Two recent reports sound a warning that most Big Law 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 [ PDF]. The other is Citi Private Bank’s Annual Law Firm Survey, which The Am Law Daily covered here.
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 part, 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 those same mistakes.
Dewey wasn’t an outlier; it was among the elite of The Am Law 100. The firm embodied the culmination of prevailing Big Law trends that can—and will—produce future disasters. As the Georgetown/Peer Monitor Report explains, those trends include raising the bar for promoting homegrown 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 there are important underlying details that 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 head count grew more than demand. That's a decidedly mixed bag of financial results.
In fact, Citi’s Dan DiPietro and Gretta Rusanow fear that the fourth quarter revenue surge that salvaged the year for many big firms “may not be sustainable.” For example, they write, “survivorship bias” contributed to the final 2012 numbers. That is, Citi’s analysis removed Dewey's revenue, demand, and equity partner figures from the 2011 base year because the firm disappeared in 2012. But most of Dewey’s 2012 revenue went to surviving firms, thereby artificially inflating the overall numbers for the year. To some extent, it’s like comparing 2012's apples to 2011's oranges. Including Dewey’s 2011 numbers would have resulted in negative growth in demand last year.
The Citi report also assessed the impact of accelerated year-end collections. While they are an annual event at most firms, 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 due and owing in December 2012. If Citi's report for the first quarter of this year 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 10 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 either fail or become absorbed in last-resort mergers.
Fragile Winners
Even firms that regard themselves as financial winners in 2012 should beware. Many would do well to heed the Georgetown/Thomson Reuters caution about how the loss of traditional partnership values undermined Dewey. Considered from a different perspective, numbers that appear to demonstrate success can actually reveal lurking failure.
After all, as recently as the Am Law 100 list published in May 2011, Dewey ranked twenty-third average equity partner profits ($1.8 million), twenty-second in gross revenue per lawyer ($910,000), and nineteenth on the magazine's profitability index with a margin of 36 percent. In February 2012, the firm made The American Lawyer's annual “most lateral hires” list, 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.
Steven J. Harper is an adjunct professor at Northwestern University and author of the forthcoming The Lawyer Bubble: A Profession in Crisis (Basic Books, April 2, 2013). He recently retired as a partner at Kirkland & Ellis, after 30 years in private practice. His blog about the legal profession, The Belly of the Beast, can be found at http://thebellyofthebeast.wordpress.com . A version of the column above was first published on The Belly of the Beast.
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