From Russia with fraud: BakerHostetler fights former client to stay in money-laundering case

March 2, 2016

(Reuters) – It is no exaggeration to call the theft of $230 million from the Russian Treasury in 2007 a life and death matter. The money was stolen in a complex tax fraud that began with the alleged misappropriation of the corporate identities of three companies in the Russian portfolio of Hermitage Capital, a U.S. hedge fund. A Hermitage lawyer in Moscow who helped expose the fraud, Sergei Magnitsky, was arrested in 2008, detained for nearly a year and ultimately died in custody at the age of 37. Russian authorities later charged Magnitsky posthumously. Hermitage’s American founder, William Browder, was convicted in absentia by Russian courts and faces the possibility of additional charges.

For Hermitage’s former lawyers at BakerHostetler, the consequences of the Russian Treasury fraud case are not that dire. But the firm’s subsequent defense of a Cyprus-based business called Prevezon – which federal prosecutors in Manhattan have accused of laundering some of the proceeds of the Russian Treasury fraud – has landed BakerHostetler in an awkward and unusual disqualification fight at the 2nd U.S. Circuit Court of Appeals.

Right now, under a Jan. 8 decision by U.S. District Judge Thomas Griesa of Manhattan, the firm remains in the case for Prevezon. The forfeiture proceeding, however, has been stayed by a motions panel at the 2nd Circuit so the appeals court can hear arguments on the merits of Hermitage’s argument to disqualify BakerHostetler. Hermitage is not a party in the U.S. government’s case against Prevezon, but it claims, with backing from federal prosecutors, that BakerHostetler’s defense plans for Prevezon put Hermitage and Browder at risk. BakerHostetler responded last Friday, asserting that Hermitage has no interest in the forfeiture case and that the firm has not compromised its former client in defense of its current one.

There’s not much dispute over the basic facts. BakerHostetler represented a Hermitage entity for nine months in 2008 and 2009 in connection with the $230 million Russian Treasury fraud theft. Its chief responsibilities were to investigate the crime, trace the proceeds and tell U.S. prosecutors what it found out about the money trail. The firm billed Hermitage about $190,000. Hermitage terminated the engagement in 2009.

Four years later, after receiving information from Hermitage, the Manhattan U.S. attorney’s office brought the civil forfeiture action against Prevezon, alleging that the Cyprus company had, to quote the government’s brief at the 2nd Circuit, “received a portion of (the Treasury fraud) proceeds through an international network of shell companies and laundered it by purchasing Manhattan real estate using funds that, at a minimum, had been commingled with fraud proceeds.” BakerHostetler entered its appearance for Prevezon a month into the case, in October 2013.

Hermitage was not happy to find its former lawyers now representing a client accused of profiting from the Russian Treasury scam, which Hermitage considered itself to be a victim of. The fund asked Judge Griesa to bounce BakerHostetler. In October 2014, the judge refused, noting that BakerHostetler would not have to attack its former client Hermitage to defend Prevezon.

But in a response to a government motion for summary judgment in late 2015, BakerHostetler did, in fact, go after Hermitage and its founder. “Browder and his agents engaged in a series of misrepresentations to execute the fraud, to distance themselves from it, and to pin it on the Russian officials investigating Browder for a separate tax fraud his companies committed,” the firm said in a filing for Prevezon.

Based on the new defense strategy, Hermitage moved again for BakerHostetler’s disqualification. Judge Griesa granted the motion in December. BakerHostetler asked for leave to bring an interlocutory appeal, which apparently prompted Judge Griesa to change his mind. He withdrew the disqualification order, asked for new briefing and ended up concluding that BakerHostetler could stay in the case.

Hermitage, which is represented at the 2nd Circuit by Susman Godfrey, said its former lawyers have taken an untenable position. “Unless it is reversed by this court,” the fund’s appellate brief said, “the ruling below will sanction behavior that has never previously been permitted by any court in any jurisdiction: A lawyer trying to prove to a jury that its former client committed the very crime that the client had previously retained the lawyer to refute.” (The government brief wasn’t as vivid but made essentially the same argument.)

In last week’s response, BakerHostetler’s lawyers at Debevoise & Plimpton offered several technical arguments, including a challenge to the 2nd Circuit’s jurisdiction over a non-final order. Substantively, the firm said Hermitage had offered no evidence that BakerHostetler had misused client confidences or that the fund would actually be affected by the forfeiture proceeding. Hermitage and the government have claimed Hermitage faces retribution from Russian authorities, but, according to BakerHostetler, “speculation about potential foreign consequences  does not carry much weight on motion to disqualify.” Disqualifying BakerHostetler would leave Prevezon in a bind, the brief said in a footnote; its co-counsel Baker Botts withdrew from the case in December and Prevezon’s accounts have been frozen so paying new lawyers is “a concern.”

The 2nd Circuit has proposed hearing the case next month. It should be quite an interesting argument.

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