Three former executives at Dewey & LeBoeuf LLP, once the No. 3 legal adviser to banks handling merger deals, were charged with a “blatant” $200 million fraud that spurred the largest law firm bankruptcy in history.
The three, including the chairman, executive director and chief financial officer, were accused of using accounting gimmicks similar to those that sent top executives at WorldCom Inc. and Tyco International Ltd. to prison a decade ago. Authorities cited e-mails in which the men referred to “fake income,” “cooking the books” and “accounting tricks.”
“Fraud is not an acceptable accounting practice,” Manhattan District Attorney Cyrus R. Vance Jr. said today in announcing the charges. “The defendants are accused of concocting and overseeing a massive effort to cook the books” that “contributed to the collapse of a prestigious international law firm.”
Dewey, which once had 1,300 lawyers in Manhattan and 3,000 internationally, filed for bankruptcy protection in May 2012, owing creditors $245 million. The New York-based firm, the product of a 2007 merger between Dewey Ballantine and LeBoeuf, Lamb, Greene & MacRae, fell apart within weeks after ousting Chairman Steven Davis in April 2012 and watching virtually all its partners quit for competing firms.
Accused in a 106-count indictment were Davis; Stephen DiCarmine, the former executive director; and Joel Sanders, the ex-chief financial officer. Ex-client relations manager Zachary Warren was also arrested. Seven others, some of whom are cooperating with prosecutors, have pleaded guilty, Vance said. They weren’t identified.
The Securities and Exchange Commission today sued Davis, DiCarmine, Sanders and two others, alleging a “bold and long-running accounting fraud.”
The four criminal defendants, in handcuffs and suits, appeared in state Supreme Court in Manhattan and denied wrongdoing. Davis, DiCarmine and Sanders were freed on $2 million bail, Warren on $200,000.
The allegations concern “similar techniques to all the great cases where people have gone to jail,” said Lynn Sarko, a securities lawyer at Seattle-based Keller Rohrback LLP, in a telephone interview. Sarko, who has represented workers suing Enron Corp. after its 2001 collapse, is not involved in the case. “As a managing partner of a law firm, I’m sitting there going, ‘Wow.’ This is not business as usual.”
Lies to auditors, partners and the firm’s own executive committee began in November 2008 as Dewey’s cash flow slowed amid the financial crisis and continued until March 2012, according to the indictment.
The executives inflated revenue and hid expenses to comply with lending agreements and as part of a $150 million bond offering, prosecutors said. The defendants stole almost $200 million from 13 insurers and two financial firms, they said.
“Rather than speak openly with creditors about mounting debt and shrinking revenue, the defendants began deliberately manipulating the firm’s financial statements,” said Richard Frankel, who heads the FBI’s criminal division in New York, in a statement. “They backdated checks, changed write-offs and even misappropriated loan payments as revenue. All in an elaborate attempt to cover up the increasingly dire situation.”
Davis, 60, DiCarmine, 57, and Sanders, 55, face as many as 25 years in prison if convicted, Vance said. Warren, 29, faces as many as four years. Charges include grand larceny, a scheme to defraud, Martin Act securities fraud and falsifying records.
According to authorities, the firm in 2008 signed a credit agreement with four banks, requiring it to maintain an annual cash flow of $290 million. At year’s end, they said, Sanders and the firm’s finance director told Davis and DiCarmine that Dewey was in danger of violating the cash-flow requirements, threatening its credit and ability to operate.
Sanders and others then began scheming to falsify Dewey’s books to inflate its revenue, according to authorities. Dewey cut expenses by mischaracterizing payments to salaried lawyers, reversing disbursements that had been written off, double-booking income, encouraging clients to backdate checks and delaying expenses, they said.
“I don’t want to cook the books anymore,” Sanders said in a Dec. 4, 2008 e-mail, according to the SEC. “We need to stop doing that.”
In a June 27, 2009 e-mail, Sanders asked finance director Frank Canellas, “Can you find another clueless auditor?”
“That’s the plan,” Canellas responded. “Worked perfect this year.”
Canellas was sued by the SEC and not criminally charged. His lawyer, Brian Maas, declined to comment on the allegations. Dewey’s ex-auditor, Ernst & Young LP, said in a statement that it was “lied to by the defendants who withheld information and affirmatively concealed their scheme.”
At one point, the firm booked a $1 million capital contribution from a partner as revenue, then moved it back into partner equity, then transfered it back again into revenue when it needed to boost finances, prosecutors said.
At the end of 2009, Dewey owed $206 million, $118 million of which was due in a year, authorities said. The firm raised $150 million from insurers that invested in a bond offering based on phony financial statements, they said. Still, its finances continued to deteriorate and the firm filed for bankruptcy protection in May 2012.
Prosecutors said the defendants memorialized their plot in a document the accused called the “Master Plan.” It included a reference to accounting changes that made it appear that Dewey had greater revenue and fewer expenses, Vance said.
Elkan Abramowitz, an attorney for Davis, who lives in London, said his client acted in “good faith” and “in service of the firm’s best interest.” DiCarmine’s lawyer, Austin Campriello, said the indictment “is guilty of scapegoating” and “spins some inartful e-mails into crimes.”
“They are attempting to elevate traditional and typical accounting adjustments to crimes,” Ned Bassen, a lawyer for Sanders, said in a phone interview.
Michael F. Armstrong, Warren’s lawyer, declined to comment.
Aviva Life & Annuity Co. has sued Davis, DiCarmine and Sanders, alleging they induced the insurer to buy $35 million of secured notes in April 2010. Des Moines, Iowa-based Aviva said Dewey kept its debt secret from partners to avoid the “possibility of a mass defection” of lawyers.
Dewey’s privately placed bonds, which traded sparsely, were quoted at 45 cents to 55 cents on the dollar in the month before the May 2012 bankruptcy, according to a report by CRT Capital Group LLC, which buys and sells distressed debt, then including Dewey’s.
A bankruptcy court approved Dewey’s liquidation plan in February 2013 and it was implemented the following month, creating a trust to bring lawsuits and knock out claims. Dewey’s Chapter 11 petition listed assets of $193 million and liabilities of $245.4 million.
The firm’s namesake is two-time Republican presidential candidate Thomas E. Dewey, a former New York governor and district attorney. It had a long practice of guaranteeing pay for lawyers who had been there for as many as 20 years, ex-partners said in 2012. As much as 80 percent of the firm’s compensation was guaranteed.
About 100 partners had guarantees totaling about $100 million a year, people familiar with Dewey’s finances said in 2012. DiCarmine was promised his salary and bonus of $2 million a year, a person familiar said.
The criminal case is People v. Davis, 773-2014, New York State Supreme Court (Manhattan). The SEC case is SEC v. Davis, 14-cv-01528, U.S. District Court, Southern District of New York (Manhattan).