Ethics authorities have recommended a reprimand for Lawrence Schwartz, a founding partner at Schwartz, Simon, Edelstein & Celso, for failing to supervise an employee who stopped paying taxes while the firm was in financial straits.

Schwartz, as managing partner, "neglected to oversee a business office operation that was consistently failing to withhold and pay over to the IRS … at times well in excess of one million dollars," the Disciplinary Review Board said Monday in Matter of Schwartz, DRB 12-70.

The board voted 5 to 2 for a reprimand — not a censure as the Office of Attorney Ethics urged, though still more serious than the private discipline Schwartz sought.

Firm partner Stephen Edelstein, who represents Schwartz, says they are "strongly considering" petitioning for Supreme Court review.

In early 2008, Schwartz Simon’s cash flow waned as a result of an economic downturn that followed the firm’s move in 2007 from its Florham Park office to a larger, much more expensive space in Morristown.

Also around that time, the firm’s outside accountant fell ill, leaving him unable to make monthly visits and perform periodic audits.

While the accountant was unavailable, Doreen Formato — Schwartz Simon’s business manager and a firm employee for 15 years — handled all business matters with the help of other office staff, according to a stipulation between Schwartz and the Office of Attorney Ethics.

With revenue plummeting, Formato largely stopped collecting and paying federal withholding taxes, instead paying other pressing bills when possible.

Edelstein says another staffer was more directly responsible for handling firm tax matters at the time and no longer is with the firm. He declines to identify her or indicate whether she was terminated as a result of the issue.

It was May 2008 before Formato informed Schwartz, or anyone else at the firm, about the cash shortages.

Meanwhile, the firm was beset by defections. In May and June 2009, eight lawyers that anchored the Insurance Coverage Practice Group left. One partner and two associates went to Gordon & Rees, while two partners and three associates went to Saiber.

It wasn’t until September 2009 that Formato told Schwartz about the tax issue. In 2008, the firm had paid $1.19 million of its $1.48 million tax obligation. In 2009, it paid only $373,000 of the $1.33 million owed, leaving a $1.24 million deficiency.

In December 2009, Schwartz ordered a tax payment of $550,086, money that otherwise would have compensated firm partners.

More was owed, however, and Schwartz Simon entered into a payment plan with the Internal Revenue Service in June 2010, requiring installments of $20,000 a month. The firm was current and had paid $335,000 in total as of the stipulation.

After the agreement with the IRS, Diane Pereira, a partner’s secretary, filed a grievance with the OAE, alleging that money withheld from her pay, purportedly for taxes, was being used for other purposes.

An OAE investigation revealed that the firm, despite not remitting tax payments, had indicated on employee paychecks and W-2 forms that the payments had been made. There was no evidence that anyone, including Schwartz, misused the funds.

Schwartz stipulated violations of Rule of Professional Conduct 5.3(a) and (b), failure to supervise a nonattorney employee, and 1.15(b), failure to promptly deliver funds to a third party.

The OAE recommended a censure, while Schwartz requested no discipline, or an agreement in lieu of discipline under Rule 1:20-3(i)(2)(B).

In its decision, two members voted for admonition, one member recused and another did not participate.

Although the stipulation did not indicate when exactly Schwartz learned of the tax issue — sometime between September 2008 and September 2009, it said — the latter date is more likely, the DRB said.

"There’s no indication … to suggest that respondent ‘sat’ on Formato’s tax wrongdoing for a year or that he was complicit," DRB Chairman Louis Pashman wrote, calling it "unlikely … that both the IRS and the OAE would have given respondent ‘a pass’ if there was evidence that he knew about the problem in September 2008."

The panel cited as mitigating factors Schwartz’s 47-year, unblemished career and swift corrective action. But the fact that employees were misled — albeit not harmed — along with the sheer size of the tax debt, were aggravating factors, the board said.

Deputy Ethics Counsel Melissa Urban, who prosecuted the matter, did not return a call.

‘A Perfect Storm’

Edelstein says Schwartz Simon’s administrative system was effective then and remains so today, but 2008 and 2009 was "a perfect storm" — the loss of the firm’s accountant coupled with a lease that became unaffordable after the economy crashed.

"To suggest that Larry is at all unethical … is an unfair conclusion from all this," Edelstein says. "For a decision that ultimately decides he should be reprimanded, it pays him an awful lot of compliments."

Edelstein adds: "Anybody running a big business, which a modern law firm is, really can’t know, as a practical matter, every single check that’s written or every single document that’s filed."

Edelstein adds that the firm is financially "quite stable" now and the managing partner role now is divided among Schwartz and three others.

In the Law Journal‘s annual survey of New Jersey’s 40 highest-grossing firms, for fiscal year 2011, the firm ranked 40th, with gross revenue of $18 million and net profits of $6.3 million.

The firm also ranked 40th in fiscal year 2010, with $20 million in revenue and $7 million in profits.