A DIRTY LITTLE SECRET

The Wall Street Journal’s front page headline tells only part of story: “Legal Fees Cross New Mark: $1500.” The February 9 article lists the range of partner hourly rates at some big firms: Proskauer Rose from $925 to $1475; Ropes & Gray from $895 to $1450; Kirkland & Ellis from $875 to $1445; and so on and so on and so on.

That’s great if you can get it, but most firms can’t. The 2016 Georgetown/Thomson Reuters Peer Monitor “State of the Legal Profession” tells a second part of the story: realization and collection rates have plummeted. How much a firm bills doesn’t matter; what it actually brings in the door does. In 2005, collections totaled 93 percent of standard rates. By the end of 2015, it was down to 83 percent.

The Music Stopped, Almost

Annual standard hourly rate increases have blunted the profit impact of declining collections, but trees stopped growing to the sky about ten years ago. Except in bankruptcy courts. That’s the third element of the story and the profession’s dirty little secret: one of the most lucrative big law practice areas has no client accountability for its fees. Even worse, the process facilitates pricing behavior that spills over into other practice areas.

Take the recent Journal article. Where did the reporters get the detailed hourly rates for the firms it identified? A note at the bottom of the chart reveals the answer: “Source: Bankruptcy court filings.” If managing partners exchanged their firms’ hourly rates privately, it would raise serious antitrust issues. But in bankruptcy, publicly filed fee petitions do all of that work for them.

It gets worse. In bankruptcy, no one forces attorneys into the discounting that produces the current 83 percent overall average collections rate. Remember the infamous “Churn that bill, baby” email involving DLA Piper a few years ago? That was a bankruptcy case. Traditional mechanisms of accountability are ineffective. Unlike a solvent corporate client, a company in trouble has little leverage in dealing with its outside counsel. Until it emerges from a Chapter 11 reorganization, the days of minimizing legal expenses to maximize shareholder value are suspended. If it winds up in Chapter 7 liquidation, those days are gone forever.

At the same, time, the lawyers handling the bankruptcy have little risk. They get paid ahead of everyone else. Lawyers for creditor committees are a theoretical check only. They, too, get paid first and the members of the exclusive club of big law firm attorneys reappear. Their roles may change — debtor’s counsel in one bankruptcy may be creditors’ attorney in another and the liquidating trustee’s lawyer in yet another. In none of those capacities is there any incentive to rock the long-term, “paid-in-full hourly rate” boat.

More Theoretical Accountability

The U.S. Trustee receives all attorneys’ fees petitions before courts approve them. The Trustee can object, but it doesn’t have sufficient resources to analyze detailed line item time and expense entries on the thousands of pages that firms submit. The Trustee issued new guidelines that became effective for cases filed after November 1, 2013. Perhaps they will make a difference. But in the end, they are still guidelines and the final decision on attorneys fees resides with the bankruptcy judge.

As hourly rates have increased to the $1500 level that the Journal highlights, courts have given their rubber stamps of approval to the trend. Rather than challenge the high rates that all firms charge, bankruptcy judges determine merely that they are “reasonable and customary” because, after all, comparable firms are charging them for comparable work. The circularity is as obvious as the resulting payday for the lawyers. Someday, media attention and popular outrage may force meaningful change that has yet to occur.

Worse Than It Seems

Considering the 83 percent collection rate in the context of the nearly 100 percent rate for bankruptcy lawyers yields an insight relevant to the fourth and final part of the larger big law firm story. In particular, the current 83 percent collection rate is deceptively high. If a firm’s average is 83 percent and its bankruptcy lawyers collect close to 100 percent, then firms with large bankruptcy practices have non-bankruptcy clients pushing some practice areas into deep concessions off standard rates.

Likewise, combining this fact with two conclusions from the Georgetown/Thomson Reuters Peer Monitor Report produces ominous implications for such firms:

— “Demand for law firm services…was essentially flat in 2015,” and

— Bankruptcy experienced the largest negative growth rate in demand by practice area.

Unless the country heads into a recession that few economists expect, the continuing reduction in bankruptcies will drive overall average collections dramatically lower. That’s bad news for big law firms with significant bankruptcy practices.

Back in 2011, an icon of the bankruptcy bar, the late Harvey Miller of Weil, Gotshal and Manges, defended his firm’s approach to legal fees: “The underlying principle is, if you can get it, get it.”

Miller isn’t around anymore, but his unfortunate credo for a noble profession survives — for now.

[NOTE: The trade paperback edition of my book, The Lawyer Bubble – A Profession in Crisis (Basic Books) — complete with an extensive new AFTERWORD — will be released on March 8, 2016 and is now available for pre-order at Amazon and Barnes & Noble.]

THE TRUE COST OF THE WEIL LAYOFFS

The Wall Street Journal describes the layoffs of 60 lawyers and 110 staff as “the starkest sign yet that the legal industry continues to struggle after the recession.” But who, exactly, is struggling?

Not the owners of the business. The overall average profits for equity partners in the Am Law 100 reached record levels in 2012. Even during the darkest days of the Great Recession in 2008, PPP for that group remained comfortably above $1.2 million before resuming the climb toward almost $1.5 million last year.

Not equity partners at Weil, Gotshal & Manges, who earned a reported average PPP of $2.2 million in 2012, according the the American Lawyer.

So Who Suffers?

One group of victims consists of 60 young people who had done everything right until everything went wrong for them on June 24. They’re intelligent, ambitious, and hard-working. Exemplary performance in high school earned them places in good colleges where they graduated at the top of their classes. They attended excellent law schools and excelled, even as the competition got tougher.

All of those accomplishments landed them great jobs. In the midst of a dismal legal job market, they went to work at one of the nation’s most prestigious law firms. Making more than $160,000 a year, many believed that soon they might throw off the yoke of six-figure student loan debt.

Now, they’re unemployed.

Another group of victims consists of 110 staffers who also got the boot. According to the NY Times, approximately half of them were secretaries. These behind-the-scenes workers often go unappreciated by lawyers who mistakenly take all of the credit for their own success.

A third group is a reported 10 percent of partners, many of whom who will suffer compensation cuts of “hundreds of thousands of dollars,” according to the NY Times.

“It’s All About the Future”

Announcing the layoffs, executive partner Barry Wolf described the move as “about the future of the firm and strategically positioning us for the next five years.” But layoffs aren’t about weeding out associates who don’t measure up to the rigorous quality standards necessary for equity partnerships. They’re about matching supply (of associates) with demand (for legal work) according to undisclosed criteria.

In fact, it seems a bit strange to talk about a firm positioning itself for the future while simultaneously dropping a morale bomb on its associates (and some partners) during the height of the summer program. The best and the brightest young prospects are working in big firms where luring that talent into the firms is a top priority. Bad public relations from a high-profile layoff can have a chilling effect that outlasts a single news cycle.

And what is that future going to look like? Will Weil be hiring any new associates over the next 12 months? Or 18 months? Or even 24 months? If so, I know 60 candidates with big firm experience (at Weil) who may be interested.

There is no shortage of current students who will continue to seek high-paying jobs at Weil, Gotshal & Manges. But what if negative publicity dissuades those few with the rare qualities necessary to become superstar partners from even signing up for on-campus interviews? By its very nature, such longer-run damage is impossible to know, much less measure.

Big Law’s Cheerleaders Applaud the Move

Law firm management consultants applauded Weil’s move. That’s not surprising because they have been central players in the profession’s transformation to just another business. They consistently endorse businesslike steps to maximize short-term profits. They expect other firms to follow Weil’s lead, and perhaps some will. Law firm consultant Peter Zeughauser said, “Weil is a bellwether firm and this will be a real wake up call.”

The etymology of bellwether may be relevant. In the mid-15th century, a bell was hung on a wether, a castrated ram that led a domesticated flock. In that way, the noise from the bellwether made it possible to hear the flock coming before anyone saw it.

In an informal Am Law survey, other firm leaders have distanced themselves from Weil. Before following that lead ram, perhaps they’re giving some thought to where it is going.

ANOTHER COMMENDABLE CONDUCT AWARD

Big law bankruptcy attorneys may have finally killed their golden goose. We’ll never know if less hubris and more thought might have prevented the U.S. Trustee from releasing new attorney compensation guidelines that surely have prominent members of that bar squirming. Those guidelines earn my latest “Commendable Conduct Award.” Starting November 1, we’ll see how many judges have the courage to apply them.

Restraint in the race to $1,000 an hour billing rates to maximize short-term profits might have served practitioners better in the long run. Likewise, more discretion in responding to media inquiries about the lucrative bankruptcy law world might have been wiser than Weil, Gotshal & Manges partner Harvey Miller’s stunning comment to the Wall Street Journal in 2011: “The underlying principle is, if you can get it, get it.”

Flying Under the Radar

The bankruptcy practice in big firms is unique because there’s no real client putting the usual counter-pressure on attorneys seeking to enhance their personal wealth. It’s the billable hour regime at its worst.

Outside bankruptcy, corporate clients everywhere are pushing back on big law firms’ hourly rate increases, refusing to pay for high-priced first-year associates, demanding budgets, scrutinizing attorney activities, and generally seeking greater economy in the delivery of outside legal services. Bankruptcy attorneys have little comparable accountability. They simply set their rates, decide what tasks to perform, and assign manpower as they see fit.

Hello and Good-bye

Unlike corporate clients who dangle the prospect of long-term relationships and future business to encourage their outside attorneys to be more efficient, bankruptcy practitioners have a series of one-shot engagements. When the current proceeding is over, their bankruptcy “client” of the moment disappears, never to return.

Bankruptcy petitions are also vehicles for law firm oligopolists to share pricing information. When most senior big firm bankruptcy partners request $1,000 an hour, it becomes the reasonable and customary rate. But even more remarkable are the $400 an hour and up rates that they can often get for junior associates — the same ones who add so little value that real clients refuse to pay for them at all.

Theoretical Oversight

The U.S. Trustee reviews fee petitions. But to date, those efforts have amounted to quibbling over obviously suspect expenses, such as $500 hotel rooms when cheaper accommodations were available or taking limos when taxis were a reasonable alternative.

Likewise, attorneys representing competing interests in the bankrupt’s estate — creditors, for example — can object to the fees of other attorneys in the proceeding. But none has any incentive to rock the lucrative hourly rate boat in which they all sit. Bankruptcy judges have the final word on attorneys’ fees petitions and they routinely rubber-stamp them.

Now It’s Becoming Real

When the U.S. Trustee first proposed the new guidelines, big firm bankruptcy lawyers throughout the country united in opposition. The most strident objections were to the idea that firms should reveal hourly rates for comparable non-bankruptcy associates and partners working for real clients.

Were firms worried about providing data that would allow the U.S. Trustee and supervising courts to compare hourly rates sought in bankruptcy with those resulting from a market that is at least somewhat more competitive? Soon, we’ll find out.

The new forms accompanying the guidelines require, among other things, that firms reveal the “blended hourly rates” of their personnel in 10 different categories ranging from equity partners to paralegals. In addition to the blended rates sought in the fee petition, firms also must disclose their firmwide (or, in some cases, office wide) blended rates for each category.

A Step on the Road to Transparency

The new guidelines aren’t perfect and attorneys will manipulate them. Budgets are optional. Hourly “step rate” increases are automatic as attorneys gain seniority. Attorney categories are too broad, with a single category for all equity partners and with associates grouped into categories covering three years. An especially large loophole allows firms to report either the “billed” or “collected” comparable hourly rate. (Real clients request discounts from standard hourly rates, and they often get them.)

Even so, the U.S. Trustee deserves credit for moving a dark corner of the profession from opacity to translucence. Free market devotees — of which big law has many — should embrace the changes. So far, big firm partners have resisted them vehemently.

The governing principle for too much of the large law firm world has become “if you can get it, get it.” Perhaps many of those espousing that view are about to “get it” in a much different way than they have in the past.

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.

DEWEY’S JEFFREY KESSLER: STARS IN THEIR EYES

This is the third in a series profiling Dewey & LeBoeuf’s former leaders. Apparently, Jeffrey Kessler (Columbia University, B.A., 1975; Columbia Law School, J.D., 1977) has become a prisoner of his celebrity clients’ mentality. A prominent sports lawyer, he analogizes big-name attorneys to top athletes: “The value for the stars has gone up, while the value of service partners has gone down.”

Kessler was a long-time partner at Weil, Gotshal & Manges before joining Dewey Ballantine in 2003. After the firm’s 2007 merger with LeBoeuf Lamb, he became chairman of the Global Litigation Department, co-chairman of the Sports Litigation Practice Group and a member of the Executive and Leadership Committees. Long before he became a member of the Gang of Four in Dewey & LeBoeuf’s office of the chairman, he was a powerhouse in the firm.

Blinded by their own light

Some attorneys have difficulty resisting the urge to absorb the ambitions and ethos of their clients. Many corporate transactional attorneys have long been investment banker and venture capital wannabees, at least when it comes to the money they’d like to make.

Of course, not all corporate practitioners are myopic thinkers. Kessler proves that narrow vision isn’t limited to transactional attorneys. But the rise of such attitudes to the top of many large law firms has occurred simultaneously with the profession’s devolution to models aimed at maximizing short-term profits and growth.

Kessler was a vocal proponent of the Dewey & LeBoeuf star system that produced staggering spreads between people like him — reportedly earning $5.5 million a year — and the service partners, some of whom made about five percent of that. It was the “barbell” system: top partners on one side; everybody else on the other.

In such a regime, there’s no shared sacrifice. What kind of partnership issues IOUs to star partners when the firm doesn’t make its target profits? Something that isn’t a partnership at all.

Lost in their own press releases

Kessler regularly finds himself in the presence of celebrity athletes. That can be a challenging environment. But once you start believing your own press releases, the result can be the plan that he and fellow Dewey & LeBoeuf partner Charles Landgraf “spearheaded” (according to fellow Gang of Four member Martin Bienenstock).

To deal with outstanding IOUs to Dewey partners whose guaranteed compensation couldn’t be paid when the firm underperformed for the year, Kessler helped to mortgage its future: for “a six- or seven-year period, starting in 2014, [a]bout six percent of the firm’s income would be put away to pay for this….”

It’s a remarkable notion. Partners didn’t get all of their previously guaranteed earnings because the firm didn’t do well enough to pay it. But rather than rethink the entire house of cards, it morphed into a scheme whereby future partnership earnings — for six or seven years — would satisfy the shortfall. Never mind that there was no way to know who would be among the firm’s partners in those future years. The money had to be promised away because the stars had to be paid.

Sense of entitlement

Kessler gives voice to the pervasive big law firm attitude that without stars there is no firm. It’s certainly true that every firm has to attract business and that some lawyers are more adept at that task than others. But Kessler’s approach produced yawning income gaps at Dewey. Similar attitudes have contributed to exploding inequality afflicting many equity partnerships. For insight into the resulting destabilization, read the recent article by Edwin Reeser and Patrick McKenna. “Spread Too Thin.”

But does Kessler really think that he and a handful of his fellow former Dewey partners are the first-ever generation of attorney stars? Twenty-five years ago when average partner profits for the Am Law 100 were $325,000 a year, did his mentors at Weil Gotshal earn twenty times more than some of their partners — or anything close in absolute dollars to what Kessler thinks he’s worth today? Does he believe that there are no stars at firms such as Skadden Arps, Simpson Thacher or other firms that have retained top-to-bottom spreads of 5-to-1 or less?

Beyond his prominence in the profession, Kessler is shaping tomorrow’s legal minds as a Lecturer-in-Law at Columbia. For anyone who cares about the future, that’s worth pondering.

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.