“I DON’T WANT TO COOK THE BOOKS ANYMORE”

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THE FALL OF DEWEY & LEBOEUF

This is a story we have followed for over a year. For those unfamiliar with it, Dewey & LeBoeuf, LLP, at its height had over 1,300 lawyers world wide. The firm crashed during the financial crisis and ultimately filed bankruptcy in 2012. As is often the case when there is significant financial stress and a culture of entitlement —  financial misconduct and bad judgment follows. This proved to be the case at Dewey as four members of the firm were recently indicted in New York in a 106 count indictment which accuses them of participating in a scheme to overstate revenue and hide losses in order to continue accessing a much needed line of credit. In other words, the desire of the members to continue getting paid was allegedly more important to them than telling the truth. The specific crimes charged included grand larceny, securities fraud, conspiracy and falsifying records. Seven of the firm’s employees have already pled guilty to related crimes.

FELONY FRAUD CHARGES

The recent indictment alleges that the firm was struggling to meet its financial obligations in 2008. The firm was apparently dependent on a revolving credit line extended jointly by four banks. This credit line had a covenant requiring the firm to maintain certain cash flow levels in order to access the line. Perhaps the most damaging evidence referenced in the indictment is that allegation that the firm’s Chief Operating Officer sent an email on December 4, 2008, saying “I don’t want to cook the books anymore.” However, this was apparently only a fleeting concern as the firm allegedly continued to report to lenders that it had satisfied the loan covenants.

SECURITIES FRAUD

The firm allegedly made matters worse in 2010 when it floated a 150 million dollar bond offering to a group of insurance companies apparently desperate for yield. In a separate Securities and Exchange Commission complaint the S.E.C. alleges that the offering inflated the firm’s 2008 and 2009 financial statements by a combined 59 million. These S.E.C. charges may be more difficult to defend against than the criminal charges since the S.E.C. has a lower burden of proof (proof by a preponderance of the evidence) than what is required in the criminal case (proof beyond a reasonable doubt). Proof of knowledge is also not required for certain civil securities violations while a criminal fraud case requires knowledge and specific intent.

The Dewey & LeBoeuf firm also allegedly lied to its outside accountants, Ernst & Young. Members of the firm even ridiculed Ernst & Young auditors in at least one email. After a young Ernst & Young accountant changed jobs, one of the law firm’s executives sent an email saying “can you find us another clueless auditor for next year.”

TAKEAWAYS?

For those who use email, one easy takeaway is to think before you hit “send”. For the managers and officers of professional firms, this case is also a reminder of the that even if you are not the ultimate decision maker, your title alone may expose you to civil penalties and criminal indictment. Even good D&O insurance is not likely to protect you from the financial devastation that could result from being merely associated with misconduct.

For creditors such as equipment lessors who regularly provide products and services on an unsecured basis (and who will be big losers in this case), the takeaway is to be careful in dealing with professional businesses that show signs of significant financial distress. While it is obviously difficult to predict which customers may end up bankrupt, the only way to identify red flags and potentially mitigate any losses is by doing your due diligence. The more substantial the contract/lease, the more important it is to exercise sound credit judgment on the front end.

Finally, for the clients of professional firms, this is a reminder to pay attention to the financial stability of any firm you hire as well as the firm’s culture. Unfortunately, some professional firms view each client matter as an opportunity to bill the most hours possible. The temptation is even greater when there is financial distress. It is unlikely that a firm culture that would encourage lying to creditors to keep bonuses flowing would have any hesitation about over-staffing legal matters and padding bills.

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