THE BINGHAM CASE STUDY: PART II

Starting with the introduction, Harvard Law Professor Ashish Nanda’s case study on Bingham McCutchen depicts Jay Zimmerman as the architect of the firm’s evolution “from a ‘middle-of-the-road-downtown-pack’ Boston law firm in the early 1990s to a preeminent international law firm by 2010″:

“Zimmerman was elected chairman in 1994. Over the next 15 years, he shepherded the firm through 10 mergers, or ‘combinations’ in the Bingham lexicon, the establishment of 11 new offices, and a ten-fold increase in the firm’s revenues to $800 million… Given its impressive expansion, [journalist Jeffrey] Klineman said, ‘Bingham McCutchen has shown it could probably open an office on the moon.'” (p. 1)

Harvard published the study in September 2011.

Another Case Study

Ten months later, Nanda released another case study, “The Demise of Howrey” — a firm that was dying as he considered Bingham. Interestingly, several footnotes in the Howrey study refer to articles explaining how aggressive inorganic growth compromised that firm’s cohesiveness and hastened its collapse. (E.g., “Howrey’s Lessons” by me, ““Why Howrey Law Firm Could Not Hold It Together”, by the Washington Post’s Steven Pearlstein, and “The Fall of Howrey,” by the American Lawyer’s Julie Triedman) But Nanda’s 15-page narrative of Howrey barely mentions that topic.

Instead, he invites consideration of “the alternative paths Howrey, and managing partner Robert Ruyak, might have taken to avoid dissolution of the firm” after that growth had occurred. The abstract concludes with these suggested discussion points:

“What could Howrey have done differently as clients demanded contingency payment plans and deep discounts? Should Ruyak have been more transparent about the financial difficulties the firm faced? Should he have consulted with a group of senior partners instead of relying on the counsel of outside consultants? Is a litigation-focused firm at a disadvantage when it comes to leadership, as compared to a corporate practice? Participants will reflect on the leadership structure of Howrey while discussing issues related to crisis management.”

With all due respect, those inquiries don’t reach a key lesson of Howrey’s (and now Bingham’s) collapse. The following sentence in the study does, but it goes unexplored:

“Howrey continued to add laterals over the concerns of some partners that increased lateral expansion might detract from the firm’s strategic focus and weaken its cultural glue.” (p. 6)

The Metrics Trap

Nanda’s case studies report that at Howrey. as at Bingham, a few key metrics suggested short-term success: revenues soared, equity partner profits increased, and Am Law rankings went up. But beneath those superficially appealing trends was a long-term danger that such metrics didn’t capture: institutional instability. When Howrey’s projected average partner profits dipped to $850,000 in 2009, many ran for the exits and the death spiral accelerated.

Likewise, Bingham’s record high equity partner profits in 2012 of $1.7 million dropped by 13 percent — far less than Howrey’s 2009 decline of 35 percent — to $1.5 million in 2013. But a steady stream of partner departures led to destabilization and a speedy end.

Balancing the Presentation

According to the final sentence of the Bingham case study abstract, “The case allows participants to explore the positives and negatives of following a strategy of inorganic growth in professional service firms….”

The negatives now dwarf the positives. No one should fault Nanda for failing to predict Bingham’s collapse two years later. The most spectacular law firm failures have come as surprises, even to many insiders at such firms. But the Bingham study emphasizes how Zimmerman conquered the challenges of an aggressive growth strategy, with little consideration to whether the overall strategy itself was wise over the long run.

For example:

– The study notes that after Bingham’s 2002 merger with 300-attorney McCutchen Doyle, “Cultural differences…loomed over the combined organization….” But the study goes on to observe, “[T]hese issues did not slow the firm’s growth on the West Coast.” (p. 11) By 2006, “Bingham had achieved remarkable success and unprecedented growth.” (p. 14)

– The study reports that the firm’s American Lawyer associate satisfaction ranking improved from 107 in 2007 to 79 in 2008, which Bingham’s chief human resources officer attributed to “an appreciation for the leadership of the firm. People have confidence in Jay’s competence.” (p. 17). The study doesn’t mention that the firm’s associate satisfaction ranking dropped to 100 in 2009 and to 106 (out of 137) in 2010. (American Lawyer, Sept. 2010, p. 78)

– “Our management committee has people from all over,” the study quotes Zimmerman. “You don’t have to have been at Bingham Dana forever to lead at the firm.” (p. 15) But the study doesn’t consider how too many laterals parachuting into the top of a firm can produce a concentration of power and a problematic distribution of partner compensation. When Bingham began to unravel, the spread between its highest and lowest paid partners was 12:1.

– Bingham’s final acquisition — McKee Nelson — was the largest law firm combination of 2009. The study doesn’t discuss the destructive impact of accompanying multi-year compensation guarantees that put some McKee Nelson partners at the very top of the Bingham McCutchen pay scale. To be fair, Nanda probably didn’t know about the guarantees, but the omission reveals the limitations of his investigation. The guarantees came to light publicly when the American Lawyer spoke recently with former partners who said that “the size and scope of the McKee Nelson guarantees led to internal fissures…that caused at least some partners to leave the firm.”

No Regrets

Looking to the future, Zimmerman told the Harvard researchers, “[W]e’re competing with the best every day. We know we are among the best.” (p. 19)

I wonder if he would now offer the same self-assessment of his leadership that Robert Ruyak provided to the American Lawyer at the time of Howrey’s bankruptcy, namely, “I don’t have any regrets.” Nanda’s case study on Howrey’s demise concludes with “Ruyak’s Reflections.” The “no regrets” line could lead to interesting classroom discussions about accepting responsibility, but it doesn’t appear in the Howrey study. Ruyak’s explanations for the firm’s failure do.

One explanation that receives no serious attention in the case study is Ruyak’s observation that the partnership lacked patience and loyalty to the firm: “The longer-term Howrey people realized that our profitability jumped around a bit,” he said. “The people who were laterals, maybe, did not.” (p. 15)

Perhaps the potential for institutional instability that can accompany aggressive inorganic law firm growth receives greater emphasis in classroom discussions of Howrey and Bingham than it does in Nanda’s written materials. In that respect, both firms are case studies in management failure that is regrettably pervasive: a wrongheaded vision of success and a reliance on misguided metrics by which to measure it.

THE BINGHAM CASE STUDY — PART I

“For the first time since I’ve been in this job, we have all the pieces we need to do our job.”

That was former Bingham McCutchen chairman Jay Zimmerman’s penultimate line in the September 2011 Harvard Law School Case Study of his firm.

Oops.

Harvard Law School Professor Ashish Nanda and a research fellow developed the study for classroom use. According to the abstract, it’s a textbook example of successful management. It demonstrates how a firm could evolve “from a ‘middle-of-the-downtown pack’ Boston law firm in the early 1990s to a preeminent international law firm by 2010.”

Oops, again.

Familiar Plaudits

At the time of Nanda’s study, the profession had already witnessed a string of recent big firm failures. He should have taken a closer look at them. In fact, only seven months before publication of the Harvard Study, Howrey LLP was in the highly publicized death throes of what was a preview Bingham’s unfortunate fate.

Bingham’s Zimmerman and Howrey’s last chairman, Robert Ruyak, had several things in common, including accolades for their leadership. Just as Nanda highlighted Zimmerman’s tenure in his study, two years before Howrey’s collapse, Legal Times honored Ruyak as one of the profession’s Visionaries. Along similar lines, less than a month after publication of the Harvard study, Dewey & LeBeouf’s unraveling began as partners learned in October 2011 that the firm was not meeting its revenue projections for the year. But Dewey chairman Steven Davis continued to receive leadership awards.

Perhaps such public acclaim for a senior partner is the big firm equivalent of the Sports Illustrated curse. Being on the cover of that magazine seems to assure disaster down the road. (According to one analyst, the SI curse isn’t the worst in sports history. That distinction belongs to the Chicago Cubs and the Billy Goat hex. But hey, anyone can have a bad century.)

Underlying Behavior

The Lawyer Bubble investigates Howrey, Dewey, and other recent failures of large law firms. The purpose is not to identify what distinguishes them from each other, but to expose common themes that contributed to their demise. With the next printing of the book, I’m going to add an afterword that includes Bingham.

If Nanda had considered those larger themes, he might have viewed Bingham’s evolution much differently from the conclusions set forth in his study. He certainly would have backed away from what he thought was the key development proving Bingham’s success, namely, aggressive growth through law firm mergers and lateral hiring. He might even have considered that such a strategy could contribute to Bingham’s subsequent failure — which it did.

To find those recent precedents, he need not have looked very far. Similar trends undermined Howrey, Dewey, and others dating back to Finley Kumble in 1988. As a profession, we don’t seem to learn much from our mistakes.

The MBA Mentality Strikes Again

What caused Professor Nanda to line up with those who had missed the fault lines that had undone similar firms embracing the “bigger is always better” approach? One answer could be that he’s not a lawyer.

Nanda has a Ph.D in economics from Harvard Business School, where he taught for 13 years before becoming a professor of practice, faculty director of executive education, and research director at the program on the legal profession at Harvard Law School. Before getting his doctorate, he spent five years at the Tata group of companies as an administrative services officer. He co-authored a case book on “Professional Services” and advises law firms and corporate inside counsel.

It’s obvious that Nanda is intelligent. But it seems equally clear that his business orientation focused him on the enticing short-term metrics that have become ubiquitous measures of success. They can also be traps for the unwary.

In Part II of this series, I’ll review some of those traps. Nanda fell into them. As a consequence, he missed clues that should have led him to pause before joining the Bingham cheerleading squad.

Meanwhile, through December 6, Amazon is offering a special deal on my novel, The Partnership: It’s FREE as an ebook download. I’m currently negotiating a sale of the film rights to the book.

LAW & FOOTBALL: RANKINGS DOUBLETHINK

For many people, the holiday season means an intense focus on college football. This year, a 12-person committee develops weekly team rankings. They will culminate in playoffs that produce head-to-head competition for the national championship in January.

A recent comment from the chairman of that committee, Jeff Long, is reminiscent of something U.S. News rankings czar Robert Morse said about his ranking system last year. Both remarks reveal how those responsible for rankings methodology rationalize distance between themselves and the behavior they incentivize.

Nobody Wants Credit?

Explaining why undefeated Florida State dropped from second to third in the November 11 rankings, Long told ESPN that making distinctions among the top teams was difficult. He explained that the relevant factors include a team’s “body of work, their strength of schedule.” Teams that defeat other strong teams get a higher rank than those beating weaker opponents. So even though Oregon has suffered a loss this year, its three victories against top-25 opponents jumped it ahead of undefeated FSU, which had only two such wins. Long repeated his explanation on November 19: “Strength of schedule is an important factor….”

Whether Oregon should be ahead of FSU isn’t the point. Long’s response to a follow-up question on November 11 is the eye-catcher: Was the committee sending a message to teams that they should schedule games against tougher opponents?

“We don’t think it’s our job to send messages,” he said. “We believe the rankings will do that.”

But who develops the criteria underlying the rankings? Long’s committee. The logic circle is complete.

Agency Moment Lost: Students

In his November 14 column for the New York Times, David Brooks writes more broadly about “The Agency Moment.” It occurs when an individual accepts complete responsibility for his or her decisions. Some people never experience it.

Rankings can provide opportunities for agency moments. For example, some prelaw students avoid serious inquiry into an important question: which law school might be the best fit for their individual circumstances? Instead, I’ve heard undergraduates say they’ll attend the best law school that accepts them, and U.S. News rankings will make that determination.

If they were talking about choosing from law schools in different groups, that would make some sense. There’s a reason that Harvard doesn’t lose students to Boston University. But too many students take the rankings too far. If the choice is between school number 22 and the one ranked number 23, they’re picking number 22, period. That’s idiotic.

In abandoning independent judgment, such students (and their parents) cede one of life’s most important decisions to Robert Morse, the non-lawyer master of the rankings methodology. It’s also an agency moment lost.

Agency Moment Lost: Deans, Administrators, and Alumni

Likewise, deans who let U.S. News dictate their management decisions say they’re just responding to incentives. As long as university administrators, alumni, and prospective students view the rankings as meaningful, they have to act accordingly. Any complaint — and there are many — should go to the person who develops the rankings methodology.

All roads of responsibility lead back to U.S. News’ Robert Morse, they say. But following that trail leads to another lost agency moment. In March 2013, Lee Pacchia of Bloomberg asked Morse if he took any responsibility for what’s ailing legal education today:

“No…U.S. News isn’t the ABA. U.S. News doesn’t regulate the reporting requirements. No….”

Agency Moment Lost: Methodology Masters

Morse went on to say that U.S. News was not responsible for the cost of law school, either. Pacchia didn’t ask him why the methodology rewards a school that increases expenditures without regard to the beneficial impact on student experiences or employment outcomes. Or how schools game the system by aggressively recruiting transfer students whose tuition adds revenue at minimal cost and whose lower LSAT scores don’t count in the school’s ranking methodology. (Vivia Chen recently reported on the dramatic increase in incoming transfer students at some schools.)

Cassius was only half-right. The fault lies not in our stars; but it doesn’t lie anywhere else, either!

The many ways that U.S. News rankings methodology has distorted law school deans’ decision-making is the subject of Part I of my book, The Lawyer Bubble – A Profession in Crisis. Part II investigates the analogous behavior of law firm leaders who rely on metrics that maximize short-term Am Law rankings in running their businesses (e.g., billings, billable hours, hourly rates, and leverage ratios).

Aggregate Rankings v. Individual Outcomes

In the end, “sending a message” through a rankings methodology is only one part of an agency equation. The message itself doesn’t require the recipient to engage in any particular behavior. That’s still a choice, although incentive structures can limit perceived options and create first-mover dilemmas.

Importantly, individual outcomes don’t always conform to rankings-based predictions. Successful participants still have to play — and win — each game. That doesn’t always happen. Just ask Mississippi State — ranked number one in the college football playoff sweepstakes after week 12, but then losing to Alabama on November 15. Or even better, look at number 18 ranked Notre Dame, losing on the same day to unranked Northwestern.

Maybe that’s the real lesson for college coaches, prelaw students, law school deans, and law firm leaders. Rather than rely on rankings and pander to the methodology behind them, focus on winning the game.

INFILAW AND THE ABA

After a setback last summer, Inflilaw has flown under the radar in its quest to acquire the Charleston School of Law. Since July 2013, the private equity owners of Infilaw  — a consortium of three for-profit law schools (Florida Coastal, Charlotte, and Arizona Summit (formerly the University of Phoenix)) — have been trying to add Charleston to their portfolio.  (For more on Infilaw, see Paul Campos’ recent article in The Atlantic.)

The persistence of Infilaw’s effort alone says something about the situation: There’s money to be made in legal education. Venture capitalists specialize in finding opportunities for above average investment returns. It doesn’t matter to them that the main source of that money is federal student loans. Nor do they care if the vast majority of students who obtain those loans to attend marginal schools are unable find JD-required employment. If there’s a market failure to exploit for profit, they’re on it.

On November 6, 2014, the ABA Accreditation Committee issued its recommendation of acquiescence — yes, that’s what it’s called — in connection with Infilaw’s proposed acquisition. It found that the desired change in control “will not detract from [Charleston School of Law’s] ability to remain in compliance” with ABA accreditation standards.

The Deal

The ABA recommendation identifies key aspects of the proposed acquisition, but then ignores their implications. For example, under the Asset Purchase Agreement, Infilaw would acquire most of the school’s assets, but it makes no promise of post-acquisition employment for any existing employees. None. Only on the “eve of closing” will Infilaw disclose the faculty members it wants to keep. Nevertheless, the ABA is willing to accept on faith that this pig in a poke — whatever it turns out to be — won’t “detract from the school’s ability” to retain its accreditation.

Under a separate Administrative and Consulting Services Agreement, Infilaw will receive “substantial consideration” to provide “non-academic, administrative, and consulting services” to the law school. Those services probably account for these troubling lines in the ABA committee’s recommendation:

“Infilaw contemplates that…the legal market permitting, it will increase the size of entering classes to approximately 250, or ‘pre-downturn levels.’…The law school will have access to and benefit from the collective knowledge of Infilaw and its three existing law schools with respect to student recruiting and enrollment.”

The Market?

What does “the legal market permitting” mean? Charleston enrolled 145 full-time students for its expected graduating class of 2017. Returning to “pre-downturn” levels would increase that number by 75 percent. Such near-term growth in demand for the school’s new lawyers is a pipe dream. The recent Bureau of Labor Statistics report on legal sector employment confirms painful reality: Over the past year, the number of all legal jobs — not just lawyers — is actually 1,300 lower than a year ago.

But “access to and benefit from” Infilaw’s existing three schools “with respect to student recruiting and enrollment” means law school behavior that has little to do with actual “legal market” employment conditions for new graduates. Rather, as I’ve discussed previously, the current operation of the Inflilaw business model makes the future of Charleston as an Infilaw holding apparent.

A Race To…The Bottom?

The Infilaw model depends on federal student loans to produce revenue streams that create profits for investors. As the demand for lawyers languished during the Great Recession, Infilaw schools increased enrollment and tuition.

Meanwhile, North Carolina bar passage rates for first-time takers graduating from Infilaw’s Charlotte School of Law dropped from 87 percent in July 2010 to 58 percent in July 2013. The school placed seventh (out of seven NC schools) in its July 2014 bar passage rate: 56 percentFlorida Coastal’s first-time rate dropped from 75 percent in July 2012 to 67 percent in July 2013. Its first-time Florida bar passage rate in July 2014 was 58 percent (10th out of 11 Florida schools). Arizona Summit’s first-time bar pass rate in its home state for July 2014 was 55 percent (third out of three Arizona schools).

Overall, only 35 percent of 2013 graduates from Infilaw schools found full-time long-term JD-required employment. By comparison, 53 percent of Charleston School of Law  graduates from the class of 2013 secured full-time long-term JD-required jobs — just below the national average for all law schools.

A Statistic On The Rise

At Florida Coastal, average student loan debt for 2014 graduates was $175,274. The other two Infilaw schools haven’t updated their websites to provide 2014 information. For 2013 graduates of Arizona Summit, average student law school debt was $184,825. At Charlotte, it was $155,697, plus another $20,000 in private student loans. (Average law school debt for Charleston graduates in 2013 was also too high ($146,595). But its 2013 employment outcomes were much better than any Infilaw school.)

Infliaw isn’t home free in its quest. After a closed session of the Accreditation Committee on December 5 in Puerto Rico, the recommendation will go to the ABA’s Council of the Section on Legal Education and Admissions. Then the South Carolina Commission on Higher Education has to approve the deal. Last summer, a committee of that commission voted 3-to-1 against, prompting Infilaw to withdraw its application while promising a return bout that will probably occur in early 2015.

The ABA

People sometimes ask where the ABA has been in the ongoing search for solutions to the current crisis involving law schools whose graduates are incurring staggering debt for JD degrees of dubious value. The answer is becoming clearer.

It’s “acquiescing.”

But wait. The ABA has done one more thing. It has convened a special Task Force on the Financing of Legal Education to recommend fixes for a dysfunctional legal education market. Former Detroit Mayor Dennis W. Archer, the chairman of Infilaw’s National Policy Board, is still chairman of that Task Force. In 2003-2004, he was president of the ABA.

BULLET DODGED? OR REDIRECTED TOWARD YOU?

For the past six months, Thomas Jefferson School of Law in San Diego seemed poised to become the first ABA-accredited law school to fail since the Great Recession began. For anyone paying attention to employment trends in the legal sector, the passage of six years without a law school closing somewhere is itself remarkable. It also says much about market dysfunction in legal education.

In his November 5 column in the New York TimesUniversity of California-Berkeley law professor Steven Davidoff Solomon has a different view. Solomon argues that recent enrollment declines prove that a functioning market has corrected itself: “[T]he bottom is almost here for law schools. This is how economics works: Markets tend to overshoot on the way up, and down.”

Solomon urges that the proper course is to keep marginal law schools such as Thomas Jefferson alive for a while “and see what happens.” I disagree.

Take Thomas Jefferson, Please

As I’ve discussed previously, in 2008 the school issued bonds for a new building. When the specter of default loomed large in early 2014, the question was whether some accommodation with bondholders would keep the school alive. Solomon suggests that creditors made the only deal possible and the school is the ultimate winner. He gives little attention to the real losers in this latest example of a legal education market that is not working: Thomas Jefferson’s students, the legal profession, and taxpayers.

In retrospect, the restructuring agreement between the school and its bondholders reveals that a deal was always likely. That’s because both sides could use other people’s money to make it, as they have since 2008.

According to published reports, interest on the taxable portion of the 2008 bond issuance was 11 percent. Tax-exempt bondholders earned more than 7 percent interest. Thanks to federally-backed student tuition loans, taxpayers then subsidized the school’s revenue streams that provided quarterly interest and principal payments to those bondholders.

Outcomes? Irrelevant In This Market

Last year, Thomas Jefferson accepted 80 percent of applicants. According to its latest required ABA disclosures, first-year attrition was over 30 percent. The school’s California bar passage rate for first-time takers in February and July 2012 was 54 percent, compared to the state average of 71 percent.

Solomon cites the school’s other dismal statistics, but ignores their implications. For example, Thomas Jefferson’s low bar passage rate made no difference to most of its graduates because the full-time long-term bar passage-employment rate for the class of 2013 was 29 percent, as it was for the class of 2012.

Meanwhile, its perennially high tuition (currently $44,900 a year) put Thomas Jefferson #1 on the U.S. News list of schools whose students incurred the greatest law school indebtedness: $180,665 for the class of 2013. According to National Jurist, the school generates 95 percent of its income from tuition.

It’s Alive

This invites an obvious question: How did the school survive so long and what is prolonging its life?

First, owing to unemployed recent graduates with massive student loans, bondholders received handsome quarterly payments for more than five years — much of it tax-exempt interest. The disconnect between student outcomes and the easy availability for federal loans blocked a true market response to a deteriorating situation. Bondholders should also give an appreciative nod to federal taxpayers who are guaranteeing those loans and will foot the bill for graduates entering income-based loan forgiveness programs.

Second, headlines touted Thomas Jefferson’s new deal as “slashing debt” by $87 million, but bondholders now own the law school building and will reportedly receive a market rate rent from the school — $5 million a year. Future student loans unrelated to student outcomes will provide those funds.

Third, the school issued $40 million in new bonds that will pay the current bondholders two percent interest. Student loan debt will make those payments possible.

Net-net, win-win, lose-lose

The bottom line benefit for Thomas Jefferson is immediate relief from its current cash crunch. Instead of $12 million in principal and interest payments annually, the school will pay $6 million in rent and bond interest — funded by students who borrow to obtain a Thomas Jefferson law degree of dubious value.

“I think the whole deal is a reflection of the fact that the bondholders were very desirous for us to succeed,” [Thomas Jefferson Dean Thomas] Guernsey said.

Actually, it reflects the bondholders’ ability to tap into the proceeds of future federal student loans as they cut a deal with a wounded adversary. Instead of cash flow corresponding to bond interest rates of 7 and 11 percent, bondholders will receive about half that amount, along with an office building and the tax advantages that come with ownership (e.g., depreciation deductions). Think of it as refinancing your home mortgage, except the bank gets to keep your house.

Erroneous Assumptions Produce Dubious Strategies

“This restructuring is a major step toward achieving our goals,” said Thomas Guernsey, dean of Thomas Jefferson. “It puts the school on a solid financial footing.”

Throwing furniture into the fireplace to keep the house warm is not a viable long-run survival strategy. Consider future students and their willingness to borrow as the “furniture” and you have a picture of the Thomas Jefferson School of Law’s business plan.

Meanwhile, Solomon echoes the hopes of law school faculty and administrators everywhere when he says, “[T]he decline in enrollment could lead to a shortage of lawyers five years from now.”

In assuming a unitary market demand for lawyers, he conflates the separate and distinct submarkets for law school graduates. His resulting leap of faith is that a rising tide — even if it arrives — will lift Thomas Jefferson’s boat and the debt-ridden graduates adrift in it. It won’t.

RECENT APPEARANCES

THURSDAY, OCTOBER 23, 2014, 11:00 am to 12:00 pm
“The Lawyer Bubble – Barriers Facing Minorities”
Pennsylvania Bar Institute Diversity Summit
Wanamaker Building
100 Penn Square East – 10th floor
Philadelphia, PA

FRIDAY, OCTOBER 24, 9:15 am to 11:00 am
“Bankruptcy & Education”
American Bankruptcy Institute Law Review Symposium
St. John’s University School of Law
8000 Utopia Parkway
Jamaica, NY

My next post will be in November.