Fund of Funds, Ltd. v. Arthur Andersen & Co.

• Decision Date: 07 November 1977
• Docket Number: No. 311,D,311
• Citation: 567 F.2d 225
• Parties: Fed. Sec. L. Rep. P 96,237 The FUND OF FUNDS, LIMITED, FOF Proprietary Funds, Ltd., and IOS Growth Fund, Limited, a/k/a Transglobal Growth Fund, Limited, Plaintiffs-Appellees, v. ARTHUR ANDERSEN & CO., Arthur Andersen & Co. (Switzerland), and Arthur Andersen & Co., S.A., Defendants-Appellants. ocket 77-7387.
• Court: U.S. Court of Appeals — Second Circuit

Page 225

567 F.2d 225

Fed. Sec. L. Rep. P 96,237

The FUND OF FUNDS, LIMITED, FOF Proprietary Funds, Ltd., and

IOS Growth Fund, Limited, a/k/a Transglobal Growth

Fund, Limited, Plaintiffs-Appellees, v. ARTHUR ANDERSEN & CO., Arthur Andersen & Co. (Switzerland), and Arthur Andersen & Co., S.A., Defendants-Appellants.

No. 311, Docket 77-7387.

United States Court of Appeals, Second Circuit.

Argued Oct. 11, 1977.

Decided Nov. 7, 1977.

Edward J. Ross, New York City (James D. Zirin, Breed, Abbott & Morgan, New York City, Charles W. Boand, Wilson & McIlvaine, Chicago, Ill., of counsel), for defendants-appellants.

Robert A. Meister, New York City (George L. Graff, Robert Thomajan and Milgrim, Thomajan & Jacobs, New York City, of counsel), for plaintiffs-appellees.

Before KAUFMAN, Chief Judge, and SMITH and OAKES, Circuit Judges.

IRVING R. KAUFMAN, Chief Judge:

The unusual facts of this case, which we shall present with painstaking care, impel us to the irresistible conclusion that counsel for the plaintiffs have failed in their duty to comply with both the letter and spirit of Canons 4, 5 and 9 of the Code of Professional Responsibility and must be disqualified. We hasten to add that the lawyers involved in this dispute are individuals who enjoy the high regard of the profession. Compliance or noncompliance with Canons of Ethics frequently do not involve morality or venality, but differences of opinions among honest men over the ethical propriety of conduct.

Arthur Andersen & Co., an international accounting concern, charges that, in 1973, its regional counsel, Morgan Lewis & Bockius, a firm of repute, accepted a retainer from Fund of Funds ¹ with the knowledge that Andersen might be implicated in securities actions brought on behalf of the Fund, and that such representation constituted a breach of the Morgan firm's duty of undivided loyalty to its client, Andersen. Andersen now asserts that Robert Meister, an able member of the bar and partner in the firm of Milgrim Thomajan & Jacobs, also a respected firm of lawyers, had served throughout as the Morgan firm's "understudy," and emerged from the wings in February, 1975, when the action against Andersen was commenced. It is claimed Meister and his firm Milgrim Thomajan aided and abetted Morgan Lewis & Bockius's breach of fiduciary duty and thereby violated Canons 4, 5 and 9 of the Code of Professional Responsibility. ² We agree, and believe that in light of the interesting background of this case, Meister or his firm cannot continue to prosecute the underlying action. Accordingly, we reverse that part of Judge Stewart's holding which permits Meister to proceed on behalf of the Fund. We affirm, however, Judge Stewart's denial of the ancillary relief requested by Andersen. ³

I.

It is a longstanding rule that,

When dealing with ethical principles, . . . we cannot paint with broad strokes. The lines are fine and must be so marked. Guideposts can be established when virgin ground is being explored, and the conclusion in a particular case can be reached only after painstaking analysis of the facts and precise application of precedent. ⁴

We approach our task in this factually complex case conscious of this oft-repeated admonition and with the recognition that in deciding questions of professional ethics men of good will often differ in their conclusions.

At the outset, it is necessary to describe the two actions which are at the heart of this case: Fund of Funds v. King and Fund of Funds v. Arthur Andersen & Co. Both actions assert violations of the federal securities laws and arise out of a common series of transactions involving the purchase, valuation and revaluation of certain natural resource assets. The King complaint, filed by Meister for Milgrim Thomajan on May 8, 1974, with the Morgan firm designated "of counsel," alleged that Edward Cowett (a director of Investors Overseas Ltd.) conspired with John King and A. Rowland Boucher (who jointly controlled King Resources Inc.) ⁵ to have King Resources sell natural resource assets to the Fund at highly inflated prices. ⁶ Those assets were thereafter revalued to an even higher figure so that Investors Overseas Ltd. (IOS Ltd.), the Fund's management advisor, could be paid a performance fee equal to 10% Of such upward revaluation. ⁷ This alleged conspiracy was effected through the creation of a Natural Resources Fund Account to pay for the assets on behalf of the Fund. The Bank of New York, the account's manager, was also named as a defendant in the King action. Finally, the attorneys for Fund of Funds, the venerable law firm of Willkie Farr & Gallagher, were sued for their failure to advise the Fund's directors of the alleged wrongdoing.

The Andersen complaint, filed by Meister for Milgrim Thomajan on February 4, 1975, claimed that Andersen, as the independent auditor for Fund of Funds, IOS Ltd., and King Resources was aware of this fraudulent scheme and neglected to disclose it to the Fund's directors. Moreover, the complaint stated that Andersen actively participated in the wrongdoing by certifying the Fund's financial statements.

A.

The tortuous history leading to the institution of these actions began in the winter of 1973 when a group of German investors formed an organization called the International Association of Shareholders of IOS Funds, referred to by the acronym "IASIF." On January 8, 1973, IASIF retained Morgan Lewis & Bockius as its counsel, empowering it to bring lawsuits in the United States regarding the fraudulent transactions in natural resource assets. No action was taken, however, until June 28 or 29, 1973, when Park Dilks, Jr., a partner of the Morgan firm, met with other representatives of Fund of Funds shareholders in Luxembourg. It was there determined that Fund of Funds would be liquidated under Ontario law ⁸ and that the liquidator, appointed by the Supreme Court of Ontario, would sue the persons and firms allegedly responsible for FOF's losses. John Orr, a partner in the accounting firm of Touche, Ross Ltd., was appointed as liquidator and he, in turn, named Borden & Elliot as his general solicitors. Andersen stresses that the Morgan firm conceived and executed these appointments to ensure that it would be named counsel for the liquidator in the United States, and there is testimony in the record which would support Andersen's claim. ⁹ Indeed, Morgan Lewis was retained as American counsel soon after Borden's appointment. In accepting the retainers from IASIF and John Orr (through Borden & Elliot), certain members of Morgan Lewis were aware that the firm's client of 15 years, Arthur Andersen & Co., might well be implicated in the natural resources scheme. Indeed, on July 22, 1974, Park Dilks, Jr. (the partner at Morgan Lewis in charge of FOF matters) wrote to Rino Stradiotto (a partner at Borden & Elliot), and commented on the choice of liquidator:

On July 20, 1973, you . . . and I, while having dinner at the Union League, discussed who should be liquidator and considered various accounting firms as alternatives. . . . We ticked off Price Waterhouse, Peat Marwick, Ernst & Ernst, Coopers & Lybrand, and AA (Arthur Andersen). When we got to AA we remarked that, even though we were regional counsel for them and might otherwise want to favor them, they had been auditors for FOF . . . and would probably end up being sued.

In a partial response to this nascent ethical dilemma, Morgan Lewis, whose representation of Andersen involved a variety of matters unrelated to Fund of Funds, made it a policy of the firm that no attorneys involved with Andersen matters would work on the Fund of Funds case. ¹⁰

For the next nine months, a squadron of Morgan Lewis attorneys investigated the allegedly fraudulent transactions. John Lewis, a partner with the Morgan firm, noted, in an affidavit submitted in King, that his firm was instructed to "analyze, examine and review all substantial transactions affecting the interests of the plaintiff funds and their shareholders" and that the investigation undertaken pursuant to that directive "required several hundred hours of time and involved the examination of thousands of documents." This extensive inquiry ultimately led to the institution of approximately twenty actions, including King, on behalf of the Liquidator in the United States.

From the investigation's inception, Morgan Lewis tried to avoid "making a case" against Andersen, and Morgan attorneys repeatedly informed their counterparts at Borden & Elliot that they would not participate in any way in the consideration of Andersen's possible wrongdoing. Indeed, Park Dilks, Jr. made his firm's position clear throughout the summer of 1974 to the evident distress of George Cihra, an attorney at Borden & Elliot. Cihra felt that the Morgan lawyers had not been altogether forthright in failing to clearly spell out their existing and continuing involvement with Andersen. Amidst this ill-feeling, consideration of a suit against Andersen was held in abeyance.

During this very period, when Morgan Lewis was loudly protesting its desire to be 'cleaner than a hound's tooth' with regard to Arthur Andersen, the firm did not shut its eyes altogether to their client's possible liability. As the group of Morgan Lewis attorneys pored through documents, they put aside anything that was 'really hot' as to Andersen and sent it to Borden & Elliot. And on several occasions, correspondence between the two firms suggests that Morgan Lewis had inquired as to the "status of the (Andersen) matter."

For some time, Morgan Lewis had maintained a close working relationship with Robert Meister and his firm, Milgrim Thomajan and Jacobs. As Morgan Lewis's investigation in what was to be the action FOF v. King began to take shape, John Lewis, a partner in the Morgan firm, asked Meister whether he would assist in the contemplated litigation. Meister was the logical choice for local counsel. He and his firm had been co-counsel with...