A DEWEY “FOOT SOLDIER”?

Back in March, I wrote about Zachary Warren. In 2007, his first job out of college was client relations coordinator at Dewey & LeBoeuf. In July 2009, he left the firm to attend law school. Unfortunately, his brief tenure was sufficient, years later, for the Manhattan District Attorney to name him as one of four undifferentiated “Schemers” in a 106-count criminal indictment.

When he joined the firm, Warren was a generation younger than his fellow alleged “Schemers”: former chairman Steven Davis, former executive director Stephen DiCarmine, and former chief financial officer Joel Sanders. Understandably, Warren would prefer not to be tried with his co-defendants, so he has moved to sever his trial.

Timing is Everything

In its latest filing, the Manhattan District Attorney acknowledges that Warren “was not the mastermind of the Dewey fraud scheme.” However, the government’s objection to Warren’s motion adds, “[H]e certainly was a willing foot soldier.” We learn some other things from the filing, too.

For example, it turns out that Warren was the first “Schemer” to be indicted. In December 2013, the grand jury charged him alone with six counts of “Falsifying Business Records in the First Degree.” But Warren first learned of the charges two months later, when a broader indictment named him along with Davis, DiCarmine, and Sanders.

Presumably, the timing of Warren’s indictment related to the five-year statute of limitations governing the claims against him. The government relies heavily on a handful of December 2008 events to make the case.

December 2008

According to the District Attorney, on December 30, 2008, Warren had dinner with two of his superiors, Joel Sanders and then-Dewey finance director Frank Canellas. To satisfy its year-end bank loan covenants, Dewey needed another $50 million by the end of the following day. Allegedly, Sanders and Canellas had developed a contingency plan of potential financial adjustments that Warren helped to implement.

The District Attorney emphasizes Warren’s supposed sophistication regarding accounting issues. But that’s a far cry from proving his competence to challenge directives from superiors holding CPAs and MBAs. In fact, the propriety of whatever transpired on December 31, 2008 with respect to Dewey & LeBoeuf’s financial statements is likely to become the subject of battling expert accounting witnesses at trial. Dive into those weeds at your peril.

Motive?

As for the aftermath of the alleged New Year’s Eve scheme, the Manhattan District Attorney cites Warren’s “$115,000 in bonus compensation in 2009” as evidence of something sinister. The government claims that the amount exceeded bonuses paid to all but five other Dewey employees. At best, that argument is disingenuous.

Warren received his $75,000 bonus for 2008 in early 2009, as expected. When he left Dewey in July 2009, Sanders promised Warren a $40,000 bonus for his half-year of service, payable in the fall.

Three months later, Warren was at Georgetown Law and still waiting for his final bonus. He left messages for Sanders, who eventually wrote, “If you’re wondering about your bonus, I have you down to receive $40k right after our year end close.”

Warren replied, “I didn’t take out any student loans this semester because I was anticipating the bonus to be paid in the fall as we discussed before I left.” (For unknown reasons, the District Attorney’s brief italicizes for emphasis the last phrase — “as we discussed before I left.”) When Warren still hadn’t received the bonus In November, he tried again and, shortly thereafter, the firm sent him $20,000 — almost the entire net amount. He received the final installment of $1,400 in April 2010.

For the District Attorney, Warren’s requests of his former employer are proof of his ongoing involvement in the original scheme: “In September 2009, he began chasing down the additional bonus that defendant Sanders had promised him.”

Seriously?

 The Continuing Mystery

A fundamental question still begs for an answer: How does whatever happened in the presence of Zach Warren during December 2008 relate to the demise of a storied law firm in May 2012?

So far, it doesn’t. Unless the prosecution develops that connection, something will remain terribly wrong with this picture — and with the effort to put Zachary Warren in prison.

DEWEY – PROSECUTING THE VICTIMS

[NOTE: On Friday, April 11 at 9:00 am (PDT), I’ll be delivering the plenary address at the Annual NALP Education Conference in Seattle.

On Wednesday, April 16 at 5:00 pm (CDT), I’ll be discussing The Lawyer Bubble — A Profession in Crisis as part of the Chicago Bar Association Young Lawyers Section year-long focus on “The Future of the Legal Profession.”]

The trip from victim to perpetrator can be surprisingly short. Just ask some former Dewey & LeBoeuf employees who pled guilty for their roles in what the Manhattan District Attorney calls a massive financial fraud. Anyone as puzzled as I was by 29-year-old Zachary Warren’s perp walk last month will find recently unsealed guilty plea agreements in the case positively mind-boggling. In some ways, those agreements are also deeply disturbing, but not for the reasons you might think.

Warren, you may recall, was a 24-year-old former Dewey staffer when he allegedly had the misfortune of attending a New Year’s Eve day meeting in 2008 with two of his superiors. According to the grand jury indictment, they were among the “schemers” who developed a “Master Plan” of accounting fraud that persisted for years.

When Warren left Dewey in 2009 to attend law school, the firm was making hundreds of millions of dollars in profits, many individual partners enjoyed seven-figure paychecks, and no one foresaw the firm’s total collapse three years later. Nevertheless, last month Warren was indicted with three others who had held positions of responsibility right up to the firm’s ignominious end: former chairman Steven H. Davis, former executive director Stephen DiCarmine, and former chief financial officer Joel Sanders.

A fateful New Year’s Eve meeting

The indictment alleges that CFO Sanders was one of two people with Warren at their December 31 meeting. Now we’ve learned the identity of the other: Frank Canellas.

Canellas’ ascent in the firm had been meteoric. While finishing his bachelor’s degree at Pace University, he joined LeBoeuf, Lamb, Greene & MacRae in 2000 as a part-time accounting intern. Only seven years later, he became — at the tender age of 28 — director of finance for the newly formed Dewey & LeBoeuf. Thereafter, his compensation increased dramatically, rising to more than $600,000 annually by 2011.

In February 2014, Canellas copped a plea. He agreed to cooperate with prosecutors and plead guilty to a felony charge of grand larceny for his role in allegedly cooking Dewey’s books. In exchange, the DA will recommend a light sentence – only two-to-six years of jail time compared to the 15-year maximum penalty for the offense.

Using the boss to get underlings?

Presumably, one reason that the Manhattan DA squeezed Canellas was to help prove culpability at higher levels of the defunct firm, particularly CFO Sanders. But there is something more troubling here than the use of that standard prosecutorial tactic to get at the higher-ups. In his plea agreement statement, Canellas also implicates downstream employees who, he says, implemented the accounting adjustments that he and his bosses developed.

Ironically, in 2012, the people whom Canellas now fingers were among the hundreds of non-lawyers who suffered the most in the wake of Dewey & LeBoeuf’s spectacular implosion. When that was happening, observers properly regarded the firm’s low-level staffers generally as helpless victims. Now, for some of them, guilty pleas in exchange for recommendations of leniency give new meaning to the phrase “adding insult to injury.”

What’s the point?

Why go after the underlings at all? Does it really take a criminal prosecution coupled with the promise of a plea deal to assure the truthful testimony of pawns in a much larger game? With Canellas on the hook, wouldn’t a trial subpoena do the trick for those working under him?

The policy ramifications are even more profound. What message does the Manhattan DA send by flipping a cooperating superior to nail underlings for doing what the superior asked them to do? What does this approach mean for employees far down the food chain in a big law firm or any other organization? Even if you don’t have an accounting degree, should you now second-guess the bookkeeping directives that you receive from people who do? Then what? Complain to your local district attorney that you have concerns about your instructions? And why draw the line at accounting issues?

For any employee now worried about becoming the target of a subsequent criminal proceeding, other options make even less practical sense. As the economy crashed in 2008 and 2009, was it the low-level staffer’s duty to refuse a directive relating to the firm’s accounting procedures or any other issue that caused the staffer concern? To quit or get fired from a decent job and enter a collapsing labor market? To apply for work elsewhere, only to have a prospective new employer solicit a prior job reference and learn that the would-be hire is not a “team player”?

Losing sight of the mission

Unlike many senior partners at Dewey & LeBoeuf, the six relatively low-level staffers who did as Canellas directed (and have now pled guilty to resulting crimes) did not walk away with millions of dollars. Other than the jobs they held until the firm disintegrated, none benefitted financially from the alleged financial fraud.

The situation brings to mind a November 2012 court filing on behalf of Dewey’s former chairman, Steven H. Davis. Responding to the motion of the Dewey & LeBoeuf Official Committee of Unsecured Creditors for permission to sue Davis personally, Davis’s brief concluded: “While ‘greed’ is a theme of the Committee’s Motion, the litigation that eventually ensues will address the question of whose greed.” (Docket #654; emphasis in original)

The Manhattan DA’s investigative efforts could center on that question, too. So far, as indictments and plea deals get unsealed, the situation looks more like an unrestrained effort to secure notches on a conviction belt.

Perhaps it’s just too early to tell where the prosecution is headed. Then again, maybe vulnerable scapegoats make easier targets than the wealthy, high-powered lawyers who created and benefitted from the culture in which those scapegoats did their jobs.

A DEWEY GUILTY PLEA COULD BECOME MORE THAN ANYONE BARGAINED FOR

Sometimes there’s more to a news story than meets the eye. For example, recent indictments and guilty pleas involving former Dewey & LeBoeuf personnel focus on a handful of individuals who allegedly cooked the firm’s books for years prior to its implosion. The sordid details make for entertaining press conferences and great headlines.

But maybe a more interesting question is: who will be standing naked when the Manhattan DA finishes pulling the threads on that sweater? A careful look at Frank Canellas’ plea agreement suggests some surprising possibilities. But it takes a brief history of the Dewey bankruptcy proceeding to understand some of them. So bear with me.

Remember the PCP?

Back in October 2012, the Dewey & LeBoeuf bankruptcy judge approved a novel Partnership Contribution Plan. For a collective $71.5 million, participating former Dewey partners received releases of creditor claims totaling more than $500 million. That meant creditors could not seek to “clawback” additional amounts that partners received while the firm was insolvent.

When did the firm become insolvent? The PCP answered that question with a specific date, January 1, 2011. A progressive payment table determined each partner’s required contribution based on the amount the partner received from Dewey after that date. Partners who had received $400,000 or less paid back 10 percent of the total. From there, the percentage rose so that partners who had received $3 million or more paid 30 percent. (Former Chairman Steven Davis was not allowed to participate in the plan.)

Remember the 2010 bond offering?

The January 1, 2011 cutoff date was important because Dewey & LeBoeuf’s unusual $150 million bond offering closed in 2010. Under the PCP, any money that participating partners received that year — including proceeds from bond investors and funds from banks that refinanced the firm’s debt — remained off the potential clawback table.

A group of retired Dewey partners objected to the PCP, claiming that its terms favored former firm leaders.  Attorneys for the Dewey bankruptcy estate responded that they had retained an outside professional, Jonathan Mitchell of Zolfo Cooper, who had “controlled the development and promulgation of the PCP.” (Docket #482 at 10) Mitchell worked on the project with David Pauker of Goldin Associates.

Remember the court’s approval of the PCP?

Dewey’s bankruptcy judge overruled objections to the PCP and determined that the January 1, 2011 cutoff date was reasonable. In doing so, he relied in part on Mitchell and Pauker, who testified to the difficulty of efforts aimed at proving that the firm was insolvent earlier:

“Based on investigations of the Debtor’s finances by the Debtor’s professionals, Pauker and Mitchell testified that there was strong evidence to support the assertion that the Debtor was insolvent in 2012, but insolvency would be more difficult to prove for 2011, and even harder for 2010. Determining the exact insolvency date is both difficult and expensive because several complex tests are used, leading to extended expensive litigation as those tests can produce contradictory results.” (10/09/12 Mem. Op. at 23; transcript record citations omitted)

Of particular interest in light of Canellas’ recent guilty plea regarding his role in creating the firm’s financial statements, the court went on to observe: “Further complicating the issue, the firm had a clean audit opinion issued in 2010 and was able to refinance a significant portion of its debt,….” (Id.)

Now things get interesting

Flash forward to March 2014, when the Manhattan DA unseals Canellas’ plea agreement. In his accompanying statement, the former Dewey director of finance says that, far from clean, audit opinions for 2008, 2009, and 2010 were based on financial statements that he knew to be false.

Meanwhile, the Dewey bankruptcy attorneys who persuaded the court to approve the PCP gave way to a liquidating trustee. That trustee is asserting clawback claims against individual partners who refused to participate in the PCP. Those complaints allege that the firm was insolvent no later than January 1, 2009 and seek recovery based on that much earlier date.

Now what?

Here’s another way to look what has happened so far:

1. Lawyers for the Dewey bankruptcy estate presented the court with a plan whereby former Dewey partners returned a percentage of the amounts that they received after January 1, 2011 — but anything they received prior to that date became off limits to Dewey’s creditors. (The court-approved final confirmation plan estimated that general unsecured creditors with claims collectively approaching $300 million would eventually receive between 4 cents and 15 cents for every dollar that the firm owed them.)

2.  A group of objectors claimed that the PCP favored Dewey’s most wealthy and powerful former partners.

3. The court overruled that objection and approved the PCP with its January 1, 2011 cutoff date because, among other reasons, professional advisers to the Dewey estate testified that it was reasonable and the firm got what the court called a “clean” audit for 2010.

4. The Manhattan DA has now indicted four former Dewey employees — and obtained guilty pleas from seven others — for their roles in allegedly cooking the books in ways that, if true, would render the 2010 audit not so clean.

5.  One more thing. According to Canellas’ statement appended to his February 13, 2014 plea agreement, after Dewey filed its bankruptcy petition on May 28, 2012, he continued working for the firm’s wind down committee and, at the time he signed the statement, was still working for Dewey’s liquidating trustee. (The plea agreement required him to resign from that position.)

As you try to wrap your head around all of this, remember that “foolish consistency is the hobgoblin of little minds.” So think big and follow the money, if you can find it.

In my next post, I’ll discuss another aspect of the Canellas plea agreement that is likewise deeper than the current headlines — and far more troubling.