May 12, 2014

Lessons Learned from Law Firm Collapse

By Danielle Clarity, Esq., Supervisor, Advisory Services

Lessons Learned from LeBoeuf

The chief financial officer of a multinational law firm orders a billing director to prepare invoices recording revenue that they both know will never be sent to clients or actually collected.The Firm’s finance director and controller falsify certifications to the Firm’s bank and auditor that the Firm has complied with loan covenants.The finance director also instructs an accounting department clerk to reclassify partners’ capital contributions as Firm revenue and to record some partners’ administrative travel and entertainment expenses as client expenses of other partners to make them falsely appear to be client receivables. A senior partner threatens to have the Firm’s executive director’s, a first cousin to the acting head of the Bonanno crime family, “head on a stick.”

This may sound like the plot of a new John Grisham novel, but, in reality, it is part of the “Downton Abbey meets The Wolf of Wall Street” story of a global law firm (the “Firm”), which filed for bankruptcy in May 2012.The Firm’s apparently precipitous collapse was likely the result of a number of factors including un-maintainable compensation guarantees and the recent “Great Recession,” which decimated the Firm’s principle practice areas.While the Firm’s economics may have inevitably led to its dissolution, the tactics that the Firm’s management engaged in, such as those discussed above, allowed the Firm to delay that end.These tactics, which resulted in guilty pleas and indictments of at least 11 former employees and partners, present learning opportunities to prevent this kind of debacle at other Firms.

Setting the Tone at the Top

One of the most critical influences to encouraging ethical behavior is the “Tone at the Top,” which according to the Association of Certified Fraud Examiners is the ethical atmosphere that is created in the workplace by the organization’s leadership and has a trickle-down effect on the company’s employees.¹Assuming members of the Firm’s management are convicted of the crimes for which they have been indicted, they will join the list of people such as Ken Lay from Enron; Bernie Ebbers from MCI/WorldCom; and Dennis Kozlowski from Tyco who have come to symbolize what is wrong with our corporate system.

The Model Rules of Professional Conduct (the “Rules”), enacted in every state but California² as well as the District of Columbia and the U.S. Virgin Islands, mandate that law Firm management implement systems that reasonably assure that all of the Firm’s lawyers conform to the Rules and that non-lawyers working for or with the Firm also adhere to similar standards.³ Additionally, all lawyers, regardless of their positions in the Firm, have an independent obligation to act in accordance with the Rules even when acting at the direction of another person.⁴ Since it is admittedly difficult for a junior attorney or non-professional staffer to challenge the actions of the senior attorneys to whom they report, it is incumbent on Firms to facilitate ethical conduct by implementing mechanisms that enable personnel to overcome impediments to their compliance with the Rules.

Ethics Hotline
One particularly effective tool that addresses the difficulties faced by junior attorneys and non-lawyer staff in reporting misconduct of senior personnel is an anonymous reporting tool such as a compliance hotline.According to a recent study from the ACFE, the likelihood that misconduct would be detected by a tip was 51% in organizations that had an anonymous reporting tool compared to 35% in organizations that did not.⁵ While the ACFE study was analyzing occupational fraud, the concepts apply equally to professional ethics.

The key to an effective ethics hotline is response. Employees and partners need to understand that information provided to the ethics hotline is not only secure and confidential, but is also taken seriously. If staff perceive that the program is merely “window dressing,” then the hotline will quickly become irrelevant and unused.Therefore, whoever is in charge of the ethics hotline should be outside the regular chain of authority within the Firm but have direct access to the Firm’s management team.

Management Transparency and Firm wide Engagement

One of the problems at the Firm was the consolidation of authority in a small management team which consisted of the Firm’s chairman, executive director and chief financial officer.While the Firm had an executive committee, it effectively abdicated its oversight role, giving free reign to the management team.The Firm’s management team had so much power that when a potential political rival for management began to gather support, the chairman outmaneuvered him by packing the executive committee with allies.Ultimately the rival, one of the Firm’s leading rainmakers, withdrew from all management roles and isolated his practice group from the rest of the Firm until mid-March 2012, when the practice group left to join another Firm.

The chairman reportedly executed excessively lavish employment contracts with the other management team members that effectively guaranteed their continued employment and his own chairmanship.He also negotiated preferential deals with certain partners that in addition to not being economically viable, instilled a sense of privilege among some and ultimately created dissention within the Firm.

Unlike the Firm Fox Rothschild LLP has an open management structure where that Firm’s co-chairs and managing partner handle the day-to-day affairs of the Firm while the strategic authority, including approval of all partner compensation, resides in a broader Executive Committee that includes representation from all Firm constituencies, including all offices. Much like the intended balance of powers in the U.S. Constitution, this structure affords transparency in the Firm’s management, recognizes input from a variety of voices and encourages engagement in Firm management. While not a universal prescription, Fox Rothschild’s management structure represents the concepts of transparency and Firm-wide engagement in leadership that should be the goal of all Firms.

Law Can Be a Higher Calling

The Firm’s former chair is reported to have said, “If it is only money that holds a firm and its partners together, then there is really no glue at all.” Unfortunately, it seems that he orchestrated a Firm structure that was exactly that.

That the practice of law is also a business is indisputable. That it is only a business is an altogether different issue. In professional service businesses, Firm culture and professional standards are fundamental and successful law Firms in particular are more than just a collection of “books of business.”

While revenue is important, focusing on billable hours and growth for growth’s sake can lead to bill padding and individual attorneys or practice groups focusing on their relationships with clients over the Firm’s relationship.Promoting a Firm wide perspective and collegial relations among the professional staff can help overcome these ruinous behaviors. As with an ethics hotline, management’s attitude must be genuine.If the concepts of honesty, integrity and Firm culture are perceived as lip service, it will not serve as a check on misconduct.

Can a more active approach to Firm management and the promotion of ethical behavior catch infractions such as those committed by the Firm’s employees sooner? Maybe; maybe not, but as one U.S. senator pointed out in the debate over private securities litigation legislation, a strategy’s success is not only measured by the wrongs it catches, but also by the wrongs it prevents.

1 ACFE, “Tone at the Top: How Management Can Prevent Fraud in the Workplace” (http://www.acfe.com/uploadedFiles/ACFE_Website/Content/documents/tone-at-the-top-research.pdf)

2 California’s Commission for the Revision of the Rules of Professional Conduct is currently considering the Rules.

5 ACFE, Report to the Nations on Occupational Fraud and Abuse: 2012 Global Fraud Study, p. 16.