Investment banks v law firms: who wears the trousers?

Very recently, a leading US investment bank decided to review its legal fees.
Sick and tired of paying good money to lawyers for photocopying and other miscellaneous tasks, the legal department put its foot down and brought in a costs draftsman, who then proceeded to tear the bank’s legal bills to shreds.
Apparently, this bank, which is at the top of any lawyer’s client wish-list, now intends to be more systematic about what it will and will not pay for.
This little tale should strike fear into the heart of any lawyer, not least corporate specialists who so assiduously court investment banks. Because let’s face it (and many corporate partners don’t want to), investment banks are not easy clients.
In-house lawyers at financial institutions openly admit that certain perks partners provide to woo and keep these clients – secondees, for example – are a ‘loss-leader’ for law firms.
Freshfields Bruckhaus Deringer has on average around 15 lawyers seconded to investment banks at any one time, albeit from a number of departments.
Clifford Chance loans out an average of four, while Herbert Smith might have around half-a-dozen of its associates working in-house. That’s not cheap.
As well as this, consider the kind of fees M&A lawyers make by acting for investment banks.
If a partner and a couple of associates advised a bank on, for example, a cash confirmation for a bank acting for an offeror, a law firm might earn £50,000 tops.
Surprisingly, while it would be easy to assume that all the good fees come from hostile bids, working with a bank might only stretch to £200,000, although one highly-rated magic circle partner admitted that his firm had done this kind of work for £20,000.
Also, although it is an obvious point, it is one that is nevertheless worth making: corporate activity is still in the doldrums.
Thomson Financial figures show that for 2002 global M&A activity fell by 29.6 per cent to $1.1bn (£669.7m), while the value of deals in Europe dropped to 1997 levels, showing a decline of 12.8 per cent.
So even the scant fees that corporate lawyers charge investment banks are not exactly flowing in this market.
Also, the sheer number of lawyers that firms throw at these clients to manage and maintain these relationships can be huge.
Take Freshfields for example, which is the doyen of law firms when it comes to investment banking relationships.
Famously, back in the 1980s when the firm’s income came mainly from the Bank of England and various private clients, Freshfields successfully targeted investment banks in order to build up its corporate department.
It also had the foresight to leap on the US investment banks, such as Morgan Stanley and Goldman Sachs when they made their entrance into the UK at the back end of the decade. Today, the firm has between 20 and 25 partners who look after investment bank clients.
Over at Linklaters, which three years ago made a concerted move under the direction of Matthew Middleditch to court investment banks, at least 15 of its corporate partners look after these clients.
Herbert Smith over the last five years has also made a concerted move towards this area.
Herbert Smith corporate partner Henry Raine, who has had first-hand experience of financial institutions, working previously for the likes of BZW, the investment banking arm of Barclays which was sold to Credit Suisse First Boston (CSFB), has made some significant progress in raising the firm’s profile here.
However, given the kind of economics and resources these clients cost, why on earth is it that law firms chase investment banks with a fervour that frankly borders on the fanatical?
Referrals, referrals, referrals… that’s what the lawyers say. It is easy to see the wisdom of this, especially when it comes to, say, capital markets, where, for example, Freshfields scored a beaut by winning the Orange initial public offering in 2001.
Headed by corporate partner Tim Emmerson, (now at Milbank Tweed Hadley & McCloy), the firm leveraged off its relationships with Morgan Stanley and Dresdner Kleinwort Benson, which, along with Société Générale, underwrote the deal.
And yes, of course other practice areas in law firms benefit from strong relationships with banks. But winning a new corporate client because an investment bank recommended you?
There are not that many examples. Herbert Smith attributes winning retailer Next as a client through Lazard and Freeserve via its CSFB connections.
Clifford Chance has Goldman Sachs to thank for Lendlease – but really the incidence of this is scant.
Law firms probably use the referral argument to make themselves feel better because, in the cold light of day, the economics of chasing these clients just does not make sense.
The real reason that law firms court investment banks is fear.
It is better to be on the right side of these institutions in the hope of catching whatever crumbs they might throw you than not being in there at all. Also, lawyers are utterly petrified of being blackballed by banks.
Because of reasons such as these and because some corporate departments have only recently begun targeting them, law firms still lack confidence in dealing with investment banks. They therefore find it difficult to put their foot down and say no to costly demands for deep discounts and secondees.
Investment banks should be wary, however. Experienced lawyers now talk of a shift in the market in that they themselves are being asked by corporates which financial institutions they would recommend.
Whether the investment banks are aware of this is not clear – but they should watch out. There may be a day when lawyers decide to bite back.
dearbail.jordan@thelawyer.com