The glue that binds

As the Swiss Verein legal structure becomes increasingly popular among global law firms, the debate hots up over whether its use is a true representation of global expansion. But what is a Verein and who does it benefit?

The Swiss Verein is all the rage. Law firms have turned to the legal structure to help co-ordinate large international mergers, modelling their expansive structures after the Big Four accounting firms: KPMG, PwC, Deloitte and Ernst & Young. With the appetite for mergers continuing unabated in 2012, as seen recently with the March collaboration of King & Wood Mallesons, the Verein seems to be the structure of choice for law firms.

Firms including Hogan Lovells, Norton Rose, DLA Piper, Baker & McKenzie, SNR Denton and Squire Sanders are just some of the big legal players now ditching the traditional ‘one firm’ model of merging for the Verein.

While an easy vehicle for large-scale international expansion, the Verein also comes equipped with tough exit rules, high costs and onerous contractual agreements.

Despite the controversy surrounding its use (some believe using the Swiss legal structure is a cop-out and doesn’t represent a real merger), Vereins are here to stay as they bypass the administrative nightmare of global ‘all in’ mergers. But are they really a legitimate expansion model or just a cynical manipulation of an archaic structure?

To Verein

Jeremy Black, a partner in Deloitte’s professional practices group, says that until fairly recently law firms thought the only way to merge was to use the ‘one firm’ model – fully integrating financially. ‘Firms thought they had to have one big profit pool to become one firm. That was very much seen as the only way,’ he says. But in recent years, many UK and US firms have turned to the Verein to help grow their businesses. Black thinks that at first this was intended to be a transitional measure but firms soon saw the benefits of it.

‘Firms then thought: “Do we need to go into a single profit pool or can we achieve what we want with the structure we have in place?”’ he says.

The benefits of using a Verein system are that member firms only have to abide by the tax and regulatory rules in their home jurisdiction. A one-firm model would have to take into account all the differing rules where all the constituent firms are situated, and this can prove extremely problematic.

‘Trying to integrate a multinational operation in professional services globally is an extraordinarily daunting task, both administratively and legally. There are extremely difficult barriers to entry in local markets around the world and a number of tax issues. Who would like to be filing different tax returns in 12 countries you’ve never visited?’ says Edwin Reeser, president of Edwin B Reeser, A Professional Law Corporation in California, who used to specialise in partnership agreements. He is also the former managing partner of Sonnenschein Nath & Rosenthal, the US firm, which merged with Denton Wilde Sapte in 2010 under a Verein agreement.

Norton Rose counts currency problems as one of the reasons it decided to move to a Verein system. Peter Martyr, group chief executive of the firm, says: ‘The real advantage from our point of view is that we don’t have to face what would be quite a complicated currency issue.’

A currency issue would arise if a firm had to use exchange rates to convert all the funds into a single profit pool.

The Verein is an extremely flexible model, which further compounds its attractiveness to firms. Its fluidity stems from the fact that every Verein agreement is different and can have various forms depending on the wording of the agreement. According to Martyr: ‘They can be all things to all people.’ This is to say they can be customised to suit the firms’ needs.

Alan Hodgart, managing director of Huron Consulting Group, has previously drawn up Verein agreements from a business context and has listened to what his clients want from the agreement. ‘Usually we have been very involved in helping with the strategic thinking that led to the need for the Verein. We then discuss with the management of the firms involved how they see the Verein working,’ he says.

Law firms may be attracted to the Verein model because, according to Hodgart, they mistakenly believe nothing has to change after the merger. In his view this isn’t the case. ‘The idea is that you’ve got to be able to present to the client that there’s something going on in this grouping of firms that they’re going to get value from and to simply act as independent firms isn’t going to give them that,’ he says. In other words, there’s no point entering into a Verein without some level of integration as clients won’t see any benefit.

The clients’ perspective is probably the most important element for a professional services firm and there is some doubt whether clients care about what type of structure a firm employs.

‘Clients probably don’t care how firms are structured, all they care about is the level of service they get,’ remarks Black.

This is further reinforced by Lisa Hart Shepherd, chief executive of legal market commentators Acritas, who says: ‘Our experience shows that, for clients, as long as the quality of service and advice remains high and that partners are working together effectively to meet their clients’ needs, the structure of the chosen firm is of little consequence.’

Clients who have business in different jurisdictions will probably choose a global firm and expect the same level of service wherever they are located. Standardised services seems to be the thinking behind King & Wood Mallesons’ recent tie-up, as Stuart Fuller,
global managing partner of the newly merged firm, says: ‘We are working over 11 further matters, have made over 40 pitches to clients and have had almost 70 partners travel between China, Hong Kong and Australia in our first six weeks.’

Firms will also use a Verein to open offices in more jurisdictions, and firms like Hogan Lovells and DLA Piper could use this structure to satisfy global expansion plans by doing a non-financially integrated merger using a Verein.

Integration is the key

Swiss Verein is a nebulous term and some Vereins may have very little integration. ‘You could have a Verein that meets once a year and chats over tea about what the market’s like,’ muses Aster Crawshaw, a partner in the professional practices group at Addleshaw Goddard. When asked, others were dubious of Crawshaw’s example, except for Martyr, who says: ‘You can use a Verein to hold loose associations together.’

At the other extreme is a firm that is so highly integrated, it almost doesn’t consider itself a Verein. Hogan Lovells, which formed in 2010 after UK firm Lovells merged with US outfit Hogan & Hartson, fits into this category.

David Harris, co-chief executive of Hogan Lovells, says: ‘Clients tend not to be interested in the minutiae of how law firms organise themselves. They are more interested that we work on a fully integrated basis in delivering a high quality service and helping them solve their problems.’

‘Clients tend not to be interested in the minutiae of how law firms organise themselves.’

There’s little structural difference between the firm pre and post-merger. Before the tie-up with Hogan & Hartson, Lovells was run as one firm internationally, operating different legal entities reflecting the local legal and regulatory requirements demanded by the various regional markets the firm had offices in.

‘Under our structure, all partners have a common financial incentive to develop work and operate collaboratively – a 40 unit partner in Germany and a 40 unit partner in New York receive the same,’ according to Harris. Using this system if the equity points are the same, so is the remuneration. Crucially, this means that there is not one single profit pool.

Similarly, King & Wood Mallesons is also using the Verein structure as an intermediate system to facilitate full integration. ‘We have a clear plan to fully integrate the firms within three to five years, which will start with the integration and alignment of policies, systems and cultures,’ says Fuller.

Some firms have decided to change the structure of their Verein after merging. SNR Denton, Norton Rose and Squire Sanders have all made this move. Tony Williams, a principal at legal consultancy Jomati, says: ‘Many firms quickly moved to one remuneration system shortly after entering into a Swiss Verein. This is because there are the same incentives and encouragement across the entire firm.’

This is certainly true of Squire Sanders, as Peter Crossley, European managing partner of the firm, says: ‘All of the partners in our combined firm are subject to the same compensation system and the principles and values which underlie it.’

Baker & McKenzie is probably the biggest Verein in use today. It has almost 3,800 lawyers spread across 70 offices in 42 countries. The firm moved from being an LLP governed by Illinois state law to a Verein in 2004 under former chair Christine Lagarde and can be distinguished from other firms using the Verein model as it rarely merges with another firm when expanding internationally.

Hodgart thinks this longer experience of a Verein structure benefits clients, and comments: ‘Baker & McKenzie in Europe has been at it somewhat longer and clients are reporting a much better service so they are doing something right.’

It’ll cost you

There is no cost for joining a Verein, but there are costs associated with membership. The costs can vary dramatically depending on the level of centralisation. Williams explains: ‘You have to decide what you are wanting to achieve first with your Verein before you can identify what the cost is going to be.’

One theory estimates that the cost of joining a Verein is between 2-3% of yearly revenues for each separate entity. Take the Norton Rose Group for example. In 2010 the firm merged with Canada’s Ogilvy Renault and South Africa’s Deneys Reitz. Assuming that Ogilvy Renault paid 3% of its £200m revenues for that year into the Verein, the firm would have been staring at a £6m bill to be part of the enlarged Group. Similarly, Deneys Reitz would have paid £1.5m based on its £50m turnover to join the Norton Rose Verein, while Norton Rose would have had to put £9.2m into the pot (based on its 2009/10 revenue of £307m).

Reeser says that Verein-related costs can be as high as $100m for a firm with 1,500 lawyers, although for this amount the Verein would probably have an integrated IT system as well as other centralised systems. He gets to this figure by assuming a revenue per lawyer of $800,000, which would translate to $1.2bn of annual gross revenue. This means that the figure comes out as 8.3% of revenues.

How firms use the Verein money will vary considerably. Some may use it to fund the opening of an office in a new jurisdiction or on an overhaul of a global IT system. However, what can be a very expensive proposition is deciding to leave a Verein.

If a member firm wants to leave the Verein network, depending on the agreement itself, this could prove difficult. Although penalties are illegal under UK law, there can be financial disincentives for firms wishing to leave the Verein. An ‘exit fee’ is payable for firms wishing to leave and these can be considerable. Exit terms will typically be written into a Verein, as well as notice periods needed.

Martyr says two things are important when considering a merger: what is the name and can you get out of it?

‘As far as we’re concerned we entered into this on a one-way street, there’s no street on the way back,’ he says.

Martyr wouldn’t discuss the details of Norton Rose’s Verein agreement nor would he detail the measures in place which prevent any of the new joiner firms from leaving. He did say: ‘It is incredibly difficult to leave our Verein. You can’t just try it out and see how it fits.’

The concept of a severe exit fee also seems fair to BDO’s head of professional services tax Colin Ives, who recalls what happened when another accounting firm acquired a BDO firm. ‘Some firms have sought to strengthen the “tie in” to their organisation with increased payments becoming due to their voluntary departing members,’ says Ives, who explained these charges are fair when considering the amount of money firms have put into integrating the member firms.

However, Tony Williams doesn’t think that firms entering into a Verein structure are likely to be thinking of exit strategies. ‘I think the intention behind Vereins is to play for keeps. The fact that people have used a Verein is to recognise the position of different economies, different currencies, rather than saying we’re not committed to it forever,’
he says.

There are also practicalities that would dissuade a firm from leaving a Verein, including the money that has been spent on implementing the structure. If a member firm decides to withdraw after going through a major IT adjustment, for example, it would have to shut it down and start again with a new system.

Reeser believes there may also be political motivations that would prevent the winding up of a Verein network.

‘No one wants to look like an idiot for suggesting something like this which could diminish the income of partners by $50,000 to $100,000 and then say it was a bad idea,’ he says.

He believes that people get a vested interest in perpetuating the Verein as they get positions within the Verein global management. ‘If these are undone they may see their positions significantly diminished,’ he says. Reeser is somewhat dubious of Vereins and thinks that there is a big financial incentive for people involved in their management. ‘The Verein also allows for some compensation benefits for the “big dogs” that may not be explained or disclosed to the partners at large either,’ he says.

If it is difficult to leave a Verein, then the structure within law firms is likely to be present for the long term. However, even with a highly integrated Verein the lack of a shared profit pool still provides the ammunition for criticism.

Under pressure

One of the most vocal opponents of the Swiss Verein is Peter Kalis, global chairman and managing partner of K&L Gates.
He told LB that the system is ‘a farce’ and is ‘merger-lite for brands, leaving everything else behind’. But for the 1 March merger between China’s King & Wood and Australia’s Mallesons Stephen Jaques, branding was certainly an important motive behind the move.

‘We have a common brand, common management across the combined firm and have fully merged our practices in Hong Kong,’ says global managing partner Fuller. However, Fuller is keen to point out that branding is not the only driving force behind the merger.

‘In terms of our structure, while we retain three separate partnerships in Hong Kong, Australia and China, our brand is the same and the detailed steps to full integration mean that ours is more than a branding alliance and is focused on the long term,’ he explains.

Norton Rose has also invested heavily in branding after its merger with Deacons in Australia, Ogilvy Renault and Macleod Dixon in Canada and Deneys Reitz in South Africa. The firm features heavily on airport billboards and sporting events. However, as Hodgart points out: ‘It [a merger] requires some sort of commonality and standardisation of processes to be of benefit to the client, it is not simply about branding.’

The Norton Rose brand is now present in Asia, Australia, Europe, Canada, the Middle East, South Africa and the UK,
with a combined revenue of over $1bn and a partnership numbering more than 750.

One of Kalis’ key criticisms of the Verein structure is the differing functions that member firms have access to. He says this means that ‘they [firms] can’t deliver a seamless service around the world’. However, this is true of firms under one partnership
as well. Having different legal entities depending on the regulatory market is standard.

Jomati’s Tony Williams believes that it is not a question of one method of merging being better than another.

‘It’s important to bear in mind that even when you have a one-firm approach globally, there are still challenges to making people work across borders so it’s not a matter of one system being perfect and another one being flawed,’ he says.

He continues: ‘It is a matter of how much effort and what carrot and sticks you’ve got to encourage the right sort of behaviour and discourage the wrong sort of behaviour.’

Although profit centres are kept separate in a Verein, this doesn’t mean that profitability between firms should vary considerably.
‘You want to get the profits at least at a comparable position in each market, not necessarily the same figure but if you’re in the top ten profitability in your country you want them [another member firm] to be heading the same way,’ says Hodgart.

As the Swiss Verein is extremely flexible it is hard to predict what firms that use the structure will look like in a few years time.
The general theme is to become more financially integrated and this is true of Norton Rose, SNR Denton and King & Wood Mallesons. But make no mistake, Swiss Verein is set to become a permanent fixture. LB

david.stevenson@legalease.co.uk