As the Capitol Steps liked to remark, everyone loves a skicious vandal. Schadenfreude sprang up like mushrooms in that springtime many of us are still longing for, first as Dewey & LeBoeuf became the biggest law-firm failure ever; then when stories of secret salary guarantees to the Pigs Who Were More Equal Than Others began to proliferate; then when the firm’s bankruptcy spawned “clawback” claims and widespread settlements with former partners who the Trustee contended had received more than their fair share before they left, or had exposed themselves to “unfinished business” claims by taking work and clients with them to their new firms. Rumors flew that various unhappy partners had taken their displeasures to the Manhattan District Attorney, who was investigating alleged financial improprieties.
And now the DA, having extracted guilty pleas and cooperation from half a dozen underlings, has indicted Dewey’s former Chair (managing partner), Steven Davis; his deputies, former Executive Director Stephen DiCarmine and former Chief Financial Officer Joel Sanders; and (somewhat puzzlingly) a 29-year-old former Client Relations Manager named Zachary Warren. The charges include fraud, theft, falsifying business records and conspiracy. The SEC has filed its own civil complaint, naming Davis, DiCarmine and Sanders as well as former Finance Director Frank Canellas and former Controller Thomas Mullikan. The New York Times’ coverage, with copies of the indictment and related SEC complaint, can be found here.
The widespread glee at the mighty fallen notwithstanding, we would all do well to remember that this is a genuine human tragedy. Dewey employed over 1,000 lawyers and thousands more staff when it crashed. All of them lost their jobs in the midst of the Great Recession. While the legal press has chronicled the soft landings enjoyed by many of the more senior partners, many more were not so fortunate.
All of which should make us want to ask what we might learn here. There will be the usual rash of sanctimony in the comments (you may consider your points made, and save them for another day), reducing the situation to the obvious, simplistic and therefore ineffectual admonition not to lie, cheat or steal. These observations are usually coupled with the much less obvious but theologically entrenched creed that BigLawyers are all just Gordon Gekkos with bar cards, genetically predisposed to or trained from day one for greed, deceit and exploitation of their fellow man, so why is anyone surprised?
Please. There are hundreds of large law firms today, populated with well over 100,000 lawyers, that are not in bankruptcy, never will be, and are not (in the words by which one of the Dewey defendants allegedly described his activities to some of the others) cooking their books. They may be more or less well-managed (a great many less, but that’s for another day), more or less forward-looking and responsive to their environments and clients (same comment), and more or less humane employers and community members, but they are not roiling dens of thieves.
So what was different about Dewey? I want to suggest that, among the lawyers and law firms that have found themselves on the wrong end of criminal and SEC enforcement complaints, there are some unusual and noteworthy things about Dewey, things that illustrate some trends in this sector of the profession and offer a lesson or two more focused than a bare, if emphatic, rebuke of the deadly sins.
Set aside the regrettable population of those who become garden-variety criminals and happen to be licensed to practice. Most lawyers who commit crimes and frauds as lawyers fall into two general categories: Some steal from their clients—many by the simple expedient of taking client funds from their trust accounts, but some of the more ambitious and creative by kiting or otherwise perverting client trust accounts in Ponzi schemes and similar frauds. Marc Dreier and Scott Rothstein are recent rather spectacular examples. Others assist their clients in stealing from others—for example former Mayer Brown partner Joseph Collins, who is currently in federal prison for developing and implementing strategies allowing his client Refco to conceal devastating losses and omit them from a series of securities filings. Neither happens all that much at large firms, not least because there is usually enough infrastructure and oversight to keep most rogue behavior in check.
But Dewey is neither of these. The allegations of the New York indictment are that the defendants, all (except Warren) senior management of a billion-dollar professional firm, developed and implemented a scheme they portentously dubbed the “Master Plan” to manipulate the firm’s accounting records in order to be able to report to their banks and other lenders at a time when firm performance fell well below projections that were probably unrealistic to start with that they had met loan covenants or deserved additional extensions of credit. The SEC complaint focuses on the alleged accounting fraud the firm, through its management, employed in violation of the securities laws to float a $150 million private debt offering to various institutional investors that supplemented the firm’s $100 million revolving bank line. In short, Dewey & LeBoeuf defrauded its own lenders.
This is an all too common story in the business world, but among law firms—whose members regularly rehearse and dispute the details of such stories in which their clients are involved, and put their shoulders to the shovels that excavate the wreckage—it is unusual. I have little doubt that it has happened before, but it is nowhere near as common among lawyers’ frauds as fraud on their clients or on those with whom their clients are dealing. And to the best of my knowledge it hasn’t ever happened with anything approaching the scale or dishonesty alleged here.
It’s often enlightening to look behind the fraud to see what the alleged fraudsters wanted the money for. And that’s where Dewey stands apart from most other lawyer frauds. As chronicled in the most detail by James Stewart in the New Yorker, management was so concerned about keeping old and recruiting new rainmakers that they gave many partners extravagant salary guarantees, guarantees that exceeded the revenue necessary to support them. By definition, then, the firm overpaid many of those partners, and then borrowed to cover the difference between what it had promised them and what they generated. And then allegedly lied to its lenders for the wherewithal to keep the spiral rising. Some of the partners apparently knew about some of the salary guarantees, and some knew about more of them than others. All of the partners knew about the shortfalls when year-end bonus time came, as the firm proved unable to meet most of the guarantees management had made, and then had very little left after other expenses to pay the partners not shrewd, or valuable, or (more to the point) institutionally indifferent enough to have extracted one. How many of the partners appreciated how directly the borrowed money translated to borrowed time is unclear. Though many were deeply sophisticated observers and analysts of business and finance, few seem to have known or guessed that someone might be lying to keep their own thing going well after the clock had actually run out.
So what’s new and what’s different? In an extended time of flat demand for complex legal services—the first in the experience of almost anyone living today—compounded by downward price pressure on the limited pool of available work from (among other things) increasing commodification of much such work in the eyes (and checkbooks) of increasingly sophisticated and aggressive general-counsel consumers, BigLaw managing partners must struggle harder and harder to live within their means. As Dave McGowan and I noted several years ago (see here at pages 14-18, 70), and Bill Henderson argued more recently (see, e.g., here), many law-firm managers today stubbornly cling to the belief that they can somehow earn their way out of an increasingly competitive market by buying revenue (that is, bidding for lateral partners with portable business) for a price equal to or even greater than the profits that revenue will generate. For an astonishingly long time, the limited efficacy of this strategy was masked by the inexorably rising tide of client demand, which lifted even the leakiest and most ill-skippered boats, and allowed the lucky to believe they were smart. But in the current market, if you pay a million dollars for a million dollars in profit, you don’t make it up on volume.
Dewey indulged in the errors of the current age to a greater degree than most. Management hired more laterals at higher prices, and then found themselves forced to overvalue complaining incumbents equally in order to retain them, compounding the problem. They did so in an uncritical belief that the conditions that had generally prevailed from 1980-2007 would go on forever—after all, in the experience of the senior lawyers implementing what eventually devolved into the “Master Plan,” they effectively had—and allow them to earn their way out of any hole they could afford to dig. When the music suddenly stopped, it is alleged that they chose to lie about how many chairs they had—imagining, I would guess, as many who maneuver themselves into this position do, that the band would strike up again momentarily, and no one would ever need to count the chairs.
The pattern is familiar to anyone who studies financial fraud. Management robbed debt (the firm’s lenders) to pay equity (the partners); as owners themselves, management benefited too, though apparently not disproportionately more than their innocent (or ignorant) colleagues. Ironically, the beneficiaries of the alleged fraud (Dewey’s partners) were among its victims. Most of that can be said, to about the same degree, about any Ponzi scheme (though I am not suggesting that the Dewey fraud is a conventional Ponzi scheme, just that it shares the feature that its beneficiaries and its victims overlap significantly). What is unusual here is that the fraud appears to have happened in a large and highly pedigreed New York law firm, the sort of institution people imagine steeped in prudence and restraint. And it happened in the service of mismanagement of a kind that, while not at all uncommon among large law firms today, was uncommonly carried beyond the practical limits that constrain most firms by what is alleged to have been sustained and systematic dishonesty amounting to theft.