The unfolding Dewey story has surprised people only with its apparently inexhaustible capacity to continue surprising us, and with its reliable pattern of consistently surpassing our own worst fears about how many things can go wrong at one and the same law firm.
With last night’s announcement that partners are being invited to seek “alternative opportunities,” the firm has finally admitted what has been obvious to so many for so long—and frankly inevitable.
Sure, Martin Bienenstock can stoutly deny what’s plainly afoot:
“There are no plans to file bankruptcy,” Martin Bienenstock, the head of Dewey’s restructuring practice and a member of the office of the chairman, said late Monday. “And anyone who says differently doesn’t know what they’re talking about.”
but it has all the credibility of Groucho Marx’s famous line, “Who are you going to believe, me or your lyin’ eyes?”
At this historic juncture, what might be called the end of the beginning of the Dewey downfall saga, it makes sense to review how we got here.
The story begins, temporally and thematically, with the tale of debt. The most comprehensive accounts have converged on these totals:
- 2010 bond issue, privately placed with insurance companies, $145-million coming due in tranches from 2013 to 2020. The largest purchasers were Hartford ($45M), the British firm Aviva ($35M), and the Dutch Aegon ($25M), accounting for $100 of the $145M. Bloomberg reports the bonds are trading at 60 cents on the dollar.
- A revolving credit line of $100M, on which Dewey has drawn down about $75M
- “Soft” indebtedness, including:
- unfunded pension obligations to former and current partners, which could easily total $100M
- promised or guaranteed compensation to about 100 lateral and incumbent partners, which is now years in arrears (back of the envelope: $1M/year unpaid x 100 partners x 2 years = $200M–this figure could be wildly off but I haven’t seen any estimates whatsoever elsewhere)
- Note that the compensation was promised and payable without regard to the individual’s or the firm’s overall performance, and that such guarantees are, to be charitable, ill-advised for laterals and unheard-of for incumbents.
- A law firm’s typical lease obligations on everything from AAA office space to computers, furnishings, and fixtures.
We only have the roughest sense of the priorities among these claims, or the security/collateral behind them, if any.
If any of you out there believe priority and security don’t matter because the firm will be able to satisfy all the claims against it, I’ll be peeking inside your medicine cabinet while you’re out snapping up those $0.60/$1.00 bonds.
So I estimate the total liabilities at not less than $220M hard and easily that much or more in soft obligations.
Note that this doesn’t address the fundamental timing mismatch between extremely short-term assets (lawyers and to some extent clients) and long-term liabilities. Business models built on the expectation that short-term assets will always be available to satisfy long-term liabilities tend to end in tears (cf. Lehman, Bear Stearns, the entire 1980’s S&L debacle), as I’ve discussed previously.
Next we have misrepresentations—there’s no other word for them—of the firm’s annual revenue to American Lawyer Media, and hence to the legal world at large, no mean offense to propriety and decency in itself. We don’t yet know for sure whether similar misrepresentations were made to internal audiences as well, nor, a fortiori, what figures were used with lenders.
But we do now understand the practice. Dewey apparently had a habit of reporting “14-month” years of revenue when convenient, consisting of one calendar year’s cash receipts plus outstanding accounts receivable at year-end. This obviously has the result of double-counting the same revenue as accounts receivable in year 1 and cash received in year 2. The only way to break the cycle of misrepresentation would be to report a “10-month” year, which, ceteris paribus, would result in a reported revenue decrease of about 30%.
Before entirely leaving this topic of fun with revenue recognition, it’s worth re-emphasizing the harm done to trust in the integrity of publicly reported and widely disseminated numbers. Annual revenue numbers are the bedrock of AmLaw rankings, and Dewey has demeaned and cheapened them with, we can only surmise, eyes wide open. Memories of this will be long.
Guarantees upon guarantees
Guarantees, like opioids, are not per se a bad thing; they definitely have their place in life. But they are powerful and not to be dispensed promiscuously or without safeguards in place against abuse.
When are guarantees justified? I would argue affirmatively the case for guarantees that are:
- Limited to a strictly defined subset of lateral partner arrivals, whose practices:
- Will take more than the usual amount of time to transition in full strength to the new firm;
- Who are demonstrably sacrificing material amounts of income during the transition compared to what they would have earned had they not moved,
- And who would not have moved otherwise—and not all laterals can avail themselves of this harbor.
- Strictly limited in time—I would put a clear and convincing burden of proof on proponents of any extending beyond 12 months.
- Quantitatively tied to the performance of the individual lawyer and the firm as a whole.
- And transparently and conspicuously disclosed to the entire firm, for hygienic reasons.
These would not be the Dewey guarantees. In fact, so far as we have been told or has been reported, they failed on all four of the above counts, in that they were:
- Available not just to a highly selective subset of laterals but to all laterals and a significant proportion of incumbents—the latter being a phenomenon I had never heard of until now.
- If not open-ended, then of multi-year duration.
- Entirely disconnected from firm or individual performance.
- And opaque.
How widely available were these guarantees? About 100 partners had them, per published reports, but note that’s not 100 on a base of 300 partners (Dewey’s partner head count in the last AmLaw ranking), but 100 on a base of 185 equity partners, so more common than not among the equity ranks.
What’s wrong with that? Just one little thing.
Double-digit to one partnership compensation ratios
We don’t yet know what the true highest to lowest partner compensation ratio will be revealed to have been, but 12:1 and 15:1 have been widely reported and if you put together the $6-million/year figure for Mort Pierce and the $300,000/year figure for service partners, it’s a nice round 20:1.
Ratios like this, plus performance-uncorrelated guarantees, constitute a dagger to the very heart of the concept of partnership. If you have made by late January what I’ll make all year, and if my compensation depends on my performance while yours does not, we are in no sense known to the English language “partners,” whatever turgid documentation to the contrary might say.
The Haves and the Have-Nots
One of the more memorable quotes to have emerged from 1301 Sixth Avenue in the past several weeks has been this:
“For years you had the haves and have-nots,” an ex-partner said, earlier this week [this was March 17]. “What’s happening now, is the haves are not getting paid.”
Actually, reports from former Dewey partners are consistent that very few people were getting paid, at least not above and beyond their regular draw amounts, for the past year and more—and that some partners haven’t seen any 2012 compensation at all. This may be understandable when you’re so cash-strapped you can’t pay your black car service or FedEx bills.
Lending further credence to the notion of some partners being more equal than others are reports such as this (from California’s Daily Journal, paywall-protected online alas):
Two ex-Dewey partners described how legacy partners would often approach Dewey management when they got word of guaranteed compensation being paid to laterals, demanding a re-up of their own compensations. One ex-Dewey partner said former Dewey Chairman Steve Davis, chief financial officer Joel Sanders and executive director Stephen DiCarmine sometimes increased those partners’ compensation.
[…] The ex-Dewey partner also said partners would often shop themselves around the legal market, receive lucrative offers elsewhere and use the offers as leverage to get raises. Two partners who were known to use that tactic, sources said, were New York mergers and acquisitions partner Morton Pierce and Los Angeles tax specialist Sean Moran.
“It was a basic play in the playbook of people at our firm,” said one ex-Dewey partner. “If you really wanted to get a raise, you had to go in and threaten to leave. You had to have an offer in your back pocket.” Pierce and Moran did not immediately respond to requests for comment.
Need we point out that this sort of behavior is not calculated to ingratiate you with current or potential partners—and that firms looking at Dewey partners might want to inquire about whether their prospective laterals have engaged in antisocial behavior like this.
The Criminal Investigation
And of course just last Friday the Manhattan DA’s office announced a criminal probe into the firm focused on misconduct by Steven Davis. One of the more poetic angles to this head-snapping development was provided by Peter Lattman writing in The New York Times, whose article concluded quite magically: “Dewey’s namesake is Thomas E. Dewey, the three-term New York governor who also served as Manhattan district attorney.”
The “You’re Free to Leave” Memo
Finally—at least as far as the end of the beginning is concerned—we have last night’s memo from the Executive Committee releasing partners of their fiduciary obligation to act in the firm’s best interest and inviting them to pursue “alternative opportunities.” Game over.
It’s not coincidence, I suggest, that the timing of this memo came more or less immediately on the heels of the news of the criminal investigation. Why? Because the criminal investigation would serve as a bunker-buster sized catalyst for clients to head for the exits. Yes, we all believe in the presumption of innocence (we really do), but the optics of entrusting high-value, sensitive legal work to a firm whose recent leadership is the subject of a probe by the Manhattan DA is unthinkable. Imagine the conversation between a Fortune 500/FTSE 100 CEO and the GC:
CEO: “So we’re using a firm under criminal investigation for counsel on our company’s most critical issues?”*
GC: “Not as of right now we’re not.”
Did I say, “Lights out?”
*(CEOs don’t split hairs between firms and individuals under investigation, nor should they.)
Do we have a teachable moment here?
This brings us to the beginnings of the outline of a moral to this gruesome human tragedy.
But first, let me hasten to head off the yawning trap all too many may be tempted to fall into, if not to affirmatively embrace.
This is not a story about alleged criminal wrongdoing. Yes, we don’t know where if anywhere Cy Vance’s investigation will go, but that’s not the point I’m making. If everyone targeted is entirely cleared it is perforce not a story about criminal wrongdoing, but if everyone targeted is sentenced or pleads to real honest to God jail time it’s equally—so far as we care—not a story about criminal wrongdoing.
The only “teachable moment” about criminal investigations is don’t break the law.
The teachable moment that matters to all the rest of us in the profession and the industry is the litany of management 101 missteps indulged in to bring Dewey to this pass.
I said it’s a human tragedy, and first and foremost that must be respected: Indeed it is, and the more powerless the innocent bystanders the harder, I fear, they’ll suffer. It reminds me of the crash of Air France Flight 447, a perfectly functioning Airbus 330-200 (a model with zero crashes in its history) which the crew flew into the Atlantic Ocean in the course of four minutes three years ago. A human tragedy brought about by a sequence of utterly wrong-headed decisions, with no one willing to speak up, take control, and raise the alarm that whatever was being done was not working and doing more of the same would only accelerate the dismal inevitable. With the passengers in the rear paying with their lives.
But as with every air crash in the modern history of aviation, while the damage cannot be undone the causes of the crackup can be analyzed, pored over, and widely discussed in the hope that no one will repeat the mistakes.
So here we are with a nasty confluence of management miscues, which it pained me to rehearse, and the only remaining question has less to do with why such behavior should be avoided than with how it could have happened in the first place.
I’m no psychoanalyst, but for at least a couple of years, with zero inside information, I have detected the oddest and most inexplicable whiff of unreality emanating from Dewey. No, I never wrote about it because it seemed so improbable that senior leaders of such an august firm would behave immaturely, as if actions had no consequences, utterly lacking (so it would appear) in impulse control or the ability to say no. Where were the adults?
I don’t have a better theory, and in a profound sense it doesn’t matter why they did what they did. All that matters is that we never ever repeat this series of errors.
Or any one of them.
Excellent analysis and important insights, Bruce, as always.
The sinking of Dewey Leboeuf: http://www.flickr.com/photos/expd/7132403935/in/photostream
1. I believe that there might be covenants in the debt documents that pushed the firm into giving the guarantees. I think that the payments on the notes (but not the banks) are subordinated to payments made to partners that had certain guarantees. By guaranteeing the salaries, the firm may have been giving the partners a higher priority to payment over the note holders. ( I can’t for the life of me remember where I saw this, it might have been in old accounts of the debt issuance.)
2. You don’t explain, and I don’t know why the issued the debts. And we don’t know where the proceeds for the notes went. There was speculation it was to cover historic Dewey debt from unfunded pensions to the partners. But it might have been used for the expansion costs to laterals.
3. The summer associates and the incoming associates are truly harmed by the misrepresentations of this firm. How might students look out for firms that could be in similar situations? What would you look for if you were looking for a firm that will offer stability for at least the next few years.
I have at least one more question, why did the partners complain to the DA when the bank extension and the potential mergers were at a critical juncture? That complaint, and the fact the DA chose to open the investigation, had to put an incredible obstacle if not an end,to any negotiations.
Is it possible they knew evidence of malfeasance was being destroyed? Is there some criminal activity that has not yet come to light? Did those partners know the firm was over?
I don’t understand why they didn’t wait until the banks gave them an extension. I suppose it is possible they knew the banks wouldn’t call a default so the bonds would not accelerate.
As European Partner I can tell you that the misrepresentation of revenues (which brings the misrepresentation of profits, financial position, ppp …) was served also internally to the “partnership”. I never saw a balance sheet or a proper statement of account and, obviously, a balance sheet was never presented for approval (and thus “approved”) by the partnership. When I asked, the answer was that it can’t circulate because there are people who sent it to the media … the number were showed in a slide and commented by the Chairman and the CFO to the annual meeting only. It should be noted that the final numbers (revenues) as presented in the slide were the aggregate of the revenues of each office. Thus, each office managing partner (which means basically the whole ExCom members) was able to see if the number of his/her office were correct or not …
Similarly, no one was aware of the outrageous salaries paid to people as Sanders and diCarmine to name a few and no one (within the so called “service partners” not close to the management, as I am) was aware that there were around guaranteed contracts for 100 people.
My comments/questions here are:
– how many people would have remained in 2009/2010/2011 knowing the real situation of the firm?
– knowing that revenues were approx 750 million and not 980 million?
– does this remain a partnership in the technical sense or one could argue that the original partnership agreement was “de facto abandoned” by the management who builded a new “legal entity” (based on a complete different model and structure) excluding the service partners from any of their rights and prerogatives?
– what is this other than a fraud?