UPDATE 4-Pali's future unclear after deal fails

* Founders in acrimonious legal battle

* Company faces millions in legal bills

(Adds that Reifler declined comment, details on firm size and background on legal costs)

By Elinor Comlay

NEW YORK, Jan 29 (Reuters) - The future of Pali Capital hung in the balance on Friday after the boutique investment bank said it failed to sell itself to a firm that it had been talking to for months.

The New York-based company, with a reputation as a strong derivatives trading firm, had been in talks for almost a year with Braver Stern Securities Corp, a mortgage boutique that former Bear Stearns Cos Chief Financial Officer Sam Molinaro was advising, according to people familiar with the matter.

Braver Stern was one of a series of groups that looked at buying Pali, according to people familiar with the matter. Prospective buyers have balked in large part because of the firm's substantial legal bills and obligations, according to people familiar with the matter.

The boutique's parent company, Pali Holdings, is embroiled in legal disputes with Pali Capital's founders, board members, and former employees that have consumed much of its capital, according to people familiar with the situation.

In one lawsuit, filed in June 2008, one of the firm's co-founders, Bert Cohen, said the other, Bradley Reifler, had sent him an e-mail that said "your kids think you are nuts... you are a bitter lonely ass... you are dead to me."

A wave of high-profile analysts and sales and trading staff have departed in recent months, also hurting Pali Capital's chances of selling itself, since a bank's staff is typically its most valuable asset. At its peak, Pali had more than 200 employees.

Some observers have questioned whether the company can survive without a sale, given its legal costs and a wave of staff departures in the last year. It is also not clear whether there are any other potential bidders for Pali.

"Pali is currently evaluating a range of strategic alternatives," the company said in a statement. The deal with Braver Stern fell through "despite the efforts of everyone involved."

The fall of Pali might have received scarce notice a few years ago, but since the financial crisis, boutique investment banks have played a more prominent role on Wall Street and they are among the few financial institutions hiring now.

Many senior executives in the financial sector argue that boutique firms are more stable than large banks because of the "partnership culture" -- principals know that their own money is at stake, and they are less likely to take risk recklessly.

But as Pali illustrates, the truth is more complicated. Even before firms began going public in the 1970s, many Wall Street partnerships suffered from the same problems as Pali -- painful and protracted turf wars among partners, board members and employees.

Lehman Brothers teetered on the brink of failure several times as a partnership before selling itself to American Express Co (AXP.N) in 1984.

"There were two limitations to partnerships: the personalities and their capital," said Charles Geisst, a finance professor at Manhattan College and author of "The Last Partnerships: Inside the Great Wall Street Money Dynasties."

At many firms, the partners who believed they were making the most revenue for the firm fought other partners for power and money, said Geisst, who added that he has no specific knowledge of Pali's operations.

FOUNDER FEUD

At its peak in 2008, Pali employed more than 200 staff in banking, sales and trading, as well as a wealth management team and a Latin American desk. The company at this time produced more than $1 million in revenue per employee, a person familiar with Pali estimated.

At least three parties apart from Molinaro have looked into buying Pali Capital, according to people familiar with the matter. At least one of those parties made a bid that was rejected by the board because the directors believed another bidder would offer more, one person said.

But a sticking point for prospective buyers is Pali's lawsuits, many of which are linked to a feud between co-founders Cohen and Reifler. Reifler, then CEO, left Pali in October 2008.

The legal bills for some of the parties and for Pali Holdings have run into millions of dollars and the litigation has been acrimonious. In June 2008 pleadings, Cohen said Reifler sent him the e-mail calling him a "bitter lonely ass." It also allegedly said, "you are insane... you are poison."

Reifler filed an arbitration demand a year ago with FINRA, the broker-dealer watchdog, seeking compensation due from Pali under his employment agreement, according to a filing with the Securities and Exchange Commission.

According to FINRA documents, Reifler was "permitted to resign during an internal review regarding the authenticity of a document proffered by Pali in litigation."

Reifler, head of institutional trading at failed commodities broker Refco until 2000, wrote on what appears to be his Twitter profile that he is now "starting Forefront Advisory with non-criminal partners."

Reifler, reached on his cell phone, declined to comment. Cohen did not respond to e-mailed messages sent this week.

Pali had unpaid legal and settlement bills of more than $4.85 million at the end of 2008, compared with cash of about $1.1 million, according to a report filed by accounting firm KPMG in May 2009.

Those figures are only a snapshot of the firm's condition at a particular date, but the same report said there was substantial doubt about Pali's ability to continue as a going concern, and said the company had hired outside bankers to help it raise capital.

In December, Pali Holdings' other main subsidiary, Pali International, suspended trading and applied to the local regulator to wind down its business. The company had employed about 60 staff in London. [ID:nLDE5BF2B]

In a bid to revive its fortunes, Pali Capital has shaken up management over the last two years, replacing Reifler with Joseph Schenk, previously chief financial officer at Jefferies Group. Schenk left last year.

The current co-CEOs are Gerald Burke and Kevin Fisher. Fisher is also co-head of U.S. equities and has been at Pali since 1998. He was previously at Cantor Fitzgerald.

Burke, previously at Merrill Lynch, is also Pali's chief operating officer.

The company's board has also been reshuffled. It is now operating with just two directors, co-CEOs Burke and Fisher, according to a letter sent earlier this month by Reifler and two others who call themselves the 'committee of concerned Pali shareholders.' Pali's by-laws say that it should have five directors, according to that letter. (Reporting by Elinor Comlay; additional reporting by Dan Wilchins; editing by Andre Grenon, Gerald E. McCormick, Tim Dobbyn and Robert MacMillan)