Feature: Herbies’ growing pains

Herbert Smith’s conservatism stops here, with the firm embracing Allen Hanen’s strategy to catch up to the magic circle on both profitability and international spread

(l-r) Scott and Willis: forward thinking
(l-r) Scott and Willis: forward thinking

Two years ago Herbert Smith faced a choice. With maverick senior partner David Gold preparing for retirement, it could either keep the faith and ­install another litigator to succeed him or, as many had begun pushing for, it could go back to its roots and elect a corporate lawyer.

Two candidates were Herbert Smith men born and bred: competition partner Jonathan Scott and ­litigator Tim Parkes. But a third was an outsider in the shape of Allen Hanen, a Moscow-based Canadian who had not even trained at the firm.
The third man’s chances looked slim.

“A number of guys said Allen’s got good ideas but he’ll never be senior partner because he’s not British and he’s not spent his life at Herbert Smith,” reveals a source close to the firm.

But there was a shock in store for Herbert Smith. In the first round of voting the outsider beat quintessential firm man Parkes.

“That really surprised people,” says a former partner.

What drove Hanen’s success in that first vote was sheer cultural novelty in this most straitlaced of City firms. He displayed an attention to detail and articulation of strategic ­vision that many partners found ­refreshing.

“He had a very good manifesto and gave a very compelling speech to the partnership,” recalls one partner who has since left the firm. “He also spoke one-on-one to every single partner. Every partner outside London voted for him and a lot in London too.”

Ultimately the London partners backed one of their own: Scott emerged as the victor, and his career-long history at the firm was a deciding factor. But then something extraordinary happened. Hanen, the loser in the race, was given a seat on the ­executive committee, which had been charged with undertaking a strategic review of the firm. The ­outsider was brought inside the tent.

The result? Project Blue Sky, a blueprint for internationalisation and ­financial resurgence that if successful would radically remodel the firm and ready it for membership of the legal world’s elite.

In with the in-crowd

Club membership is something Herbert Smith does well. The mentality that kept Hanen out of the senior partner job is the very mentality that has held the firm back from global ­expansion until now.

But however you slice and dice it, Herbert Smith is a firm riven by ­factions. Whether it is the litigators versus the corporate partners, the homegrown elder statesmen versus the firm-hopping upstarts, or the energy group versus practically everyone else, you are either in the ’in group’ or you are not.

“It’s a political firm and it suits a lot of people to have factions,” says a source. “It’s an anarchic place.”

Psychologically, that’s damaging. Strategically, it’s paralysing.

A big part of the problem is that many of the senior partners who have remained with the firm since their trainee days 20-30 years ago have a warped concept of what the firm is.

“For the people who are senior at Herbert Smith now, the peer group 20 years ago was Clifford Chance and Slaughter and May,” says a ­partner who left the firm in 2011. “The ­psychological difficulty now is ­saying, ’That was your peer group then, and maybe even 10 years ago, but ­somewhere in between it’s changed’.”

Unless these partners, who have traditionally held all the power, can take a realistic view of their firm and its position in the market, Project Blue Sky’s ambitions will not be ­realised.

For Scott, undertaking the project at all shows that the firm is at least willing to embrace some kind of change.

“I hope you feel that we’re grasping some of the nettles there’s been a ­perception that the management at Herbert Smith has been ­unwilling to grasp,” he says. “We’re thinking about our platform and are obviously ­running a business-­improvement project as well.

“We’re very focused on driving up profitability, which might be a ­challenge in the current market, but we’re taking the right decisions now with the long-term hope of addressing top-line growth and we’re not ­exactly going over the top in terms of adding to the profit share.”

All change

First mooted at the beginning of 2011, the Hanen-led review was supposed to see the firm ease itself into a spot of international expansion. But something that began as an adjunct to daily firm life soon morphed into a sole strategic preoccupation after a series of high-profile departures served as a wake-up call. The status quo was no longer an option.
Even a member of the group overseeing the strategic review, Asia head Ashley Alder, left the firm during the course of the review to join the Hong Kong Securities & Futures Commission in October 2011.

According to one of numerous sources interviewed by The Lawyer, there had been frustration among many partners about the way the firm was being run, leading some to seek positions elsewhere.

“In order to try to stop them or get them to stay a bit longer, they accelerated Project Blue Sky,” one partner recalls. “It’s more advanced now than the original timetable, partly because there were so many departures.”

To outsiders the strategic sea change that has seen Herbert Smith sever its European alliance, eye launches from New York to South Korea and carry out a round of long overdue de-equitisations has come as something of a shock. This is,
after all, what one former partner terms a “staggeringly conservative” operation.

However, the meat of Blue Sky was all found in Hanen’s election ­programme back in 2009, confirm several sources.
“A lot of what was in Project Blue Sky was in [Hanen’s senior partner election] manifesto,” says a source. “He’s driven all this forward.”

You’ve got to be in it to win it

For Hanen, the key for any firm looking to compete on an international basis is an integrated platform, something Herbert Smith has offered on a piecemeal basis since allying itself to Germany’s Gleiss Lutz and Benelux firm Stibbe a decade ago.

“One of the things we’ve seen is that if you’re not in a jurisdiction where your peer firms are then they’ll get more work than you,” he states. “It’s also true that when you’re in some markets, such as Kazakhstan, while we don’t have an office there, neither do many firms like Freshfields [Bruckhaus Deringer], Linklaters or Cleary ­[Gottlieb Steen & Hamilton].

“We still see a very healthy flow of instructions there, but in jurisdictions where your peer firms are and you’re not, over time your flow of work will diminish and their flow of work will increase.”

Thinking differently

And while from a PR perspective the firm thought it could sell the European alliance as being as seamless as a one-firm approach, the reality could not have been further from the truth.

“The various firms didn’t have the same conception of the alliance,” confides a partner at one of the European alliance firms. “Herbert Smith thought it would complement its ­international offering, while Stibbe and Gleiss saw it more as a referral network where they could send or ­receive work, but not really work with the other offices as if it was one entity.
“Partners saw themselves as ­partners of Herbert Smith, Gleiss Lutz or Stibbe, but not as partners of the alliance.”

Hanen’s Blue Sky team recognised that clients did not buy the setup ­either, meaning the firm was missing out on complex and – crucially – highly ­remunerated cross-border deals. Something had to give.

“We decided that the alliance was no longer meeting our strategic goals; we decided that the alliance was coming to an end,” asserts Hanen. “We went to our alliance partners and said, ’If you’re interested in a merger then lets get together and talk about this, but the alliance isn’t the answer for us going forward’. This was us ­precipitating events.”

The clear preference within Herbert Smith was for a merger.

“The alliance had stood still and I think that relationships that stand still, whether marriages or personal relationships or whatever, reach the end of their useful lives,” says Scott. “You don’t put 10 years into a relationship and then give up without trying. We thought about it very carefully and were very clear that we needed to have an international platform. We’d much rather have done that with Gleiss. But am I surprised that they said no? No.”

Without the alliance Herbert Smith’s coverage of Europe is patchy at best, with offices in Paris, Madrid, Moscow and Brussels. And missing out on the German story at a time when most other European markets are in meltdown is more than painful, especially given the uphill struggle Herbert Smith now faces in building a presence there from scratch (see Trouble Deutsche box, above right).

Of course, the gaps in Herbert Smith’s international coverage go ­beyond just Europe. Hanen’s Project Blue Sky aims to address at least some of them, with launches in ­Germany and New York a priority, while deals in Australia – most likely via a tie-up with Freehills – and South Korea are high up the list and South Africa, Ghana and Vietnam are all also in the mix.

A key facet of the strategy is that ­individual partners or teams take ­ownership of each separate recommendation, with minimal interference from central management.

James and the Big Apple

A New York launch has long been on the litigation team’s wishlist, ­although until now any move has been thwarted by the erstwhile big-billing corporate faction.

“It was always resisted by [global head of corporate James] Palmer,” ­reveals a former corporate partner of the firm. “Herbert Smith was a real beneficiary of other UK firms opening in New York. The people who benefited most were those doing the European part of M&A deals that ­Cravath [Swaine & Moore] and Simpson Thacher [& Bartlett] couldn’t do themselves, which was divided between Herbert Smith and Slaughter and May. They were excited that ­Cravath called them and didn’t want to jeopardise that relationship.”

The perception of conflicts was also an issue, with the corporate and finance teams forcing the litigators to turn down quality mandates for fear of denting their standing with banking clients.

“There are litigation partners who complain about the fact that we turn down significant cases on the basis of soft conflicts, not even hard ­conflicts,” says an ex-partner. “Ten to 15 years ago Herbert Smith would take an investment bank down a dark alley and kick the sh*t out of it. It won’t do that now.”

But with the corporate group now pitching in with only a fraction of what litigation contributes to the firm’s profit – being forced to cut back its share of the equity as a result (see Magic numbers box on facing page) – it is the litigators who are now calling the shots.

And global litigation head Sonya ­Leydecker, who is leading the US push alongside global arbitration co-head Paula Hodges, has clearly been converted to Hanen’s cause.

Referring to the investigations work that she envisages New York handling, Leydecker stresses that having a team conversant with the US Foreign Corrupt Practices Act (FCPA), which has an influence way beyond the US shoreline, should stop clients straying to US firms for help on such matters. “It’s a means of making sure we can win work in ­jurisdictions we’re already in by having New York,” she argues.

The firm’s Australian bid is being led by corporate partner Greg Mulley, who as an Australian previously worked at Allens Arthur Robinson and has strong relationships with Freehills and Clayton Utz. It is ­understood that Hong Kong-based US ­securities partner Kevin Roy, who speaks fluent German and was at one point going to relocate to Frankfurt to take a role in the ­alliance, will be active in driving the firm’s German plans.

So far, so strategic, but planning is the easy part. A source in New York says Herbert Smith is wooing two teams for its litigation launch and is waving its chequebook in a bid to ­entice them across. But at a time when it is having to cut partners out of the equity just to make its bottom line attractive, questions hang over how the firm will finance its Blue Sky aspirations.

Scott dismisses this. “We’re comfortable that we have the resources to do what we want to do,” he stresses. “There are ways of doing it. One of the joys of being a private business is that we’re not answerable to private shareholders, so we’d rather keep [how we’ll fund it] to ­ourselves.”

Another concern is that Herbert Smith is so late to the global party that it should consider a different strategy completely.
“They should bite the bullet and go to a US firm; there’s absolutely no ­alternative for them but a US merger,” opines a source close to the firm. “They won’t be radical enough. They’ve missed the boat to become a global elite firm.”

These sentiments are echoed by a partner at a US firm who believes that “Herbert Smith missed the international boat at least 15 years ago”.

Not so, says Hanen, who claims that the firm has just been ­biding its time until all of its partners were ready to come along for the ride.

“We’re an institution that needs to be persuaded by facts and evidence,” he asserts. “Herbert Smith’s mischaracterised as being conservative and unwilling to change.

“What Herbert Smith is about is having a lot of very smart people who want to see the ­evidence, want to see the proof, want to see the ­arguments. We have to show that to partners, and when that happens we’re very bold.”

Despite this, partners who left ­because they were exasperated with what they saw as the firm’s lack of strategic vision fear the new ­direction will not be radical enough, although all agree that if it is to be done Hanen is the man to push it through.

“Everyone recognises now that they should have gone for him,” ­reflects a source close to the firm.

Hanen may have lost the senior partner race, but Herbert Smith is ­relying on his vision. History is not always written by the winners.

  • Magic numbers

For Herbert Smith, attaining magic circle-level profitability, for which read average profit per equity ­partner (PEP) rather than net profit, is the Holy Grail.

It is no coincidence, then, that when the firm’s profit margin dropped from 35 per cent in 2007-08 to 26 per cent the following financial year, the number of partners in its salaried ’B’ class increased.

One of the easiest ways of boosting PEP is to decrease the number of people eligible for a profit share, which is why the firm is currently engaged in a round of de-equitisations in its corporate and finance ­practices.

In the 2010-11 financial year the ­average profit generated by each corporate and finance partner was around £500,000 against the £1.4m generated by the average litigator. Meanwhile, equity partners across all practice groups received an average share of £900,000.

One former partner claims the ­situation has arisen due to the firm’s solid opposition to managing its lockstep, meaning partners progress to and remain on plateau regardless of their contribution to the firm.

“It’s very difficult to get into the lockstep, but once you’re in you’re not managed any more,” the ex-­partner reveals. “We had some partner ­meetings where they circulated partner billings. Some did £100,000 or £200,000 in a year, but collected £1m.”

Under Project Blue Sky the firm will now remove 1,200 equity points from its corporate and finance teams and has identified a number of ­partners who will be asked to either move from ’A’ partner equity status to the ’B’ partner salaried level – that or leave the firm.

The aim is to propel PEP into the £1m-plus level of the magic circle. But, of course, PEP does not tell the full story. Earnings per partner (EPP), which takes account of the earnings of all classes of partner, gives a more accurate reflection of a firm’s remuneration.

While Herbert Smith saw its PEP rise by 10 per cent over the five years to 2010-11, with some fluctuations in between, EPP rose by just 4 per cent.

Boosting PEP is the easy part; ­improving EPP is a whole other ­challenge.

  • The two at the top

Managing partner David Willis and senior partner Jonathan Scott have spent their entire working careers at Herbert Smith, joining as trainees in 1981 and 1979 respectively. Both have management experience and have spent time in overseas offices. Corporate lawyer Willis headed Asia between 1997 and 2001, while Scott set up Brussels in 1989 before ­returning to London to lead the EU and competition practice from the mid-1990s to 2007.

Willis was handed the managing partner role in 2008 by former ­senior partner and litigator extraordinaire David Gold in a political move ­designed to appease the ­factions in the firm that were uncomfortable with having a litigator at the helm. Scott joined Willis at the top table upon Gold’s retirement in 2010.

One source claims that the firm thought the Willis-Scott partner-ship would be akin to the success-ful ­Clifford Chance double act of technocratic managing partner David Childs and ambassadorial senior partner Stuart Popham.

“Childs and Popham [who was ­replaced as senior partner by ­Malcolm Sweeting a year ago] were a very good combination,” says the source. “Childs was the tough ­manager, Popham was the charmer, and it worked brilliantly. A lot of ­people thought Willis and Scott could have been that, but it hasn’t worked out that way.”

The problem, according to a source, is that Willis “isn’t as tough as people think”, with what one ex-partner calls the firm’s “club mentality” holding it back from ­upsetting the status quo.

Another ex-partner agrees. “I’m not sure management’s strong enough,” asserts the ex-partner. “Scott’s a strong senior partner, but neither he nor Willis will manage to ram anything through Herbert Smith. That will be one of the dangers: if what it needs is something very aggressive or forceful, all hell will break loose.”