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Brown Rudnick Berlack Israels is facing legal malpractice and fraud claims arising from the work of a New York partner who held a substantial financial interest in one of his client companies. A shareholder in the company, Veritas Financial Corp., a holding company for New York-based small-business investment firm East Coast Venture Capital Inc., filed suit in Manhattan federal court charging fraud on behalf of Veritas. Besides Brown Rudnick, the suit named the partner, Stuart Neuhauser. The suit also charges East Coast Venture Capital and its chairman, Zindel Zelmanovitch, with breach of fiduciary duty. It claims more than $10 million in damages. The suit alleges similar facts to East Coast’s own October 2003 legal malpractice suit against Brown Rudnick and Neuhauser, filed in Manhattan Supreme Court, which is seeking more than $25 million in damages. Both suits allege that Neuhauser, motivated by a personal stake in Veritas worth up to $500,000, advised the company to pursue a $2.5 million private stock sale to an investor, a sale that violated federal securities laws. The plaintiffs contend that the illegality of the transaction forced the company to settle a subsequent recision claim by the same investor. The plaintiffs further claim the legal problems damaged East Coast’s relationship with its main source of investment funds, the federal Small Business Administration. Because of the investor’s suit, the agency did not process East Coast’s applications for $10 million in loans, causing the company to forgo several investment opportunities, the plaintiffs claim. Boston-based Brown Rudnick, which has about 200 lawyers, acquired in 2002 New York’s Berlack Israels & Lieberman, where Neuhauser had been a partner. The combined firm has about 27 lawyers in New York. Lawyers at Brown Rudnick did not respond to repeated calls for comment. The firm’s lawyer, Frank W. Ryan of Nixon Peabody, also did not return calls. Neuhauser, now a partner at the New York firm of Ellenoff Grossman & Schole, declined to comment on the suits. According to papers filed in the state court case, the law firm acknowledges that shares in Veritas were held in Neuhauser’s wife’s name but argues that this interest was irrelevant to Neuhauser’s advice to East Coast. The firm also claims the harm the company has suffered, particularly its problems with the Small Business Administration, had origins other than lawyer misconduct. The state Supreme Court case, which is before Manhattan Justice Ira Gammerman, is awaiting discovery from the federal agency, which claims immunity from state court subpoena but is cooperating voluntarily. The judge has indicated he may dismiss Small Business Administration-related claims, the basis for most of the damages, if he does not feel discovery from the agency is sufficient. In that event, the case would go forward seeking recoupment of legal fees estimated to be in the hundreds of thousands of dollars. The judge previously dismissed a breach of fiduciary duty claim against Brown Rudnick and Neuhauser as duplicative of the malpractice claim. According to Fred Schulman, the president of East Coast, Neuhauser acquired his shares in Veritas around 1994, when he was a partner at Bernstein & Wasserman. That firm was breaking up at the time amid allegations concerning senior partner Hartley T. Bernstein, who pleaded guilty in 1999 to participating in stock fraud schemes. Schulman said Neuhauser, East Coast’s longtime lawyer, received the shares in lieu of legal fees owed by the company. REGISTRATION STATEMENT In 1998, East Coast asked Neuhauser, then at Berlack Israels, to prepare a registration statement in anticipation of a public offering by its holding company, Veritas. The company, founded in 1983 to provide financing to purchasers of taxicab medallions in immigrant communities, was hoping to raise capital to expand into financing of small supermarkets, also within immigrant communities. Neuhauser filed East Coast’s registration statement with the U.S. Securities and Exchange Commission in September 1998. The following year, the company accepted the $2.5 million investment from a private investor named Meyer Appel, a transaction handled by Neuhauser. According to East Coast’s lawsuit, Neuhauser failed to advise his client that accepting the investment without filing a new registration statement or qualifying under an exemption from registration violated federal securities law. East Coast claims Neuhauser instead said he had structured the transaction so that it was exempt from registration. The company claims Neuhauser and others expected their interests in Veritas to greatly appreciate with Appel’s investment and the future offering. But subsequent market conditions prevented the public offering from taking place and, in 2002, Appel sued East Coast for recision on the grounds that the company sold him unregistered shares in violation of securities laws. East Coast hired Brown Rudnick to defend it against Appel’s suit, but the company claims other lawyers at the firm quickly advised them the transaction did not fall under SEC exemptions. The company sought to defeat Appel’s suit on statute of limitations grounds but claims it was forced to settle after Neuhauser allegedly acknowledged providing Appel’s counsel with an “opinion letter” stating that the transaction was legal. East Coast claims in its lawsuit that Neuhauser asked company officers to lie to other Brown Rudnick partners by telling them that he had advised them of the risks of proceeding with the Appel transaction, even though he had not. Anthony Davis, a partner at Hinshaw & Culbertson and a legal ethics columnist for the New York Law Journal, said state ethics rules do not bar lawyers from holding interests in clients but set forth stringent client disclosure requirements. Even when the rules are followed, he said, such investments “hang like swords over the heads of lawyers” in any litigation charging attorney misconduct. “In a lot of ways, the rules are a trap for lawyers. They make it appear these [investments] are permissible,” said Davis. “But when things blow up, the client can always argue they didn’t understand the implications.” The acceptance of stock in exchange for legal services was a common practice throughout the 1990s, especially in dealing with tech startups and other ventures with hopes of a big initial public offering. Davis said he expected litigation over such arrangements to mount. “A lot of lawyers in those days saved up a lot of nasty problems,” he said.

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