ANOTHER BIG LAW FIRM STUMBLES

King & Wood Mallesons was never really a law firm. For starters, it was a verein — a structure that allowed three distinct firms to create a branding opportunity — King & Wood in China, Mallesons in Australia, and SJ Berwin in the United Kingdom. As things turned out, when SJ Berwin came on board in 2013, the verein whole quickly became less than the sum of its parts.

As The American Lawyer’s Chris Johnson and Rose Walker put it in their recent article, a verein is “a holding structure that allows member firms to retain their existing form. The structure…enabled the three practices to combine quickly and keep their finances separate.”

But the structure also means that when one member of the verein hits hard times, the others can walk away. For KWM, “the Chinese and Australian partnerships have effectively been able to stand back and watch as the European practice burned.”

Not Just a Verein Problem

To be sure, the verein structure exacerbates SJ Berwin’s current difficulties. But before leaders of big non-verein firms become too self-satisfied, they might consider whether their own firms risk the same dangers now afflicting KWM.

As Johnson and Walker report, the firm’s compensation system produced bad behavior. KWM awarded client credit to the partner who physically signed the invoice. That effectively encouraged partners to refer work to rival firms, rather than other KWM partners.

Think about that last sentence for a minute.

“It was one of the things that killed the firm,” says one former London partner. “If I sent work to other [KWM] partners, it would be out of my numbers at the end of the year. It was better for me to send it to another firm, as I’d then still be the one invoicing the client, so I’d get the credit for everything.”

A Team of One, Not One Team

When it came to cross selling among offices and practice groups, management talked a good game. Indeed, the verein’s 2013 merger tag line was “The Power of Together.” But here, too, behavior followed internal financial incentives. The compensation committee focused on individual partner performance, not the “one team, one firm” sound bite on its “vision and values” website page.

“There was a complete disconnect between what management said we should do and what the remuneration committee would reward us for doing,” says a former partner.

Lessons Not Learned, Again

As KWM’s European arm disintegrates, most law firm leaders will probably draw the wrong conclusions about what went wrong. Emerging narratives include: SJ Berwin had been on shaky ground since the financial crisis hit in 2008; the firm lacked competent management; the principal idea behind the combination — creating a global platform — was sound; only a failure of execution produced the bad outcome.

For students of law firm failures, the list sounds familiar. It certainly echoes narratives that developed to explain the 2012 collapse of Dewey & LeBoeuf. But the plight of KWM — especially the SJ Berwin piece — is best understood as the natural consequence of a partnership that ceased to become a partnership. In that sense, it resembles Dewey & LeBoeuf, too.

The organizational structure through which attorneys practice law together matters. The verein form allows King & Wood and Mallesons to back away from Sj Berwin with limited fear of direct financial exposure. But as SJ Berwin careens toward disaster, fellow verein members will suffer, at a minimum, collateral damage to the KWM brand.

What’s the Future Worth?

The lesson for big law firm leaders seems obvious. Since the demise of Dewey, that lesson has also gone unheeded. A true partnership requires a compensation structure that rewards partner-like behavior — collegially, mentoring, expansion and transition of client relationships to fellow partners, and a consensus to pursue long-term strategies promoting institutional stability rather than maximizing short-term profit metrics.

Firms that encourage attorneys to build individual client silos from which partners eat what they kill risk devastating long-term costs. They’re starving firm of their very futures. Unfortunately, too many big law firm leaders share a common attitude: the long-term will be someone else’s problem.

In a line that stretches back to Finley Kumble and includes Dewey & LeBoeuf, Bingham McCutchen, and a host of others, the names change, but the story remains the same. So does a single word that serves both as those firms’ central operating theme and as their final epitaph: greed.

A FOOL FOR A CLIENT

Abraham Lincoln often gets credit for the line, but in 1814 clergyman Henry Kett’s collection of proverbs in The Flowers of Wit included, “I hesitate not to pronounce that every man who is his own lawyer has a fool for client.”

More than two centuries later, it’s still true. But don’t tell Stephen DiCarmine, former executive director of the now-defunct Dewey & LeBoeuf. He doesn’t believe it. Recently, he appeared before Acting Justice Robert Stolz and explained that he wants to fire his attorney and represent himself.

Last year, three weeks of deliberation following a three-month trial produced a defense verdict on some counts and a deadlocked jury on the remaining charges against DiCarmine, former firm chairman Steven Davis, and former chief financial officer Joel Sanders. Davis then entered into a deferred prosecution agreement and Justice Stolz dismissed additional counts. Retrial on the remaining charges against DiCarmine and Sanders is set for September.

Judicial Skepticism

“The consequences are very severe in this case,” Justice Stolz told DiCarmine. “You could go to state prison if convicted.”

DiCarmine thinks he knows better. A graduate of California Western School of Law in 1983, he told the judge that he had discussed the issue with several lawyer friends. Their reactions: “Bad idea.”

But DiCarmine heard what he wanted to hear. At least, that’s what he told the judge: “They said if anyone can do it, you can do it.”

The truth is that when incarceration is a potential outcome, no one can do it. And no one should try. Gideon v. Wainwright’s guarantee of a right to counsel in criminal cases exists for a reason. And it doesn’t matter if the defendant is a lawyer.

Justice Stolz warned DiCarmine that he might think he knows what the case is all about because he’s been through it once. “But I assure you,” he urged, “it will be a different jury. It will be a different presentation from the People.”

An Unfortunate Moment

DiCarmine’s current lawyer, Austin Campriello, did a masterful job at the first trial. For good reason, he’s among the most highly respected criminal defense lawyers in New York. Campriello told the court that although his client’s finances were a factor, the motivating reason for DiCarmine’s request related to defense strategy.

DiCarmine then offered an unfortunate comment that unfairly tarred other big firms.

“I’ve run a law firm,” DiCarmine said. “When the client is not paying the bill, the services that are being rendered are not necessarily the same as if he were being paid.”

Nonsense. He displayed a remarkable ignorance of what the lawyers in his firm were actually doing while he was “running” it. Directly, he insulted all former Dewey & LeBoeuf attorneys who worked on pro bono matters. Indirectly, he put a cloud over the noble efforts of big firm lawyers who provide millions of dollars in free legal services to clients every year. Implicit in his remarks are widespread violations of ethical rules to advocate on behalf of all clients with the same seal. Those rules apply to all lawyers.

Natural Consequences

Justice Stolz properly put DiCarmine in his place, saying that Campriello would work to the best of his professional capacity, regardless of DiCarmine’s financial situation. He also told DiCarmine to think long and hard about his pro se request before the next hearing on May 27.

DiCarmine seeks to jettison a great lawyer for someone who, apparently, has been in a courtroom only as a witness or a defendant — that is, himself. It reminds me of the joke that one of my mentors told about the importance of using experienced trial lawyers in important cases.

“A patient goes to a doctor with a serious medical condition for which there is an elaborate surgical cure,” the joke begins. “The doctor describes in great detail how the procedure will go — start to finish. The patient is impressed, but has one more question: ‘How many of these operations have you performed?’ the patient asks. ‘Oh, none,’ says the doctor, ‘But I’ve watch a lot of them.'”

Revise the scenario slightly so that the doctor has observed the procedure only once — and is going to perform it on himself. Now you have a sense of DiCarmine’s plan.

THE LATEST BIG LAW FIRM STRATEGY: PERFECTING ERROR

NOTE: Amazon is running a promotion. The KINDLE version of my novel, The Partnership, is available as a free download from March 30 through April 3, 2016.

Two months ago in “Big Law Leaders Perpetuating Mistakes,” I outlined evidence of failure that most big law firm leaders ignore. Back in December 2011, I’d covered the topic in “Fed to Death” The recently released trade paperback version of my latest book, The Lawyer Bubble – A Profession in Crisis, includes an extensive new afterword that begins, “The more things change…”

The failure is a ubiquitous strategy: aggressive inorganic growth. In response to facts and data, big law firm leaders aren’t stepping back to take a long, hard look at the wisdom of the approach. Instead, they’re tinkering at the margins in the desperate attempt to turn a loser into a winner. To help them, outside consultants — perennial enablers of big law firms’ worst impulses — have developed reassuring and superficially appealing metrics. For anyone who forgot, numbers are the answer to everything.

Broken Promises

One measure of failure is empirical. Financially, many lateral partners aren’t delivering on their promises to bring big client billings with them. Even self-reporting managing partners admit that only about half of their lateral hires are above breakeven (however they measure it), and the percentage has been dropping steadily. In “How to Hire a Home-Run Lateral? Look at Their Stats,” MP McQueen of The American Lawyer writes that the “fix” is underway: more than 20 percent of Am Law 200 firms are now using techniques made famous by the book and movie “Moneyball.”

“Using performance-oriented data, firms try to create profiles of the types of lawyers they need to hire to help boost profits, then search for candidates who fit the profile,” McQueen reports. “They may also use the tools to estimate whether a certain candidate would help the firm’s bottom line.”

There’s an old computer programmer’s maxim: “Garbage in, garbage out.”

Useless Data

Unlike baseball’s immutable data about hits, runs, strikeouts, walks, and errors, assessing attorney talent is far more complicated and far less objective. Ask a prospective lateral partner about his or her billings. Those expecting an honest answer deserve what they get. Ask the partner whether billings actually reflect clients and work that will make the move to a new firm. Even the partner doesn’t know the answer to that one.

Group Dewey Consulting’s Eric Dewey, who is appropriately skeptical about using prescriptive analytics in this process, notes, “An attorney needs to bring roughly 70 percent of their book of business with them within 12 months just to break even.” He also observes that more than one-third bring with them less than 50 percent.

Of course, there’s nothing wrong with assessing the likely value that a strategically targeted lateral hire might bring to the firm. And there’s nothing wrong with using data to inform decisions. But that’s different from using flawed numerical results to justify growth for the sake of growth.

Becoming What You Eat

Beyond the numbers is an even more important reality. Partners who might contribute to a firm’s short-term bottom line may have a more important long-term cultural impact. It might even be devastating.

Dewey & LeBoeuf — no relation to Group Dewey Consulting — learned that lesson the hard way. During the years prior to its collapse, the firm hired dozens of lateral rainmakers. But as the firm was coming apart in early 2012, chairman Steven H. Davis was wasting his breath when he told fellow partners there wasn’t enough cash to pay all of them everything they thought they deserved: “I have the sense that we have lost our focus on our culture and what it means to be a Dewey & LeBoeuf partner.”

Half of the partners he was addressing had been lateral hires over the previous five years. Most of them had joined the firm because it promised them more money. They hadn’t lost their focus on culture. They had redefined it.

DEWEY, THE D.A., AND SECRETS

“There aren’t too many secrets in this case,” said Judge Robert Stoltz on December 5. He was referring to the Dewey & LeBoeuf trial over which he presided. The multi-year effort to convict Steven Davis, Stephen DiCarmine, and Joel Sanders produced a raft of acquittals on many charges and a hung jury on the more serious offenses.

Actually, there are two big secrets in the case, but no one is talking about them.

Secret #1: Why Zachary Warren?

Former Dewey chairman Steven H. Davis won’t face a retrial. Assistant DA Peirce Moser has offered him a deferred prosecution agreement. As reported, he will not have to admit guilt and can continue practicing law. When my kids were young, they would have called this a “do-over.”

Judge Stoltz’s reference to secrets was in response to Moser’s suggestion that the retrial of executive director DiCarmine and finance director Sanders should precede the first trial of former low-level staffer Zachary Warren. The longer Warren dangled in a world of uncertainty, the more leverage it would give Moser in his relentless pursuit of someone who never should have been indicted in the first place. Appropriately, the judge denied Moser’s request.

That leads to secret number one: Why is the Manhattan DA’s office squandering its scarce resources to pursue Zachary Warren at all?

I’ve written extensively about Warren’s plight. At age 24, he worked at Dewey & LeBoeuf for about a year from mid-2008 to mid-2009 as a client relations specialist. His principal job was to pester Dewey & LeBoeuf partners into making sure clients paid their bills.

Apparently, his mistake of a lifetime came on December 30, 2008. That’s when he accepted an invitation to join 29-year-old finance director Frank Canellas and 53-year-old chief financial officer Sanders for dinner at Del Frisco’s steakhouse. There he allegedly witnessed the creation of what the DA’s office called a master plan of accounting fraud. As his price for that free dinner, Warren would get indicted five years later.

When Zachary Warren left Dewey & LeBoeuf in June 2009, did anyone in the world think that the firm was unlikely to repay its bills, much less collapse — ever? No.

In 2010, was Warren even at the firm as others worked on the bond offering at the center of the DA’s case? No, he was a one-L at Georgetown.

Even if obtained, would a conviction of Warren result in anything positive for anyone inside or outside our justice system? No.

Warren’s indictment was a travesty. The jury’s rejection of the DA’s case against his superiors is reason alone to drop the effort to prosecute him.

Unsatisfying Answers

So why is Moser so determined to try Zach Warren? One possibility is that the same phenomena contributing to Dewey & LeBoeuf’s downfall infects the DA’s office: hubris, ego, lack of accountability for mistakes, and an unwillingness to admit errors that would prompt thoughtful individuals to change course. Maybe it’s a lawyer personality thing.

Another possibility is the public servant manifestation of greed: the DA wants to put a Dewey & Le Boeuf notch — any Dewey & LeBoeuf notch — on its convictions holster. After Cyrus Vance, Jr. personally announced the indictments in a circus-like press conference on March 6, 2014, Moser suffered unambiguous defeat. In fact, even the plea agreements that the DA’s office squeezed from former firm staffers who later testified at trial now look silly. Unfortunately, the resulting penalties aren’t silly for those who are stuck with them.

To put the DA’s pursuit of Zachary Warren in context consider this. According to published reports, assistant DA Peirce Moser has offered him a plea deal, too. But it is more onerous than the DA’s deferred prosecution agreement with Davis.

There is no just world in which that makes any sense.

Secret #2: Where is the Money?

Prosecutors told the jury that it would not see a “smoking gun.” That’s because the DA didn’t know how to look for or describe it. But the gun was there. It was pervasive, insidious, and hiding in plain sight. It was the environment that caused staffers to fear for their jobs if powerful partners weren’t happy. That meant making sure they received millions more than the firm had available to distribute, even if it came from bank credit lines and outside investors in the firm’s 2010 bond offering.

That leads to secret number two: Why didn’t the DA follow the money?

The public could have reasonably expected Vance to direct the power of his office toward the most egregious offenders and offenses. That didn’t happen. Sure, Davis had a major responsibility for the strategy that brought the firm down. But the executive committee consisted of top partners who were supposed to be fiduciaries in running the firm for the benefit of all partners and the institution. Likewise, as most of the firm’s so-called leaders walked away with millions — far more than Davis, DiCarimine, Sanders, or Warren received — bankruptcy creditors got between five and fifteen cents for every dollar the firm owed them.

In a November 2012 bankruptcy court filing, Davis himself teed up what should have been the central issue in any attempt to assign blame for the firm’s problems:

“While ‘greed’ is a theme…, the litigation that eventually ensues will address the question of whose greed.”

The DA’s office never pursued that question.

Just Rewards

Shortly after Vance’s March 2014 press conference, assistant district attorney Peirce Moser received a promotion. He became chief of the tax crimes unit. The DA’s office announced that Moser’s new position would not preclude him from continuing to run the Dewey & LeBoeuf case. Based on his prominence at the most recent court hearing, it’s still Moser’s case.

If no good deed goes unpunished, sometimes it seems that no bad deed goes unrewarded.

DEWEY: 10 LESSONS LOST

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National news organizations began working on stories about the verdicts in the Dewey & LeBoeuf case long before the jury’s deliberations ended.

“What are the lessons?” several reporters asked me.

My initial inclination was to state the obvious: Until the jury renders its decision, who can say? But that would be an unfortunately limited way of viewing the tragedy that befell a once noble law firm. In fact, the trial obscured the most important lessons to be learned from the collapse of Dewey & LeBoeuf.

Lesson #1: You Are What You Eat

During the twelve months prior to the firms’ October 2007 merger, Dewey Ballantine hired 30 lateral partners; LeBoeuf Lamb hired 19. The combined firm continued that trend as Dewey & LeBoeuf became one of the top 10 firms in lateral recruiting. By 2011, 50 percent of the firm’s partners were post-2005 laterals into Dewey & LeBoeuf or its predecessors.

A partnership of relative strangers is not well-positioned to withstand adversity.

Lesson #2: Mind the Gap

To accomplish aggressive lateral hiring often means overpaying for talent and offering multi-year compensation promises. By 2012, Dewey & LeBoeuf’s ratio of highest-to-lowest paid equity partners was 20-to-1.

A lopsided, eat-what-you-kill partnership of haves and have-nots has difficulty adhering to a common mission.

Lesson #3: Not All Partners Are Partners

One corollary to a vast income gap within the equity ranks is the resulting partnership-within-a-partnership. As those at the top focus on the short-term interests of a select few, the long-run health of the institution suffers.

A partnership within a partnership can be a dangerous management structure.

Lesson #4: The Perils of Confirmation Bias

Firm leaders and their fellow partners are vulnerable to the same psychological tendencies that afflict us all. When former Dewey chairman Steven H. Davis held fast to his perennial view that better times were just around the corner, fellow partners wanted to believe him.

Magical thinking is not a business strategy.

Lesson #5: Short-termism Can Be Lethal

Short-term thinking dominates our society, even for people who view themselves as long-term strategists. At Dewey, the need to maximize current year partner profits and distribute cash to some partners overwhelmed any long-term vision that Davis sought to pursue.

In the not-so-long run, a firm can die.

Lesson #6: Behavior Follows Incentive Structures

Most firms hire lateral partners because they will add clients and billings. To prove their worth, laterals build client silos to prevent others from developing relationships with “their clients.” Similarly, there’s no incentive for partners in “eat-what-you-kill” firms to mentor young attorneys or facilitate the smooth intergenerational transition of client relationships.

Over time, the whole can become far less than the sum of its parts.

Lesson #7: Disaster Is Closer Than You Think

When the central feature of a firm’s culture is ever-increasing partner profits, even small dips become magnified. Incomes that are staggering to ordinary workers become insufficient to keep restless partners from finding a new place to work.

Death spirals accelerate.

Lesson #8: Underlings Beware

On cross-examination, some of the prosecution’s witnesses testified that at the time they made various accounting adjustments to Dewey’s books, they didn’t think they’d done anything wrong. But now they are parties to plea agreements that could produce prison time.

Deciding that something isn’t wrong is not always the same as determining that it’s right.

Lesson #9: Greed Governs

Who among the Dewey partners received the $150 million in bond proceeds from the firm’s 2010 bond offering? I posed that question a year ago and we still don’t know the answer. During the first five months of 2012 — as the firm was in its death throes — a small group of 25 partners received $21 million while the firm drew down its bank credit lines. Who masterminded that strategy?

In a November 2012 filing with the Dewey bankruptcy court, Steven Davis explained why Dewey collapsed: “While ‘greed’ is a theme…, the litigation that eventually ensues will address the question of whose greed.” (Docket #654) He was referring to some of his former partners who ignored the role that fortuity had played in creating their personal wealth.

Hubris is a powerfully destructive force.

Lesson #10: Superficial Differences Don’t Change Outcomes

For the three years that Dewey has been in the news, many big law firm leaders have been performing the task at which attorneys excel: distinguishing adverse precedent. In great detail, they explain all of the ways that their firms are nothing like Dewey. But they fail to consider the more significant ways in which their firms are similar.

A walk past the graveyard is easier when you whistle. Louder is better. Extremely loud and running is best.

THE DEWEY TRIAL: FOUR EXAMPLES OF NOT-SO-FUNNY COMIC RELIEF

The ongoing criminal trial against three former leaders of Dewey & LeBoeuf has consumed six weeks. Time flies when you’re having fun. For example:

#1: Funny, If It Weren’t So Sad

For a bunch of smart people, some senior partners did some dumb things. One of the prosecution’s first witnesses was a former member of Dewey’s executive committee who retired at the end of 2010. She had contributed more than $600,000 in capital to the firm and, upon retirement, expected to get it back. Although the partnership agreement permitted the firm to spread the payments to her over three annual installments, she testified that chairman Steve Davis had discretion to accelerate them.

Davis declined her request to do so. Instead, he encouraged her to get a bank loan from Barclays for the full amount and told her that over the subsequent three years the firm would repay the loan for her. She followed his recommendation and borrowed the money.

The firm failed to repay the Barclays loan. She remained on the hook and paid the full amount herself. Adding insult to injury, she lost again when the firm filed for bankruptcy and her $175,000 annual pension disappeared.

#2: Funny, If You Were Not a Fellow Partner

For a bunch of high-powered former Dewey partners who rose to the very top of the firm, titles typically associated with power didn’t mean leadership. Likewise, becoming a member of the firm’s governing structure apparently didn’t result in any duties or responsibilities that involved actual knowledge of the firm’s finances or operations.

For example, during the fifth week of trial, Ralph Ferrara testified that even though he had no equity stake in the firm, he held an impressive title — vice chairman — and had an agreement whereby the firm paid him a salary around $5 million a year. He told the jury that former chairman Steven Davis’ announcement that Ferrara would assume the vice-chairmanship became an offer that he couldn’t refuse.

“I’m embarrassed to say, my ego overcame my good judgment,” Ferrara, a former general counsel of the U.S. Securities and Exchange Commission, said on the witness stand.

That line could describe leaders of big law firms everywhere. But it’s a flimsy excuse for abdicating responsibilities that come with power. So is another of Ferrara’s quoted lines: “I’m a practicing lawyer. I’m not a law firm administrator.”

Dewey’s other vice-chairman was Mort Pierce. As the firm was failing and Pierce was jumping ship in 2012, he similarly disclaimed any leadership responsibilities associated with his title and position.

#3: Funny, For a Lawyer

For a bunch of lawyers who make a lot of money advising clients not to write stupid stuff, some of them sure wrote stupid stuff. As the trial plodded through its fifth week, the jury saw these colorful messages from former Dewey partner Alexander Dye:

“Fellas: Time to start spending Momma LeBoeuf’s money like its water.”

“Steve DiCarmine, if you are reading this, I’ll have your f-cking head on a stick.”

During week six, one former executive committee member, Richard Shutran, testified about his internal firm emails, including these nuggets:

“I spend most days bulls–ing people…”

“Do what I do. Work out a lot and do drugs…”

“If he calls me, I’ll kill him…”

A defense attorney for Dewey’s former chief financial officer Joel Sanders had Shutran explain that these were all jokes. Apparently, the strategy is to convince the jury that Shutran’s email jests were part of a culture producing defendants’ supposed email “jokes” about finding “a clueless auditor” and using “fake income” in crafting the firm’s financial statements. Good luck with that one.

#4: Funny, If You’re Not A Juror

At the end of week six, jurors listened as the presiding trial judge, Manhattan Supreme Court Justice Robert Stoltz, interrupted Stephen DiCarmine’s defense counsel in mid-question. He wanted counsel to explain a term he was using in cross-examining Dewey’s former budget and planning director:

“What does the phrase ‘unreconciled expense write-off’ mean?”

Riveting.

Only three more months to go.

THE DEWEY TRIAL: TRUTH, JUSTICE, OR NEITHER?

[NOTE: My recent post, “Cravath Gets It Right, Again,” was a BigLaw Pick of the Week.]

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“Not all the evidence that you hear and see will be riveting,” said Steve Pilnyak last Tuesday as he opened the prosecution’s case against three former leaders of the now-defunct Dewey & LeBoeuf. The judge warned jurors that they will probably be there past Labor Day. The antagonists will present dueling views of what the New York Times called “arcane accounting treatments and year-end adjustments” three years before Dewey’s collapse. As you read between the yawns, watch to see if the trial leaves the most important questions about the final days of a storied firm unanswered.

Victims?

The prosecution’s case requires victims. It settled on insurance companies who bought the firm’s bonds in 2010 and big banks that lent the firm money for years. We’ll see how that plays, but it’s difficult to imagine aggrieved parties that would generate less juror sympathy than insurers and Wall Street bankers. Then again, rich lawyers aren’t exactly the most desirable defendants, either.

The prosecution’s cooperating witnesses will take the stand to explain what it calls a “Master Plan” of accounting adjustments that are the centerpiece of the case. The battle of experts over those adjustments is more likely to induce sleep than courtroom fireworks.

Villains?

If you think former firm chairman Steven Davis and his two co-defendants, Stephen DiCarmine and Joel Sanders, are the only villains in this saga, you’re allowing the trees to obscure a view of the forest. In that respect, the trial will fail at its most fundamental level if it doesn’t address a central question in the search for justice among Dewey’s ruins: Who actually received — and kept — the hundreds of millions of dollars that entered the firm’s coffers as a result of the allegedly fraudulent bond offering and bank loans?

As the firm collapsed in early 2012, it drew down tens of millions of dollars from bank credit lines while simultaneously distributing millions to Dewey partners. As I’ve reported previously, during the five months from January to May 2012 alone, a mere 25 Dewey partners received a combined $21 million. Are they all defendants in the Manhattan District Attorney’s criminal case? Nope. Will we learn the identity of those 25 partners, as well was the others who received all of that borrowed money? I hope so.

Shortly after those 2012 distributions, Wall Street Journal reporters asked former Dewey partner Martin Bienenstock whether the firm used those bank loans to fund partner distributions. Bienenstock replied, “Look, money is fungible.”

It sounds like his answer to the question was yes.

Unwitting Accomplices?

With respect to the proceeds from Dewey’s $150 million bond offering, the picture is murkier, thanks to protective cover from the bankruptcy court. When Judge Martin Glenn approved a Partner Contribution Plan, he capped each participating partner’s potential financial obligation to Dewey’s creditors at a level so low that unsecured creditors had a likely a recovery of only 15 cents for every dollar the firm owed them. That was a pretty good deal for Dewey’s partners.

But here’s the more important point. As it approved that deal, the court did not require the firm to reveal who among Dewey’s partners received the $150 million bond money. In calculating each partner’s required contribution to the PCP, only distributions after January 1, 2011 counted. The PCP excluded consideration of any amounts that partners received in 2010, including the bond money. That meant they could keep all of it.

In light of the bankruptcy code‘s two-year “look back” period, that seemed to be a peculiar outcome. Under the “look back” rule, a debtor’s asset transfers to others within two years of its bankruptcy filing are subject to special scrutiny that is supposed to protect against fraudulent transfers.

Dewey filed for bankruptcy on May 28, 2012. The “look back” period would have extended all the way to May 28, 2010 — thereby including distributions of the bond proceeds to partners. Which partners received that money and how much did they get? We don’t know.

Connecting Dots

As the firm’s death spiral became apparent, a four-man office of the chairman — one of whom was Bienenstock — took the leadership reins from Steven Davis in March 2012. A month later, it fired him. In an October 12, 2012 Wall Street Journal interview, Bienenstock described himself as part of a team that, even before the firm filed for bankruptcy, came up with the idea that became the PCP. He called it an “insurance policy” for partners.

Taking Bienenstock’s “money is fungible” and “insurance policy” comments together leads to an intriguing hypothetical. Suppose that a major management objective during the firm’s final months was to protect distributions that top partners had received from the 2010 bond offering. Suppose further that in early 2012 some of those partners also received distributions that the firm’s bank loans made possible. Finally, suppose that those partners used their bank loan-funded distributions to make their contributions to the PCP — the “insurance policy” that absolved them of Dewey’s obligations to creditors.

When the complete story of Dewey gets told, the end game could be its climax. It could reveal that a relatively few partners at the top of the firm won; far more partners, associates, staff, and creditors lost.

Or maybe I’m wrong and the only villains in this sad saga are the three defendants currently on trial. But I don’t think so.

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.

DEWEY & LEBOEUF: CONNECTING MORE DOTS

[NOTE: August 8, 2014 at 5:00 pm EDT is the deadline for nominations to the ABA’s annual list of the “100 best websites by lawyers, for lawyers.” To nominate The Belly of the Beast, please click here.]

Two years ago, Dewey & LeBeouf filed for bankruptcy. Intriguing aspects of the firm’s unraveling are still emerging.

Recently, three of the firm’s former leaders, chairman Steven Davis, executive director Stephen DiCarmine, and chief financial officer Joel Sanders, filed an omnibus motion to dismiss the criminal charges against them. Such filings are not unusual. But their joint memorandum in support, along with DiCarmine’s separate supplemental brief, contain fascinating insights into the firm’s collapse. As the dots get added, it’s becoming easier to connect some of them.

Beyond the Scapegoats

Back in November 2012, former Dewey chairman Steven Davis hinted at the flaws in any narrative suggesting that he alone took the firm down. His filing in the Dewey bankruptcy proceeding promised another perspective:

“While ‘greed’ is a theme…, the litigation that eventually ensues will address the question of whose greed.” (Docket #654; emphasis in original)

The three co-defendants’ joint memorandum returns to that theme. It argues that the firm’s distress resulted from, among other things, “the voracious greed of some of the firm’s partners.” DiCarmine’s supplemental brief describes the greed of some former partners as “insatiable.”

The 2010 Bond Offering and 2012 Partner Contribution Plan

Some former Dewey partners might find the defendants’ recent filings uncomfortable. For example, much of the government’s case turns on the firm’s 2010 bond offering that brought in $150 million from outside investors. DiCarmine’s supplemental brief asks why, except for Davis, “the Executive Committee members who approved and authorized it have not been charged with any wrongdoing.”

Later, as the firm collapsed during the first five months of 2012, it drew down millions from bank credit lines while simultaneously distributing millions to Dewey partners. As I’ve reported previously, from January to May 2012, 25 Dewey partners received a combined $21 million.

The joint memorandum suggests that “if the grand jury presentation was fair and thorough, it demonstrates that drawdowns the firm made in 2012, prior to filing for bankruptcy, were made at the direction of several partners on the firm’s Operations Committee, and against the advice of Mr. Sanders, and despite the concerns of Mr. Davis and objections raised by Mr. DiCarmine.”

Shortly after those 2012 distributions occurred, Wall Street Journal reporters asked former Dewey partner Martin Bienenstock whether the firm used those bank credit lines to fund partner distributions. Bienenstock replied, “Look, money is fungible.”

He’s right. But that raises another question: Did some partners then use those eleventh-hour distributions of fungible dollars for their subsequent payments to the bankruptcy court-approved Partner Contribution Plan? The answer matters because the PCP capped each participating partner’s potential financial obligation to the Dewey estate. Unsecured creditors will recover an estimated 15 cents for every dollar the firm owed them.

There’s another twist. Dewey made its way through the bankruptcy proceeding without disclosing how partners shared those 2010 bond proceeds. In calculating each partner’s required contribution to the PCP, only partner distributions after January 1, 2011 counted. The PCP excluded consideration of any amounts that partners received in 2010.

Remember Zachary Warren?

The joint memorandum also counters the Manhattan District Attorney’s characterization of the accounting issues in the case as open and shut: “lf the grand jury had been properly instructed on these [accounting] standards, it would have concluded that the accounting methods were permissible,….”

Which takes us back to the curious case against Zachary Warren, a subject of several earlier posts. The charges against the former low-level Dewey staffer are predicated on an underlying violation of those accounting standards, too.

Warren has sought to sever his trial from that of his co-defendants, Davis, DiCarmine, and Sanders. Warren argues that plea agreements from witnesses who are cooperating with the government, notably Frank Canellas, demonstrate how thin the case against him is.

The Manhattan District Attorney responds that statements in the plea agreements are just the beginning: “[T]he purpose of the allocutions was to set forth facts implicating the witnesses in the crimes they committed; any part of them that inculpates the defendant is merely incidental.” (District Attorney’s letter to Hon. Robert Stolz, July 3, 2014) (App. I of Defendants Davis, DiCarmine, and Sanders Omnibus Memorandum in Support of Motion to Dismiss))

Really? Some career prosecutors might find it surprising to learn that when they get a defendant to “flip” and provide statements fingering a different target, the flipper’s statements are “merely incidental” insofar as they inculpate that target.

But the best line in the District Attorney’s surreply tries to connect Warren’s alleged December 2008 activities to Dewey’s collapse more than three years later: “[H]e was there to light the spark that fueled the scheme until its implosion in 2012.” (p. 6)

At least with respect to Zachary Warren, methinks the government doth protest too much. Meanwhile, his co-defendants are focusing on questions that cry out for answers.

 

 

A DEWEY GUILTY PLEA COULD BECOME MORE THAN ANYONE BARGAINED FOR

Sometimes there’s more to a news story than meets the eye. For example, recent indictments and guilty pleas involving former Dewey & LeBoeuf personnel focus on a handful of individuals who allegedly cooked the firm’s books for years prior to its implosion. The sordid details make for entertaining press conferences and great headlines.

But maybe a more interesting question is: who will be standing naked when the Manhattan DA finishes pulling the threads on that sweater? A careful look at Frank Canellas’ plea agreement suggests some surprising possibilities. But it takes a brief history of the Dewey bankruptcy proceeding to understand some of them. So bear with me.

Remember the PCP?

Back in October 2012, the Dewey & LeBoeuf bankruptcy judge approved a novel Partnership Contribution Plan. For a collective $71.5 million, participating former Dewey partners received releases of creditor claims totaling more than $500 million. That meant creditors could not seek to “clawback” additional amounts that partners received while the firm was insolvent.

When did the firm become insolvent? The PCP answered that question with a specific date, January 1, 2011. A progressive payment table determined each partner’s required contribution based on the amount the partner received from Dewey after that date. Partners who had received $400,000 or less paid back 10 percent of the total. From there, the percentage rose so that partners who had received $3 million or more paid 30 percent. (Former Chairman Steven Davis was not allowed to participate in the plan.)

Remember the 2010 bond offering?

The January 1, 2011 cutoff date was important because Dewey & LeBoeuf’s unusual $150 million bond offering closed in 2010. Under the PCP, any money that participating partners received that year — including proceeds from bond investors and funds from banks that refinanced the firm’s debt — remained off the potential clawback table.

A group of retired Dewey partners objected to the PCP, claiming that its terms favored former firm leaders.  Attorneys for the Dewey bankruptcy estate responded that they had retained an outside professional, Jonathan Mitchell of Zolfo Cooper, who had “controlled the development and promulgation of the PCP.” (Docket #482 at 10) Mitchell worked on the project with David Pauker of Goldin Associates.

Remember the court’s approval of the PCP?

Dewey’s bankruptcy judge overruled objections to the PCP and determined that the January 1, 2011 cutoff date was reasonable. In doing so, he relied in part on Mitchell and Pauker, who testified to the difficulty of efforts aimed at proving that the firm was insolvent earlier:

“Based on investigations of the Debtor’s finances by the Debtor’s professionals, Pauker and Mitchell testified that there was strong evidence to support the assertion that the Debtor was insolvent in 2012, but insolvency would be more difficult to prove for 2011, and even harder for 2010. Determining the exact insolvency date is both difficult and expensive because several complex tests are used, leading to extended expensive litigation as those tests can produce contradictory results.” (10/09/12 Mem. Op. at 23; transcript record citations omitted)

Of particular interest in light of Canellas’ recent guilty plea regarding his role in creating the firm’s financial statements, the court went on to observe: “Further complicating the issue, the firm had a clean audit opinion issued in 2010 and was able to refinance a significant portion of its debt,….” (Id.)

Now things get interesting

Flash forward to March 2014, when the Manhattan DA unseals Canellas’ plea agreement. In his accompanying statement, the former Dewey director of finance says that, far from clean, audit opinions for 2008, 2009, and 2010 were based on financial statements that he knew to be false.

Meanwhile, the Dewey bankruptcy attorneys who persuaded the court to approve the PCP gave way to a liquidating trustee. That trustee is asserting clawback claims against individual partners who refused to participate in the PCP. Those complaints allege that the firm was insolvent no later than January 1, 2009 and seek recovery based on that much earlier date.

Now what?

Here’s another way to look what has happened so far:

1. Lawyers for the Dewey bankruptcy estate presented the court with a plan whereby former Dewey partners returned a percentage of the amounts that they received after January 1, 2011 — but anything they received prior to that date became off limits to Dewey’s creditors. (The court-approved final confirmation plan estimated that general unsecured creditors with claims collectively approaching $300 million would eventually receive between 4 cents and 15 cents for every dollar that the firm owed them.)

2.  A group of objectors claimed that the PCP favored Dewey’s most wealthy and powerful former partners.

3. The court overruled that objection and approved the PCP with its January 1, 2011 cutoff date because, among other reasons, professional advisers to the Dewey estate testified that it was reasonable and the firm got what the court called a “clean” audit for 2010.

4. The Manhattan DA has now indicted four former Dewey employees — and obtained guilty pleas from seven others — for their roles in allegedly cooking the books in ways that, if true, would render the 2010 audit not so clean.

5.  One more thing. According to Canellas’ statement appended to his February 13, 2014 plea agreement, after Dewey filed its bankruptcy petition on May 28, 2012, he continued working for the firm’s wind down committee and, at the time he signed the statement, was still working for Dewey’s liquidating trustee. (The plea agreement required him to resign from that position.)

As you try to wrap your head around all of this, remember that “foolish consistency is the hobgoblin of little minds.” So think big and follow the money, if you can find it.

In my next post, I’ll discuss another aspect of the Canellas plea agreement that is likewise deeper than the current headlines — and far more troubling.

DEWEY & LE BOEUF: MORE COLLATERAL DAMAGE

Does 29-year-old Zachary Warren hold the key to understanding the demise of the storied white-shoe law firm, Dewey & LeBoeuf’? Apparently, New York County District Attorney Cyrus R. Vance, Jr. thinks so.

Zachary Who?

In 2006, Warren graduated from Stanford University with a degree in international relations. In 2008, he went to work for Dewey & LeBoeuf as a client relations manager; it was his first job out of college. His work at Dewey, Am Law Daily’s Sara Randazzo reports, was “to pester partners to make sure clients paid their bills, according to two former Dewey employees.” That, by the way, is an annual ritual at every big firm, and it’s no fun.

When Warren started at Dewey, he was 24 years old. After spending his “gap year” there, he attended Georgetown Law where he served on the law review. After graduation, he took a federal district court clerkship in Maryland. Then he accepted another clerkship that he still has for Judge Julia Smith Gibbons on the Sixth Circuit Court of Appeals.

Having left Dewey three years before its demise, Warren must have found it odd when Vance’s office called to discuss the firm’s failure. Most people who once worked at the firm would have been surprised, too. They’d never heard of Zachary Warren until last week, when he was indicted, along with three more familiar Dewey names — Steven Davis, Stephen DiCarmine, and Joel Sanders, respectively, the firm’s last chairman, executive director, and chief financial officer.

An Observer’s Perilous Plight

What did Warren do to merit inclusion with such a powerful and notorious threesome, thereby creating a foursome that the indictment identifies collectively as the “Schemers”? Based on the allegations of the 106-count indictment, not much.

On or about December 30, 2008 — the end of the first full calendar year of operation following the blockbuster merger of Dewey Ballantine and LeBoeuf Lamb — Warren’s boss, CFO Joel Sanders, allegedly told him that he would receive his full bonus “if the Firm satisfied its bank covenants.” The indictment doesn’t say whether Warren knew what that phrase meant.

The following day, the indictment alleges, Warren sat in a meeting with Sanders and an unnamed “Employee C” while Sanders and Employee C discussed “financial adjustments.” That evening — New Year’s Eve at 7:24 pm, to be precise — Employee C wrote to Warren: “Great job, dude. We kicked ass! Time to get paid.”

Twelve minutes later, Warren responded, “Hey man, I don’t know where you come up with some of this stuff, but you saved the day. It’s been a rough year but it’s been damn good. Nice work dude. Let’s get paid!”

Finally, two months after that, on February 24, 2009, Warren supposedly responded falsely to a message from a Dewey employee about an allegedly inappropriate financial adjustment in 2008.

Only one of the 106 counts against the “Schemers” includes Warren. It is #106 and is a bit confusing: “CONSPIRACY IN THE FIFTH DEGREE… as follows: The defendants…during the period from on or about November 3, 2008, to on or about March 7, 2012, with intent that conduct constituting the crime of SCHEME TO DEFRAUD IN THE FIRST DEGREE be performed, such crime being a felony, agreed with one and more persons to engage in and cause the performance of such conduct.” I’m not sure where to put the “[sic].”

Warren has another distinction: He is also the subject of his own, separate indictment, alleging six counts of falsifying business records.

The Awesome Power of Government

To understand what is happening to Zachary Warren — a millennial whose first dream job has turned into a nightmare — look no farther than prosectuor Vance’s press conference. He announced that seven former employees who worked in Dewey & LeBoeuf’s accounting department have already pled guilty “for their individual roles in the scheme.”

That’s how these things work. Government investigators start at the bottom of an organization, identify low-level employees who might know something, apply pressure, and acquire guilty pleas that create cooperating witnesses who can testify against the real targets. Indicting a low-level person can also have an in terrorem effect, demonstrating to others the government’s seriousness.

I’ve never met or communicated with Zachary Warren. But as with any attorney, a plea deal poses special problems that don’t affect non-lawyers. Reportedly, Warren passed the bar last July. Among other things, a guilty plea could end forever his ability to practice law. That would be a tough way to close out an investment of five years (law school plus two clerkships) and $150,000 in tuition.

Abandoning Common Sense

Warren’s co-defendants may have something to say about whether any crime occurred at all. The presumption of innocence has not yet lost all meaning. Still, some aspects of the case against Zachary Warren, seem particularly peculiar.

“Pestering partners at year-end to get clients to pay outstanding bills” is not exactly a policy-making position. How can anyone who worked in the bureaucratic bowels of a big firm for less than a year bear responsibility for what went wrong three years later? Should low-ranking administrative staff members everywhere start asking questions about what superiors want them to do and why? How should they assess the answers? When should they resign in protest?

Likewise, when Warren left Dewey in 2009, the partnership collectively was making hundreds of millions of dollars in profits. At the time, no one in the profession could have foreseen the firm’s disastrous demise in 2012. And before making too much of the juicy emails allegedly attributed to Zachary Warren, please pause, add a little context, and consider how all of us sometimes fire off quick, mindless responses to emails and text messages.

Most importantly, think about how you’d feel if someone you knew found himself in Zachary Warren’s position. Twenty-four years old and only months into his first job after college, he participated in an end-of-the-year revenue collection meeting with superiors. More than five years later, that meeting led to a “perp walk” with three codefendants, any of whom could have made or broken his career at Dewey & LeBoeuf.

Then think about the government’s awesome power to turn lives upside down in a pursuit that Warren’s lawyer called a “travesty.” You might conclude that he has a point. Anyone truly interested in what went wrong at Dewey & LeBoeuf should take a look at Chapter 8 of The Lawyer Bubble – A Profession in CrisisThen you’ll really wonder why Zachary Warren is part of this mess.

UGLINESS INSIDE THE AM LAW 100 – PART 2

Part I of this series considered the possibility that a key metric — average partner profits — has lost much of its value in describing anything meaningful about big law firms. In eat-what-you-kill firms, the explosive growth of top-to-bottom spreads within equity partnerships has skewed the distribution of income away from the bell-shaped curve that underpins the statistical validity of any average.

Part II considers the implications.

Searching for explanations beyond the obvious

In recent years, equity partners at the top of most big firms have engineered a massive redistribution of incomes in their favor. Why? The next time a senior partner talks about holding the line on equity partner headcount or reducing entry-level partner compensation as a way to strengthen the partnership, consider the source and scrutinize the claim.

One popular assertion is that the high end of the internal equity partner income gap attracts lateral partners. In fact, some firms boast about their large spreads because they hope it will entice laterals. But Professor William Henderson’s recent analysis demonstrates that lateral hiring typically doesn’t enhance a firm’s profits. Sometimes selective lateral hiring works. But infrequent success doesn’t make aggressive and indiscriminate lateral hiring to enhance top line revenues a wise business plan.

According to Citi’s 2012 Law Firm Leaders Survey, even law firm managing partners acknowledge that, financially, almost half of all lateral hires are no better than a break-even proposition. If leaders are willing to admit that an ongoing strategy has a failure rate approaching 50 percent, imagine how bad the reality must actually be. Even worse, the non-financial implications for the acquiring firm’s culture can be devastating — but there’s no metric for assessing those untoward consequences.

A related argument is that without the high end of the range, legacy partners will leave. Firm leaders should consider resisting such threats. Even if such partners aren’t bluffing, it may be wiser to let them go.

“We’re helping young attorneys and building a future”

Other supposed benefits to recruiting rainmakers at the high end of a firm’s internal partner income distribution are the supposedly new opportunities that they can provide to younger attorneys. But the 2013 Client Advisory from Citi Private Bank-Hildebrandt Consulting shows that lateral partner hiring comes at the expense of associate promotions from within. Homegrown talent is losing the equity partner race to outsiders.

In a similar attempt to spin another current trend as beneficial to young lawyers, some managing partners assert that lower equity partner compensation levels lower the bar for admission, making equity status easier to attain. Someone under consideration for promotion can more persuasively make the business case (i.e., that potential partner’s client billings) required for equity participation.

Such sophistry assumes that an economic test makes any sense for most young partners in today’s big firms. In fact, it never did. But now the prevailing model incentivizes senior partners to hoard billings, preserve their own positions, and build client silos — just in case they someday find themselves searching for a better deal elsewhere in the overheated lateral market.

Finally, senior leaders urge that current growth strategies will better position their firms for the future. Such appealing rhetoric is difficult to reconcile with many partners’ contradictory behavior: guarding client silos, pulling up the equity partner ladder, reducing entry level partner compensation, and making it increasingly difficult for home-grown talent ever to reach the rarified profit participation levels of today’s managing partners.

Broader implications of short-term greed

In his latest book, Tomorrow’s Lawyers, Richard Susskind wrote that most law firm leaders he meets “have only a few years left to serve and hope they can hold out until retirement… Operating as managers rather than leaders, they are more focused on short-term profitability than long-term strategic health.”

Viewed through that lens, the annual Am Law 100 rankings make greed respectable while masking insidious internal equity partner compensation gaps that benefit a relatively few. Annual increases in average partner profits imply the presence of sound leadership and a firm’s financial success. But an undisclosed metric — growing internal inequality — may actually portend failure.

Don’t take my word for it. Ask lawyers from what was once Dewey & LeBoeuf and a host of other recent fatalities. Their average partner profits looked pretty good — all the way to the end.

UGLINESS INSIDE THE AM LAW 100 — PART I

Every spring, the eyes of big firm attorneys everywhere turn to the American Lawyer rankings — the Am Law 100 — and the contest surrounding its key metric: average profits per equity partner (PPP). But if the goal is to obtain meaningful insight into a firm’s culture, financial strength or profitability for most of its partners, those focusing on PPP are looking at the wrong ball.

Start with the basics

For years, firms have been increasing their PPP by reducing the number of equity partners. American Lawyer reports that cutbacks in equity partners, when done correctly, are “a solid management technique, not financial chicanery.” But as firms are now executing the strategy, it looks more like throwing furniture into the fireplace to keep the equity house warm.

Since 1985, the average leverage ratio (of all attorneys to equity partners) for the Am Law 50 has doubled from 1.76 to more than 3.5. It’s now twice as difficult to become an equity partner as it was when today’s senior partners entered that club. Between 1999 and 2009, the ranks of Am Law 100 non-equity partners grew threefold; the number of equity partners increased by less than one-third.

Arithmetic did the rest: average partner profits for the Am Law 50 soared from $300,000 in 1985 ($650,000 in today’s dollars) to more than $1.7 million in 2012.

The beat goes on

Perhaps it’s not financial chicanery, but many firms admit that they’re still turning the screws on equity partner head count as a way to increase PPP. According to the American Lawyer’s most recent Law Firm Leaders’ Survey, 45 percent of respondent firms de-equitized partners in 2012 and 46 percent planned to do so in 2013.

But even when year-to-year equity headcount remains flat, as it did this year, that nominal result masks a destabilizing trend: the growing concentration of income and power at the top. In fact, it is undermining the very validity of the PPP metric itself.

An unpublished metric more important than PPP

The internal top-to-bottom spread within the equity ranks of most firms doesn’t appear in the Am Law survey or anywhere else, but it should, along with the distribution of partners at various data points. As meaningful metrics, they’re far more important than PPP.

Even as overall leverage ratios have increased dramatically, the internal gap within equity partnerships has skyrocketed. A few firms adhere to lock-step equity partner compensation within a narrow overall range (3-to-1 or 4-to-1). But most have adopted higher spreads. In its 2012 financial statement, K&L Gates disclosed an 8-to-1 gap — up from 6-to-1 in 2011. Dewey & LeBoeuf’s range exceeded 20-to-1.

This growing internal gap undermines the informational value of PPP. In any statistical analysis, an average is meaningful if the underlying sample is distributed normally (i.e., along a bell-shaped curve where the average is the peak). But the distribution of incomes within most big firm equity partnerships bears no resemblance to such a curve.

Cultural consequences

Rules governing statistical validity have real world implications. Growing internal income spreads render even nominally stable equity partner head counts misleading. Lower minimum profit participation levels make room for more equity partner bodies, but what results over time is Dewey & LeBoeuf’s “barbell” system. A handful of rainmakers dominates one side of the barbell; many more so-called service partners populate the other — and they rarely advance very far.

As Edwin B. Reeser and Patrick J. McKenna wrote last year, in Am Law 200 firms, “Typically, two-thirds of the equity partners earn less, and some perhaps only half, of the average PPP.” Statisticians know that for such a skewed distribution, the arithmetic average conveys little that is useful about the underlying population from which it is drawn.

Why it matters

For firms that don’t have lock-step partner compensation, the PPP metric doesn’t reveal very much. For example, consider a firm with two partners and an 8-to-1 equity partner spread. If Partner A earns $4 million and Partner B earns $500,000, average PPP is $2.25 million — a number that doesn’t describe either partner’s situation or the stability of the firm itself. But the underlying details say quite a bit about the culture of that partnership.

Firms with the courage to do so would follow the lead of K&L Gates and disclose what that firm calls its “compression ratio” and then take it a step farther: reveal their internal income distributions as well. But such revelations might lead to uncomfortable conversations about why, especially during the last decade, managing partners have engineered explosive increases in internal equity partner income gaps.

A future post will consider that topic. It’s not pretty.

BIG LAW’S 2012 PERFORMANCE — NUMBERS AND NUANCE

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.

BANKRUPTCY AND BILLABLES

Let’s replace a recent Am Law Daily headline — “Judge Slashes Fees in Dewey Bankruptcy” — with this: “Golden Age for Bankruptcy Professionals Continues.”

In bankruptcy proceedings, lawyers get paid ahead of everyone else. If they didn’t, insolvent debtors would go without representation. But that doesn’t explain why high-profile bankruptcies have become increasingly lucrative for lawyers. An absence of accountability does.

Professional compensation in bankruptcy matters comes from a dying entity’s estate. As the client disappears, so does close scrutiny of its legal bills. In its place, the United States Trustee reviews bankruptcy fee petitions, as does the supervising judge who eventually approves them. But both offices have limited capabilities and a restrictive mandate.

Low-hanging fruit

The limited capabilities arise from an understandable reluctance to second-guess lawyers’ strategies and, more importantly, the deployment of manpower to execute them. As a result, post-facto review of fee petitions usually focuses on obvious abuses.

For example, at the recent Dewey & LeBoeuf fee hearing, Judge Martin Glenn criticized $550 per night stays at the Waldorf-Astoria, private car expenses for driving around Manhattan, and excessively vague time entries. But the sanctions were minimal. According to the article, the court reduced a restructuring expert’s $250,000 request by “$4,455 in fees and $9,175 in expenses in addition to the amount Glenn axed [$4,400] during the hearing.”

Dewey’s lead bankruptcy attorney, Al Togut, wasn’t in court for a tongue-lashing over certain of his firm’s “excessively vague time entries” and “a page of expenses related to car rides,” according to the Am Law Daily. But at the end of the day, Togut, Segal & Segal’s $4.7 million bill for five months of work emerged largely unscathed, save for “$57,139 in fee cuts and $1,378 in expense cuts after consultation with the U.S. Trustee’s office, which had objections to several of the fee requests.”

The real money

The real story isn’t unique to Dewey’s professionals. In fact, small boutique firms such as Togut’s probably conduct their cases more efficiently than big firms that can throw armies of bodies at any problem. But all such attorneys benefit from extraordinarily high hourly rates that result from the absence of a competitive market and the perverse incentives of a billable hour regime.

That’s where the restrictive legal standard for approval enters the picture. In particular, the fees sought must be reasonable for the services rendered. However, law firms in the select club of prominent bankruptcy practitioners use publicly available information, including other firms’ fee petitions, to set hourly rates for their own personnel. Voila! The relative uniformity of such rates makes them “reasonable” — including the $700 an hour associate and the $300 an hour legal assistant.

The key players in this tautological circle don’t compete on hourly rates. What economists call conscious parallelism is far more lucrative for them. Because there’s no paying client searching for better value in response to rising legal costs, that potential market-driven constraint disappears. When Weil Gotshal submitted a $430 million fee petition for the Lehman bankruptcy, it listed 40 partners with hourly rates of $1,000 and some senior associates at $800 to $900 an hour.

The market gone awry

Defenders argue that complicated restructuring matters require talent and skill comparable to trying a big case or guiding a large transaction. After all, in 1978 Congress specifically made that determination in adopting a new compensation standard for bankruptcy lawyers. Today, they say, the market sets everybody’s rates. That position would be more compelling if hourly rates for bankruptcy attorneys were the result of a well-functioning market, but they aren’t.

If big law firms already competed on price in bankruptcy cases, they wouldn’t fear the transparency that the U.S. Trustee proposed last summer. The Trustee wanted firms to disclose whether they use a differential fee schedule — charging one rate for attorneys working on bankruptcy cases and a lower rate for the same attorneys working on other matters. More than 100 big firms united in strenuous opposition to that idea.

It’s easy to see why they objected. Especially in recent years, paying clients have demanded discounts and alternative fee arrangements to reduce legal costs. In bankruptcy, it’s not happening. Where else can firms charge more than $400 an hour for first-year associates, which Weil Gotshal sought for many such newbies in the Lehman case?

Add incentives for inefficiency and abuse that accompany the billable hour regime generally and the consequences become even more ironic: one of the most lucrative pockets of the profession reaps outsized rewards from the carcasses of distressed enterprises (and those enterprises’ creditors).

The entire system is uniquely vulnerable to creative innovation. Someday, it will arrive. But then again, for those currently reaping the greatest rewards, someday always seems to be somebody else’s problem.

THE BIG LAW FIRM STORY OF 2012: DEWEY & LEBOEUF

Question #14.A. in the Wall Street Journal’s year-end quiz on December 28, 2012:

“True or False:

Before law firm Dewey & LeBoeuf LLP filed for bankruptcy in May, it was sued by a janitorial services company saying it was owed $299,000.”

Answer: True.”

This small item brought to mind reports of a January 2012 meeting where Dewey & LeBoeuf’s former chairman Steven H. Davis is said to have described the firm’s financial condition: profits in 2011 of $250 million, but more than half was already committed to pension obligations and IOUs to partners for shortfalls in prior years’ earnings. Together, partners would have to devise an action plan. “You have to own this problem,” he allegedly told them.

Who owns the problem now?

One simplistic narrative suggests that Davis himself should bear most of the blame for everything that went wrong with the firm. But in Dewey docket filing #654, his attorneys recently cautioned against such a rush to judgment.

For example, they assert that during the 12-month period immediately preceding the firm’s bankruptcy filing, “fifty-one partners received a higher distribution than Mr. Davis,” who, the say, got $1 million. Is that the behavior of a self-aggrandizing villain?

No names, please

The firm’s July 26, 2012 “Statement of Financial Affairs” (docket filing #294) identifies Dewey partners only by employee number, but it offers a window into some of those 51 highly paid partners. The dollars that some received as the firm imploded contrast sharply with Davis’s January admonition that they should “own the problem.”

For example, Dewey partner 06780 received more than $6 million in draws and distributions between May 31, 2011 and May 21, 2012. Starting in January 2012 alone, that partner received the following:

1/3/12:     $391,667,67 – Partner Distribution

1/3/12:       $25,000.00 – Partner Draw

1/11/12:    $250,000.00 – Partner Distribution

2/3/12:       $25,000.00 – Partner Draw

3/1/12:        $25,000.00 – Partner Draw

3/14/12:     $391,666.67 – Partner Distribution

4/4/12:       $264,166.67 – Partner Distribution

4/4/12:         $25,000.00 – Partner Draw

5/21/12:      $264,166.67 – Partner Distribution

5/21/12:       $25,000.00 – Partner Draw

The May 21 payments totaling $289,000 occurred shortly after the firm’s cleaning service had filed its complaint seeking approximately that amount for services rendered through April 30. A week later, Dewey filed for bankruptcy.

Dewey Partner 06512 received distributions of $2.8 million in January 2012 alone, accounting for a big chunk of the more than $6.5 million in draws and distributions that this partner received between May 31, 2011 and May 21, 2012.

Dewey Partner 86059 received $3.4 million in draws and distributions from May 30, 2011 to May 8, 2012, including more than $1 million after January 30, 2012.

Overall, 25 top Dewey partners received $21 million during the final five months of the firm’s existence. During the last seven months of 2011, the same group of 25 had already received another $49 million.

Stated another way, of the $234 million distributed to all partners during the 12 months preceding the firm’s bankruptcy, the top 25 (out of 300) received more than $70 million. Someday, we might learn how much this select group also received from the proceeds of the firm’s $150 million bond offering in April 2010.

Fungible money

Complementing the “Davis-as-sole-villain” narrative, another current theme is that the recently approved partner compensation plan proves that former partners are, in fact, “owning the problem.” That may be true for most of the more than 400 who will return a combined $71 million to the Dewey estate. But consider another set of facts.

Back in May, former Dewey partner Martin Bienenstock had just resigned from the firm when he gave a wide-ranging interview to the Wall Street JournalReporters Jennifer Smith and Ashby Jones asked him whether “it was safe to say that the firm used credit lines to pay partners, at least in part.”

Bienenstock answered: “Look, money is fungible. The $250 million in profits [for 2011] were real profits. Instead of using it to pay partners, a lot of it went to pay other things, like capital that other partners were due, and pension payments to retired LeBoeuf lawyers.”

In the same interview, Bienenstock said that at the end of December 2011 the firm had drawn down $30 million of its $100 million revolving bank credit line. As the firm disintegrated during the first five months of 2012, it tapped another $45 million.

You may be wondering whether any former Dewey partner’s contribution under the recently approved “clawback” plan may be, at least in part, simply returning money that the firm borrowed and then distributed to that partner as the firm collapsed. Perhaps one answer is Bienenstock’s retort that “money is fungible.”

Collateral damage

Another answer is that any time a bankrupt’s liabilities exceed its assets, the shortfall comes from somebody. Those victims wind up “owning the problem,” too. In addition to partners who lost their capital and didn’t receive a fair share of distributions in 2011 and 2012, unsecured creditors became involuntary lenders who will never be repaid in full.

Which takes us back to Dewey’s cleaning service. Even with their outstanding April invoice of $299,000, ABM Janitorial Services apparently kept working into May. According to Dewey’s July 26, 2012 “Schedule of Creditors Holding Unsecured Nonpriority Claims,” ABM’s claim had grown to $346,000 by May 28.

How much will ABM  recover? Dewey & LeBoeuf’s December 31, 2012 “Amended Confirmation Plan Disclosure Statement” predicts that general unsecured debtors will get between a nickel and 15 cents on the dollar.

The saga of Dewey & LeBoeuf isn’t over, but it’s the big law firm story of the year. And it’s a sad one.

A BIG LAW FIRM THREE-WAY

With Hurricane Sandy and the election dominating last week’s headlines, news of another blockbuster merger didn’t receive the attention that it deserved. Later this month, the combination of SNR Denton, the Canadian firm (Fraser, Milner & Casgrain – FMC), and Paris-based Salans will create a 2,500-attorney enterprise known as Dentons, assuming their respective partners approve the merger. The transaction merits a closer look.

Not so long ago

Twenty years ago, Elliott Portnoy graduated from Harvard Law School. In 2002, he joined Sonnenschein, Nath & Rosenthal. Prior to that, he’d headed the public policy group of Arent Fox, an Am Law 200 firm, in Washington, D.C.

In June 2006, at age 40, Portnoy became the youngest chairman in Sonnenschein’s history. At the same time, the firm released a new strategic plan whereby it would increase average equity partner profits from $800,000 to $1.4 million by 2008. That didn’t happen.

In 2007, Sonnenschein had 600 lawyers and average partner profits of $915,000, but since then it hasn’t seen profits numbers that high. Central components of its strategy have been the aggressive recruitment of lateral partners and the pruning away of others. In early 2008, 37 lawyers and 87 non-attorney employees received their walking papers. By year-end, average partner profits had dropped to $805,000. Of course, the onset of the Great Recession contributed to that decline, but many other firms weathered the storm with much less damage.

Time to merge

The 2008 drop in average partner profits didn’t seem to affect Sonnenschein’s strategic plan. Aggressive lateral hiring continued, including 100 lawyers from failing Thacher, Proffitt & Wood in December 2008. Average partner profits kept dropping — to $780,000 in 2009. The following year, 2010, brought the ultimate lateral hiring event: Sonnenschein’s merger with U.K.-based Denton, Wilde & Sapte to create a 1,200-lawyer firm.

As a Swiss verein, the two firms retained their independent financial status. But according to the Am Law Global 100, SNR Denton’s first full year as a combined entity produced overall average partner profits of $700,000 in 2011. The former Sonnenschein side of the firm reported $880,000 in average partner profits, so Portnoy heralded the merger a success and “not a destination, but a part of the journey.”

The journey continues

In 2011, SNR Denton was one of several firms exploring merger possibilities with Dewey & LeBoeuf as it careened toward disaster. According to the Wall Street Journal, Sonnenschein’s leadership had named its proposed deal “A Phoenix Rises from the Ashes” and contemplated a full-scale merger that combined all 1,000 Dewey & LeBoeuf attorneys with SNR Denton. Borrowed money would have financed the transaction — a tactic apparently drawn from the big law firm “lessons not learned” list.

Unexpected bad news may have saved SNR Denton from itself. According to the Journal, the deal was gaining momentum when it cratered after Dewey’s revelation that Manhattan district attorney Cyrus Vance, Jr. had opened a criminal investigation into Dewey.

Doubling down on a dubious approach

The journey has now led to the proposed combination of SNR Denton, FMC, and Salans. If consummated, the merger would double the size of the current SNR Denton. If the transaction goes through, what results won’t be a partnership. Whether it would become a profitable business venture for the participants is an open question.

To help answer that question, SNR Denton’s management got limited outside help. According to Portnoy and SNR Denton’s global chairman Joseph Andrew, “branding and advertising advisers” recommended a single-name moniker, Dentons. (Do they know that Dr. Dentons are children’s pajamas with feet?) But Andrew also noted that the firm used no strategic legal consultants or advisers in its process.

I don’t know if the other firms had advisers. Nor do I know if Salans had advisers in 1998, when it blazed a trail by becoming the first major law firm to complete a transatlantic merger, acquiring Christy & Viener. But that transaction didn’t turn out very well.

Maybe this time will be different. For the sake of many fine lawyers and even greater numbers of staff who are relying on management to chart a wise course for three law firms, let’s hope so. Among the most important lessons of Dewey & LeBoeuf are these: the margin for leadership error is slim and the consequences of missteps can be catastrophic.

IS IT REALLY MORE COMPLEX THAN GREED?

Revisionism is already obfuscating the story of Dewey & LeBoeuf’s demise. If facts get lost, the profession’s leaders will learn precious little from an important tragedy.

For example, the day after Dewey & LeBoeuf filed its bankruptcy petition, Clifford Winston and Robert W. Crandall, two non-lawyer fellows at the Brookings Institution, wrote an op-ed piece for The Wall Street Journal offering this analysis: “Dewey’s collapse has been attributed to the firm being highly leveraged and unable to attract investment from businesses outside the legal profession.”

Attributed by whom? They don’t say. Anyone paying attention knows that outside investors bought $150 million in Dewey bonds. But apparently for commentators whose agenda includes proving that overregulation is the cause of everyone’s problems — including the legal profession’s — there’s no reason to let facts get in the way.

Another miss

On the same day that the Winston & Crandall article appeared, a less egregious but equally mistaken assessment came from Indiana University Maurer School of Law Professor William Henderson in the Am Law Daily: “More Complex than Greed.” Bill and I agree on many things. I consider him a friend and an important voice in a troubled profession. But I think his analysis of Dewey & LeBoeuf’s failure misses the mark.

Henderson suggests, “One storyline that will attract many followers is that large law firm lawyers, long viewed as the profession’s elite class, have lost their way, betraying their professional ideals in the pursuit of money and glory. This narrative reinforces that lawyer-joke mentality that lawyers just need to become better people. That narrative is wrong.”

What’s wrong with it? In my view, not much, as “House of Cards” in the July/August issue of The American Lawyer now makes painfully clear.

What happened?

Rather than the greed that pervades “House of Cards,” Henderson suggests that Dewey & LeBoeuf reveals the failure of law firms to innovate in response to growing threats from new business models, such as Axiom and Novus Law. Innovation is an important issue and Henderson is right to push it. But as the story of Dewey’s failure unfolds, the inability to innovate in the ways that Henderson suggests — using technology and cheaper labor to achieve efficiencies and cost savings — won’t emerge as the leading culprit.

Rather, greed and the betrayal of professional ideals lie at the heart of what is destabilizing many big law firms. In that respect, most current leaders have changed the model from what it was 25 years ago. Am Law 100 firms’ average partner profits soared from $325,000 in 1987 to $1.4 million in 2011. Behind that stunning increase are leadership choices, some of which eroded partnership values. As a result, many big firms have become more fragile. If greed doesn’t explain the following pervasive trends, what does?

— Short-term metrics — billings, billlable hours, leverage — drive partner compensation decisions in most big firms. Values that can’t be measured — collegiality, community, sense of shared purpose — get ignored. When a K-1 becomes the glue that holds partnerships together, disintegration comes rapidly with a financial setback.

— Yawning gaps in the highest-to-lowest equity partner compensation. Twenty-five years ago at non-lockstep firms, the typical spread was 4-to-1 or 5-to-1; now it often exceeds 10-to-1 and is growing. That happens because people at the top decide that “more” is better (for them). Among other things, the concomitant loss of the equity partner “middle class” reduces the accountability of senior leaders.

— Leverage has more than doubled since 1985 and the ranks of non-equity partners have swelled. That happens when people in charge pull up the ladder.

— Lateral hiring and merger frenzy is rampant. One reason is that many law firm leaders have decided that bigger is better. The fact that “everybody else is doing it” reinforces errant behavior. Growth also allows managers to rationalize their bigger paychecks on the grounds that they’re presiding over larger institutions.

Throughout it all, associate satisfaction languishes at historic lows. No one surveys partners systematically, but plenty of them are unhappy, too. Unfortunately, such metrics that don’t connect directly to the short-term bottom line often get ignored.

Innovation won’t solve the problem

A few successful, stable law firms have shunned the now prevailing big law model. They innovate as needed, but far more important has been their ability to create a culture in which some short-term profit gives way to the profession’s long-term values. What is now missing from most big law firms was once pervasive: a long-run institutional vision and the willingness to implement it. Too often, greed gets in the way.

With all due respect to Messrs. Winston, Crandall and Henderson, sometimes the simplest explanation may also be the correct one.

DEWEY’S RICHARD SHUTRAN — RUNNING THE NUMBERS

This is the fourth of a five-part series profiling Dewey & LeBoeuf’s former leaders. Richard Shutran (Trinity College, B.A., 1974; New York University, J.D., 1978) joined Dewey Ballantine in 1986 and rose to co-chair of the firm’s Corporate Department and Chairman of its Global Finance Practice Group. He left his position on Dewey’s Executive Committee in 2010, but in 2012 became a member of the four-man office of the chairman tasked to save the firm.

The Dewey & LeBoeuf website described Shutran’s transactional practice as “counseling…with respect to leveraged finance and project finance matters, mergers and acquisitions, and restructurings and reorganizations….” That makes him a numbers guy, someone especially well-suited to the challenges facing his firm when it asked him to return to leadership as one of the Gang of Four.

The 2010 bond issuance

Dewey’s 2010 private placement memorandum included Shutran’s biography in its “Senior Management” section. At the time, Bloomberg news reported on the $125 million bond offering for which Shutran said that the bonds’ interest rates were more favorable than the firm’s bank loans. That was true.

As partners were checking out two years later, the Daily Journal reported that Dewey was renegotiating those bank loans: “Richard Shutran, co-chair of Dewey’s corporate department, described the negotiations as standard.” At that point, perhaps they were.

Another “bond” issuance

Meanwhile, the firm was pursuing what fellow Gang of Four member Martin Bienenstock described as “a plan to deal with the shortage of payments to some partners.” In particular, those with guaranteed compensation deals had taken IOUs during earlier years when profits had fallen short of targets. The “plan” was to dedicate six percent of the firm’s income for six or seven years to pay them off, starting in 2014.

In addition to ongoing bank debt, the first wave of 2010 bond payments came due in 2013 and would continue through 2023. Now another debt repayment plan — to a special class of so-called partners — would take another chunk of future partnership earnings from 2014 to 2020.

Funny numbers

At about the same time, Shutran moved to the center of another controversy – also not of his making – relating to his firm’s financial health. He assured a Bloomberg reporter that the departure of Dewey’s elite insurance group “had no impact on our firm’s profitability. That group was break-even at best.” But he also said the firm had earned about $250 million in profits for 2011. The American Lawyer didn’t think that number jibed with what Dewey had provided for the magazine’s annual rankings.

On March 21, 2012, The Wall Street Journal reported The American Lawyer’s retroactive revisions to Dewey & LeBeouf revenue and profits numbers for 2010 and 2011 — by a lot. For example, Dewey’s 2011 average partner profits dropped from $1.8 million to $1.04 million. Shutran suggested methodological differences were to blame:

“‘They’re just not comparable numbers,’ Mr. Shutran said. ‘That’s something people like to pick on.’ Robin Sparkman, the editor-in-chief of the American Lawyer, said Dewey & LeBoeuf’s numbers were given to them by the firm’s management.”

About that bank loan

On April 11, 2012, Dewey identified seven key players essential to the firm’s survival. Shutran wasn’t among them, but he responded to questions about whether the wave of partner defections had triggered bank loan covenants: “It has not had any effect under (the) agreements,” he said. There’s no reason to doubt him.

But the real problem by then wasn’t the bank loans. It was the accumulated amounts owed for annual distributions to partners in excess of the firm’s net income. As Bruce MacEwen’s analysis suggests, whether it’s called mortgaging the future or something worse, the result is the same.

Something went terribly awry at Dewey & LeBoeuf, but here’s the scary part: among big law firms, some of the things that created Dewey’s predicament aren’t unique.

DEWEY’S MARTIN BIENENSTOCK: PARTNERSHIP, PROFESSIONALISM AND WHAT TO TELL THE KIDS

This is the second in a series profiling Dewey & LeBoeuf’s former leaders. Martin Bienenstock (University of Pennsylvania, B.S., Wharton School, 1974; University of Michigan, J.D., 1977) was heralded as “one of the most innovative, creative restructuring attorneys in the country” when the Dewey & LeBoeuf spin machine put him at the center of an April 21, 2012 article in The New York TimesHe seemed to be the perfect candidate to save his firm.

One item that probably impressed NY Times’ readers was his presence on the Harvard Law School faculty. That credential showed up on the firm’s Private Placement Memorandum for its 2010 bond offering, too. According to the school’s website, he taught the Corporate Reorganization course during the spring term 2012.
Apart from imparting substantive knowledge, he — like any educator — is also a role model for students. In that respect, what have future attorneys been learning from Bienenstock?

What does partnership mean?

Every law student learns the basic concepts: partners owe each other fiduciary duties; they share risk, gains and losses; they’re accountable to all other partners. But theoretical partnership principles played out much differently in Bienenstock’s firm after he joined Dewey & LeBoeuf and its Executive Committee in November 2007.

—  Multi-year compensation guarantees went to some partners, including Bienenstock, but their pay didn’t depend on performance. Some partners say they were unaware of the scope and magnitude of such deals until an October 2011 partner meeting.

—  Partner income spreads reportedly grew to more than twenty-to-one. In “Spread Too Thin,” Patrick McKenna and Edwin Reeser describe the destabilizing effects of that ubiquitous big law trend.

—  A 2010 bond issuance obligated future partners to payments of at least $125 million, starting in 2013 and continuing to 2023.

—  Top partners, including Bienenstock, thought they were making great sacrifices when the firm missed its income targets in 2011: they “capped” themselves at $2.5 million and took firm IOU’s to make up annual shortfalls from their guaranteed amounts. Continuing strategies that mortgaged the future, Dewey & LeBoeuf planned to dedicate six percent of its income from 2014 to 2020 to repay those IOUs.

—  Questions have surfaced about the accuracy and sufficiency of the firm’s financial disclosures to fellow partners and third parties.

What does professionalism mean?

After Steven H. Davis left his management position, the Dewey & LeBoeuf spin machine put Bienenstock center stage as the go-to person who could work a miracle. Maybe it would be a “prepack” – a prepackaged bankruptcy that would allow the firm to shed some debts and become more attractive to a merger partner.

Maybe it would be a traditional merger.

Maybe, maybe, maybe.

One thing Bienenstock made clear throughout: “There are no plans to file bankruptcy. And anyone who says differently doesn’t know what they’re talking about.”

Ten days later, he and members of his bankruptcy group were on their way to Proskauer Rose.

Parsing Bienenstock’s statement about a bankruptcy filing is akin to dissecting President Clinton’s response to questions about his sexual encounters with a White House intern: “It depends on what the meaning of is, is.”

What does leadership mean?

Did Beinenstock have an actual plan for the firm’s survival or did chaos better serve the economic interests of a few top partners? Was he personally committed for the long haul or arranging his own exit? Was anyone really in charge?

Those questions went unanswered as speculation and uncertainty swamped the firm: One-third of the firm’s partners gone by the end of April? A memo invites others to build their own lifeboats, but attorneys and staff should keep working diligently for clients? Use personal credit cards for client copying charges? No mailroom? No IT? Why do senior partners keep asking for empty packing boxes?

Leadership is needed most in times of crisis. As Dewey & LeBoeuf’s Office of the Chairman went from four to three to two to one to none, leadership was nowhere to be found.

Accepting responsibility

When asked who or what was to blame for Dewey’s demise, Bienenstock demurred: “[N]o one saw the new world coming.”

Except plenty of other people did.

Were any of the summer or permanent associates whom Dewey stiffed Bienenstock’s former students at Harvard? If so, their real life experiences of the past three months taught them more about partnership, professionalism and leadership in some big firms than Bienenstock or anyone else could have communicated in years of classes. The question now is whether Bienenstock will be on Harvard’s faculty list next year.

DEWEY’S MORTON PIERCE: ACCEPTING RESPONSIBILITY

This is the first in a series profiling Dewey & LeBoeuf’s former leaders. Morton Pierce (Yale University, B.A., 1970; University of Pennsylvania, J.D., 1974) is an appropriate place to begin because on May 3, 2012, he told The Wall Street Journal that he hadn’t been actively involved in Dewey’s management for years and had stepped down from the firm’s Executive Committee in 2010.

Pierce is widely acclaimed as one of the country’s top mergers and acquisitions attorneys. He was chairman of Dewey Ballantine when its attempt to merge with Orrick, Herrington & Sutcliffe failed in 2007.

A partnership within a partnership

Pierce was a principal architect of Dewey Ballantine’s merger with LeBoeuf Lamb. Based on Bruce MacEwen’s analysis of the financial data, Dewey got the better end of that deal. As for Pierce himself, The Wall Street Journal reports that he “had negotiated a pay package that guaranteed him $6 million a year for six years, according to a person with direct knowledge of the arrangement.” The subject of my next post, Martin Bienenstock, said that there were many such deals to lock up talent for at least four years after the merger.

Early in 2010 — the year Pierce says he left the firm’s Executive Committee — Dewey mortgaged its future with a $125 million bond offering (repayment due from 2013 to 2023). In 2011, the sixty-two-year-old Pierce negotiated a new deal for himself. The Journal continues: “[H]e secured a new, eight-year contract that would pay him $8 million for several years and wind down to $6 million in later years, that person said.”

Dewey’s next gambit: IOUs to the oxymoronic group — guaranteed compensation partners — when the firm didn’t earn enough current income to pay them in full. Committing future profits to make up for prior periods of missed earnings is, at best, a dubious strategy. At worst, it transforms a partnership into something that looks like a Ponzi scheme. It’s difficult to envision an attorney recommending the idea to a client.

A firm leader?

Pierce’s effort to distance himself from management is interesting. He’s featured prominently as part of the firm’s “Executive Office” in the 2010 Private Placement Memorandum for its bonds. Two years later, an April 11 2012 article identified Pierce as “one of seven key lawyers” who determined Dewey’s fate.

Until the day he left in May 2012, the firm’s website still introduced his biographical page as follows:  “Morton Pierce is a Vice Chair of Dewey & LeBoeuf and co-chair of the Mergers and Acquisitions Practice Group. He is also a member of the firm’s global Executive Committee.”

Not my job

From a self-proclaimed distance, Pierce described Dewey’s leaders in the third person. When asked about an April 2012 meeting at which senior partners supposedly recommitted themselves to the firm and its survival, Pierce’s only comment was: “There was a meeting and I was there.”

Three weeks later, he told the Journal, “I think the executive committee did the best job that they could under the circumstances.” That article continued, “Mr. Pierce didn’t assign blame for the firm’s current situation.”

Pierce told the NY Times, “I am sorry about what happened”  — as if some external event or rogue actor was responsible.

The nature of leadership

Even so, Pierce kept his sense of gallows humor while packing up for White & Case. Describing how he’d like to merge all of the wonderful firms that had expressed interest in taking him as Dewey imploded, he told The Wall Street Journal on May 3: “Although looking at the Dewey & LeBoeuf merger, maybe mergers aren’t such a good idea.”

I suspect that most of the 2,000 Dewey lawyers and staffers who once worked at the firm don’t think Pierce has much of a future in comedy. He didn’t mention his other non-joke: that his resignation letter reportedly claimed that the firm owed him $61 million.

If the Dewey spin machine and website description were accurate, Pierce remained at the center of power until the moment he resigned from the firm. If, as he claims, he wasn’t involved in management after 2010, that’s worse. The notion that someone of Pierce’s professional stature would remain on the sidelines as his firm pursued misguided strategies and then would watch it spin into oblivion is stunning.

Senior partners in big firms often complain about young lawyers’ unwillingness to take responsibility for mistakes and their consequences. Perhaps some of the profession’s so-called leaders could set a better example.

DEWEY: PROFILES IN SOMETHING

Some key players in the Dewey & LeBoeuf debacle are also among the profession’s leaders; that makes them role models. Some teach at law schools; that means they’re shaping tomorrow’s attorneys, too. But how do they look and sound without the Dewey spin machine?

Some readers might worry that spotlighting them erodes civility. But civility goes to the nature of discourse; it can never mean turning a blind eye to terrible things that a few powerful people do to innocent victims. Sadly, the personalities and trends that unraveled Dewey aren’t unique to it.

As to former chairman Steven H. Davis, David Lat’s analysis at Above the Law and Peter Lattman’s report at the NY Times  are sufficient; there’s no reason to pile on. Rather, I’ll look at the “Gang of Four” plus one: the men comprising the four-man office of the chairman who replaced Davis as the firm came unglued, and Morton Pierce. Here’s a preview.

Morton Pierce was chairman of Dewey Ballantine when merger discussions with Orrick, Herrington & Sutcliffe failed and LeBoeuf, Lamb, Greene & McRae entered the picture. After spearheading the deal with Davis, Pierce locked in a multi-year $6 million annual contract that he reportedly enhanced in the fall of 2011. In his May 3 resignation later, he reportedly claimed that the firm owed him $61 million.

As he spoke with The Wall Street Journal while packing boxes for White & Case, Pierce said that he hadn’t been actively involved in firm management since 2010. But the Dewey & LeBoeuf website said otherwise: “Morton Pierce is a Vice Chair of Dewey & LeBoeuf and co-chair of the Mergers and Acquisitions Practice Group. He is also a member of the firm’s global Executive Committee.” [UPDATE: Two days after this May 15 post, Pierce’s page on the Dewey & LeBoeuf website finally disappeared. Such are the perils of losing an IT department too early in the unraveling process.] My post on Pierce will be titled “Accepting Responsibility.”

Martin Bienenstock, one of the Gang of Four, was an early big name hire for the newly formed Dewey & LeBoeuf. In November 2007, he left Weil, Gotshal & Manges after 30 years there. He got a guaranteed compensation deal and sat on the Executive Committee as his new firm careened toward disaster. As Dewey & LeBoeuf’s end neared, he maintained a consistent position throughout: “There are no plans to file bankruptcy. And anyone who says differently doesn’t know what they’re talking about.”

No one asked if he had a realistic plan for the firm’s survival. Ten days later, he and members of his bankruptcy group were on the way to Proskauer Rose. The title of my upcoming post on Pierce could work for Bienenstock, too. But because he teaches at Harvard Law School, I’m going to call it “Partnership, Professionalism, and What To Tell the Kids.”

Jeffrey Kessler, another of the Gang of Four, was also a lateral hire from Weil, Gotshal & Manges. He joined Dewey Ballantine in 2003. As a member of Dewey & LeBoeuf’s Executive Committee, he became a vocal proponent of the firm’s star system that gave top producers multi-year, multimillion-dollar contracts — one of which was his.

A sports law expert, Kessler analogized big-name attorneys to top athletes: “The value for the stars has gone up, while the value of service partners has gone down.” The title of my post on Kessler will be “Stars In Their Eyes.”

Richard Shutran, the third of the Gang of Four, was a Dewey Ballantine partner before the 2007 merger. He became co-chair of Dewey & LeBoeuf’s Corporate Department and Chairman of its Global Finance Practice Group. At the time of the firm’s $125 million bond offering in 2010, he told Bloomberg News that the bonds’ interest rates were more favorable than those from the firm’s bank. In March 2012, he said Dewey was in routine negotiations with lenders over its credit line. He also dismissed The American Lawyer’s retroactive revision of Dewey’s 2010 and 2011 financial performance numbers as much ado about nothing. My post on Shutran will be “Running the Numbers.”

L. Charles Landgraf, the last of the four, began his career at LeBoeuf Lamb 34 years ago. I don’t know him (or any of  the others), but my hunch is that Charley (as people call him) is a decent guy. My post on him will be called “The Plight of the Loyal Company Man.”

In future installments, we’ll take a closer look at each of them. Sometimes it won’t be pretty, but neither is what some of them personify about the profession’s evolution.

DEWEY: WHEN PARTNERS AREN’T REALLY PARTNERS

Lost in the haze of battle over Dewey & LeBoeuf’s struggle is a remark that former chairman Steven H. Davis made in his March 22 Fortune magazine interview. That was Dewey’s first public relations initiative after it began squandering money on a crisis management/public relations expert. But it offered this kernel of inadvertent insight:

“One fundamental change in the way the firm has operated since the merger is that they moved away from the traditional lockstep compensation approach — where partners are basically paid in terms of tenure — and toward a star system in which the top moneymakers can out-earn their colleagues by a ratio of up to 10-to-1. Davis says the extremes shouldn’t define the system, though, and that the more ‘normal’ band is about 6-to-1. Still, it must chafe to be the guy who’s earning the ‘1’ and knows it. Hard to see oneself as a ‘partner’ of the ‘6s,’ let alone the ’10s.'”

In The Wall Street Journal story that the Manhattan district attorney had opened an investigation into Davis, this sentence offered a poignant flashback to his March 22 interview:

“While some junior partners made as little as $300,000 a year, other partners were pulling down $6 million or $7 million, according to former and current partners.”

That’s a twenty-to-one spread within a so-called partnership. And some of the biggest winners had multi-year guaranteed compensation deals.

There’s an asterisk. According to The American Lawyer‘s definitions, Dewey & LeBoeuf has equity and non-equity partners. Everyone knows that with respect to the internal power dynamics of two-tier firms, management pays no attention to non-equity partners. But the real kicker is that most equity partners don’t have much influence with senior leaders, either.

The growing non-equity partner bubble

Start with the non-equity partners. In January 2000, predecessor firm Dewey Ballantine had 118 equity partners and 21 non-equity partners. At the time, its eventual merger partner, LeBoeuf Lamb, had a similar ratio: 187 equity partners and 33 non-equity partners. Between them, they had 305 equity partners and 54 non-equity partners.

As of January 1, 2012, Dewey & LeBoeuf had 190 equity partners (one-third fewer than the separate firms’ combined total in 2000) and 114 non-equity partners (twice as many as in 2000).

Many firms have adopted and expanded two-tier partnership structures. That has many unfortunate consequences for the firms that create a permanent sub-class of such individuals. But non-equity partners are profit centers and most big law leaders say that ever-increasing profits are necessary to attract and retain top talent.

The equity partner income gap

That leads to a second point. Whether it’s Davis’s earlier “10-to-1” spread, the more recently reported “20-to-1,” or something in between, the income gap within equity partnerships has exploded throughout big law. That’s destabilizing.

The gap results from and reinforces a failing a business model. In the relentless pursuit of high-profile lateral hires, law firms bid up the price. Many laterals never justify their outsized compensation packages; some become serial laterals moving from firm to firm.

Even when the subsequent economic contributions of hot prospects seem to validate their worth on paper, aggressive lateral hiring erodes partnership values. The prevailing business model has no metric for collegiality, a shared sense of purpose, or the willingness to weather tough times. How badly frayed have partnership bonds become when, as at Dewey, some partners ask a district attorney to prosecute the firm’s most recent chairman? That’s the definition of bottoming-out.

It’s easy to identify the ways that Dewey’s problems were unique, such as guaranteeing partner compensation and issuing bonds. Leaders of other firms could benefit from a different exercise: assessing how their own institutions are similar to what Dewey & LeBoeuf became after their 2007 merger. Growing partnership inequality is pervasive and its implications are profound.

Legal consultant Peter Zeughauser told The Wall Street Journal, “It’s not your mother’s legal industry anymore. It’s a tougher business.” Implicit in that observation lies a deeper truth: partnerships aren’t really partnerships anymore.

They’re businesses, only worse. Those at the top of most big law firms function with far greater independence than corporate CEOs who must answer to a board of directors and shareholders. In many big firms, a growing internal wealth gap reinforces the hubris of senior leaders who answer to no one — except each other. With Dewey’s disintegration, we’re seeing where that can lead.

SPINNING DEWEY’S HEROES

Dewey & LeBoeuf’s latest designated savior is Martin J. Bienenstock. The NY Times says that he faces “perhaps the most challenging assignment of his career: the restructuring of his own law firm.”

According to the Times, his challenges include bank negotiations to restructure Dewey’s outstanding loans, consideration of reorganization options, and avoiding liquidation. Given the complex array of fiduciary duties accompanying such a job description — as a partner to his fellow partners while also acting as counsel to the partnership as a whole without favoring any individual partner or group of partners — it’s a daunting task.

Last month’s star was Steven H. Davis, whose assurances during an interview for Fortune magazine produced an article titled “Dewey & LeBoeuf: Partner exodus is no big deal.” Right — Dewey started the year with 300 partners; 30 were gone by the time of Davis’s interview; 40 more have left since then. Among his least prescient remarks: “If the direction we’re taking the firm in was somehow disapproved of, then the reality is that there ought to be a change in management. But I don’t sense that.”

The more things change…

Less than a week later, a five-man executive committee replaced Davis. One member of the new “office of the chairman” is Bienenstock. It’s ironic because he exemplifies Dewey’s business strategies that may have worked well in his case, but less so in others’, namely, lateral hiring and compensation guarantees. Prior to joining Dewey & Leboeuf in November 2007 (a month after the merger creating it), he’d spent 30 years at Weil, Gotshal & Manges. While he sat on Dewey’s management committee that Davis chaired, his new firm became one of the top-10 in 2011 lateral partner hiring.

According to The Lawyer, Bienenstock was reportedly among those who recently agreed to cap personal earnings at $2.5 million. That’s a start, but the article also said that some partners’ deferred income took the form of promissory notes due in 2014. It’s interesting that a firm already on a $125 million hook for something that law firms rarely do — offering bonds that begin to come due in April 2013 — would add even more short-term debt to its balance sheet. Add it to the list of unexpected complications that accompany partnership compensation guarantees.

The real Dewey heroes

This rotating focus on a handful of lawyers at the top obfuscates the importance of everyone else. Rainmakers come and go — and their seven-figure incomes survive. Bienenstock is an example. So are the many former Dewey management committee members who have already left, including John Altorelli, whose parting words showed little compassion for his former partners, associates, paralegals and staff. Even top partners who managed firms that went bust seem to land on their feet. After Howrey failed, its former vice chairman, Henry Bunsow, got a reported multi-million guaranteed compensation deal at Dewey in January 2011. Welcome to the lateral partner bubble.

Lost in the headlines about the stars are the worker bees with limited options and real fears. An Above the Law post from a seasoned Dewey paralegal captures the angst:

“I know these facts do not necessarily make for sexy headlines but I do ask that you report on the following. While some laugh and play their lyre as the city of Rome burns, it will be well over one thousand staff members who will also be gainfully unemployed.”

Add the nearly one thousand Dewey lawyers who have been watching quietly at the unfolding public relations nightmare since Davis’s bizarre interview. As Dewey’s publicity machine pumps out celebrity saviors of the moment, each has drawn more unwanted attention to the firm’s plight than the last. Martin Bienenstock’s appearance in the Times along with the proffered “pre-packaged bankruptcy” option is the latest example.

If Dewey survives the current crisis, Bienenstock’s suddenly magical touch won’t be the reason. Rather, it will survive because an entire law firm —  partners, associates and staff — kept noses to the grindstone. The real heroes didn’t go looking for more media coverage of a troubled situation.

Perhaps Dewey’s leaders thought that better press could solve the firm’s crisis. But that approach reverses the relationship between public relations and crisis management, which is simple: manage a crisis properly and the resulting story will write itself.

Here’s the obvious corollary: manage the firm properly and there is no crisis to manage.

UNFORTUNATE (AND IRONIC) COMMENT AWARD

If Dewey & LeBeouf has so-called friends like its former partner John Altorelli…well, you know the rest.

Altorelli’s recent comments to Am Law Daily include so many candidates for my Unfortunate Comment Award that it’s difficult to choose just one. So let’s go with the most ironic. In discussing whether Dewey could have done a better job managing information — presumably referring to publicity about attorney layoffs, partner departures and financial results — Altorelli said:

“In most law firms, I think, as good as the lawyers are at advising clients, they’re not as good at taking their own advice. They are surprisingly obtuse when it comes to their own situation.”

He then proceeded to reveal himself as someone surprisingly obtuse about his own situation. Before listing those inadvertent revelations, consider how Altorelli himself embodies the lateral partner hiring phenomenon that has overtaken much of big law as a dominant business strategy.

The revolving lateral door

After  graduating from Cornell Law School in 1993, Altorelli made his way through four law firms in only fourteen years — LeBeouf, Lamb, Greene & MacRae, Paul Hastings, Reed Smith, and Dewey Ballantine (shortly after the collapse of Dewey’s merger talks with Orrick, Herrington & Sutcliffe and a few months before its October 2007 merger with his original firm, LeBeouf Lamb). Such a journey is not likely to produce deep institutional loyalties anywhere.

He’s not unique. For example, as I composed this post The Wall Street Journal reported that Brette Simon had left Jones Day to join Bryan Cave. Since graduating in 1994, she’s also worked at O’Melveney & Myers, Gibson, Dunn & Crutcher, and Sheppard, Mullin, Richter & Hampton.

Still, Altorelli’s book of business apparently qualified him for a place on Dewey & LeBeouf’s executive committee. He says former chairman Steven H. Davis will “take the axe” for whatever is going wrong now, but surely the firm’s executive committee wasn’t a collection of potted plants. It seems improbable that Davis alone could have forged and executed Dewey initiatives that issued bonds and used guaranteed multi-year compensation contracts to lure prominent lateral partners.

But now Altorelli says: “The only people who need contracts are those who are not so secure. I feel bad that firms have to go that way, in competition for laterals and the like.”

Not my fault

Then again, Altorelli also suggests that management hasn’t contributed to Dewey’s current problems. Rather, it was just “bad timing” of a long recession that didn’t allow the firm to burn off expenses associated with the Dewey-LeBeouf merger: “We kept thinking it’ll get better tomorrow, then it doesn’t get better. The next thing you know it’s been four years.”

Magical thinking rarely results in a winning strategic plan. Curiously, Altorelli also notes that during that same period while he was at the firm, he and Dewey prospered: “I had five of the best years of my career.”

As he headed for his fifth big firm in nineteen years, Altorelli offered several additional insights that qualify for stand alone Unfortunate Comment Awards, especially coming from one of the firm’s recent executive committee members who professes continuing hope for Dewey’s future:

— “I’m not sure how they can weather the departures.”

— “It doesn’t take a rocket scientist to say, I don’t know how many more they can suffer.”

— “[There] could be a survival path for a smaller Dewey. I don’t know how that would work. They seem to have a strategy. Or the firm will be busted up into a bunch of little pieces and survive in the hearts and souls of a lot of good people.”

Yet perhaps the unkindest cut of all came in contrasting his professional life at Dewey with things that will be better at DLA Piper, where he will serve on its executive committee:

“Altorelli says he was drawn to his new firm by the chance to help change the way he practices law. Altorelli…says the firm is experimenting with ways to ‘try to get back to more of an intellectual pursuit, rather than just grinding out the paper.'”

If Altorelli’s interview had appeared five days earlier, I would have looked for this concluding line: “April Fool!”

Just delete “April.”

DEWEY’S DILEMMA

Dewey & LeBoeuf has talented lawyers, great clients, and 2011 average equity partner profits exceeding $1.7 million. So what required a March 2 firmwide memo from Chairman Steven H. Davis in response to “press stories on U.S. legal blogs”? If the firm paid some media relations consultant to advise him on the missive, it should demand a refund.

Lessons about communicating

Davis says that he planned to outline cost-cutting and other measures when he “knew exactly how they would impact individual offices and departments, but given the press attention,” he advanced his timetable. There’s the first lesson to learn from his approach: When management makes decisions, it shouldn’t attribute the timing of announcements to outside media influences, even if they are a factor.

The second lesson is to avoid firmwide memoranda on sensitive issues. That’s not because transparency is bad (although sometimes less is more). Rather, it’s because difficult news should be communicated in a way that best serves the institution, its people, and its clients.

In the age of global mega-firms, it’s difficult to bring all personnel — or even all partners — together for a candid conversation about what’s happening and why. But there’s no better use for all of that fancy videoconferencing technology than promoting the right narrative, rallying the troops, and instructing partners to inform clients and staff directly about internal firm situations that generate press.

Mixed messages

The substance of the memo presents other issues. Davis starts with the “many successes last year” and “improved financial performance” in 2011 that continued during the first two months of 2012. The problem, he suggests, is a “significant increase in our cost base.” Taking “proactive steps to align the firm’s resources with anticipated demand,” he notes that “[s]ome recent departures have been consistent with the firm’s strategic planning for 2012, and we expect some additional partners to leave.”

That leads to a third lesson about these situations. If a firm is pushing some partners out, don’t make a big deal about it while also touting the firm’s improved financial performance. As they’re losing their jobs, let subpar performers who were once valued firm assets keep their dignity. In fact, public characterizations invite scrutiny. For example, attrition and pruning are one thing, but did the firm’s strategic plan really contemplate losing current and former practice group leaders?

Then comes the punch line: the firm will reduce another five percent of attorneys and six percent of staff. Perhaps, as Davis suggests, the firm does “very much regret the impact” on affected colleagues, but with average equity partner earnings well above the million dollar mark, describing layoffs of 50 to 60 lawyers as “necessary to ensure the firm’s competitiveness” seems disingenuous to most observers.

Misleading metric?

Underlying all of this could be the fact that a key firm metric — average equity partner profits — is misleading. Perhaps, like many big firm trends, the real story is the internal gap between the highest and lowest equity partners.

According to the February issue of The American Lawyer, “Davis says that the firm resisted making mass lateral hires for three years after it was created in October 2007 through the merger of Dewey Ballantine and LeBoeuf, Lamb, Greene & MacRae, choosing to focus on integration first. ‘Now, we’re moving into a new part of the cycle….'”

One new part of the cycle is lateral partner hiring, for which Dewey was among the top ten firms in 2011. Some of its newest partners were probably expensive, such as former chairs of their previous firms’ practice areas. In 2009, Davis said that the firm rewarded superior performance and denied giving compensation guarantees to rainmakers. If, as recent reports suggest, that policy changed, guarantees could present risks. When a lateral bubble pops, it can inflict significant collateral damage.

Even so, Dewey remains a great firm. On the strength of its ranking surge from 33 to 14 in the Midlevel Associate Satisfaction survey, together with its numerous awards for diversity and pro bono initatives, the firm made the 2011 Am Law “A-list.” That requires decent people creating a culture worth preserving. Hopefully, “moving to the new part of the cycle” hasn’t taken the firm in an errant direction — or, alternatively, any detour is temporary.