It always starts small:
Photo: Petr Kratochvil. Source: Public Domain Pictures
A little “fudging” on the bank statement; Overstating income to obtain a loan; Rounding errors that round the wrong way; Fixed assets that aren’t so fixed, where amortization slows to a crawl—all boosting the bottom line. These are some of the ways accounting can be distorted to serve nefarious ends.
In 2007 a 100-year old law firm merged with an 80-year old firm. Former partners included Wall Street scions, Presidential candidates, and counselors to Fortune 500 firms. The combined entity—Dewey LeBoeuf—had an international reach, with offices in New York, London, Paris, Moscow, and Hong Kong. At its peak the new firm employed 1300 lawyers and had almost $1 billion in revenues.
But there was financial trouble almost from the beginning. In order to entice high-grossing “rainmakers” to join, they offered guaranteed contracts worth millions to some new partners. When revenue ran short, the firm borrowed funds to make its payroll. Normally, a professional firm doesn’t need much leverage. But as the shortfall persisted and the loans got bigger, Dewey LeBoeuf was in danger of violating its loan covenants.
So management went to the finance department with their earnings objectives. And this wasn’t a normal time, this was December 2008. Corporate clients were holding back payments, conserving cash during the Financial Crisis. So the bookkeeping got creative. They brought back bills that had been previously written off; they reclassified salaries as profit distributions; they even double-counted certain revenues.
In the end, these financial shenanigans resulted in a shell game that ended in a $550 million default and the biggest law firm failure ever. The full story is an epic tale of dysfunction and mismanagement following an ill-advised ego-and-greed driven merger. But it’s also a story of over-promising.
Professional firms are rarely filled with people who act unprofessionally. But financial compromise is like an avalanche. It starts small, and grows, until it sweeps everything away. In this case, it destroyed Dewey LeBoeuf.
Douglas R. Tengdin, CFA
Chief Investment Officer