Federal Deposit Insurance Corporation v. O’Melveny & Myers

Brief Fact Summary.

When the law firm of O’Melveny & Myers (the Firm) (Defendant) was sued for professional negligence by the Federal Deposit Insurance Corporation (FDIC) (Plaintiff), as the receiver of a savings and loan association which failed because of the dishonesty of the association’s officers, the Firm (Defendant) argued that it had no duty to determine the honesty of its own client

Synopsis of Rule of Law.

An attorney must act with competence to avoid public harm when learning a client is dishonest

Facts.

The Federal Deposit Insurance Corporation (FDIC) (Plaintiff), as receiver for the failed savings and loan association American Diversified Savings Banks (ADSB), brought suit against the law firm of O’Melveny & Myers (Defendant) claiming professional negligence in connection with its legal advice and services to ADSB.  During the period of Defendant’s ADSB representation, officers of ADSB were engaged in fraud and other internal wrongdoings.  In its representation of ADSB as to a major real estate development, Defendant failed to communicate with ADSB’s accountants or chief financial officer or with federal or state regulators.  The Plaintiff stepped in as conservator for ADSB, having come to the conclusion that ADSB was insolvent and had incurred substantial dissipation of its assets and earnings due to its violations of state and federal laws and regulations, and its unsound business practices.  Then, the Plaintiff sued Defendant, charging it with professional negligence, negligent misrepresentation, and breach of fiduciary duty.  The Defendant argued that it owed no duty to ADSB to ferret out ADSB’s own fraud.  The federal district court agreed and granted the Defendant’s motion for summary judgment.  The Plaintiff appealed

Issue.

Must an attorney act with competence to avoid public harm when learning a client is dishonest?

 

Held.

(Poole, J.)  Yes.  An attorney must act with competence to avoid public harm when learning a client is dishonest.  In this case, Defendant concedes the existence of a duty by a principal and its agent of complete and accurate disclosure to potential investors in a securities offering.  A lawyer has a duty to protect the client in every possible way.  They fulfill this duty by performing the legal services for which they have been engaged with the skill, prudence, and diligence that lawyers of ordinary skill and capacity commonly possess.  In addition, if an attorney specializes within the profession, the attorney must meet the standards of knowledge and skill required of such a specialist.  When an attorney fails to perform according to such a duty, negligence results because even as to doubtful matters, an attorney is expected to perform sufficient research.  In this case, Defendant’s attorneys were actually specialists in securities matters.  The Defendant is incorrect in its argument that if the client happens to be committing fraud, of which the attorney may or may not be aware, the presence of the fraud cancels the attorney’s duty to use due care.  The essential part of effectively protecting a client, and therefore discharging the attorney’s duty of care, is to protect the client from the liability which may flow from promulgating a false or misleading offering to investors.  An important duty of securities counsel is to make a reasonable, independent investigation to detect and correct false or misleading materials.  The Defendant failed to do this.  Accordingly, Defendant failed in its duty to guide ADSB as to its obligations and to protect it against liability.  In its “high specialty field,†the Firm (Defendant) owed a duty of care to the client, ADSB, as well as the investors.  Reversed and remanded

Discussion.

The court made clear in the O’Melveny & Myers case that due diligence requires an attorney’s independent investigation of information supplied by an issuer for incorporation into offering materials.