The U.S. Supreme Court, in cases stemming from failed thrifts in Orange County and Texas, made it harder for federal regulators to sue lawyers and accountants on malpractice claims and cut off most lawsuits that are not filed within state-mandated deadlines.
The nation's high court decided unanimously that state common law, not a small area of federal common law, should be used in most lawsuits brought by regulators against professionals.
The decisions could wipe out pending cases seeking damages that, regulators said, "substantially exceed $1.5 billion" for alleged wrongdoing that led to the collapse of banks and thrifts nationwide.
"Both of these cases are big disappointments for us," said Jack Smith, deputy general counsel for the Federal Deposit Insurance Corp.
But for the professionals feeling the heat of regulators for more than five years, the Supreme Court has restored some balance that will allow them to continue rendering advice under long-established state laws.
"This is going to make clear that whatever the state law is, it will be the law that is going to govern these cases," said Gregory A. Smith, a lawyer representing the Los Angeles law firm of O'Melveny & Myers, the main defendant in the case.
The other S&L decision denied the FDIC's appeal of a Texas case in which the agency filed suit alleging negligence against directors and officers after the filing deadline had passed. Banking regulators argue that deadlines often pass in these cases before they even seize the institutions and discover the wrongdoing.
But the court's primary decision involved a $20-million claim against O'Melveny, California's fourth-largest law firm.
Regulators said that they will still want to take the malpractice case to trial so they can prove that lawyers were negligent in handling two real estate transactions for now-defunct American Diversified Savings Bank in Costa Mesa.
In the aftermath of the 1980's debacle in the S&L industry, which is expected to cost taxpayers more than $100 billion, regulators have sought to hold an array of professionals--lawyers, accountants, investment bankers, appraisers--liable for negligence or more intentional wrongdoing, like aiding and abetting frauds.
The Resolution Trust Corp., which liquidates failed thrifts, has recovered $184 million from lawyers and $492 million from accountants through the end of March. Professionals in the fraud-riddled Lincoln Savings & Loan collapse paid most of those amounts, an RTC spokeswoman said.
Lawyers and other professionals had mounted a counterattack to the aggressive efforts of the RTC and the FDIC, and have recently seen their efforts pay off.
In April, the Supreme Court overturned a half-century of legal precedents by ruling that defrauded investors cannot sue lawyers, accountants and other "third parties" who aided and abetted a fraud scheme. Monday's cases provided another victory.
Regulators accused O'Melveny of negligence in preparing documents for two syndications put together by American Diversified's primary owner-operator, Ranbir S. Sahni. The documents did not reveal to investors the thrift's financial difficulties or any fraud on the part of American Diversified executives. The FDIC asserts that O'Melveny should have known about both.
After regulators seized the thrift in 1986, investors in the real estate partnerships demanded their money back. Regulators returned the money and later sued O'Melveny & Myers, as well as Sahni along with other officers and directors.
The syndications were only a small part of the labyrinthine structure of investments in a host of real estate deals, alternative energy ventures and other transactions that Sahni put together. Regulators spent months unraveling the deals and trying to determine who owned what.
Regulators eventually closed American Diversified and refunded $1.14 billion to depositors, the biggest depositor refund ever.
O'Melveny fought the suit, contending that it performed its work on two transactions diligently and wasn't required to determine if the institution was being operated fraudulently.
The federal district court in Los Angeles agreed, and threw the case out before trial. The U.S. 9th Circuit Court of Appeals, however, said the lower court should have based its decision on federal common law--or case law--instead of state common law. Now, the Supreme Court has sent the case back to the 9th Circuit for a decision under state law.
In other action Monday, the Supreme Court let stand a ruling that an employer can be held liable for alleged sexual harassment even if the company has a policy barring such conduct and procedures to deal with any complaints. It also ruled that California violated a unionized worker's rights when it refused to handle a complaint she filed with state labor authorities about a pay dispute.
Times staff writer Stuart Silverstein in Los Angeles contributed to this report.
Related Supreme Court stories: A1, A18