Katten Muchin Must Defend Malpractice Suit

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By Carla Main

July 9 — Katten Muchin Rosenman LLP must defend a lawsuit claiming the firm committed malpractice when it failed to keep an investment fund client from being cheated by a con man, the U.S. Court of Appeals for the Seventh Circuit ruled.

When the funds went belly up in 2008 as the result of fraud, a trustee was appointed by the bankruptcy court. He sued Katten Muchin in federal court in Chicago as part of a broader effort to recover from several sources the $3.5 billion lost in a fraud scheme orchestrated by Minnesota businessman Thomas Petters, who's now in prison.

Ronald Peterson, the trustee, claimed that when Katten Muchin advised fund manager Gregory Bell, the firm “failed to detect the peril the funds were in and help curtail their risk,” Circuit Judge Frank Easterbrook wrote July 7 for a three-judge panel.

Petters told Bell he was financing Costco's consumer electronics inventory, according to a court filing. The funds loaned money to vehicles set up by Petters. He insisted the funds not contact Costco, saying it would interfere with his business relationship. Proof of the collateral for the funds' loans was supposed to come from Costco paperwork and from Petters, who told Bell there would also be a so-called lockbox bank account into which Costco would deposit payments, according to court papers.

Costco never put money in the lockbox account.


“All of the money came from Petters,” the judge said. The setup left the funds “at Petters's mercy,” Easterbrook wrote. When the scheme collapsed, so did Bell's investment funds.

The trustee said Katten Muchin committed malpractice in the advice it gave on structuring the transactions with Petters. The firm argued that Gregory Bell, who set up and ran the funds, knew he was bypassing proof of payment from Costco to obtain a higher interest rate from Petters.

The district court dismissed the case, saying it was not the lawyers' job to provide advice on reducing risk.

The appeals court disagreed, noting that a main contention of the complaint is that Katten Muchin was obliged to alert its client to the risk of allowing repayments through Petters as part of its work in structuring the transaction.

Bell didn't understand the difference between funds from Costco and funds from Petters, and repayment through Costco “offers much better security,” Easterbrook wrote.

Advice Not Given

A client doesn't have to take a lawyer's advice. In this case, the complaint alleges the advice wasn't given, the court noted. The lower court didn't cite any law that says a transactions lawyer doesn't have to give a client legal information that could affect his business risk, Easterbrook said.

Petters was convicted in 2009 of 20 counts including fraud, conspiracy and money laundering. He's serving a 50-year prison sentence. Bell pleaded guilty in October 2009 to fraud for his role in feeding assets to Petters.

“It was anticipated,” the trustee's attorney, Edward T. Joyce of Chicago, said of the ruling. “There was nothing extraordinary about that decision” because it applied Illinois law.

Joyce expects the case to settle. “Unless somebody screws up, it won't go to trial,” he said.

Katten Muchin was represented by Peter C. John, a partner at Williams Montgomery & John Ltd. He didn't respond to a request seeking comment about the decision.

With assistance from Andrew Harris in Chicago; Bill Rochelle in New York; Sophia Pearson in Wilmington, Del.; and Manisha Jha and Jeremy Hodges in London

To contact the reporter on this story: Carla Main in New Jersey at cmain2@bloomberg.net

To contact the editor responsible for this story: Michael Hytha at mhytha@bloomberg.net

The Seventh Circuit opinion is available at http://www.bloomberglaw.com/public/document/Peterson_v_Katten_Muchin_ Rosenman_Llp_No_143632_ 2015_BL_216370_7t.

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