Do as I say; Not as I do.
The bankruptcy of Dewey & LeBoeuf sent shivers throughout big law firms. The firm could trace its history back 100 years and employed over 1000 lawyers when it exploded. Last week, key leaders of the firm were charged with securities law violations and criminal theft charges related to the law firm’s bond issuance.
When Dewey went under, the first thing that caught my eye was its bond issuance. That seemed an unusual way for a law firm to finance its cash flow and capital needs. Unfortunately for the Dewey leaders, its one thing to lie to the firm’s partners and lenders about the firm’s financial health. But the lying to the bond purchasers is securities fraud.
According to the indictment and SEC complaint, the firm was behind on its lender covenants and started reclassifying items to make its financial statements meet the targets. In reading through the charges, some of those accounting adjustments sound bad and some sound questionable. An accountant would probably not approve, but that Dewey managers may have some arguments to justify the changes.
“I assume you new [sic] this but just in case. Can you find another clueless auditor for next year?”
Oh my… What would a lawyer say to his client who put something like this in an email?
What ever argument the Dewey managers may have had about the accounting treatment is going to be questioned when there are emails discussing the decisions with phrases like: “fake income”, “accounting tricks” and my favorite: “cooking the books”. At this point, we only have the government’s side of the story and the Dewey managers have not had a chance to tell their side of the story.
There is an email asking for back-dated checks so the firm can book revenue to the prior year in an effort to make 2009 year-end numbers. That is followed by a response from another manager asking the email to be re-worded so it does not sound like it’s engaging in accounting fraud.
The firm is not meeting its financial goals. That’s disappointing and the its lenders are going to reel the firm in. The solution was a bond offering. According the SEC and district attorney, the firm’s financial statements were fraudulent.
This seems like a classic “company gone bad” fraud scheme. The firm insists on making its numbers and pushes its accounting treatment to make the numbers in that quarter, but ends up robbing income from the following quarter. It hopes it can catch up, but never does.
The firm managers had been fraudulently claiming revenue that Dewey did not have and kept pushing expenses and financial obligations off into the future. Dewey had to cut partner compensation and that was not enough to prevent them from leaving. With the loss of partners, there was a loss of revenue. At some point the rubber band is stretched too far (not that law firms are that flexible) and snaps. The firm managers could no longer fool Dewey’s lenders and bond holder. It had no choice but to file bankruptcy, sending thousands onto the unemployment line.
But this was a law firm who, on a regular basis, dispensed advice about compliance and SEC enforcement and accounting fraud. As Donna Boehme and Joseph Murphy point out in 10 Inconvenient Truths About Law Firm Compliance (.pdf):
Fact 1: People create risks. Fact 2: Law firms have people.
It seems like Dewey had a case of not following the advice it dispensed to its clients.