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A Timely Niche
by Nathan Koppel, The American Lawyer

With the bar now obsessed about all things Sarbanes-Oxley, it's easy to forget about the lethal private regulators, aka the plaintiffs' bar, who stand ever ready to blame lawyers for corporate malfeasance. Curtis, Mallet-Prevost, Colt & Mosle needs no reminder.

The New York-based firm has been sued in Texas by hundreds of investors who claim that the firm aided a securities brokerage client in defrauding them out of hundreds of millions of dollars. The investors and their cast of lawyers have reached a tentative settlement with the firm for $24 million, an amount said by lawyers in the case to be fully covered by insurance.

The case is a reminder of the danger that law firms face when they associate with unsavory clients. At the center of the controversy is Jose Zollino, a former Curtis Mallet client and native of Mexico City. Zollino moved to San Antonio in the early 1980s and formed a group of investment companies under the moniker InverWorld. According to lawyers familiar with the operation, Zollino courted Mexican investors with promises that their money would be invested conservatively in United States-backed securities. But Zollino allegedly used client funds as collateral for loans, which he then used to purchase risky investments, such as Russian and Brazilian bonds and shares of real estate ventures.

InverWorld attracted more than 1,000 investors, according to court documents, and ultimately amassed more than $300 million. And through charm and money, say plaintiffs' lawyers, Zollino rose to the upper echelon of San Antonio society. But it all imploded in 1999, when InverWorld declared bankruptcy. In May, Zollino pleaded guilty to conspiracy to commit fraud and agreed to serve a 12-year sentence.

According to a class action filed against Curtis Mallet in 2000, the firm started advising InverWorld soon after the company's inception in 1981. Curtis Mallet, the investor plaintiffs' claim, helped Zollino incorporate various InverWorld entities in the Cayman Islands -- even though they were operated out of San Antonio -- so that InverWorld could evade SEC oversight. The firm also, according to the class complaint, drafted investor agreements that allowed InverWorld to use client funds as collateral for loans, without the clients' knowing about it. The class plaintiffs accused Curtis Mallet of fraud and of aiding InverWorld's breach of fiduciary duty.

"Curtis Mallet had massive conflicts of interest," says the investors' lawyer, Allan Diamond, a partner in Houston's Diamond McCarthy Taylor Finley Bryant & Lee. "It represented Zollino personally and it put its personal relationship with Zollino above its duties to [InverWorld] and its investors."

"The reality," responds Curtis Mallet's Peter Fleming Jr., "is that InverWorld was a client, InverWorld went bankrupt, and Curtis, among others, was sued." Fleming, the firm's litigation head, wouldn't comment on the case in detail but says that "the firm acted professionally and properly in its representation of InverWorld." The case was settled, he says, to "avoid the continuing cost and distraction of protracted litigation." Houston's Gibbs & Bruns represented Curtis Mallet.

At press time the bankruptcy and class action judges hadn't yet signed off on the $24 million settlement. Diamond says there is a "near zero" chance that the judges will object.

If he's right, Diamond will have overcome a high hurdle. The Private Securities Litigation Reform Act of 1995 requires most securities fraud claims to be litigated in federal court, where lawyers enjoy broad protection against fraud liability. But Diamond was able to sidestep federal court by focusing on common law fraud and breach of fiduciary duty claims. He raised some securities fraud claims against Curtis Mallet, but none involving U.S.-traded securities, which would have triggered federal court preemption.

Unfortunately for firms, Diamond sees more lawyer liability on the horizon. The 47-year-old lawyer specializes in a niche he calls "who-killed-the-company" litigation.

When a company goes under, banks, investors, or other parties connected to the company hire Diamond McCarthy to search for professional deep pockets, including lawyers and accountants. The firm, for example, is representing directors and officers of AgriBioTech Inc., a Henderson, Nev.-based forage and seed company that filed for Chapter 11 in 2000, in a suit against New York's Snow Becker Krauss and Charlotte's Womble Carlyle Sandridge & Rice. And earlier this year, Diamond McCarthy reached a $26 million malpractice settlement with Miami's Steel Hector & Davis and Chicago's Ross & Hardies, stemming from the Miami bankruptcy of Southeast Banking Corp.

Diamond first plied his who-killed-the-company trade at Dallas' Hughes & Luce, but, he says, he constantly encountered conflicts. So in March 2000 he and three other Hughes partners formed their own firm, which now stands at 36 lawyers.

That rapid growth is no surprise, given the tenor of the times. But it's bound to evoke more fear among lawyers than Messrs. Sarbanes and Oxley could have ever hoped for.