The Firms

May 7, 2009 10:30 PM

Davis Wright, K&L Gates, Thompson & Knight Ensnared in Ponzi Probe

Posted by Brian Baxter

UPDATE: June 17, 11:15 a.m. The Am Law Litigation Daily reports that Davis Wright has been hit with a $400 million suit by Sunwest receiver Michael Grassmueck.

The collapse of Sunwest Management has spawned a series of civil actions by aggrieved investors. The SEC is charging that the retirement home operator once worth $2 billion is actually a Ponzi scheme. And plaintiffs lawyers for Sunwest investors are suing three of the company's outside law firms: Davis Wright Tremaine, K&L Gates, and Thompson & Knight.

The suits all have been filed in state court in Oregon. Plaintiffs lawyers are quick to cite the state's strict securities laws when confronted with the U.S. Supreme Court's decision in Stoneridge Investment Partners v. Scientific-Atlanta, which limits the means by which third-party defendants can be held liable for their alleged roles in corporate frauds.

But it's not only plaintiffs that are picking on Sunwest's outside lawyers. A court-appointed receiver for the company requesting documents from the three firms was none-to-pleased when Davis Wright charged $250,000 for copying fees. The escalating legal costs associated with the receiver's investigation into Sunwest's finances are further infuriating investors.

Sunwest's Sunset

Sunwest's problems arose from credit crunch-related losses on some of the 200 nursing homes and assisted living communities it owns nationwide. While Sunwest itself has not yet filed for bankruptcy, the SEC's 23-page complaint alleges that the company began putting some of its individual holdings into Chapter 11 to forestall foreclosure efforts by certain lenders.

The SEC even dropped the Ponzi bomb in its complaint, alleging that under increasing financial duress, Sunwest raised more than $300 million from new investors to help pay back old lenders seeking to recoup losses tied to the company's operational retirement facilities.

"The way this thing was structured is that Sunwest basically did [hundreds of] separate offerings--one for each assisted living center," says Michael Esler, a name partner at Portland plaintiffs firm Esler, Stephens & Buckley who represents 300 Sunwest investors. "And each center has anywhere from half a dozen to 18 or so investors."

Speculation surrounding Sunwest's questionable financials has picked up in recent months, ever since former CEO Jon Harder filed for personal bankruptcy in December; Harder resigned the following month. Investors started lawyering up for civil actions against the company and its outside vendors. (The Recorder's Petra Pasternak recently reported that litigation against assisted living facilities is on the upswing.)

Enter Sunwest's outside law firms. The Puget Sound Business Journal reported in April that some investors had filed a class action against Davis Wright and corporate finance and securities partner Timothy Dozois in Multnomah County Circuit Court in Portland.

As detailed in the 55-page complaint filed by plaintiffs firm Cohen Milstein Sellers & Toll and Portland solo practitioner Justine Fischer, eight name plaintiffs are seeking to represent an additional 1,200 Oregon investors of Sunwest in the putative class.

Fischer says Davis Wright and Dozois are liable for her client's losses because they drafted documents misrepresenting how investments would be allocated among the various Sunwest entities, which helped further the fraud. (Cohen Milstein partner Kit Pierson, formerly of Heller Ehrman, did not return a request for comment.)

Plaintiffs lawyer Esler has filed three suits against Davis Wright on behalf of investors in three Sunwest assisted living centers. (Click herehere, and here for copies of those state court complaints.)

"Davis Wright were the principal lawyers used by Sunwest for their securities work," says Esler, who has also filed suit against K&L Gates and real estate and finance partner R. Gibson Masters in Portland. "K&L Gates was used when Sunwest had too much work for Davis Wright to handle. The firm did mostly bare land projects where Sunwest invested in land to build its assisted living centers on."

With Davis Wright predominantly advising on assisted living offerings and K&L Gates focused on new construction sites, Esler says Thompson & Knight provided tax opinions for Sunwest. On Wednesday he sued the firm and Dallas-based tax partner Kevin Thomason in state court in Oregon.

Unlike the suit against Davis Wright filed by Cohen Milstein and Fischer, Esler says he's not pursuing class certifications. He also doesn't plan on filing hundreds of separate suits against Sunwest's outside counsel "that starts to spend down the defendant's insurance policy quite quickly." (Oregon State Bar rules limit malpractice insurance to $300,000 per case, but large firms usually have higher premiums.)

Instead Esler's obtained tolling agreements with Davis Wright and K&L Gates that will allow him to take two or three plaintiffs claims and push them through at the state court level to see what becomes of them.

Seeking Scheme Liability

Standing in the plaintiffs way is the Supreme Court's Stoneridge decision.

"I think what [plaintiffs lawyers] are trying to do is an end-run around Stoneridge," says Davis Wright defense lawyer Joseph Arellano of Portland's Kennedy, Watts, Arellano & Ricks. "I expect this issue will be addressed in some early motions, but this case is just out of the blocks. We're still scheduling status conferences, so we really haven't tested any of those issues yet."

Esler isn't intimidated by Stoneridge.

"Oregon securities law is unique in that it's probably the most protective in the country," he says. "And while there's no aider-and-abettor liability under the federal cases, it's pretty clear in Oregon that a lawyer who prepares offering materials is held to a standard of due diligence--a little bit like a gatekeeper. So if a lawyer works for an issuer, they better exercise reasonable care."

But Esler also thinks that he can hold Sunwest's outside lawyers liable for damages but showing that they knew something was awry at the company when they drafted offering materials for investors.

He points to a 2004 case called Kraus v. Sunwest Management as the "smoking gun" against the firms. In that case Sunwest was sued by former CFO Jeffrey Kraus, who was a partner involved in the company's formation. Esler says Kraus accused Sunwest of violating the RICO Act by "co-mingling funds" and operating the company's separate assisted living centers as one enterprise.

"[Kraus] basically said Sunwest was taking money from one checking account and putting it in another based on where the cash need was, without any accounting," Esler says. "When Kraus sought a preliminary injunction, the trial judge issued an opinion in which he found funds were improperly transferred between businesses, said [ex-CEO] Harder was not a credible witness, and basically outlined [the fraud] going on at the company."

Esler says the fact that a federal judge found evidence to support accusations of fraud at Sunwest is something that should have been disclosed to investors. (It should be noted that the Kraus suit didn't involve any outside investors and U.S. district court judge Michael Mosman ultimately ruled against Kraus; Perkins Coie represented Sunwest executives and the matter was later resolved through mediation.)

"In Oregon that's the test--what would a reasonable investor want to know before making an investment?" Esler says. "We believe the law firms were certainly aware of the Kraus case. And in these kinds of real estate investment deals the SEC has guidelines for what should be disclosed to investors."

With Sunwest operating at a yearly loss of between $200 to $300 million, Esler says that the only way for the company to survive was by recruiting new investors.

K&L Gates's defense lawyer, Barnes Ellis from Portland's Stoel Rives, did not return a request for comment. At the time of this story, it was not immediately known who was representing Thompson & Knight.

Mounting Costs

Not all of the attention in Sunwest is falling on its outside lawyers.

U.S. district court judge Michael Hogan in Eugene, Ore., is in the process of consolidating the thicket of Sunwest-related litigation. Plaintiffs lawyer Fischer says that Hogan is serving as a mediator between Sunwest and ex-CEO Harder in another case, as well as overseeing bankruptcy proceedings for Sunwest entities and the SEC suit against the company.

As a result of the SEC action, Hogan appointed Michael Grassmueck of Portland's The Grassmueck Group to serve as receiver for Sunwest. Grassmueck has hired bankruptcy and creditors' rights partner David Osias and commercial litigation partner Stephen Walters from San Francisco's Allen Matkins Leck Gamble Mallory & Natsis to investigate suing third parties in the Sunwest case. (Neither Grassmueck, Osias, or Walters responded to requests for comment.)

The Oregonian reported earlier this week that Grassmueck's lawyers have been requesting documents from Davis Wright, K&L Gates, and Thompson & Knight. The Am Law Daily has learned that a lawyer from a fourth firm--litigation partner Milo Petranovich of Portland's Lane Powell--served as post-crisis counsel to Sunwest and is not the target of any plaintiff or receiver actions.

Within that same Oregonian story, it emerged that some investors are fed up with what they see are runaway legal costs associated with the receiver's investigation. The company is paying for lawyers for several former Sunwest executives. (Former CEO Harder, who has yet to be charged with a crime, is represented by Stephen English of Portland's Bullivant Houser Bailey.)

Quoting from a filing submitted by Grassmueck to Judge Hogan, The Oregonian reports that Davis Wright has been "dilatory and creative in erecting hurdles to the receiver's access to client files." And while K&L Gates and Thompson & Knight have voluntarily produced Sunwest documents, the Portland paper reports Davis Wright didn't endear itself to Grassmueck when it charged the receiver $250,000 in copying fees.

Arellano says that Davis Wright was waiting for permission from the court to turn over former client files and that the firm will continue to cooperate with the receiver. He adds that the real issue over fees pertains to those paid by the receivership itself to "restructuring advisers and legal counsel to the chief restructuring officer."

The defense lawyer says that the investor suits themselves aren't anything unusual.

"[Davis Wright] believes that it advised its client appropriately and that [this case] is like most of these financial collapses--plaintiffs go after those with the deep pockets to try and put together a settlement," Arellano says. "There's a lot of people in this environment who have suffered losses and are looking for ways to recoup them."

A tentative trial date for Davis Wright's first case has been set for August, but will likely be delayed until later this year or early 2010. Discovery is ongoing.

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