* US Trustee seeks to vacate retentions for Kaye Scholer, Capstone
* Says firms concealed key relationships, should disgorge $10 mln in fees
* GSC, a former investment manager, went bankrupt in 2010
By Nick Brown
NEW YORK, Jan 7 (Reuters) - The U.S. Justice Department wants a bankruptcy court to strip law firm Kaye Scholer LLP and financial adviser Capstone of more than $10 million they earned through the bankruptcy of investment management firm GSC Group Inc.
The firms covered up key business relationships that may have served to inflate their fees, according to court papers filed on Friday by the U.S. Trustee Program, the DOJ arm that oversees bankruptcies.
GSC, founded by former Goldman Sachs Group Inc partner Alfred Eckert III, declared bankruptcy in August 2010, hampered by a liquidity squeeze and declining asset values brought on by global recession. The case in U.S. Bankruptcy Court in Manhattan culminated in the 2011 sale of GSC's assets to lender Black Diamond Capital Management.
GSC tapped Kaye Scholer and Capstone as legal and financial advisers, respectively. Robert Manzo, the trustee in charge of liquidating certain GSC assets in the wake of the sale, was listed in court filings as a Capstone employee, the U.S. Trustee said in its filing.
But Manzo was actually an independent contractor with whom Capstone had signed a fee-sharing agreement, information the firms kept from the court in violation of bankruptcy laws, the U.S. Trustee claimed.
The parties "perpetrated a fraud on this court by willfully concealing and affirmatively misrepresenting the true nature of Capstone's employment and financial relationship with" Manzo, the regulator said.
An attorney for Capstone called the allegations "without merit."
"Capstone looks forward to the opportunity to respond to, and the Court's speedy determination of," the allegations, attorney Steven Mandelsberg said.
Sandi Sonnenfeld, a spokeswoman for Kaye Scholer, said the firm believes the U.S. trustee's assertions "are without merit and we will establish that in responding to the motion."
An attorney for Manzo did not respond to a request for comment on Monday evening.
Under his agreement with Capstone, Manzo was entitled to nearly all of the fees he billed, as well as 15.5 percent of the fees billed by Capstone and a percentage of any so-called "success fee" the firm collected after the case, according to court papers.
He has earned about $4 million in the case, more than half of Capstone's total bills, court papers show.
Such fee-sharing agreements are barred by bankruptcy rules, in part out of concern that firms might inflate their fees to make up for the cost of sharing.
Capstone never disclosed the agreement and referred to Manzo as an employee, not a contractor, while lawyers at Kaye Scholer created a conflict of interest by failing to disclose knowledge of Manzo's contractor status and keeping mum about longstanding relationships with Manzo.
"It is reasonable to conclude that Kaye Scholer would be hard pressed to take issue with Capstone's bills in these cases," the U.S. Trustee said, noting that Kaye Scholer attorney Michael Solow, who worked on the GSC case, was a personal friend of Manzo's and worked closely with him on major bankruptcies, including Chrysler's.
Solow did not respond to a request for comment.
Because lawyers and other professionals are paid ahead of creditors in Chapter 11, bankruptcy laws carry strict disclosure requirements to minimize conflicts of interest and ensure as much money as possible is reserved for creditors.
The U.S. Trustee, a watchdog for how money is spent in bankruptcy, has taken a hard line lately on issues of professional compensation among outside advisers and insiders of bankrupt companies.
In addition to the more than $10 million Capstone and Kaye Scholer have already pocketed, Capstone has requested a $2.75 million success fee for its work in the case, of which $1.65 million would go to Manzo, the U.S. Trustee said in its filing.
The regulator is asking the court to deny the request, vacate the retentions of Capstone and Kaye Scholer, and force the firms to disgorge money already earned.
The case is In re GSC Group Inc et al., U.S. Bankruptcy Court, Southern District of New York, No. 10-14653.