in work it did on a securities offering for American Diversified Savings Bank six weeks before the thrift was taken over by federal regulators, the Ninth Circuit Court of Appeals has ruled.

Charging O'Melveny with professional negligence, negligent misrepresentation and breach of fiduciary duty, the FDIC is suing the largest law firm in Los Angeles for an amount exceeding $10 million, the costs of the failed offering, said Ted Russell, an attorney for the federal agency which insures deposits of failed banking institutions.

In response to inquiries, O'Melveny & Myers issued a statement through a spokesperson: "The firm believes the decision is erroneous and will probably seek reconsideration in the U.S. Court of Appeals in San Francisco."

The ruling on June 29 could open a floodgate of litigation against law firms which represented failed savings and loan institutions by federal regulators looking for restitution, say banking and legal experts.

Steven Friedman, a Beverly Hills Attorney who has represented law firms in banking cases, said the ruling is important because it holds the law firm responsible for the action of its client.

"We're talking about payback time," said Sal Serrantino, president of California Research Corp., a Santa Monica-based financial consulting firm. "When a federal appeals court rules that a (bank) regulator can sue law firms for negligence . . . what about shareholders (of failed institutions) looking at huge losses? They're going to go after law firms, too."

FDIC spokesman Andrew Porterfield said the decision gives the agency the ability to sue law firms when they suspect simple negligence. "Before we had to find gross negligence or far more serious negligence," Porterfield said.

O'Melveny was hired by the Costa Mesa-based American Diversified in September 1985 to prepare a securities offering of two limited partnerships to sell to investors, according to court papers.

According to court papers, O'Melveny prepared a private placement memorandum, a document designed to induce investors to buy units in the partnership, without consulting with the bank's regulators, former law firm or two accounting firms. Five months earlier, one of the CPA firms, Touche, Ross & Co., had told the bank and federal regulators that it believed "the bank's net worth was less than zero."

Nevertheless, O'Melveny circulated its private placement memo to prospective investors in late 1985 which made no mention of the bank's financial soundness and the securities transaction closed on Dec. 31, 1985, according to court papers. American Diversified was placed in conservatorship by the Federal Savings and Loan Insurance Corp. on Feb. 14, 1986, Russell said.

Investors who put "many millions of dollars" into the limited partnership "raised a storm of protest" that they were not told of the bank's shaky financial condition, Russell said. The federal government paid the investors back all their money, he said.

Now, the FDIC, which succeeded the FSLIC as receiver of the savings and loan, is seeking to make O'Melveny pay for the legal fees, broker's fees and other costs of the failed offering, as well as the loss one of the partnerships took on a commercial office building it bought for investors before the thrift was taken over, Russell said. He said that amount exceeds $10 million.

In 1989, the FDIC brought a case against O'Melveny charging the firm was negligent in its work in the offering, but a Los Angeles district court ruled the FDIC could not sue the law firm. The latest ninth circuit court reversed that decision.

If O'Melveny does ask the court to reconsider and the court rules in favor of the FDIC again, the firm's only recourse would be to appeal to the U.S. Supreme Court, Friedman said.

The ninth circuit court decision states that both O'Melveny and the FDIC agree that the bank's financial position was far from sound and that bank officials had cooked the books.

"O'Melveny's position is that a lawyer owes no duty to uncover a client's fraud nor to advise the client and the world of that fraud," the court decision reads.

However, the ninth circuit court justices disagreed, writing that it is an attorney's duty "to protect the client from the liability which may flow from promulgating a false or misleading offering to investors."

Friedman said this part of the ruling is controversial. "What the court is saying is, 'You, Mr. Lawyer, Mr. Accountant, you have a duty when you became licensed to the public to protect them from the perpetration of a fraud."