How the Magic Circle Lost the Battle for New York
Despite decades of effort and millions of dollars spent, the U.K.'s Magic Circle firms still haven't made a dent in the New York market.
Building scale has been a consistent problem for the Magic Circle in the U.S. Much of this is due to the firms' lockstep compensation systems, in which equity partners are paid on the basis of seniority, with their remuneration rising each year as they move up the ladder. Lockstep is a deeply engrained part of the Magic Circle ethos. Each of the four U.K. firms have in recent years modified their firmwide remuneration systems to provide some much-needed flexibility, adding salaried partner ranks, bonus pools, and the ability to allow management to alter an individual's position on the lockstep. But despite this shift toward the sort of performance-related pay that is typical among American firms, lockstep remains the single greatest factor that distinguishes the U.K. firms in New York.
Freshfields's Pritchard says this is a good thing. "People might think that our remuneration system would prevent us from hiring the right people, but in fact it's one of the main reasons they join," he says. "We have a great culture, and that is driven by lockstep. There are some partners for whom money is the deciding factor [in joining a firm], but for most, it's not what they focus on."
Pritchard points to hires such as his firm's recruitment in 1998 of a highly regarded four-partner group from Milbank, Tweed, Hadley & McCloy—including project finance partner Ted Burke, who is currently Freshfields's global managing partner, and structured finance partner Brian Rance, whom Pritchard succeeded as U.S. managing partner—as evidence that lockstep firms can attract star names in New York. (Freshfields recently announced that Burke will leave in early 2014 to become general counsel at private equity firm Arclight Capital Partners.)
That's not the message we received from the partners, recruiters, and consultants we spoke to for this feature, however. Their overwhelming response was that, for the Magic Circle in New York, lockstep is a hindrance, not a help. "You can make a lot of positive arguments for lockstep, but you can't make them in a market that really doesn't embrace it," says law firm consultant Bradford Hildebrandt. "Lockstep is just not in the DNA of U.S. lawyers, so it's very hard to convince them to work under that philosophy, particularly when you can only afford to pay them 60 percent of what they'd get elsewhere."
Some of the top Wall Street firms, including Cravath; Davis Polk & Wardwell; and Paul, Weiss, Rifkind, Wharton & Garrison, also utilize lockstep systems. But those firms are much more profitable than the Magic Circle, so they can still pay top dollar for talent. Cravath's average profits per equity partner in its most recent fiscal year, for instance, was $3.44 million—more than twice that of Clifford Chance ($1.5 million) or A&O ($1.6 million).
Clifford Chance's compensation system does contain a provision that allows the firm to pay star performers above the top of its lockstep, but the firm hasn't used what it calls "super-point" packages for more than a decade in the U.S. market, last doing so in 2000 in an attempt to match the earnings of top rainmakers at Rogers & Wells following the firms' transatlantic merger. Indeed, four current and former partners say Clifford Chance would be unlikely to offer such lucrative deals again, since they failed to stop Rogers & Wells stars from leaving the combined firm over compensation, despite some being paid up to three times more than the top of the Clifford Chance lockstep.
A&O went to even more extreme lengths to attract Cravath derivatives guru Daniel Cunningham in 2001. Unlike Clifford Chance and Linklaters, A&O has no way to break its lockstep for marquee hires. Instead, the firm put together a onetime package, including the maximum permissible 50 points of equity, at that time worth around £1.5 million ($2.4 million), supplemented by five annual payments of £750,000 ($1.2 million) to match Cunningham's Cravath pension entitlement.
Most radical of all, Cunningham was at that time awarded a 15 percent stake in a new stand-alone derivatives company, Derivative Services LLP, which would net him up to $15 million. Combining the three elements gave him a total compensation that the U.K. publication Legal Business, in a feature titled "Mr Bling," calculated to be $6 million per year—more than double that of any other partner at the firm. (As is the case with Clifford Chance, A&O sources say the firm does not intend to pay partners outside its lockstep again in the U.S. A&O declined to comment, and Cunningham did not respond to requests for comment.)
One of the other weaknesses of lockstep is that when activity levels drop, firms can be left with highly paid but underutilized partners. Such tension was evident at A&O. When the derivatives market was hit hard during the recession, Cunningham's compensation placed him under increasingly intense scrutiny from London. In 2009 he left the firm to join Quinn Emanuel Urquhart & Sullivan—now The Am Law 100's second most profitable firm.
The U.S. market—and New York in particular—has been a long and sometimes painful learning experience for the Magic Circle. In their other international ventures, the U.K. firms were able to follow their formidable institutional client bases into countries where they were competing with smaller and less sophisticated practices, whom they were able to outbid in the recruitment market. In the U.S., the opposite was true. As powerful as the Magic Circle brand is in almost every jurisdiction in which they operate, that currency has proven to be significantly less valuable in the U.S.