Dewey & LeBoeuf leaders have their day in court

March 7, 2014, 1:54 AM UTC

FORTUNE — The New York District Attorney Thursday charged that the top three former leaders of the now defunct international law firm Dewey & LeBoeuf engaged in a massive criminal conspiracy for nearly four years to cover up the firm’s financial condition before it went bankrupt in 2012. It was the biggest law firm collapse in history.

D.A. Cyrus Vance Jr. unveiled more than 60 criminal felony counts, including grand larceny, fraud, falsifying business records, and conspiracy contained in a grand jury indictment against former Dewey & LeBoeuf Chairman Steven Davis, Executive Director Stephen DiCarmine and Chief Financial Officer Joel Sanders. Each faces as much as 25 years in prison for what the District Attorney characterized as a wide-ranging effort to “cook the books.”

Saying “Fraud is not an acceptable accounting practice,” the District Attorney continued: “Those at the top of the firm directed employees to hide the firm’s true financial condition from creditors, investors, auditors, and even partners of the firm, until the scheme unraveled and resulted in the largest law firm bankruptcy in history.”

MORE: The end of an era: Why Dewey & LeBoeuf went under

Also charged was Zachary Warren, a former client relations manager for the law firm who left in 2009. The D.A. said seven other employees have already pleaded guilty to indictments that remain under seal.

At the same time, the Securities and Exchange Commission filed a civil case in federal court against Davis, DiCarmine, Sanders, former Dewey & LeBoeuf finance director Frank Canellas, and former controller Thomas Mullikin charging them with lying to investors and banks about the law firm’s finances while conducting a $150 million bond offering in 2010 that was bought by insurance companies and banks. The misrepresentations also were made to banks that had extended a $100 million line of credit to the firm.

The SEC complaint says: Dewey and defendants undertook a wide-ranging campaign of fraud and deception. So pervasive was the culture of financial chicanery at Dewey’s top levels that its highest ranking officials — including the defendants — had no qualms about referring to themselves in various e-mails and to “fake income,” “accounting tricks,” “cooking the books,” and deceiving what they described as a “clueless auditor.”

As chairman of LeBoeuf, Lamb, Greene & MacRae, Davis engineered a merger, announced on Aug. 27, 2007 and finalized just five weeks later, with another New York firm, Dewey Ballantine, which ironically once included the former crime-busting former New York District Attorney Thomas Dewey. Davis portrayed the merger he engineered with Dewey Ballantine as the creation of a global powerhouse capable of handling the most complex multinational transactions for the world’s biggest clients. The deal put Davis in command of a partnership with 26 offices in 12 countries, and revenues it claimed were approaching $1 billion a year. Yet the looming financial crisis in 2008 was already straining the firm’s most lucrative clients, and the firm’s leadership quickly realized its financial projections were not only too rosy, they were unobtainable by legal methods, according to the District Attorney and the FBI.

The D.A. indicated that the two-year investigation was triggered by complaints from some of the firm’s senior partners in 2012 who felt they had been defrauded by Davis, DiCarmine, and Sanders as the firm glided toward collapse.

FBI assistant director in charge George Venizelos said: “As alleged, rather than speaking openly with creditors about mounting debt and shrinking revenue, the defendants deliberately manipulated the firm’s financial statements. In the height of the crisis, the defendants used every trick in the book in an elaborate attempt to cover up the increasingly dire situation. But as bad went to worse, the defendants doubled down, and continued to exaggerate, manipulate, and downright lie in a vain attempt to right a sinking ship.”

MORE: Dewey’s decline and the rise of big-risk law

SEC Division of Enforcement Director Andrew J. Ceresney said in a statement: “Investors were led to believe they were purchasing bonds issued by a prestigious law firm that had weathered the financial crisis and was poised for growth. Dewey & LeBoeuf’s senior-most finance personnel used a grab bag of accounting gimmicks to create that illusion, and top executives green-lighted the decision to sell $150 million in bonds to investors as a desperate grasp for cash on the basis of blatantly falsified financial results.”

The conspirators, according to investigators, misclassified millions of dollars in expenses, revenues, and payments to current and former partners in efforts to create what appeared to be on the books legitimate income held by the law firm in order to satisfy loan agreements with the banks that the firm had adequate cash flows, when in fact from the first full year of the merger in 2008 and onward, the firm always was short tens of millions to hundreds of millions of dollars.

The SEC civil complaint includes some e-mail exchanges among the alleged co-conspirators in which they congratulate themselves and note that they expect to get well paid for their chicanery inflating the firm’s revenue. The complaint says: “From 2008 through 2011, individuals at the firm improperly reclassified as fee payments millions of dollars of payments that had originally and properly been applied to client disbursements. When Sanders first devised this adjustment in late 2008, he told DiCarmine, ‘We came up with a big one. Reclass the disbursements.’ DiCarmine responded, ‘You always do in the last hours. That’s why we get the extra 10 or 20% bonus.'”

The four defendants named in the criminal indictment Thursday were arraigned Thursday afternoon in New York state court. A bail amount of $2 million each was set for Davis, DiCarmine, and Sanders. The defendants’ lawyers have asserted their clients’ innocence.