Richard Nixon's old Wall Street law firm has been accused in a California lawsuit of a serious breach of legal ethics.
The gist of the accusation is that the firm - Mudge Rose Guthrie & Alexander - undertook to represent clients on opposing sides of an issue, then shortchanged those on one side to benefit the other.
The case illuminates a problem that sometimes arises for accounting as well as law firms: what to do when they find that the executives who retained them may be milking a corporation's assets or misrepresenting its financial status to present and prospective stockholders.
Should the lawyers/accountants side with the executives who pay them, or with the investors - the owners of the corporation - whose money is at risk?
Now and then, major accounting firms have answered these questions in ways that got them into trouble in the courts. Major law firms have generally been luckier. That is why the Mudge, Rose case is a rarity: the charges against it - conflict of interest, breach of ethical and fiduciary duties, and malpractice of law - are being litigated in full public view.
The lawsuit against Mudge, Rose flows out of the complicated affairs of San Diego tycoon C. Arnholt Smith, a longtime Nixon financial supporter who raised an estimated $1 million for the candidate in the 1968 campaign. Now 78, Smith is a high school dropout and onetime grocery clerk who amassed a personal fortune once estimated at $20 million. Today, he says he subsists on a monthly Social Security payment of $380.30 and occasional benefactions from his wife.
Smith dominated a financial empire consisting mainly of the billion-dollar United States National Bank of San Diego (USNB) and Westgate-California Corp., a conglomerate with about 40 subsidiaries operating widely diverse enterprises.
The bank collapsed in October, 1973. The Federal Deposit Insurance Corp. kept it open and prevented its 335,000 depositors from losing a dime, but the losses to the FDIC's insurance fund are expected to exceed the total from all 500 other failures of FDIC-insured banks since 1933. Westgate was ruled insolvent a few months later, in February, 1974. Smith has been accused of having drained millions out of both institutions for his own uses before they folded.
The Mudge, Rose connection began in late November, 1972, when Smith went to see John N. Mitchell, who had resumed a partnership in the firm after resigning as Attorney General and directing Nixon's re-election campaign.
Smith asked Mudge, Rose to represent Westgate in connection with a Securities and Exchange Commission staff investigation that resulted six months later in a civil complaint accusing Smith and two close associates of scheming to defraud USNB and Westgate shareholders and to appropriate the corporations' assets for their own benefit.
Westgate's court-appointed trustees since have charged that over an 11-year period starting in 1962, Smith moved at least $500 million out of USNB into ventures he controlled, using technques such as unsafe and unsecured loans.
Mitchell agreed to the representation after consulting Joseph C. Daley, who was an SEC official for 7 1/2 years before joining Mudge, Rose in 1967.
It did not take long for Daley to run into ticklish questions of professional conduct, as shown by a Jan. 2, 1973, memo he wrote to Mitchell - a memo cited in the lawsuit, filed by the trustees, which alleges professional misconduct by Mudge, Rose.
The memo, part of the record of the lawsuit, cited serious inadequacies in Westgate's descriptions to the SEC of certain transactions with USNB. To correct the inadequacies, Daley suggested that Westgate make more complete disclosures. "I though this was an excellent ideas," partly because it might blunt possible suits against Westgate, Daley has testified.
But the memo - written about a month before USNB also became a Mudge, Rose client - cautioned that "it will be difficult to make the corrections without exposing the officers of the corporation, and possibly of the bank, to liability under the securities laws, or under the banking laws."
Westgate and its subsidiaries paid Mudge, Rose legal fees of at least $225,000, before Westgate was declared insolvent. Mudge, Rose then billed Westgate's trustees, whose court-assigned mission is to rehabilitate the conglomerate, for an additional $338,416. The trustees not only refused to pay, but asked federal bankruptcy Judge Ross M. Pyle in San Diego to order a refund of the $225,000 paid already. In addition, the trustees made the allegations of professional misconduct and asked for damages "in such amount as may be approved at trial."
The trial began Feb. 2, recessed a few moments into its third day and did not resume until last Wednesday, after a rumored settlement did not materialize.
In the opening statement for the Westgate trustees, Lawrence D. Solomon alleged that without either "valid consent" or public disclosure, Mudge, Rose knowingly had engaged in "multiple representation" of Westgate, USNB and its directors or former directors, and of Smith and Philip A. Toft, Smith's chief lieutenant.
"Mudge, Rose failed . . . to understand their basic ethical duties not to represent adverse interests," Solomon charged. Thus its work "was inadequate, incompetent and constituted malpractice," he alleged.
Perhaps the firm's "most egregious breach of duty' was its failure "to understand that C. Arnholt Smith could not consent or approve of Mudge, Rose's unethical conduct because he was the source of the conflict," Solomon said.
For the defense, Lee G. Paul said he would be "shocked" if the evidence at trial supported any of Solomon's charges. Instead, he said, the evidence will show that Mudge, Rose "did in fact serve its clients very well, indeed."
Westgate's and USNB's interests did not conflict, Paul said. Instead, they were "the same throughout most if not all of the period when Mudge, Rose performed professional services for both of those corporations." he added: "It is not a violation of the canons of ethics nor of a lawyer's responsibilities . . . to accept multiple representation . . . the canons prohibit such employment only . . . where the interests of the clients are in fact adverse and conflicting."
Paul said that the officers and directors of Westgate and USNB "were fully aware of the dual services that Mudge, Rose was performing . . .And under the law, as we understand it, the knowledge of officers, directors, and particularly of attorneys is imputed to the client."
Trustee lawyer Solomon asked Daley whether at the time of his memo to Mitchell - weeks before USNB retained Mudge, Rose - he had an opinion of a lawyer's responsibility "to disclose to proper authorities his discovery of criminal violations committed by his client," Daley, while objecting to the question's phrasing, replied, "I don't regard any attorney as responsible to check out violations for the benefit of public authorities."
The duty of a lawyer finding violations is to tell his client, Daley testified. And, he said, he in fact reconmended to "anybody who would listen," including Smith, Toft and an accounting firm, correction of the reports to the SEC because of the prospect of liability.
Defense counsel Paul dismissed as "sheer nonsense" Solomon's suggestion that Westgate didn't know of the law firm's services to the bank. The evidence will show that Westgate gave free and knowing consent to Mudge, Rose's representation of USNB, Paul said. He termed it "scandalous and wrong" for the trustees to try to defeat payment of fees to "an old and distinguished law firm."
Mudge, Rose is sharing its misery with Friedman, Heffner, Kahan & Dysart, a San Diego law firm formed in 1971 by C. Hugh Friedman, who had represented Smith interest for 13 years. The firm and its partners of individuals are being sued for at least $92 million by the FDIC, which alleges conflict of interest and other professional misconduct arising from simultaneous representation of USNB, Westgate and its subsideries, and other Smith ventures.
This suit, pending in federal court in San Diego, blames actions by Friedman, Heffner for huge losses to the FDIC. But the firm answered that its conduct had caused the agency "no loss . . . whatsoever." And Friedman swore to SEC investigators in 1973, "I do not, now, recall a single instance where I was consulted, in my capacity as an officer or director . . . for a judgment or an opinion that was other than legal."
The Westgate trustees, also alleging professional misconduct, are suing Friedman, Heffner for $6 million. Thus the firm is accused by the FDIC of having played a part in the looting of the bank, and by the trustees of having played a part in the looting of Westgate.
Both the trustees and Friedman, Heffner have filed thus far unsuccessful lawsuits laying primary responsibility for the debacle on the comptroller of the currency and the FDIC.
The suits said that federal bank examiner Jack Baker had warned then-Comptroller James E. Saxon as early as September, 1962, and again in February, 1963, that USNB's condition was "unsatisfactory." According to the lawsuits, his superiors reacted by smoothing over the problems behind the scenes, transferring Baker from San Diego to San Francisco - out of Smith's hair - and allowing Smith to acquire 13 more California banks by 1972.
In April, 1972 - after the SEC had begun its investigation - the comptroller assigned William E. Martin to examine USNB anew. Then and later he found the bank's condition alarming, largely because the things that Baker had faulted, such as questionable extensions of credit to Smith-related enterprises, had been allowed to proliferate.
Friedman, Heffner accused the comptroller and the FDIC of having operated "a vast cover-up" of banking-law violations. Similarly, the Westgate trustees said that the regulators and Smith had signed a secret cease-and-desist order under which Smith directed Westgate to invest $1.2 million in USNB stock while the government was preparing to liquidate the bank.
In the SEC civil action, Smith and his co-defendants consented to a permanent injuction. A federal grand jury indicted him for scheming to defraud the bank of -27.5 million and to have it lend $175 million illegally; he pleaded no contest but drew only a fine ($30,000). He also was convicted of making illegal corporate campaing contributions for which he again was fined ($10,000). Now, the state of California is preparing to try him on 11 counts (originally 64) alleging grand theft, misuse of USNB funds, forgery and evasion of state income taxes.