Tag Archives: Citi Bank Private Law Firm Group

BIG LAW LEADERS “GET IT”? SERIOUSLY?

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The concluding lines of this year’s Client Advisory from Hildebrandt/Citi are defensive, if not petulant:

“Unlike the commentary of many observers of the legal profession suggesting that today’s senior management do not ‘get it,’ we believe the large law firms today have every capability to adjust to the changing market….”

That nifty non sequitur is also a rhetorical sleight of hand. Having “every capability to adjust” is not the same as actually adjusting. The suggestion that today’s senior law firm leaders “get it” implies that they are responding in healthy and productive ways to a period of dramatic change.

Well, most of them aren’t. Instead, they’re maximizing current income at great expense to the future of their institutions. But don’t take my word for it; take theirs.

Facts get in the way

Consider the dominant big firm strategy: lateral hiring and mergers to achieve top line revenue growth. In Citi’s 2012 Law Firm Leaders Survey, senior leaders self-reported that only 60 percent of their laterals were above “break even.” For 2013, the rate dropped to 57 percent. As for mergers, anyone who thinks bigger is always better should look at the decline in operating margins that has followed most recent big firm combinations. That phenomenon is called diseconomies of scale.

Moreover, even the self-reported “success rate” is inflated. It takes years to determine the true financial impact of a lateral hire, so most managing partners touting those efforts actually have no idea whether their recent acquisitions will benefit their firms’ bottom lines. In fact, if leaders already admit to mediocre results for the laterals they personally sponsored, imagine how much worse the reality must be.

Beyond the numbers

Notwithstanding previous failures on a massive scale, managing partners are still pursuing growth for the sake of growth. Unfortunately, it can be a loser in ways that go far beyond mere financial losses. The negative impact on a firm’s culture, morale, and long-term institutional stability can be devastating.

For example, the 2013 Hildebrandt/Citi Client Advisory reported that between 2007 and 2011, law firms increased the number of lateral partners by 10 percent. Meanwhile, homegrown promotions to partner during the period dropped by 21 percent. That trend is undermining already low associate morale.

The lateral hiring frenzy has demoralized partners, too. A loss of community afflicts partnerships of people who don’t know each other. That’s one reason that forty percent of respondents to Altman Weil’s May 2013 survey of firm leaders said their partners’ morale was lower than it was at the beginning of 2008.

Another reason for diminished partner morale is the way lateral hiring has contributed to higher internal equity partner compensation spreads. Bidding to attract so-called rainmakers has pushed the high end of the range up. So have existing partners who threaten to test the lateral market. In that zero sum game of dividing the partnership pie, the bottom end of the range has moved down. (For an example, take a look at James B. Stewart’s New York Times profile of a former Dewey & LeBoeuf partner who reportedly earned $350,000 while his “protector” earned $8 million.)

More collateral damage ignored

Accompanying the lateral hiring frenzy and short-term metrics that drive the prevailing big firm business model are destructive client silos. More than 70 percent of law firm leaders responding to the Altman Weil survey said that older partners were hanging on too long. In the process, they’re hoarding clients, billings, and opportunities in ways that block the transition of firm business to younger lawyers.

But leadership’s response to this problem is perverse: 80 percent of managing partners admit that they plan to continue tightening equity partner admission standards.

The ongoing failure of leadership also reveals itself in managing partners’ overall agendas. When asked to prioritize goals for their firms, they placed “client value” number eight — behind (1) increasing revenue, (2), generating new business, (3) growth, (4) profitability, (5) management change, (6) cost management, and (7) attracting talent.

Closer to the mark

In contrast to the Hildebrandt/Citi 2014 Client Advisory, the Georgetown Law Center/Peer Monitor 2014 Report on the State of the Legal Profession concludes that most law firm leaders don’t “get it” at all:

“[G]rowth for growth’s sake is not a viable strategy in today’s legal market…Strategy should drive growth and not the other way around. In our view, much of the growth that has characterized the legal market in recent years fails to conform to this simple rule and frankly masks a bigger problem – the continuing failure of most firms to focus on strategic issues that are more important for their long-term success than the number of lawyers or offices they have.”

The report explains that, in an effort to justify the counterproductive urge to grow, “law firm leaders feel constrained to articulate some kind of strategic vision…and the message that we need to ‘build a bigger boat’ is more politically palatable than a message that we need to fundamentally change the way we do our work.”

Similarly, the author of the 2013 Altman Weil survey, Thomas Clay, says that too many firms are “almost operating like Corporate America…managing the firm quarter-to-quarter by earnings per share.” That shortsighted approach is “not taking the long view about things like truly changing the way you do things to improve client value and things of that nature.”

Even clients recognize that most outside law firms aren’t adapting to new realities. An October 2013 Altman Weil Survey asked chief legal officers to evaluate the seriousness of their outside law firms in changing the legal service delivery model to provide greater value. On a scale from zero (not at all serious) to ten (doing everything they can), “for the fifth year, the median was a dismal ‘3.’”

Perhaps the authors of the Hilebrandt/Citi 2014 Client Advisory actually believe that most of their big law managing partner constituents “get it.” No one else does.

BIG LAW’S 2012 PERFORMANCE — NUMBERS AND NUANCE

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Two recent reports sound a warning that most big law firm leaders should heed. One is the Georgetown Center for the Study of the Legal Profession/Thomson Reuters Peer Monitor Report on the State of the Legal Profession. The other is Citi Private Bank’s Annual Law Firm Survey.

Lessons from Dewey & LeBoeuf

The Georgetown/Thomson Reuters Report is noteworthy because, at long last, thoughtful analysts are giving Dewey & LeBoeuf’s collapse the larger context that it deserves. For the most past, today’s managing partners have persuaded themselves that Dewey’s failure resulted from a unique confluence of management missteps that they themselves could never make. But most current leaders are making them.

In particular, Dewey wasn’t an outlier; it was among the elite of the Am Law 100. The firm embodied a culmination of prevailing big law firm trends that can—and will—produce future disasters. As the Georgetown/Peer Monitor Report explains, those trends include raising the bar for promoting home-grown talent into equity partnerships while overpaying for lateral equity partner hires, increasing internal compensation spreads to create a subgroup of real players within equity partnerships, and ignoring the importance of morale and institutional loyalty to long-term stability.

Crunching the numbers

Meanwhile, Citi Private Bank’s annual full-year survey of big firms produced this upbeat headline: “Firms Posted a 4.3 Percent Rise in 2012 Profits.” But important underlying details are more troubling.

Although revenue and profits were up by 3.6 and 4.3 percent, respectively, overall demand at the 179 firms in the Citi sample grew by just 0.2 percent in 2012, expenses increased by 3.1 percent, and headcount grew more than demand. It’s a decidedly mixed bag of financial results.

In fact, Citi’s Dan DiPietro and Gretta Rusanow fear that the 2012 fourth quarter revenue surge saving many big firms “may not be sustainable.” For example, “survivorship bias” contributed to the final 2012 numbers. That is, Citi’s analysis removed Dewey & LeBoeuf’s revenue, demand, and equity partner figures from the 2011 base year because the firm disappeared in 2012. But most of Dewey’s revenue went to surviving firms, thereby artificially inflating the overall 2012 numbers. To some extent, it’s like comparing 2012’s apples to 2011’s oranges. Including Dewey’s 2011 numbers would have resulted in negative demand growth in 2012.

Citi also discussed the impact of accelerated year-end collections. They’re an annual event at most firms, but the expiring Bush-era tax cuts gave partners unique incentives to push clients for payment in December 2012. The report also mentioned a related possibility: firms may not have prepaid 2013 expenses.

A more insidious prospect goes unmentioned: some firms may have deferred expenses that were due and owing in December 2012. If the 2013 first quarter Citi report is surprisingly weak, look for a spike in expenses as a factor. Freedom to ignore generally accepted accounting principles in financial reporting gives law firms financial flexibility that can become dangerous.

Or maybe the numbers don’t matter

Transcending all of these possibilities is, perhaps, the simplest. Averages are often deceptive. For example, in a firm where the internal top-to-bottom equity partner income spread is ten-to-one or higher, average partner profits may reveal that some partners are players and most aren’t. But as an economic metric describing a typical partner in the firm, it’s useless.

Just as average profits can mask enormous differences within an equity partnership, so, too, overall average profits for the industry can hide the gap between successful firms and those struggling to survive. That means 2013 could be another year in which some Am Law 200 law firms will fail (or become absorbed in last-resort mergers).

Fragile winners

But even firms that regard themselves as financial winners in 2012 should beware. Many would do well to heed the Georgetown/Thomson Reuters caution about the loss of traditional partnership values that undermined Dewey & LeBouef. Considered from a different perspective, numbers that appear to demonstrate success can actually reveal lurking failure.

After all, as recently as the May 2011 list of the Am Law 100, Dewey was #23 in 2010 average equity partner profits ($1.8 million), #22 in gross revenue per lawyer ($910,000), and #19 on the Am Law profitability index with a profit margin of 36 percent. In February 2012, the firm made Am Law’s annual “most lateral hires” list for 2011, but no public report disclosed the firm’s staggering (but by no means unique) top-to-bottom equity partner income gap.

As a wise friend reminds me periodically, things are rarely as good as they seem — or as bad as they seem. He’s definitely right about the good part.

THE CULTURE OF CONTRADICTIONS

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In an ironic twist, the latest Client Advisory from the Citi Private Bank Law Firm Group and Hildebrandt Consulting warns: “Law firms discount or ignore firm culture at their peril.” Really?

Law firm management consultants have played central roles in creating the pervasive big law firm culture. But that culture seldom includes “collegiality and a commitment to share profits in a fair and transparent manner,” which Citi and Hildebrandt now suggest are vital. For years, mostly non-lawyer consultants have encouraged managing partners to focus myopically on business school-type metrics that maximize short-term profits. The report reveals the results: the unpleasant culture of most big firms.

Determinants of culture

For example, the report notes, associate ranks have shrunk in an effort to increase their average billable hours. That’s how firms have enhanced what Hildebrandt and CIti continue to misname “productivity.” From the client’s perspective, rewarding total time spent to achieve an outcome is the opposite of true productivity.

Likewise, the report notes that along with the reduction in the percentage of associates, the percentage of income (non-equity) partners has almost doubled since 2001. Hildebrandt and Citi view this development as contributing to the squeeze on partner profits. But income partners have become profit centers for most firms. As a group, they command higher hourly rates, suffer fewer write-offs, and enjoy bigger realizations.

From the standpoint of a firm’s culture, a class of permanent income partners can be a morale buster. That’s especially true where the increase in income partners results from fewer internal promotions to equity partner. Comparing 2007 to 2011, the percentage of new equity partner promotions of home-grown talent dropped by 21 percent.

Lateral culture?

In contrast to the more daunting internal path to equity partnership, laterals have thrived and the income gap within most equity partnerships has grown dramatically. “Lateral hiring is more popular than ever,” the report observes. In contrast to the drop in internal promotions, new equity partner lateral additions increased by 10 percent from 2007 to 2011.

This intense lateral activity is stunning in light of its dubious benefits to the firms involved. The report cites Citi’s 2012 Law Firm Leaders Survey: 40 percent of respondents admitted that their lateral hires were “unsuccessful” or “break even.” The remaining 60 percent characterized the results as “successful” or “very successful,” but for two reasons, that number overstates reality.

First, it typically takes a year or more to determine the net financial impact of a lateral acquisition. Most managing partners have no idea whether the partners they’ve recruited over the past two years have produced positive or negative net economic contributions. For a tutorial on the subject, see Edwin Reeser’s thorough and thoughtful analysis, “Pricing Lateral Hires.”

Second, when is the last time you heard a managing partner of a big firm admit to a mistake of any kind, much less a big error, such as hiring someone whom he or she had previously sold to fellow partners as a superstar lateral hire? These leaders may be lying to themselves, too, but in the process, they’re creating a lateral partner bubble.

Stability?

The Hildebrandt/Citi advisory gives a nod to institutional stability, mostly by observing that it’s disappearing: “The 21-year period of 1987-2007 witnessed 18 significant law firm failures. In recent years, that rate has almost doubled, with eight significant law firms failing in the last five years.” If you count struggling firms that merged to stave off dissolution, the recent number is much higher.

In a Bloomberg interview last October, Citi’s Dan DiPietro, chairman of the bank’s law firm group, said that he maintained a “somewhat robust watch list” of firms in potential trouble, ranging from “very slight concern to oh my God!”

Cognitive dissonance

Here’s a summary:

Culture is important, but associates’ productivity is a function of the hours they bill.

Culture is important, but associates face diminishing chances that years of loyalty to a single firm will result in promotion to equity partnership.

Culture is important, but lateral hiring to achieve revenue growth has become a central business strategy for many, if not most, big firms. It has also exacerbated internal equity partner income gaps.

Culture is important and, if a firm loses it, the resulting instability may cause that firm to disappear.

As you try to reconcile these themes, you’ll understand why, as with other Hildebrandt/Citi client advisories, the report’s final line is my favorite: “As always, we stand ready to assist our clients in meeting the challenges of today’s market.”

INFLATED PPP?

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Recently, the Wall Street Journal broke the story, but it’s not new. Five years ago, The American Lawyer‘s then editor-in-chief Aric Press posed this question after hearing about presentations that Citi Private Law Firm Group was making to big firm managers (I’m paraphrasing):

Were law firms providing his magazine with financial information different from what they told their bankers at Citigroup?

In 2006, Press thought not: “The American Lawyer’s report of profits per partner is essentially the same as Citi’s for 47 percent of the firms to which [Citi] has access. For another 22 percent, the difference is 10 percent or less.”

In other words, 69 percent consistency (i.e., within 10 percent) between Am Law and Citi data — and that’s before reconciling their different definitions of equity partner.

On August 22, 2011, the Journal headline read “Law Firms’ Profits Called Inflated” — a supposedly new scandal: “[A]ccording to the person briefed on Citi’s [latest] analysis, in addition to about 22% of the top 50 firms overstating their 2010 profits per partner by more than 20%, an additional 16% inflated their numbers by 10% to 20%. An additional 15% of the firms had profits-per-partner figures that were inflated by 5% to 10%….”

In other words, 62 percent consistency (within 10 percent), again before appropriate reconciliations.

For Citi’s latest sample size of 50, that’s a swing of three law firms.

Of course, no firm should inflate its Am Law PPP, but a few always have. In his 2006 article, Press wondered why. I think it’s because some metrics assume an unsavory life of their own. In that way, Am Law PPP functions similarly to U.S. News law school rankings. Even when the underlying numbers are accurate, relying on the metric to make important decisions can lead to unfortunate behavior.

Pandering to idiotic U.S. News criteria results in dubious practices that discredit the overall result: recruiting previously rejected applicants who went to other schools, but whose LSATs don’t count if they arrive as tuition-paying 2L transfer students; using post-graduation employment rates that don’t distinguish between full- and part-time positions, or jobs requiring a legal degree and those that don’t; awarding first-year scholarships to students with high GPAs and LSATs, only to crush them with mandatory grading curves that impose forfeiture for years two and three.

A similar devotion to misguided metrics dominates many firms. In the 2008 Am Law 100 issue, Press observed: “[P]rofits-per-partner [is] the metric that has turned law firm managers into contortionists…” Maximizing PPP means equity partners squeezing more billables out of everybody, raising rates, and “pulling up the ladder behind them.”

Reliance on misguided metrics isn’t unique to the legal profession. What starts as teaching to a test sometimes culminates in cheating to get higher scores — with middle school instructors at the center of alleged wrongdoing. But catching attorneys in this particular lie is more difficult than finding common erasures for a classroom of standardized test-takers. Like law schools that self-report their information to the ABA (and U.S. News), private law firms submit whatever they want to The American Lawyer. Recipients can’t verify what they get.

However, Citigroup is a lender to law firms and “independently reviews many law firms’ financial performance,” according to the Journal. The WSJ had a story only because Citi entertained an audience of big law chairmen and managing partners with discrepancies between actual law firm profits and what the firms reported for public consumption. I wonder if the bank tried to reconcile its own clients’ apparent discrepancies before highlighting what the WSJ now depicts as a pervasive scandal.

Legal consultant Jerome Kowalski urges firms to stop reporting PPP, as Orrick, Herrington & Sutcliffe LLP announced it would last year. That’s unlikely, but meanwhile, the real travesty is that the liars go unidentified. Inflating profits for Am Law is a hubristic finger in the eyes of a firm’s client.

Maybe clients have no right to care what their lawyers make, as Adam Smith, Esq. argues in a recent blog post. But the unavoidable fact is that many do. From their perspective, the truth would have been bad enough. A few firms goosing their seven-figure PPP averages even higher make all firms look worse, not better.