Accounting International Marketable Securities Standard

If we were in Corporate Land, this would be the beginning of earnings reporting season, with the close of the customary calendar year-fiscal year for most of BigLaw.

It's too early to draw any statistically solid conclusions about what 2009 looked like overall, but sometimes a report raises so many more questions than it answers that it begs for a bit of comment, analysis, and "deconstruction," if you will.

That would surely appear to be the case with Sonnenschein's reporting.

Here's the headline, from The American Lawyer:

Profits per equity partner dropped 3 percent at Sonnenschein Nath & Rosenthal in 2009, according to figures reported by the firm late Thursday, and gross revenue was flat. PPP fell from $804,000 in 2008 to $780,000 last year. Gross slipped from $473 million in 2008 to $472.5 million, according to the firm.

So far, so innocuous. But if you read a bit more carefully, there's more to the story.

First of all, Sonnenschein added 100 lawyers from Thacher Proffitt effective January, 2009. To add 100 lawyers and be "very pleased" that gross revenue was flat must establish some new apogee or highwater mark in redefining "the new normal."

Second, the decline in RPL (using an apples-to-apples, same accounting method comparison, of which more momentarily) is -11%. This is can only be viewed as a quite negative indicator which suggests the firm, despite going through three rounds of personnel cuts in the past 18 months, may not yet be "right-sized" or certainly is not achieving pre-bust utilization rates.

Third, PPP dropped more than 12% in 2009 vis-a-vis 2008, and now we are told it dropped another 3%. But I understand that partners have been told that cash distributions to them are off 19%. This doesn't quite compute if PPP is actually down just 3%, unless something strange is going on with "cash."

Which brings us--fourth--to the weirdest and most inexplicable part of the Sonnenschein news (emphasis supplied):

The firm also restated its 2008 gross revenue numbers Thursday. Last year the firm reported $492 million in gross revenue in 2008, but yesterday Sonnenschein lowered that figure to $473 million. The firm attributed the discrepancy between the two figures to a change in accounting. Sonnenschein previously reported gross revenue on an accrual basis, but now reports it on a cash basis...

This is a firm founded in 1906, which has used Arthur Andersen and now McGladry Pullen as accountants. Why would this be the year they would change accounting methodology? I have no inside information as to why that might be the case, but it strikes me as oddly convenient that the change in stated 2008 gross revenue from $492-million to $473-million quite nicely enables them to say that revenue in 2009 was "flat" at $472.5-million.

Well, aren't revenues revenues? And isn't the cash basis more rigorous than the accrual basis? Yes, and yes.

First, I for one can't imagine advising a client to "restate" revenues, any more than I can imagine restating a budget once it's set. You can miss the budget or exceed the budget, but the budget is the budget. In my book, rewriting history just shouldn't be done, however tempting it might be to succumb to the desire.  States that do this are rightly accused of Kremlinology.

And second, as for whether cash recognition of revenues is more disciplined than accrual, the short answer is of course it is. You either have the check in hand by midnight December 31st or you don't. No squishiness or wiggle room to that. No woulda-coulda-shoulda.

But ponder for a moment the other side of the Income & Expense statement: Expenses. If you were recognizing expenses on an accrual basis (conservative accounting), but now you only recognize them on a cash basis (more aggressive accounting), voila, I can virtually guarantee you that reported profits will go up. (At least as a one-time shot, but that's a story for another day.)

Now, please understand: I have no brief against Sonnenschein in the least, and I wish the firm, its clients, its partners, associates, staff, and their many dependents all the best in these times of unprecedented difficulty.

Sometimes, however, you have to look behind the story. If there are innocent and plausible explanations for all of this, I welcome them and will publish any comments I receive as updates to this piece (assuming the writers' permission).

In the meantime, take what you read with a grain of salt. Or better yet, a nod to critical thinking.

The link to the American Lawyer article on Sonnenschein's reporting appears to be intermittently broken, so here's the original article. If I've offended "fair use," I apologize forthwith to the American Lawyer but the thing about the Web is that links should work.

The Am Law 100:
Sonnenschein Profits Drop 3 Percent

The American Lawyer

By Ross Todd

January 22, 2010

 

Profits per equity partner dropped 3 percent at Sonnenschein Nath & Rosenthal in 2009, according to figures reported by the firm late Thursday, and gross revenue was flat. PPP fell from $804,000 in 2008 to $780,000 last year. Gross slipped from $473 million in 2008 to $472.5 million, according to the firm.

"[The] bottom line for us is that we are very pleased with the performance in view of the substantial investment we made in January of 2009 to add 100 new lawyers from Thacher Proffitt," Sonnenschein chair Elliott Portnoy said via e-mail Thursday. Portnoy (pictured at right) was traveling and unavailable for a phone interview.

Last year marked the second straight year of lower profits at Sonnenschein; PPP dropped more than 12 percent to $804,000 in 2008. The firm also restated its 2008 gross revenue numbers Thursday. Last year the firm reported $492 million in gross revenue in 2008, but yesterday Sonnenschein lowered that figure to $473 million. The firm attributed the discrepancy between the two figures to a change in accounting. Sonnenschein previously reported gross revenue on an accrual basis, but now reports it on a cash basis to match the method it uses to report net distribution to partners. The change in accounting affects Sonnenschein's revenue per lawyer numbers. The firm reported Thursday a drop of 7 percent from $778,000 in 2008 to $722,000 in 2009. When using the numbers the firm reported last year, the drop in RPL is 11 percent from $808,000 to $722,000.

Part of the RPL drop can be attributed to Sonnenschein's boost in head count. The firm grew from 608 lawyers in 2008 to 654 in 2009. On January 1, 2009, Sonnenschein added 100 lawyers from New York's Thacher Proffitt & Wood, including 40 partners. The hires--the largest lateral group the firm has taken on--nearly doubled the size of Sonnenschein's New York office.

The Thacher Proffitt lawyers brought with them a $500,000 contract awarded in December 2008 by the U.S. Department of the Treasury to advise on its investments in the Federal Reserve's Term Asset-Backed Securities Loan Facility (TALF). In March, Sonnenschein was chosen along with Cadwalader Wickersham & Taft and Haynes and Boone to advise the Treasury Department on its role in last year's auto industry restructurings. The auto industry contract carried a ceiling value of $8.59 million.

Sonnenschein, like many firms last year, also employed a number of cost-cutting measures. The firm cut associate compensation in June and announced in December that it would roll out a new merit-based associate compensation structure in early 2010. In September the Am Law Daily's colleagues at The National Law Journal reported that the firm cut about 30 lawyers, including 10 income partners--the third series of personnel cuts at the firm in an 18-month period.

 

This report is part of The Am Law Daily's ongoing Web coverage of The Am Law 100's 2009 financials. Results are preliminary. Final rankings and full results for The Am Law 100 will be published in The American Lawyer's May 2010 issue and on AmericanLawyer.com. The Am Law Second Hundred will be published in the June issue.

     CHICAGO (CN) - A federal judge has frozen the assets of a money manager and his hedge fund advisory firm, whom the SEC accused of lying to potential investors about the startup quantitative hedge fund, the SEC said Wednesday in announcing the unsealing of its federal complaint.
     The SEC sued Belal K. Faruki and Neural Markets LLC, and relief defendants Evolution Quantitative 1X Fund and Evolution Quantitative 1X LLC. The complaint was filed under seal on Aug. 10 and unsealed this week.
     It states: "The SEC brings this securities law enforcement action to halt an ongoing fraudulent investment scheme run since at least January 2010 to the present by Belal K. Faruki (Faruki) and Neural Markets, LLC (Neural Markets) (collectively, defendants), and to protect investor funds from further dissipation. As part of the scheme, Faruki and Neural Markets presented themselves as managers of a start-up quantitative hedge fund that began trading in 2009. Through their elaborate fraud, defendants defrauded at least one investor (Investor) out of a $1 million and have solicited other investors as well."
     The SEC claims that "Faruki and Neural Markets made the following misrepresentations, among others, to the Investor:
     "a. that Faruki, through Neural Markets, created a quantitative hedge fund called the Evolution IX Fund that was actively trading and had a successful track record of positive performance since at least December 2009;
     "b. that other wealthy individuals had invested approximately $5 million with defendants and those funds were being traded by defendants, but that the defendants could not reveal the investors' identities because of confidentiality restrictions;
     "c. that defendant Faruki had invested his own money in the Evolution IX Fund and his interests were aligned with the interests of the other supposed investors;
     "d. that defendants engaged RSM McGladry, Inc. (McGladry), a reputable auditor, to perform audit services for Neural Markets and the Evolution IX Fund and that McGladry would provide quarterly and annual audited financial statements for the Evolution IX Fund to the Investor; and
     "e. that Defendants traded securities for the Evolution IX Fund through prime brokers J.P. Morgan Securities, Inc. (JPMS) and Tradestation Securities, Inc. (Tradestation)."
     The complaint continues: "Based on these and other false representations, the Investor sent defendants $1 million in exchange for 10 units of the Evolution IX Fund plus a 1% interest in Neural Markets. Shortly after obtaining the Investor's money, Faruki, through Neural Markets, transferred the funds to a bank account in the name of Evolution Quantitative IX, LLC (Evolution LLC). Evolution LLC then transferred the funds into accounts at Tradestation Securities, Inc. (Tradestation) in the name of Evolution LLC.
     "The Investor had no knowledge of Evolution LLC. Defendants never disclosed to the Investor the existence of Evolution LLC or that his money would be transferred to accounts held by or in the name of Evolution LLC.
     "After transferring the Investor's funds to the Evolution LLC Tradestation accounts, defendants, through at least October 2010, continued to make material misrepresentations and failed to disclose other material facts to the Investor. Defendants falsely represented to the Investor that trading was generating profits for the Evolution IX Fund, when in fact losses were being incurred."
     Faruki, 39, of Aurora, owns 67 percent of Neural Markets, according to the complaint. The SEC complaint adds: "In January 2010, the State of Illinois Securities Department issued a temporary order of prohibition against Faruki prohibiting him from offering or selling securities in Illinois. The Illinois order was based on allegations of fraud in connection with a promissory note offering. The Illinois order was in effect until September 24, 2010, when the parties agreed to an order of dismissal. In 2001, Faruki was subject to a CFTC default order and reparations award for failing to respond to allegations that Faruki fraudulently opened a client account and traded in the account causing client losses."
     The Wall Street Journal reported on its web page today that Faruki denied the allegations. Faruki claimed the investor "is actually a partner in Neural Markets" who was trying to recover losses, according to the Journal, which said that Faruki told it that the investor/partner "has been blackmailing and attempting to extort money from the other partners."
     Faruki also told the Journal that he was not given time to respond to the "incredibly damaging" SEC complaint, and said he was seek an injunction to try to stop the SEC from releasing more information.Quantitative hedge fund managers, or quants, became a hot item on Wall Street before the economic meltdown. They use, or claim to use, sophisticated mathematical algorithms to measure risk, derivatives prices, hedging strategies and otherwise direct investments. 

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