The big auditors are targeting the legal sector again, and this time the mid-market had better be prepared
The accountants’ previous assault on the legal market might have turned out to be a bit of a damp squib, but this time around law firms could really have something to worry about.
With PricewaterhouseCoopers’ legal arm PwC Legal already operating under the part-ownership of PwC itself, the blueprint for the auditing giants’ re-entry into the market is set.
No wonder, then, that Ernst & Young (EY) and KPMG are in hiring mode, while the new global managing director of Deloitte Legal has been tasked with drawing up a strategy for the UK. Often easily dismissed by lawyers as serious rivals, thanks in no small part to their Enron-induced exit from the market (see box, page 15) over a decade ago, the Big Four accountants are gearing up to take the legal sector by storm. And it’s the mid-market they’re gunning for.
Mid-market firms beware
Lawyers who were around the first time the accountants tried their hand at legal services may not be quaking at the prospect of a second coming, but this time things are different.
In the 10-plus years since the demise of Arthur Andersen, some mid-market firms such as Halliwells and Manches have gone to the wall, while others such as Dundas & Wilson and Lawrence Graham have merged (with CMS and Wragge & Co respectively) to escape what has become an ever-more exposed, squeezed patch.
The Big Four, meanwhile, have grown their profitability to very decent City law firm levels. And then, of course, there are alternative business structures (ABS), which mean even lawyers joining the audit firms rather than their legal arms would only have to give up their practising certificates until a jointly owned law firm could be spun out.
The result? The accountants are looking pretty attractive, as shown by EY’s hire of Addleshaw Goddard corporate managing partner Phillip Goodstone, former Berwin Leighton Paisner finance chief Matthew Kellett and Freshfields Bruckhaus Deringer global people partner Richard Norbruis, and KPMG’s hiring of DLA Piper partner Nick Roome. As attitudes in the industry have also changed over the past 10 years, these hires are unlikely be the last.
“People were very snobby last time around – lawyers were looking down on the accountants,” recalls a source. “Lawyers now know their firms aren’t that special. Last time, law firm partners were earning more than Big Four partners but over the past 10 to 15 years the Big Four have become very profitable. They haven’t got £1m PEP but they do have PEPs of £750,000 to £800,000. They can compete in a way that wasn’t the case then.”
The PEP battleground
Profit per equity partner (PEP) of £750,000 is clearly a long way off the magic circle’s average of £1.3m for the 2012/13 financial year, but it is streets ahead of those posted by the firms facing off the legal arm of PwC – the only one of the accounting giants with a standalone legal function in the UK.
Considering that, as one source puts it, “everyone knows PwC got Lehmans from Linklaters”, the Big Four are not likely to put such lucrative referrals at risk by competing in the same segment of the market.
“They’re not ever aiming to take on Linklaters,” says the source. “They want to take on the upper middle ground. All the Big Four are on every single due diligence of every M&A deal. They’ve all got corporate finance teams that tend to be fairly dominant in the upper mid-market, deals of between £10m to £400m, but what they don’t do is compete with Morgan Stanley and Goldman Sachs. Instead, they’ll take on the likes of Eversheds, DLA [Piper], Addleshaws and Pinsents.”
When looked at purely in monetary terms it is easy to see how the accountants, even those that do not yet hold an ABS licence and so cannot allow new hires to hold themselves up as practising lawyers, are managing to recruit from these firms. In 2012/13 at DLA Piper, partners received an average of £825,000, while at Eversheds, another firm with a large non-equity partnership, the figure was £642,000. Addleshaw Goddard and Pinsent Masons, meanwhile, had PEPs of £457,000 and £387,000 respectively.
For PwC Legal senior partner Shirley Brookes, however, it is not just the money that recruits find attractive but rather the opportunity to join an ABS that is in a unique position thanks to having PwC on board as an equity partner.
“Our value proposition is that we go to market with a PwC team,” she says. “We’re not just trying to get an M&A job – we’re going to market with a multi-disciplinary angle, otherwise we’d be out there with every lawyer in London.
“ABS was a no-brainer for us. That’s why we came into existence 18 years ago – to go to market together and develop relationships together.”
When the firm pitches for work in business reorganisation, one of its largest practice groups, its lawyers go with a tax specialist and an accountant to present what Brookes terms a “joined-up offering”.
While the firm’s practice areas of corporate (business reorganisation and M&A), litigation (tax and regulatory investigations), immigration, governance and compliance, employment, pensions, real estate, and IP/IT broadly mirror what the larger group offers, the ABS allows the two businesses to explore new practices together. As a first, Fieldfisher partner Stewart Room is set to join the firm in September to launch a cyber security practice along with a PwC forensic accountant.
A broader outlook
A look at PwC’s client profile reveals that 17 per cent of its 2012/13 rev-enues came from FTSE 100 companies, while mid-caps, entrepreneurs and the public sector generated a combined 38 per cent. With PwC Legal fishing from the same pool, it is obvious that the firm does not have to be confined to the City. With PwC now officially on board, the legal arm can freely go where the accountant is without worrying about getting on the wrong side of the regulator.
“We’ve now got a couple of lawyers in Manchester and a couple in Birmingham, and we’re definitely looking to expand that,” says Brookes. “We looked at those two cities in particular because we do a lot of work with PwC there and it’s much better to have people on the ground.”
The move makes sense when PwC Legal is seen next to firms in the same revenue bracket. With turnover of £38.8m in the year to June 2013, the firm ranks at around number 70 in The Lawyer’s UK 200, placing it alongside firms such as Burness Paull, Freeth Cartwright, Lewis Silkin and Shepherd & Wedderburn, which all turned over between £35m and £40m in the 2012/13 financial year.
Although PwC Legal’s regional footprint is small at the moment, Brookes is in the process of drawing up a business plan that is likely to see lawyer numbers in Birmingham and Manchester grow to around 15 each in the near future. As PwC also has an office in Belfast it is possible the legal arm could expand there too, to take advantage of the compliance work the auditor does there.
Regional growth is a theme that also emerges in PwC’s Big Four competitor KPMG’s push into the legal market – which should prove relatively easy, considering the accountant’s UK network of 22 offices.
Until now the firm’s 50-strong legal arm, which sits within the tax practice and focuses mainly on litigation in the tax and pensions areas, has been based in London. However, with the addition of Roome from DLA Piper last month the business has set up a hub in Manchester with the view to expanding elsewhere in the UK.
“Starting out in London makes sense but we also want to serve the national market,” says KPMG’s indirect tax head, Gary Harley. “We decided the first hub would be in Manchester but the idea is that there will be more. We’d be looking at the major cities. I’m not convinced I can see us having 22 legal hubs – more like four or five.”
KPMG’s offering differs from that of PwC in that, while its lawyers, tax specialists and accountants go to market with what Harley terms an “integrated offering”, it cannot give legal advice because the ownership structure of the business will not allow lawyers to practise in the eyes of the SRA. That it too will go down the ABS route, therefore, is a given.
“We’re developing and building an integrated offering,” says Harley. “That’s an important feature of our strategy. It’s about wrapping legal around what we already do.”
Similarly, EY global law leader Cornelius Grossmann says the firm is keen to utilise regulatory changes to “leverage our competitive advantage” and “combine our services to deliver a multi-disciplinary offering”.
In other words, an ABS is in the offing.
“Due to changes in regulatory law it’s now possible in the UK to offer law services even though the organisation offering them is not owned by lawyers exclusively,” says Grossmann. “EY has appointed Philip Goodstone with a view to building a legal capability for EY in the UK, subject to regulatory approval, which would complement EY’s existing service offerings.”
Deloitte targets UK
Deloitte, which was the only one of the then Big Five (including Arthur Andersen) not to enter the UK legal market last time around, is being more tentative in its approach, although it does have a UK offering in its sights.
On 1 June Piet Hein Meeter, then Deloitte global managing director for tax and legal corporate development and strategic growth, replaced Ian Tod as global managing director of Deloitte Legal, with growth one of his key objectives.
“There’s a definite need for scale and true global coverage – that will be one of my main focus areas for my term,” he says, adding that “the UK is definitely on the list”.
Whether Deloitte will look to build a legal function from scratch or take advantage of the ABS regime to take a stake in an existing firm is not clear, although it does have form when it comes to buying into businesses. In 2010 it entered the UK property agency market by acquiring advisory business Drivers Jonas. A similar deal in the legal sector would be enough to put it at least on a level footing with EY and KPMG.
Following the PwC leader
From a regulatory point of view it should be much simpler for the remaining Big Four to gain an ABS licence than it was for PwC Legal, first, because the hard work has now all been done and second, because PwC is working with the SRA to tackle issues as they arise.
“It took about two years for us to get our ABS licence, partly because PwC is a complex business and the SRA had to get it right because it was setting a precedent,” recalls Brookes at PwC Legal. “As a result, we have a regular dialogue with the SRA, which is great.”
With the way paved for the others to follow suit, it is widely expected that EY will be first out of the blocks, most probably on 1 September, the date on which Goodstone, Kellet and Norbruis all officially join.
Of course, it is all very well for the accountants to boast of integrated services and joined-up offerings, but for their legal arms to really take off in the UK, referrals will have to flow from their audit businesses, something that is notoriously difficult to achieve.
“There will be people in the accountancy firms who will have their own relationships with lawyers and will have referred work to them for 15 years, and breaking that will be the hard part for them,” says a source. “Referrals are the Holy Grail, but no one does it particularly well. It’s difficult to get people to cross-sell, but that’s the only way they’re going to get it to work.”
But even if the legal arms get only a fraction of the referrals sent out by their accountancy namesakes, these businesses are so big that the firms will get more than enough work to assure them of a mid-market position in turnover terms.
And from the ABS point of view, the fact that accountancy firms operate in a similar regulatory environment to law firms, not to mention that, aside from Deloitte, the Big Four have been here before, keeping on the right side of the regulator should be a breeze.
“We have no more regulation than previously,” says Brookes at PwC Legal. “We always operated closely with PwC, so it’s no different for us. If you were taking in an investor cold it would be quite a change.”
Whoever came up with the term Tesco Law might have to rethink it.
How Enron’s tremors shook up the market
At the turn of the millennium things were ticking along in legal for the then Big Five accountancy firms. Having built up stand-alone legal arm Garretts in the mid-1990s, Arthur Andersen was followed into the market in 1996 by Price Waterhouse, which took on Hammonds lawyer Chris Arnheim to build Arnheim & Co.
Andersen expanded its UK operations in 1997 with the addition of Edinburgh-headquartered Dundas & Wilson (now CMS) while, in the same year Coopers & Lybrand set up its own law firm, Tite & Lewis, with Stephenson Harwood lawyers Christopher Tite and Mark Lewis.
Following the 1998 merger that created PricewaterhouseCoopers (PwC), Tite & Lewis and Arnheim & Co also joined forces, creating Arheim Tite & Lewis. However, by 2000 Tite & Lewis had broken away to join Ernst & Young, while what was left at PwC rebranded as Landwell.
By 2001 KPMG had entered the fray, signing a deal with the London arm of Scotland’s McGrigors (now Pinsent Masons), whose City branch rebranded as KLegal, leaving Deloitte & Touche as the only one of the Big Five with no standalone legal arm in the UK.
The following year things began to turn sour in legal for the accountants as the fallout from the Enron scandal hit. The energy corporation, which was audited by Andersen, filed for bankruptcy at the end of 2001 after a $100bn accounting fraud unravelled. The next year Andersen, whose staff had shredded documents relating to its auditing of Enron, was found guilty of criminal charges and, as audits cannot be accepted from convicted felons, it could no longer practise in the US.
Although the criminal conviction was later reversed, the reputational damage was felt across the entire Andersen business, which began to implode. When it looked likely that KPMG would make a rescue bid for the accountant’s UK business, Dundas pulled out of the network rather than be pitted against its old rival in Scotland, McGrigors.
In the end Deloitte took over Andersen in the UK, but the deal did not include the legal arm, which at that time numbered 200 Garretts lawyers. With its financial backing gone, Garretts had to be wound up, with then managing partner Tony Williams using his City contacts to find his colleagues new jobs.
In the wake of the Andersen collapse there was increased regulatory concern over the financial links between audit firms and their associated businesses. In 2003 KLegal was disbanded, leaving McGrigors as a standalone firm again, and in 2004 Tite & Lewis split off from EY before being subsumed into Lawrence Graham (now Wragge Lawrence Graham & Co) later that year.
Two years later PwC turned its attentions to legal again, rebranding Landwell as PwC Legal in preparation for the passing of the Legal Services Act, which made multi-disciplinary practices possible.
The act was passed in 2007 and alternative business structures have been possible since March 2012, but it has taken until now for the accountants – and the regulators – to fully get over the shock of Enron.