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From Securities Regulation Daily, March 6, 2014

Former Dewey & LeBoeuf executives face civil and criminal charges for accounting fraud

By Amanda Maine, J.D.

The SEC charged several top officials at defunct law firm Dewey & LeBoeuf LLP (Dewey) with accounting fraud designed to conceal the firm’s financial condition. The SEC alleges that they used fraudulent methods to overstate revenue and understate expenses, which allowed them to satisfy cash flow covenants and to obtain financing through a private placement of securities. The Manhattan District Attorney also brought criminal charges against the defendants in a parallel action, indicting four individuals for fraud, grand larceny, falsifying business records, and conspiracy (SEC v. Davis, et al, March 6, 2014).

Background. Dewey was formed in October 2007 with the combination of Dewey Ballantine LLP and LeBoeuf, Lamb, Greene & McRae LLP. The new firm was in a precarious financial situation that was exacerbated by the 2008 credit crisis. Dewey’s credit agreements with banks contained a cash flow covenant requiring it to maintain a minimum, defined, year-end cash flow. The firm was unable to meet this cash flow covenant and undertook a scheme to misrepresent its financial condition, according to the SEC and the district attorney. By March 2012, the scheme collapsed and the firm declared bankruptcy. The individuals who allegedly participated in this scheme included Dewey’s chairman Steven H. Davis, executive director Stephen DiCarmine, CFO Joel Sanders, client relations manager Zachary Warren, finance director Frank Canellas, and controller Thomas Mullikin.

Fraudulent accounting. In order to demonstrate compliance with the cash flow covenant, the defendants made fraudulent adjustments to Dewey’s accounting records, which SEC Enforcement Director Andrew J. Ceresney characterized as a “grab bag of accounting gimmicks.” These adjustments including reclassifying salaried partners’ and of-counsels’ compensation as equity distributions and reversing write-offs of client disbursements and of credit card charges not chargeable to clients, which had the effect of making expenses appear lower than they actually were. Other adjustments included reclassifying disbursement payments as fee payments, applying backdated checks to the prior year, applying partner capital as fee revenue, and applying loan repayments as revenue, which had the effect of making it appear that revenue was higher than it actually was. Because of this creative accounting, Dewey was able to report to its lenders that it had satisfied its cash flow covenant in February 2009.

However, even the fraudulent accounting adjustments were not enough to make up for its poor financial condition. Sanders sought a waiver of the covenant from the lenders, who reduced the floor of the covenant with several conditions attached. Despite this, Dewey was still not able to comply with the covenant and the defendants continued to make fraudulent adjustments in the firm’s accounting records in 2010 and 2011, according to the government.

Private bond offering. Facing a great deal of debt, Dewey sought to raise money in a senior secured notes offering. Dewey raised $150 million from 13 insurance companies in a private bond offering. Representations made to investors in the offering’s private placement memorandum, note purchase agreement, and in a March 8, 2010, conference call used figures from Dewey’s 2008 and 2009 financial statements, which were materially misleading due to the use of the fraudulent accounting adjustments. According to the SEC, the private placement memorandum failed to accurately disclose Dewey’s debt, misstated the firm’s practice of write-offs and recording disbursements and payments to former partners, and failed to disclose certain guaranteed contracts with select partners and other partners’ compensation agreements.

Bankruptcy. According to the SEC and the Manhattan District Attorney, due to Dewey’s continued conduct of fraudulently claiming revenue it did not have and pushing expenses off into the future, it could no longer pay its partners or fool its lenders, even after obtaining financing through the bond offering. Following its financial collapse, Dewey declared bankruptcy in 2012. Thousands of Dewey employees lost their jobs and the firm’s many creditors were owed hundreds of millions of dollars.

Charges. For their roles in perpetrating or assisting in the scheme, the SEC charged Davis with violating Securities Act Sec. 17(a) and Exchange Act Sec. 10(b) and Rule 10b-5. The SEC also charged DiCarmine, Sanders, Canellas, and Mullikin with violating Sec. 17(a) and alleged that they aided and abetted Dewey’s and Davis’s violations of Sec. 10(b) and Rule10b-5 pursuant to Exchange Act Sec. 20(e). The SEC seeks disgorgement and civil penalties as well as permanent injunctions against all five defendants, and officer and director bars against Davis, DiCarmine, and Sanders. It also intends to seek to prohibit Davis and DiCarmine from practicing as lawyers on behalf of any publicly traded company or other entity regulated by the SEC.

The District Attorney for New York County, New York also announced that a grand jury returned criminal charges against Davis, DiCarmine, Sanders, and Warren. These charges include grand larceny, scheme to defraud, Martin Act securities fraud, falsifying business records, and conspiracy. “Their wrongdoing contributed to the collapse of a prestigious international law firm, which forced thousands of people out of jobs and left creditors holding the bag on hundreds of millions of dollars owed to them,” District Attorney Cyrus R. Vance, Jr., stated.

Attorneys: Andrew M. Calamari for the SEC.

MainStory: TopStory FraudManipulation AccountingAuditing DirectorsOfficers Enforcement PrivatePlacements SECNewsSpeeches SecuritiesOfferings NewYorkNews

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