Dewey & LeBoeuf went from 26th in last year’s Global 100 to filing for bankruptcy in May this year. What can the Global 100 learn from the firm’s demise?
Finley, Kumble, Wagner, Underberg, Manley, Myerson & Casey; Brobeck, Phleger & Harrison; Heller Ehrman; and Howrey, the US legal market has quite a track record when it comes to large law firm failures.
But none of these collapses has matched the dramatic demise of Dewey & LeBoeuf through the first half of this year. In terms of scale – Dewey was 26th in last year’s Global 100 (although that was on reported revenues that look to have been inflatedby more than $100m). In terms of global reach – the firm boasted more than 1,000 lawyers across its offices in the US, Europe and Asia, including around 120 in London. And in terms of the series of high-profile partners at the firm, many of them were hired over the last five years on multi-million dollar guaranteed pay packets.
Morbid fascination
Dewey’s downfall has shocked and captivated the US and global markets in equal measure. It has heralded a period of navel-gazing as management at law firms check the foundations of their business to reassure themselves that it couldn’t happen at their firm.
‘You have to look at those mis-steps that require all law firm chairmen to ask, “could this happen at a firm of our structure?”,’ the head of one Global 100 firm says. But the extent to which the firm unravelled through a series of catastrophic decisions mixed with falling demand, has emphasised just how fragile law firms can be.
‘History will judge Dewey to be a suicide not a homicide,’ one US law firm leader reflects. It also seems unlikely that it will be the last death like it.
The merger between Dewey Ballantine, a reputable New York practice with decent cachet among the investment banks, and the vaulting LeBoeuf, Lamb, Greene & MacRae, a less patrician practice with strength in energy and insurance, created a business with combined revenues of around $1bn. By the time the deal went live in October 2007, LeBoeuf had already spent several years re-engineering itself through the acquisition of a number of star lateral hires that would bring their multimillion-dollar books of business to the firm and receive profit draws way in excess of the firm’s PEP.
LeBoeuf’s management, led by chairman Steven Davis, was happy to talk about the revamping of its partnership. In February 2006 The American Lawyer published a lengthy article on LeBoeuf’s aggressive hiring of the likes of securities litigator Ralph Ferrara from Debevoise & Plimpton in Washington DC, London-based arbitration specialist Arthur Marriott QC, also from Debevoise, and former Winston & Strawn corporate dealmaker Berge Setrakian. Ferrara’s book of business alone was estimated at $20m, while each hire was reported to be on between $2m and $3m annually for their first three years at the firm. LeBoeuf also agreed to cover the multimillion-dollar pension pots that Ferrara and Marriott had built up at Debevoise. The strategy helped LeBoeuf grow its revenues from $340m in 2004 to $514m in 2007 while PEP jumped from $935,000 to $1.4m.
The timing of the Dewey Ballantine deal, just under a year before the collapse of Lehman Brothers, gave the merged firm a relatively short period of strong market conditions in which to operate. But instead of pulling back and focusing on integrating the businesses as the economy worsened, Dewey’s management doubled down on its hiring strategy. Respectable names such as former Weil, Gotshal & Manges restructuring specialist Martin Bienenstock and Cooley Silicon Valley dealmaker Richard Climan joined the Dewey bandwagon.
But Dewey & LeBoeuf was hardly the first ambitious Global 100 firm to champion the hiring of big-name partners on multimillion-dollar guaranteed deals. Since US firms started arriving in London in true force during the 1990s, City partners have become accustomed to the enticing offers of guaranteed multimillion-dollar pay packets. Guarantees may have become rarer in recent years but they’re not unheard of today. What is unheard of is their proliferation across the Dewey partnership. The compensation of around 100 Dewey partners was guaranteed, an astonishing figure for a firm that in last year’s Global 100 had 185 equity partners and 115 non-equity partners. Former Dewey Ballantine co-chair Morton Pierce is reported to have been on $8m, firmly placing him at the top of the payscale.
To put that number of guarantees in context, Reed Smith chairman Greg Jordan says that his firm has offered just two or three similar packages in the last seven years. ‘We just have a very transparent partnership which makes offering guarantees much harder to do,’ Jordan says. ‘We shy away from guarantees and we haven’t had trouble recruiting laterals without them.’
Along with its surfeit of guarantees, Dewey was also a champion of a compensation system that handsomely rewarded those at the top but left a huge gap to those at the bottom of the payscale. The lowest paid partners at Dewey were reportedly taking home around $300,000, 20 times less than those at the top. Of course, US firms typically reward their best-paid partners far more than their UK peers. At Latham & Watkins, for example, the spread is between 4:1 and 5:1, in excess of a typical UK spread of 2:1 or 2.5:1, but far different to the Dewey payscale. And, it should be pointed out, a lopsided remuneration system is no barrier to success. In March 2010, for instance, LB reported that the compensation spread at Hogan & Hartson before its merger with Lovells was 15:1.
Will Dewey be the last firm to base part of its growth strategy around an aggressive lateral hiring policy with rich rewards at the top? That seems unlikely. But it seems equally unlikely that we’ll see anything approaching the same number of guarantees at a Global 100 firm. So much that Dewey did was magnified; its debt level, the number of guarantees it offered, the compensation spread and the lack of transparency. Managing partners shake their heads in bewilderment at the scale of it all and reassure themselves that it could never happen at their firm. But dating back to Finley Kumble, many of the traits that brought Dewey down have been clear in other law firm collapses. Among them was the firm’s debt.
A fate worse than debt
When Dewey filed for bankruptcy at the end of May its debt liabilities were put at $315m, with $225m owed to its banks and bondholders. A large chunk of that was raised in a $125m private placement in 2010 which Dewey said would be used to ‘refinance current indebtedness and for general firm purposes’.
In the eyes of some, Dewey’s predicament is further confirmation that law firms and long-term debt don’t mix.
‘As a business, our assets are not patents or factories, they are human beings who go down our elevators every day, as they do at other law firms,’ Peter Kalis, chairman of K&L Gates, comments. ‘The capitalisation of a law firm with long-term debt financing is at odds with this basic dynamic of the legal business and punishes loyal partners.’
‘The shock value has caused everyone to re-think debt,’ adds Peter Zeughauser, head of the consulting business the Zeughauser Group. ‘There aren’t many firms walking around with $500m in debt but Dewey has forced people to think about lateral guarantees and to treat them as off-balance sheet debt.’ The strength of a firm’s balance sheet has never seemed so important.
Set alongside Dewey’s ballooning debt was its declining financials. In March Dewey announced that its revenues for 2011 were $935m, up from just under $910m in 2010. PEP was marginally up at $1.8m. However, in a story published in The American Lawyer it emerged that the firm’s revenues for 2011 were $782m and $759.5m for 2010 while PEP for last year was closer to $1m.
In a statement issued to LB in April a Dewey spokesperson said that the financial results supplied to the media were prepared according to the methodology outlined by The American Lawyer, which is different to the methodology used for internal and financial accounting purposes.
Those revenues compared with a post-merger high of around $1bn mean that the firm had lost almost a quarter of its business in four years. With declining revenues and a daunting debt pile, Dewey was unable to pay out on the large guarantees that it had built so much of its business around.
The lesson that it’s a tough market is hardly a revelation. Any managing partner will tell you how difficult it is to grow revenues and profitability in the current market conditions, but the case of Dewey shows just how precipitous the drop-off in workflow has been for some firms.
‘The aggressive lateral hiring market would have worked in a rising market, as much as anything else, what took Dewey down was falling revenues,’ Zeughauser points out. ‘Everyone knows that for many large firms demand has been weak, what Dewey has highlighted is just how weak it has been.’
A few years ago, as the global economic crisis unfolded, some were spying opportunity in the turmoil. ‘In a way, challenging economic times have been a great opportunity,’ former Dewey chairman Davis told LB in 2010. ‘If it doesn’t kill you it makes you stronger.’