The Transatlantic Elite 2009: The shape of firms to come

How serious and far-reaching are the structural changes facing the world’s top law firms? That in essence was the question put by The Lawyer earlier this year to some of the world’s top lawyers. Taking a cue from one of the best-known specialists on law firm finances, Citi Private Bank’s law firm group head Dan DiPietro, we asked whether firms were facing a typical cyclical downturn or a paradigm shift and, if the latter, what that would mean for their firms.

Here, verbatim, is what they said:

David Childs
Managing partner, Clifford Chance
We have an ongoing financial crisis which has been followed by deep recessions/economic slowdowns almost right across the globe. As a result a number of financial institutions which previously provided significant volumes of revenue for law firms are now contracting, exiting some product areas and ­generally  are likely to have a reduced legal spend for the next three years or more.

Accordingly for some groups of lawyers this is a paradigm shift.  However, overall I do not believe that we are seeing a paradigm shift for law firms like my own. As deep as it is, the current recessions in the US and Western Europe will come to an end and no doubt the overall demand for legal services will at some point in the next 12 to 18 months start to rise again. The challenge for law firms at the moment is both reacting to the severe downturn in demand for our services as well as rebalancing our firms to have the right shape for when the world starts to get back to the new normal. 

Clearly some product groups are not going to see the activity levels they experienced two years ago at any time in the next five years, indeed if ever.

I do see this as very different from other ‘cyclical’ downturns in the last 30 years. The major global banks will obviously come out of this in a very different form, and probably with different functions,  and we will see the emergence of other financial organisations that will participate in the development of new structures that will help fund the growth that will undoubtedly return to world markets.

We plan to help in the development and ­implementation of those structures and the inevitably tighter regulatory landscape that is ­developing. Other areas, such as M&A and real estate investments, will return once valuations stabilise and there will be buyers looking hard at some very ­attractive assets. The depth of the recession in so many ­markets, though, suggests that the downturn will be longer and harder than we have known.

Walt Smith
Managing partner, Baker Botts

It definitely is not ‘business as usual’ and our review of the situation and the responsive actions we ­believe are necessary will be ongoing throughout the year.

Jim Rishwain
Chair, Pillsbury Winthrop Shaw Pittman

We are in a new economy where no assumption is safe. The challenges that presently exist for the world, the US, our clients and our legal industry are the most significant of our times. With these ­challenges comes a significant opportunity for the global economy and the legal industry to evolve. We hope that this opportunity is seized. 

The US economy has been simply surviving.  We have formed a global business evolution team which is exploring how our clients will need to adjust to navigate these uncharted waters and how we can best organise our legal teams to anticipate clients’ needs and position them for future success. We are focused on how our legal industry will need to adapt in addressing clients’ demand for legal services. 

We believe a global presence is important for both Pillsbury and our clients. Pillsbury has a truly global client base and must be and go where our clients are.  This is why, in addition to our London office, we’ve expanded our Shanghai office and formed an alliance with a firm in the United Arab Emirates. 

There is simply no turning away from the global approach for us - our clients are international in scale and there is tremendous demand for counsel
on different nations’ trade, financial, IP and other ­regulatory regimes, as well as advising on business strategies. 

Nations see expanding free trade as an imperative for economic recovery, and our busy international trade practice, among others, benefits from our ­presence across continents. 

Seth Zachary
Chairman, Paul Hastings Janofsky & Walker

There is no doubt that this new climate is a radical game changer for law firms. Everyone, everywhere is being forced to think differently.

It is up to law firm CEOs to get out in front of these challenges and manage them deftly. At the same time, the most successful law firm leaders will also be sure to keep their lawyers and staff ­relentlessly focused on client service.

If your firm is well-managed and your practice and client base are well diversified, you should be able to not only manage current market conditions, but unearth new opportunities. We have managed our firm prudently, stayed focused on recruiting and retaining an outstanding roster of talent, and ­invested in our practice area and geographic ­diversification. We are optimistic about our future as we find new ways to add value to our clients’ ­businesses during these challenging times.

Michael Frawley
Managing partner, Taylor Wessing

It’s both a cyclical downturn and a paradigm shift. The legal market was already starting to shift  due to client pressure on fees and a move away from chargeable hours to alternative and more ­predictable charging models. The economic ­downturn has just speeded up that process asclients become more cost-conscious.

I don’t see the pyramid structure changing but law firms will become more corporate in the way they manage themselves. 

I think the legal market will split into four distinct groups: the very large firms, a smaller mid-market group, boutiques and firms doing commoditised work (for example personal injury and ­conveyancing). 

The latter  will probably be acquired by private equity houses and the like under the Legal Services Act. Apart from the big boys, I think you will see a significant reduction/adjustment in lawyers’ ­remuneration and I don’t think we will see the heady days of 2007-08 for some time, if at all.
  
Chris Saul
Senior partner, Slaughter and May

My own view is that, in law firm terms, we are ­looking at a hybrid  between a cyclical downturn and a paradigm shift.

The explosion of credit which we’ve seen over the past 10 years or so and the deal activity which it has helped to drive the market means that this downturn has a ­different quality of intensity about it compared with previous ones. 

Law firms built up practice areas in leveraged finance, high-yield debt, asset-backed finance and elsewhere, which brought with it a level of law firm activity which was not seen when the downturns in the early 1970s and the early 1990s, for example, were beginning. 

This, by all means, presents significant challenges for law firms as business in a number of areas has slowed. Thus, we are seeing various firms taking steps aimed at reshaping themselves. 

In some senses, this is a reflection of the fact that over the past 10 years or so, many law firms have moved with success more in the direction of the investment banking product-based model. ­Accordingly, with the contraction of products in the financial services and deal-doing market, law firms have had to follow the path previously trodden by investment banks of flexing the shape of the firm.

At the same time, my suspicion is that this ­downturn, even with its more intense quality, will not fundamentally change the structure of many law firms. 

At Slaughter and May we have pursued a different approach, of course, with our ‘best friends’ model. We have found this to work well in buoyant ­markets and, with absolutely no sense of complacency, to be a strong model for more difficult times. 

The law firms that have gone with the global model, which is neither better nor worse than ours, but clearly different, will stick with their approach. 

The shape of that model will be tweaked in ­different ways between firms, but firms such as Allen & Overy, Clifford Chance, Freshfields and ­Linklaters will, I think, look broadly the same in a few years’ time to the way they look now.

So that’s why I think that we are somewhere between a cyclical downturn and a paradigm shift.  This radical change in the shape of the financial ­markets will mean that many law firms will turn the dial on their models, but I don’t think that they will be throwing away the model and getting a new one.

 Bill Lee
Co-managing partner, WilmerHale

I am not sure and I don’t think anyone else should be either.  More importantly, it does not matter. 

This is the third or fourth time that significant changes in the economy have led folks to predict a paradigm shift.

It happened when Steve Brill predicted a world dominated by 10 megafirms. It happened when ­pundits predicted that the technology firms would dominate the world. Both periods of time resulted in changes to be sure. Whether they were evolutionary or  paradigm shifts seems less important than the fact that change occurred.

What we do know is that this is an extraordinary time and extraordinary times provide important opportunities to ‘reset’ priorities. That is what strong institutions will do.

The Chinese symbol for crisis has two parts: one, by itself, means danger, the other means opportunity. Great firms will recognize this time as characterised by both. 

Whatever the characterisation is, there will be changes in the legal profession. They will include structure issues and they will certainly include the manner in which our services are billed.  Like any other institution, we need to adjust to the times.  

Sir Nigel Knowles
Joint chief executive officer, DLA Piper

This is a paradigm shift. There are going to be many long-term implications arising out of the current ­environment.

The magic circle and charmed circle will say there has been a ‘flight to quality’. There has, but there has also been a flight to value.

There will be fewer clients, particularly in the financial services sector, and the clients will want to pay less. There is going to be tremendous pressure on fee rates, particularly those rates often charged by the magic and charmed circles. 

Corporate clients could now become more ­important, and the business model and financial model of law firms  is bound to change. I think equity will get tighter and firms will get smaller and there will be some pressure on earnings for several years.

I think diversity is now very important, both from a practice group point of view and from the point of view of geography. 

The global model, with true practice group and geographical diversity, is now proven beyond any doubt to be the more sustainable. 

 Peter Kalis
Chairman, K&L Gates

 This is both a cyclical downturn and a paradigm shift. The current economic environment has all of the characteristics of a classical cyclical ­downturn in the economy, ie a recession. We see heightened ­unemployment, lowered economic ­output as ­measured by GDP, reduced stock ­valuations and ­opportunistic politicians ­contributing little by way of solution and much by way of ­obfuscation and confusion. Sounds like a ­recession to me.

But there is more. For the last decade, the global economy has been fuelled in part by the infusion of huge amounts of money without any rational nexus to underlying value. Deals were consummated, ­fractionalised and dispersed throughout the world, and in retrospect the values affixed to them at the time 
The result? The global econo

my has been pushed to the brink and perhaps beyond. The financial ­system is largely in ruin. Great financial institutions are exposed; others have toppled.

hey will recover but not in the same form. The process of deleveraging will take years, and this distinguishes our ­situation from a ‘mere’ recession.

In one sense, the current economic situation is the greatest possible compliment to globalisation. As it turns out, we not only move people, products, capital and services across national boundaries, but also move lethal financial contagions across those boundaries as well. The seamless global quality to the financial collapse also distinguishes our ­situation from a ‘mere’ recession, and this is the ­second factor suggesting a new paradigm.

But the most profound differentiator is at the ­systemic level.  Compare this situation with prior recessions.  Focus on the bursting of the dotcom bubble almost a decade ago.  In the US, that ­recession commenced in the first quarter of 2001.

It was largely premised on the untenability of the notion that earnings do not matter.  Companies could magically spring into life with some venture capital, never generate earnings, and live happily ever after. Of course, that charade ended and a recession ensued. But the fundamental financial system that underlies modern economies was not impaired. 

People were unemployed, which is always ­terrible.  Investors lost money, which is lamentable.  But the fundamentals of a modern society - great financial institutions playing their roles in moving capital to efficient outcomes - were not impaired. It took a year or two and then the economy came back. Game, set, match in favor of the status quo. 

In 2009, the status quo ante is in shreds, and this third factor points solidly in the direction of a new paradigm.

So what is the paradigm shift now? First, the process of deleveraging means that we all have to become accustomed to more subdued levels of ­economic activity for an open-ended period. 

Second, the globalisation of the downturn means that national solutions are of limited use. 

Third, the financial system is in ruins and Wall Street effectively has moved to Washington. And although the capital markets will surely reappear, they will be less robust and will certainly generate much smaller margins for their participants than they have in the past.  

The paradigm shift has a number of key ­implications for our industry. First, a law firm ­without a leading policy practice in Washington is fighting for its clients with one hand tied behind its back. 

Second, the model whereby Wall Street law firms could feast on the extraordinary margins of ­investment banks,  award lavish profits to their ­partners, pay for massive unfunded retirement ­benefits for their partners, incur substantial debt and emphasise consumption over investment in other geographical and product markets is dead as a doornail.  And those who deny that fact may be called the walking dead.

Third,  enlightened law firms for years have been offering alternative fee arrangements to clients.  To hear a leader of a Wall Street firm recently  issue a clarion call for alternative fees was amusing. One wonders whether his call to action might have ­something to do with preserving margins in an era in which they are severely threatened.

Fourth, again, enlightened law firms have been morphing from a pyramid to a diamond structure for years. Wall Street hasn’t received that message yet, or at least it hasn’t acknowledged that message. 

This of course has implications for the market for talent: smaller summer programmes, smaller ­entering classes and so on, relatively larger numbers of senior associates and income partners, re-examination of the ‘up or out’ philosophy.

Fifth, diversification is and will be the key. ­Diversification across nations, markets, currencies, industries and practices. Sometimes common ­wisdom says it all: why put all of your eggs in one basket - or even a few?

We anticipated the emergence of a new paradigm and are wholly subscribed to and grateful for our positioning. Of course, we didn’t have any idea that the events in autumn 2008 would usher in the new paradigm so quickly. But here we are. 

I think it’s an oversimplification to talk about ‘a global law firm’.  Some appear to be  global but in my view do not qualify as such. The question is whether in its far-flung venues a law firm has the ability to practise local law at the highest level while at the same time being able to handle cross-border ­matters. 

Do I have faith in that model? Yes, endless faith. Why? Not because of some abstract philosophical proposition but because that’s how our clients do business. We sell what our clients are buying.