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JDN Realty paid $46 million last year to settle a shareholders’securities fraud class action, but, for the Atlanta-based builder of retailshopping centers, the litigation was far from over. That’s because, as part of the settlement, JDN agreed to go after thoseco-defendants in the case who didn’t settle and to turn over the first$8 million the company can recover from them to shareholders. Among those JDN now has sued are the company’s former real estatelawyers: the former firm of McCullough Sherrill (which merged withSeyfarth Shaw two years ago) and former McCullough Sherrill partnersWilliam D. Brunstad, Bradley J. Taylor and James W. King. Brunstad andKing are now partners with Seyfarth Shaw, and Taylor has set up theTaylor Law Firm. In litigation in Fulton Superior Court, the company claims itsex-lawyers helped devise and carry out a secret scheme that landed JDNin trouble with its stockholders and with the Securities and ExchangeCommission. The suit, filed on behalf of JDN by John L. Latham and JulieM. O’Daniel of Alston & Bird, alleges legal malpractice, breach offiduciary duty and civil conspiracy-claims that the lawyer-defendantshave denied in their answers. At issue are allegations that, since 1994, JDN Chairman and ChiefExecutive Officer J. Donald Nichols (whose initials comprise thecompany’s name) approved the diversion of $5 million in off-the-bookscompensation to two top development officers, Jeb L. Hughes and C.Sheldon Whittelsey IV, all unbeknownst to other company officials. HOW IT WORKED According to JDN’s suit, the scheme worked two ways. On some occasionswhen JDN was purchasing a land tract, Hughes or Taylor would arrange forthe seller to deed outparcels included within the property being boughtby JDN to a company the two executives owned, ALA Associates. At othertimes, the suit says, Taylor and Hughes would tell sellers and brokersto pay “fees” or “commissions” to ALA in connection with the land deal,out of the purchase price paid by JDN. Taylor or Brunstad represented JDN or its subsidiary, JDN Development,in each transaction. The McCullough Sherrill lawyers allegedly wouldprepare a separate deed from the seller to ALA for that part of the landtransaction. Neither the fees nor the ALA conveyances would show up insettlement statements given to JDN. The suit claims the McCullough Sherrill lawyers kept the deeds anddocuments reflecting the ALA conveyances and fees at their offices andeventually forwarded or copied them to Hughes at his home. Nichols, the suit says, agreed to the extra compensation for Hughes andWhittelsey to avoid repaying a $1.8 million personal debt he owed thepair. He allegedly had signed promissory notes and agreements with themto resolve a dispute that could have blocked JDN’s initial publicoffering in 1994. The agreements, allegedly drafted by Brunstad,provided that Nichols would arrange for Hughes and Whittelsey to getpayments from JDN and its related entities, and if he did not do so, hewould be personally liable to them for the $1.8 million. Nichols’ motivation and the plan itself were kept secret from the otherofficers of JDN, according to the Fulton suit. The complaint cites aMcCullough Sherrill internal memo from King to Brunstad, dated Feb. 22,1995, that concluded Nichols was not required to disclose such propertytransactions to JDN Realty’s stockholders. A month later, Brunstad wrote Nichols and Hughes to explain how Hughescould serve as president of JDN Development and get extra compensationthrough ALA without disclosing that compensation to other corporateofficers. The issues to resolve, Brunstad wrote, were ones of “corporateopportunity” and “reasonableness of compensation.” Hughes could receivethe extra compensation, provided that Hughes’ total compensation packagewas reasonable and that Nichols approved of the compensation, Brunstadconcluded. The McCullough Sherrill lawyers never should have approved thecompensation arrangement because it violated the duties that the JDNofficers owed to the company and its shareholders, as well as theattorneys’ own obligations to act in JDN’s best interests, themalpractice suit says. If the lawyers “had fulfilled their fiduciary obligations of loyalty andcandor to the JDN Entities by refusing to participate in side deals thatbenefited Nichols, Hughes and Whittelsey to the detriment of the JDNEntities themselves, or had disclosed such transactions or Nichols’ planto enter into them,” the financial disaster that followed could havebeen averted, the suit says. Michael S. Reeves of Gorby, Reeves, Peters & Burns, who representsBrunstad, King and McCullough Sherrill, said, “There is pendinglitigation and a mediation involving all the parties to the [federal]securities case and the Superior Court action. Under thesecircumstances, we have no comment.” H. Lane Young of Hawkins & Parnell, who represents Taylor, declinedcomment. In federal court filings, however, the attorney-defendants insisted thatthey were “not aware of being part of a securities law violation nor didthey consciously intend such a violation.” They argued that it was a “far stretch to suggest the lawyers’ actionsin the multi-tiered accounting and computerized valuation process whichled to JDN’s financial statements was a highly unreasonable, extremedeparture from the standards of ordinary care and that they knew theiractions created a present danger of misleading buyers.” JDN, however, claims in the Fulton suit that the compensation schemecaused the company’s publicly filed financial statements to be wrong.When the problem was discovered, the company announced in February 2000that filings for 1994 through 1997 and half of 1998 would be restated.Hughes and Whittelsey resigned, followed by Nichols. TROUBLES FOLLOW A multitude of troubles soon engulfed the company. JDN’s stock, listed on the New York Stock Exchange, plummeted to a lowof $8 a share after climbing to $32 a share in 1998. The company wasinvestigated by the SEC, the Internal Revenue Service and the stockexchange. JDN became the first real estate investment trust to be suedfor securities fraud in Georgia, Florida or Alabama after at least 20suits alleging violations of securities laws or state racketeering lawswere filed in federal and state superior courts. Nichols, Hughes,Whittelsey, McCullough Sherrill and the three lawyers were named asdefendants. SETTLEMENT WITH STOCKHOLDERS JDN settled with its stockholders, agreeing to pay them at least $24.3million in cash and 1.68 million shares of JDN common stock. The companyalso agreed to pay stockholders’ legal fees by issuing 248,000 shares ofcommon stock worth a minimum of $11 a share to the plaintiffs’ counsel. But the deal also contained the requirement that JDN pursue claimsagainst the non-settling defendants, giving the first $8 million itrecovers to the shareholder class, and two-thirds of any amountexceeding $8 million. The Fulton Superior Court suit was filed about six weeks beforeannouncement of the settlement. JDN Realty v. Nichols, No. 2001CV39193(Fult. Super. filed June 15, 2001). Another suit, this one against theMcCullough Sherrill lawyers only, was filed recently in Fulton StateCourt by William J. Kerley, who had been JDN’s chief financial officer,but resigned in the wake of the upheaval. Kerley’s lawyer has said hisclient resigned not because of any wrongdoing but because new managementwas taking over. Kerley’s suit stated he was unaware of the “secret diversion ofcorporate assets” and was unwittingly induced to make misstatements inJDN’s public financial reports. When he began to suspect irregularitiesin the real estate transactions, Kerley said he “blew the whistle” andbrought matters to the attention of the board of directors. He is suingthe McCullough Sherrill lawyers for legal malpractice, breach ofcontract, breach of fiduciary duty, negligent misrepresentation,tortious interference with business relations and conspiracy. Kerley v.McCullough Sherrill, No. 02VS028870-E (Fult. St. filed Feb. 18, 2002). In the Kerley case, McCullough Sherrill’s malpractice carrier, ChicagoInsurance, has filed a motion to intervene. The insurer is seeking aruling that it is not required to cover McCullough Sherrill in thelitigation. The law firm’s policy application, according to theinsurance company, contained no information regarding its conduct as setout in the Kerley suit. The insurer also argues that its policy coversonly negligent acts or errors, not intentional conduct, as may be thecase here. While the lawyer-defendants face two active suits in Fulton, earlierthis year U.S. District Judge Richard W. Story dismissed McCulloughSherrill and Taylor as defendants in the securities fraud class action.However, the judge declined to dismiss Brunstad because he also had beenan assistant secretary of JDN. (King was not a defendant in the federallitigation.) In re: JDN Realty Securities Litigation, No.1:00-CV-396-RWS (N.D. Ga. order Jan. 25, 2002). Story, assuming the plaintiffs’ allegations to be true for purposes ofthe motion, found that while McCullough Sherrill’s and Taylor’s”participation in preparing false documents for JDN’s real estatetransactions is culpable, their conduct does not give rise to primaryliability for securities fraud.” They were secondary actors at best, andthe shareholders could not show they relied on misstatements oromissions publicly attributable to those lawyers or that the real estatelawyers had the power to control JDN. Brunstad, however, Story wrote,was an officer of the company and, again assuming the claims to be true,let JDN issue false disclosures, knowing his conduct posed a danger ofmisleading shareholders. The McCullough Sherrill defendants had argued that the shareholders’claims that the lawyers knew what the impact of the compensationnon-disclosures would be on JDN’s financial records, were “seriouslyinfirm” and dependent on “arcane accounting principles.” The lawyers were neither corporate counsel nor securities counsel,prepared no financial statements, and could not control JDN or its boardof directors, their brief argued. As for the compensation arrangement, the lawyer-defendants argued thatland acquisitions are sometimes negotiated in the name of one companyand then optioned to the ultimate purchaser “in order to prevent raisingsellers’ expectations.” That, they continued, was the purpose of ALA.

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