December 19, 2011 5:42 PM

Fed to Death

Posted by Steven Harper

A year ago, 60 percent of respondents to The American Lawyer's annual survey of Am Law 200 firm leaders said that the economic downturn had produced "a fundamental shift in the legal marketplace." So far, it hasn't happened. The leveraged pyramid is alive and well, and average profits per equity partner have roared back to surpass pre–Great Recession records.

The surviving (indeed, thriving) big-law business model helps to explain why the shift that managers now expect, as outlined in the results of this year's survey, is physical—namely, partners playing musical chairs across firms. Unfortunately, the predicted phenomenon illustrates a persistent case of lessons not learned.

To be sure, some lateral partners are unqualified successes for the lawyers and firms involved. But the stories surrounding the failures are truly horrific. Twenty-five years ago, Finley, Kumble, Wagner, Underberg, Manley, Myerson & Casey's unprecedented lateral recruiting binge contributed to its demise. Fifteen years later, Heller Ehrman pursued the growth-by-acquisition strategy to a tragic end. This year, Howrey became a victim. Not all lateral activity leads to such epic disasters. Still, as most of today's firm leaders confess their obsessions with other people's talent, they seem oblivious to the perils of actually hiring it.

Management isn't thinking about, or assumes that it can overcome, lateral hiring challenges that destroyed some great firms of the past and that today quietly eat away at the internal fabric of others. More than 80 percent of respondents to this year's survey expect to add lateral partners in litigation; almost 75 percent plan to supplement their partnership ranks with corporate laterals; for IP, it's almost 60 percent. More than half of managing partners spend more than 10 percent of their time on lateral hiring, but the preoccupation with laterals becomes clearest when they identify their biggest disappointment in 2011. They could pick only one, and here's a sampling of what they chose:

• "The loss of some laterals after a long recruitment."

• "We were not as successful as we would have liked in our lateral recruiting efforts."

• "Lack of success in attracting laterals."

• "Unable to attract laterals."

• "Have not attracted as many high-profile lateral partners as had hoped."

A few leaders whistle past the graveyard of prior firms' lateral hiring frenzies. In the survey they describe their "biggest challenge in 2012" as "making all the pieces run smoothly together" and "integrating the lateral partners we have taken on into our firm's culture and instilling values of teamwork and professionalism." Good luck. Their very business models are working against most of them.

The lateral imperative, including the ultimate group lateral—merger with another firm—is both a cause and consequence of leaders' myopic focus on short-term partner profits. When "the ties of partnership are no more enduring than last year's K-1," as ALM editor in chief Aric Press aptly put it last year [The American Lawyer, "Change You Can Believe In," December 2010], the traditional concept of partnership itself becomes a casualty. Self-interested partners seeking to maximize their lateral options build client silos, not institutional bridges to fellow partners and the next generation. Once they actually move to a new firm, the situation gets worse.

Except for rare lockstep systems, the prevailing eat-what-you-kill compensation model already pits partner against partner for billings. A lawyer keeping an eye on the exit competes even more intensely. Mentoring attorneys and sharing clients pay future dividends to a firm. But those who are inclined to consider such partnerlike conduct then pause: What if, someday, they have to justify their economic worth to a new set of partners elsewhere?

At the receiving end, incoming laterals get a grace period to prove their value. After all, the leaders who recruited them are loath to admit mistakes, especially high-profile ones. Nevertheless, the business model that got the laterals hired creates relentless internal pressure to satisfy dollar-based metrics. That doesn't bring out the best in anyone.

As economic structures use short-term incentives to produce predictable human behavior, the combined actions of individual partners over time create a firm's culture. The contest for laterals accelerates the race around that vicious circle, and with each new addition from outside, a sense of community disappears. How long can anyone reasonably expect the center to hold when the only shared partnership purpose is making money? Only for as long as profit trees grow to the sky.

That puts pressure on firms to continue increasing each year's profits per equity partner. In the current environment, such a strategy gives them their best shot at keeping the best people while enticing others to sign on. But this revolution of rising expectations can fuel rapid departures when it turns sour. In this year's responses, many firm leaders echo one chairman's concern about keeping up with "expectations of colleagues based on recent history."

Maybe that's what former Howrey chairman Robert Ruyak had in mind when he told The Wall Street Journal in an article published on March 10 of this year that alternative fee arrangements deferred his firm's revenue into future time periods, reduced current-year profits, and created a difficult adjustment period. "Partners at major law firms," he told the Journal, "have little tolerance for change."

"Change" was a euphemism for declining profits. In that interview Ruyak tried to explain—and perhaps understand—the speed with which events overtook a storied franchise. In retrospect, a key catalyst seems obvious: After a record year in 2008, declining profits in 2009 fueled a death spiral of departing partners, many of whom had been prominent lateral hires only a few years earlier. By early 2011, the firm was gone.

It's an odd and relatively new treadmill of potential self-destruction. When the leaders of today's big firms were in law school two or three decades ago, they didn't think that practicing law would make them rich. In 1985, average profits per partner for The Am Law 50 (the forerunner to today's Am Law 200) was $309,000—that would be $623,000 in today's dollars—and far beyond their youthful expectations. Today, the comparable profits per partner for The Am Law 200's 50 highest grossing firms is more than $1.5 million.

Likewise, when the people running today's big firms were associates, they didn't have minimum billable-hours requirements. But now, as equity partners, they dedicate themselves to increasing their extraordinary wealth. Law firm leaders' comments on their firms' "biggest challenges for 2012" make this clear:

• "Maintaining and increasing billable hours."

• "Increase productivity."

• "Reversing the productivity trend; increasing profits."

"Productivity," by the way, is big-firm speak for its antithesis: maximizing billables.

In the short run, most of these firm leaders will succeed—if that's the right word for it. Eighty-four percent of respondents to the survey predict that profits per partner will grow in 2012. The leaders' stated commitment to time-tested strategies will make it happen (the percentages responding positively for each of the following are in parentheses): Partners will get deequitized (almost 40 percent) or told to leave (more than 70 percent); associate classes will remain about the same (almost 60 percent); billing rates will go up (98 percent).

All of this raises the question of what leadership really means. Tellingly, the noneconomic well-being of their firms isn't even on the responding managers' screens, but it should be. Almost 80 percent characterized partner morale at their firms as "somewhat" or "very" optimistic; only 4 percent said "somewhat" pessimistic; the rest said that partner morale was "neutral." Selective perception? Self-serving public relations? Listening only to those telling them what they want to hear?

Associate morale? Forget it. Senior leadership has. That topic made it into only one comment expressing that firm manager's biggest disappointment in 2011. Even that lonely remark is, well, disappointing in its lack of reflection, insight, and accountability: "Associate morale isn't as good as it should be, given how well the firm is doing and the opportunities associates have here." In other words, don't blame me; associates should be happy! Only two comments allude to associates at all in listing their respective firms' biggest challenge for 2012: "associate engagement and retention" and "retaining excellent associates."

Perhaps unwittingly, one leader suggested two new topics for next year's survey that link all of these themes—the two-edged sword of the lateral imperative, the prevailing business model's drive to increase current profits per partner, and declining morale—in three ironic sentences: "The morale question is focused on revenue and profitability. I would be interested in seeing data on civility and interaction among partners and what other firms are doing to encourage such. Also, ask firm managers [about] measures they have taken to keep partners from leaving their firms."

Here's another way to put it: Among many ills, the focus on short-term profits exacerbates internal incivility, fosters the fear of partner defections, and contributes to institutional instability. As long as the prevailing big-firm business model persists, what goes around will come around—again and again and again. For those paying attention to the tide of events, history can have an unsettling circularity.

Steven J. Harper is an adjunct professor at Northwestern University and author. His latest book is The Partnership—A Novel. He maintains a blog about the legal profession at www.thebellyofthebeast.wordpress.com.

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