NEW YORK, June 8 (Reuters)(CORRECTED) - A man accused of laundering money through a Manhattan diamond store was acquitted Wednesday by a Brooklyn federal judge who faulted federal prosecutors for bringing the case in the wrong court.

Two days after the trial for Artur "Avi" Hiaeve began, and the day after the government rested its case, Senior Judge Allyne Ross granted a motion to acquit him on seven counts of money laundering and failure to file proper tax forms for cash payments.

The motion -- filed by Hiaeve's attorney, Kenneth Murphy, of Simon & Partners -- argued that Hiaeve should have been tried in Manhattan federal court, not Brooklyn. In a brief filed early Wednesday morning, Murphy argued that the government's evidence tying Hiaeve to Brooklyn -- a phone call with a cooperating witness whose testimony was later called into question -- was not sufficient to justify the current venue.

Prosecutors said Hiaeve had reason to believe the witness was laundering money coming in from drug operations within the Eastern District's jurisdiction.

But Judge Ross agreed with the defense and granted the motion to acquit.

The double-jeopardy principle protects Hiaeve from facing similar charges in Manhattan, Murphy said.

Still, he called the judge's decision unusual. "The case should not have been brought in the first place," Murphy said.

The U.S. Attorney's office in Brooklyn had no comment on the judge's decision.

CO-DEFENDANTS PLED GUILTY

In December 2010, Hiaeve was accused of using his midtown Manhattan diamond store, Avi & Co. NY Corp., to launder large sums of cash from narcotics traffickers. According to a superseding indictment filed in January, Hiaeve had laundered at least $106,000 on five different occasions. He also failed to file required reports with the Internal Revenue Service on approximately $60,000 in cash purchases, according to court documents.

Hiaeve was charged alongside Kevin and Tanny Donaldson, who laundered money from selling drugs through Hiaeve's store, according to the government. Both initially pled not guilty to all counts, but have recently changed their pleas: Kevin Donaldson pled guilty to conspiracy to distribute drugs, and Tanny Donaldson pled guilty to money laundering.

Hiaeve still faces a separate civil-forfeiture lawsuit directed against $17,900 in cash seized from his store. Federal authorities are also in possession of approximately $3 million in diamonds from Hiaeve, Murphy said.

The case is U.S. v. Kevin Donaldson et al, in the U.S. District Court for the Eastern District of New York, no. 10-00455.

For the U.S.: Assistant U.S. attorneys Karin Orenstein, Amanda Hector, Brian Morris and Evan Weitz.

For Hiaeve: Kenneth Murphy of Simon & Partners

(Reporting by Jessica Dye)

(A previous version of this story incorrectly identified the defense attorney as Kevin Murphy. His name is Kenneth Murphy. It also incorrectly named Albert Dayan as one of Hiaeve's lawyers. Dayan no longer represents Hiaeve.)