Foolish Attorneys

Gullible Law Firm in South Florida

Posted Feb 02, 2013

The story of Scott Rothstein, a now-disbarred and imprisoned Fort Lauderdale attorney, is interesting in that it involves two levels of victimhood: the over 250 individuals, hedge funds and charities that were hoodwinked (to the tune of $1.5 billion) in Rothstein’s Madoff-like Ponzi scheme, and the dozens of generally well-respected attorneys in Rothstein’s law firm, who were unwittingly lured by very high salaries, financed by the scam, into joining the firm. The two scams were joined in another way, as the investors were lured by the fact that the scheme’s profits supposedly came from lawsuits filed by the law firm. I shall here focus more on the law firm rather than the investors, as an illustration of the “Emperor’s New Clothes” phenomenon operating within an organization made up mostly of people with above-average intelligence.

 The scheme, as described to investors, involved large structured financial settlements made by deep-pocket defendants in civil lawsuits, mostly involving alleged sexual harassment or gender employment discrimination (labor law was the main specialty of Rothstein’s firm). The individuals who were the recipients of these settlements agreed to sell their interest in these structured settlements in return for deeply discounted up-front payments.

In and of itself, this is a perfectly legal activity: firms offering to buy structured settlements advertise freely on television, although I am unaware of their then turning around and bundling these settlements to other investors. Also, apparently in some cases, these were described by Rothstein as imminent future settlements, while legitimate firms deal solely in already-ratified settlements. What made this particular scheme illegal is the fact that these were wholly fabricated settlements mostly involving lawsuits that either never happened or in which Rothstein had no ownership interest. With the help of one or more assistants, Rothstein prepared phony promissory notes and settlement documents, with names of litigants redacted supposedly because of court-mandated confidentiality requirements.

 As with the Madoff scam, Rothstein dealt both directly with very rich individual investors and with a few so-called feeder hedge funds which served as intermediaries between Rothstein and the somewhat smaller-scale investors in the funds (smaller being a relative term meaning a minimum investment of a million dollars, although some fund investors lost much more than that). In the case of the feeder fund investors, it is likely that most of them never knew who their money was being invested with (this was also true of the Madoff feeder funds, where many investors had no idea who Bernard Madoff was or what connection he had to their investment).

 Investors in the feeder funds were promised annual returns from a low of fifteen percent (in the same ballpark as the Madoff feeder fund returns) to as high as thirty percent, while those who invested directly with Rothstein were promised even higher returns, sometimes over only a few months. These returns are comparable to those of Charles Ponzi (who told naïve investors they could get fifty percent returns in four months) and constitute a huge red flag which makes Rothstein victims (investors and fund intermediaries) seem more gullible to me than Madoff’s. (The genius of the Madoff scam was that the returns were modest but steady, thus deluding investors into thinking his was the equivalent of a safe but exceptional bond fund). As with all Ponzi schemes, there were no actual investments by Rothstein, who used newly obtained funds to pay off existing investors and to support an incredibly lavish lifestyle.

 Unlike most Ponzi schemers, Rothstein managed to flee to Morocco, a country with no extradition treaty with either the US or Israel (where Rothstein also broke the law) with millions of dollars of wire-transferred money just before he could be arrested. But then he improbably returned (with his cash) to face the music, allegedly to deal with threats against his family from Russian mafia confederates. (Master con man that he was, Rothstein cooperated with the FBI in getting them arrested for money laundering, before he was sent to prison essentially for the rest of his life).

 As mentioned, a notable element in the Rothstein saga is that the Ponzi scheme was embedded within a large and respected Fort Lauderdale law firm--Rothstein, Rosenfeldt and Adler--which essentially served as a front for his illegal activities. Rothstein built this from a five-member firm to one of the largest firms in South Florida in a little over four years, by offering huge salaries and bonuses. (For example, second named partner Stuart Rosenfelt was given, among other bonuses, a Ferrari, one million dollars in reimbursed personal credit card debt and a 54-four-foot yacht, and was given a check for $500,000 to cover taxes on these and other gifts on the same day that Rothstein absconded). Rothstein appeared to do almost no real legal work within the firm and the little bit he did do was incompetent. (In this respect, he differed from Marc Dreier, who also used illegally obtained funds to operate his huge New York law firm, in that Dreier by all accounts was an exceptional attorney).

 There is no evidence that Rothstein’s lawyer colleagues knew about or participated in the investment scam, but proceeds from the scam were used by him to pay them their huge bonuses. Rothstein, as managing shareholder, chairman, and CEO, ran the firm and its finances in an unusually solo and secretive manner (described by one senior partner as a “benevolent dictator”), with internal security and bodyguard protections that are not found in any other law office to my knowledge. Rothstein claimed it was because of the murder of an associate, allegedly by the estranged husband of his assistant (a woman with whom he had many business and personal ties). The real reason for all of this security was to keep other attorneys in the firm from acquiring an understanding of the firm’s complicated and shady financial picture. (In one disclosed document, Rothstein directed the firm’s accountant not to allow any firm member to examine the firm’s financial papers). Because of the merged nature of its legitimate and crooked revenue streams, collapse of the Ponzi led inevitably to the collapse of the law firm.

 Because his law partners and associates would probably have quickly figured out the bogus nature of the scam, and (one would hope) blown the whistle on it, it was essential for Rothstein to keep the investment scheme a secret from the other lawyers in the firm. Attorney colleagues were curious, but apparently not too curious, about where Rothstein obtained the funds to pay them compensation at least double what they had been earning previously. Nor did the firm’s attorneys seem too eager to look into the fact that the firm’s expenses (including enormous sums for advertising) were at least twice what the firm could be expected to bring in from client billings.

 Rothstein’s need for secrecy (which was shared by Madoff mainly with regard to the details of his investment strategy) severely limited his ability to market the scam publicly and to bring in sufficient new investors. However, some non-attorneys in the firm apparently helped Rothstein prepare phony legal settlement documents and investor payout statements. This was similar to the Bernard Madoff scam, where the illegitimate operation was kept separate from the legitimate larger firm, and he was assisted mainly by high-school educated co-conspirators who lacked the sophistication at first to spot illegalities and whose continued participation in the corrupt scheme was assured by extremely high salaries and bonuses.

 Aside from possible tax and civil liability from profiting indirectly from Rothstein’s stolen monies, some attorneys have been accused of illegal conduct in making political contributions at Rothstein’s direction, for which they were later improperly repaid through bonuses. In fact, this is one of the major reasons cited by the Justice department in (for its first time ever) charging a law firm as a conspiracy under the Federal RICO (Racketeer Influenced and Corrupt Organizations) statute.

 As with many other scams, it should not have taken a potential investor with even minimal internet search skills more than a few minutes to see some red flags. Here is an example: one of Rothstein’s reported deals involved his claim that he “represented 450 people who were due $2 million each in wrongful death cases against the fruit company Chiquita Brands International.” This was a real law suit, which was filed in a Federal Court in South Florida and which involved allegations that the company had exposed banana workers to a highly toxic pesticide. It should not have taken an approached potential investor very long, however, to have figured out (or paid someone to figure out) that neither Rothstein nor his firm represented anyone in that lawsuit and that the case was still unresolved. Yet, very few people approached with such a deal possessed the information (or the inclination to obtain the information) needed to see the fishiness of the proposition.

Such a lazy stance towards verifying a deal with the potential for bringing one to the brink of financial ruin may, however, be more a matter of one’s personality style than of one’s cognitive ability. Similarly, most investors—even those with some expertise in finance—lacked the ability or inclination to analyze or even understand complex schemes such as Rothstein’s, especially given that the details (supposedly because of confidentiality agreements) were often sketchy. Certainly, media interviews with some of Rothstein’s victims, including feeder fund managers, gives a picture of individuals who were operating more on the basis of blind trust than on the basis of in-depth knowledge or understanding.

In terms of the lawyers who agreed to work for Rothstein’s corrupt firm, it is fair to say that Affect/State played a major role. The most obvious affective consideration was greed, activated by the prospect of getting greatly increased compensation. Greed was a positive motivator, drawing dupes to their downfall, but it also caused a need to suppress any doubts that might have arisen. Thus, affect contributed to self-deception (wishing for something to be true makes one think that it is) and self-deception often plays a part in gullibility.

Affect also contributes to gullibility in one other way and that is in the positive feelings one may have, or come to develop, for the duper, who in this case was incredibly generous, both with money and continual expressions of praise and affection. Stuart Rosenfeldt, the second named partner in Rothstein’s firm, for example, told an interviewer: “…I loved Scott, he couldn’t do wrong in my eyes….” This affective infatuation was in line with Rosenfeldt’s personality, which he described in the same interview as follows: “my primary mistake was naïveté and trust…I’ve always been a [overly] trusting person”, a trait that he attributed to having grown up with a mother with multiple sclerosis, and being told to never create any disagreement that might upset her.

Rosenfeldt revealed that he did not always feel this love for Rothstein. In fact, his initial reaction, upon first meeting Rothstein (long before they ever worked together), was one of instant dislike. Rosenfeld found Rothstein to be very arrogant and he was really turned off by his personality. In hindsight, Rosenfeldt now wishes he had stuck with his initial gut reaction and not allowed himself to be charmed and won over by Rothstein.

Staying with one’s gut reaction, when encountering a seductive schemer, is one of the keys to remaining non-gullible, as there are almost always warning signs. An illustration of this can be found in the account told by a female attorney who was courted by Rothstein, but who had the sense to turn him She said that “Rothstein recruited me and during the ‘interview’ he did almost all the talking. At the conclusion of his ‘pitch,’ he only had one question: ‘how much annual salary is it going to take in order to bring you into the firm?’ ” Upon thinking for a minute, she responded: “I’ll consider joining your firm for 400 thousand dollars.” Rothstein replied “done.” Then, she let him know that currently she was part of a practice group with two additional attorneys. “How much will these attorneys need to make to come over?” asked Rothstein. “Each of them would need to make 150 thousand dollars a year,” she said. Again, Rothstein replied “done.”

The attorney told Rothstein that conversations would need to take place with her two team members. Upon leaving Rothstein’s office, the attorney realized that not only had he not asked about her current clients, he didn’t even inquire as to the “book” that her associates had or inquire further about them. Her gut feeling was that no law firm generate for the firm. She said that in spite of the substantial salary being offered by Rothstein, it was an easy decision to turn down the offer to join his firm.

                                             Copyright Stephen Greenspan