Thinking About the Dewey & LeBeouf Criminal Indictment and Law Firm Management Liability Insurance

Thinking About the Dewey & LeBeouf Criminal Indictment and Law Firm Management Liability Insurance

 The indictment last week of the top officials from the collapsed Dewey & LeBouef law firm is merely the latest development in the long-running sequence of events following the law firm’s demise. The indictment (and the accompanying SEC enforcement action) paints a vivid picture of the desperate efforts of the law firm’s top officials to avert financial disaster, which in turn allegedly led them to mislead the law firm’s partners, creditors and investors. As I have previously noted in connection with the legal proceedings following the firm’s collapse, these latest developments raise important issues surrounding management liability insurance for law firms.

In many respects, the Manhattan District Attorney’s indictment is not a complete surprise. As detailed in James B. Stewart’s fascinating (yet deeply disconcerting) October 14, 2013 New Yorker article about the events leading up to the law firm’s demise entitled “The Collapse” (here), the criminal investigation had commenced even before the law firm filed for bankruptcy in May 2012.

Dewey & LeBoeuf was the product of the ill-fated 2007 merger between the storied Dewey Ballantine law firm and the LeBouef Lamb Greene & McRae law firm. At the time, the wisecrack was that “Dewey married money, LeBoeuf married up,” but the New Yorker article shows that turmoil and fear at LeBouef and declining firm fortunes at Dewey had driven the firms to the altar. A potent mix of outsized partner compensation guarantees, infighting and the economic downturn led to serious financial problems in the first full year after the merger.

According to the indictment (here), as a result of the revenue downturn in 2008 and the pressure of the guaranteed partner payments, the company was out of compliance with certain covenants in its bank line of credit. In order to create the false impression that it was in compliance, the firm’s managers initiated a series of steps that one internal email cited in the indictment described as “accounting tricks.” The firm’s CFO described the process in another email as “cooking the books.”  The indictment describes a variety of different accounting ruses the top firm managers orchestrated to falsify the firm’s apparent financial condition.

These efforts were compounded in 2010, when the firm completed a $150 million private placement bond offering. The offering documents relied on financial statements that overstated the firm’s 2008 and 2009 revenues by tens of millions of dollars. According to the allegations, following the offering, the firm’s senior managers provided the bond investors with fraudulent quarterly certifications.

The criminal indictment names as defendants the firm’s former Chairman Steven Davis, former executive director Stephen DiCarmine and former Chief Financial Officer Joel Sanders. (A fourth individual is also named as a defendant in one count of the indictment for falsifying entries). A parallel SEC enforcement action (about which refer here) asserts securities fraud charges against Davis, DiCarmine and Sanders, as well as two members of the firm’s accounting staff. For readers that are interested, the New Yorker article linked above provides a lurid  picture of involvement of Davis and DiCarmine in the events that led up to the merger and then to the combined firm’s eventual collapse.

As discussed in Alison Frankel’s detailed March 6, 2014 post on her On the Case blog about the regulatory and criminal charges against the former Dewey firm managers (here), both the indictment and the SEC action are unprecedented. While there have previously been law firm managers that have been indicted before, those charges have mostly involved brazen self-enrichment through embezzlement or the like. Here, the criminal charges were the result of the actions the firm’s senior managers took in the course of their duties as leaders of the firm to try to stave off disaster after the global financial crisis.

But as Frankel also points out, the allegations may be unprecedented, but the precedent has now been set. The circle of potential claimants against law managers has just been widened, and the kinds of allegations that might be asserted against law firm managers have just expanded.

As I pointed out in a prior post about the settlement of various civil charges asserted in the law firm’s bankruptcy proceeding (here), among the many implications from the events surrounding the Dewey & LeBoeuf collapse are important implications in connection with management liability insurance for law firms.

First and foremost, the events following the law firm’s collapse underscore the importance for law firms of a separate program of management liability insurance. Every attorney is well aware of the need to have errors and omissions insurance in place (what they would typically think of as malpractice insurance). But while attorneys know they need insurance to protect them against claims that they erred in the delivery of client services, they may be less aware of (or persuaded of) the need for management liability insurance to protect their firm’s managers from claims for alleged wrongful acts committed in the  management of the firm.

As the latest regulatory and criminal proceedings arising out of the Dewey & LeBoeuf collapse demonstrate, law firm managers face the possibility of potential claims from a broad variety of potential claimants. Indeed, as the most recent developments underscore, the range of potential claimants includes creditors, vendors, suppliers, and even, as happened here, regulators and prosecutors. Indeed, at this point, the various claims that have arisen against the former Dewey & LeBoeuf provides something of a catalog of the kinds of claims law firm managers may face, which if nothing else will help law firm managers to understand why they need management liability insurance in place.

The events following the Dewey & LeBoeuf collapse also have important implications for law firms when they consider how much management liability insurance to buy.  Most law firms do not need to be persuaded that they need to carry significant limits of liability on their E&O insurance program, but they may underestimate their needs when it comes to management liability insurance. The cascade of claims that have been asserted against the former Dewey & LeBoeuf managers underscores the fact that in catastrophic circumstances the insurance requirements could prove to be extensive. In my prior post, I detailed how the settlements of the various claims in bankruptcy threatened to exhaust the limits of liability of the firm’s management liability insurance program. The new regulatory and criminal charges represent even more significant demands on the insurance program (or what may be left of it). This situation shows the importance of thinking about what might be required to ensure that the law firm’s managers do not run out of insurance protection before all of the claims against them have been resolved.  At a minimum, the sequence of events here ought to encourage some law firms to take a look at the possibility of increasing the limits of liability for their management liability insurance program.

The filing of regulatory and criminal charges against the law firm’s former management also raises important considerations with respect to the terms and conditions in a  law firm’s management liability insurance program. For starters, the criminal indictment has important implications for the program’s definition of a “Claim” under the policy. The typical definition of “Claim” in a management liability insurance policy will include as a covered claim a criminal proceeding after indictment or the return of criminal information. In the past, the wording of this particular provision in the law firm management liability policy may not have seemed as of high as a priority. But now the possibility of criminal indictment of law firm managers has emerged, this provision should take on added importance and receive greater attention.

The SEC’s filing of securities fraud charges may represent a particular concern. On the one hand, it is unusual for a law firm to conduct the type of offering that Dewey & LeBoeuf completed (and in light of how it played out, both law firms and investors may shy away from any future offerings of that type). On the other hand, it may make just as much sense for a law firm to try to raise capital through an offering as it does for any privately held enterprise (indeed, in Australia, there is at least one law firm that is publicly traded). The possibility of this type of offering raises a question about the availability of converge under the policy for claims arising from an offering of this type.

Most management liability policies for privately held organizations contain an exclusion precluding coverage for claims related to securities offerings. The sequence of events at the Dewey & LeBeouf highlights the fact that law firms might attempt to raise capital through a securities offering and that claims might arise in connection with such an offering. Again, given what happened with Dewey & LeBeouf, I don’t expect that there are going to be a lot of law firms rushing to try to raise capital through an offering of this type nor would I expect there to be much investor demand. Nevertheless, the possibilities for an offering and of claims related to the offering are there. These events suggest that the securities offering exclusion in the law firm management policy, which in the past may not have been the subject of a great deal of attention, may need to be reexamined. Of course, in light of what happened at Dewey & LeBeouf, the carriers providing law firm management liability insurance may now be particularly wary of adjusting the securities exclusion.

Many observers have chosen to interpret the demise of the Dewey & LeBoeuf law firm as a sort of a morality tale about the wages of supposed greed and excess. While some may find enough from the law firm’s demise to support that kind of an interpretation, it would be unfortunate if those lessons were the only ones drawn from these events. Even if the law firm’s collapse is the result of the firm’s own peculiar set of circumstances, there are still important lessons for other law firms, even those that consider their circumstances to be different from those of the late lamented Dewey & LeBoeuf firm. Among the lessons that every firm would do well to heed is the message about the importance of management liability insurance for law firm managers.

Start Spreading the News: For many years, since I spent a few months a very long time ago as a summer associate at one of the prestigious New York law firms, I have thought that one of the great curses on people who have been drawn to New York to seek their fortunes can be found in the lyrics of Frank Sinatra’s song “New York, New York.”

During my summer in New York, I often found myself in East Side watering holes full of crowds of young professionals. Inevitably, at some point (usually very late in the evening) somebody would cue up the Sinatra song and everyone in the crowd would sing along, with particular emphasis on the line that goes “If I can make it there, I’ll make it any where.” 

The song obviously is something of an anthem – as well as a battle hymn. Many do not succumb, but for some the compulsion to “make it there” turns the ordinary challenges of professional life into an existential struggle for self-validation. As the New Yorker’s account of this law firm’s demise demonstrates, the struggle to prove that you are “king of the hill, top of the heap” can, when things go wrong, lead to desperate behavior. Even in less extreme cases,   those who have discovered the steep downside to living “in a city that doesn’t sleep,” find themselves unable to make a tactical retreat for self-preservation, for fear that leaving town represents defeat and humiliation.

The amount of human misery accumulated out of a desperate effort to “make it there” and to get to and to stay “on top of the heap” is beyond calculation. It is a song for the winners, but even in New York, not everyone can win, and even in New York, not everyone can win all of the time. 

 Read other items of interest from the world of directors & officers liability, with occasional commentary, at the D&O Diary, a blog by Kevin LaCroix.

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