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June 5, 2009 10:21 AM

Hedge Fund Indictment Says Cravath, Bryan Cave Were Duped

Posted by Zach Lowe

Federal prosecutors on Thursday unsealed an indictment charging the chief executive of what used to be one of the world's largest investment funds with constructing elaborate tax shelters for some of his wealthiest clients. The executive, Jeffrey Greenstein, former head of the Seattle-based fund Quellos Group, and two other defendants (including a Quellos in-house lawyer) face 18 counts related to tax evasion and fraud for a scheme that netted them $86 million in fees and allowed six clients to avoid paying about $400 million in federal taxes, according to the indictment. 

What's interesting for our purposes is that the indictment details how lawyers from Cravath, Swaine & Moore and Bryan Cave blessed the shelters with letters indicating to the taxpayers that they were legal and would withstand scrutiny from the Internal Revenue Service. (The firms are identified as C.S.M. and B.C. in the indictment, but two sources familiar with the matter confirm they are Cravath and Bryan Cave. In addition, a 2006 Congressional investigation mentioned the role the two firms played in the Quellos tax shelters, and at least one lawyer, Lewis Steinberg, then of Cravath and currently at Linklaters, testified before a Congressional subcommittee.)

Those sources say it is extremely unlikely the named firms or their lawyers will be charged with any crime, and the indictment accuses Greenstein and the other defendants of lying to outside firm lawyers in order to get those attorneys to bless the tax shelters. 

The scheme involved the creation of sham offshore funds that would engage in fabricated money-losing securities transactions in order to produce fictitious capital losses, according to the indictment. Greenstein and Charles Wilk, an in-house lawyer at Quellos, provided the "C.S.M." and "B.C." lawyers with documentation outlining what appeared to be legitimate operations, the indictment says.  

Greenstein's attorney, Andrew Levander of Dechert, released a statement on Thursday saying that Greenstein is innocent and will be acquitted. Levander said Greenstein was not aware the shelters were illegal, and that he only approved them after several "world class professionals" and tax experts told him they were legal. Wilk's lawyer could not immediately be located. 

Quello customers who benefited from the alleged illegal tax shelters included Robert Wood Johnson IV, an heir to the Johnson & Johnson fortune, and Haim Saban, a Hollywood animation producer whose projects have included "The Mighty Morphin Power Rangers." (Saban's lawyer, Matthew Krane, is charged with taking $36 million in kickbacks from Greenstein and Quellos in the scheme. Krane, who is also in some hot water over alleged drug use, is being represented by Pamela Johnston of Foley & Lardner and the Mliwaukee-based Bernhoft Law Firm for the tax matter.)

The firms in the past have said they had no knowledge of Greenstein's alleged wrongdoing. According to a 2006 Congressional report, Steinberg testified that "he relied completely on Quellos and the taxpayer's other advisors to assure that the factual statement [Quellos provided about the shelter] was accurate." That lack of knowledge would make this case distinguishable from cases in which former lawyers at Arnold & Porter and Sidley Austin have been sentenced to prison time for writing letters giving the green light to tax shelters they knew to be illegal.

The work does not appear to have been hugely lucrative. Cravath received about $125,000 for writing four opinion letters, and Bryan Cave, which blessed a very large transaction, received about $1.3 million in fees for writing two letters, according to the Congressional report.

While Congress (and now federal prosecutors) largely absolved the firms, Congressional investigators did raise some questions about their due diligence in the 2006 report. In the last paragraph of the report, the subcommittee writes that evidence they uncovered "raises serious questions" about what the law firms knew "and whether the [law] firms had adequate practices in place to identify and review client matters that could pose significant controversies. At issue is whether, and to what extent, professionals--including lawyers--have an obligation to evaluate the facts underlying the transactions on which they opine and advise."

Steinberg did not immediately return a call seeking comment. A spokesperson for Cravath did not immediately respond to a request for comment. Bryan Cave declined to comment on the matter.

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