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The bankruptcy trustee for the Bennett Funding Group, which was involved in one of the country’s largest investor fraud schemes, does not have standing to sue third-party law firms for malpractice and negligence, a federal judge with the U.S. District Court for the Southern District of New York has ruled. The opinion in Richard C. Breeden, Trustee of the Bennett Funding Group, Inc. v. Kirkpatrick & Lockhart LLP (MDL 1153), comes more than five years after the Securities and Exchange Commission filed a lawsuit against Patrick Bennett, who was later convicted of securities fraud, bank fraud and money laundering for using fraudulent leases to bilk investors out of roughly $700 million. Richard C. Breeden, a former chairman of the SEC and trustee of Bennett Funding Group since 1996, had brought the suit against three law firms — Kirkpatrick & Lockhart; Robinson, St. John & Wayne (now St. John & Wayne); and Storch & Brenner (now Dilworth Paxson) — and the accounting firm Arthur Andersen LLP. Kirkpatrick & Lockhart and St. John & Wayne maintain offices in New York. Dilworth Paxson is based in Washington, D.C. The suit charged that the defendants were guilty of professional malpractice, breach of contract and negligence, among other claims, for failing to report fraud or suspicion of it to Bennett Funding Group’s innocent directors and officers. Those officers, the suit claimed, might have brought Mr. Bennett’s scheme to light sooner had they been warned of possible wrongdoing. The defendants moved for summary judgment, arguing that Breeden lacked standing to bring the claims. In granting the defendants’ motion, Judge John E. Sprizzo found that a bankruptcy trustee only has standing to pursue claims that the debtor company could have pursued at the time it filed for bankruptcy. His reasoning hinged on the Wagoner rule, which prevents debtor companies from seeking damages against third parties for “injuries incurred by the misconduct of the debtor’s controlling managers” ( Shearson Lehman Hutton Inc. v. Wagoner, 944 F.2d 114, 117, [2d. Cir. 1991]). None of the Bennett Funding Group officers who could be deemed innocent of the fraud, Judge Sprizzo found, had any power to change the company’s actions. Sprizzo noted that several officers testified that if they had learned of the fraud, they would have approached Bennett or other members of his family and likely accepted any assurances that the Bennetts offered. Sprizzo also noted that some officers who knew of the fraud resigned because they realized they were powerless to change the situation. As far as testimony from innocent officers that they would have told a third party, like the SEC, if one of the defendants had uncovered the fraud, Sprizzo said that such a claim is “nothing more than mere speculation and conjecture.” Writing that “actions speak louder than words,” Sprizzo noted that all the officers who resigned after learning of the fraud remained silent. And even assuming that innocent insiders would have exposed the fraud, Sprizzo wrote, the trustee still lacks standing because “these insiders were all impotent and irrelevant for the purposes of applying the Wagoner rule.” Jay G. Strum of Kaye Scholer and Dennis R. McCoy of Saperston & Day represented Breeden. Janice J. DiGennaro of Rivkin Radler represented Robinson, St. John & Wayne. Richard L. Spinogatti and Allison B. Feld of Proskauer Rose represented Kirkpatrick & Lockhart. Gary P. Naftalis and Gregory A. Horowitz of Kramer Levin Naftalis & Frankel represented Storch & Brenner. Irwin H. Warren and Jeffrey M. Greilsheimer of Weil, Gotshal & Manges represented Arthur Andersen.

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