Bunfight at the A&O corral

Allen & Overy has been attacked by US firms as it tries to reform its partnership. But as its flagship banking group loses market share, is all this tinkering too little, too late?

Allen & Overy

‘s (A&O) partnership retreat last October in the Marriott Hotel on the Edgware Road was a chummy affair by all accounts. Nearly 400 partners turned up for bonding and discussion, mostly on abstract themes.

But one moment touched on very real matters. As part of a talking heads session led by managing partner David Morley and senior partner Guy Beringer, the assembled had the chance to vote electronically on an issue close to most partners’ hearts. Morley and Beringer wanted to canvass the partners about appropriate profitability levels. On a lockstep running from 20 to 50 units, they asked, what would be the right level of profit per point to aim for?
Sixty per cent of partners voted that the firm should target the £20,000-£25,000 bracket. Forty per cent, however, were more hawkish: they said A&O should aim for over £25,000 a point – equating to £1.25m at the top of the 15-year lockstep.

Such questions, of course, are not truly about money; they are about positioning and culture. “We make more money than we ever dreamt of,” admits one partner.

However, the split encapsulated a divide within the partnership. Luckily for Morley and Beringer, the hawks were not in the majority. The 60 per cent who voted for a lower profitability band had unwittingly given management breathing space at the end of a difficult year.

For it truly has been a difficult year for Morley and Beringer. A&O sources indicate that financially the firm is in excellent shape; it is about to reach £24,500 profit per point this year, equating to £1.23m at plateau level.

However, the A&O management has had to deal with a tinderbox. First there was the associate crisis, necessitating a wholesale review of the associate career path after the attrition rate hit 25 per cent. Then almost the entire global management board was rejected in the firmwide elections in March this year, with only Amsterdam corporate partner Sietze Hepkema retaining a place.

For US firms, A&O has been a sitting duck (see box). Some departures may have been managed, but plenty were not – and A&O’s 15-year lockstep does not endear itself to young partners in a hurry (see box on page 22).

Then there is the US practice, which The Lawyer can reveal lost in the region of £15m during the last financial year after partner take, and which has lost £70m in the past five years.

But the biggest challenge for A&O’s central management is how to stop its most powerful department from losing market share with key clients. After three years of lacklustre management, the banking group – the key driver in A&O’s strategy for global expansion – has suffered unprecedented drift, while its rival Clifford Chance is riding high. A&O’s banking group is a classic example of how a bull market can mask problems.

Succession problems

One of the greatest mysteries about the A&O banking department is why, after Morley’s accession to managing partner at the beginning of 2003, it fudged the succession so badly. Morley’s particular blend of charisma and drive made him pretty much a one-off within the group, but his partners appeared to be terrified at the prospect of anyone apeing him.

Instead of electing someone to step into Morley’s shoes, it brought in a board that even A&O partners admit is cumbersome. Veteran projects partner Jonathan Brayne became non-executive chairman, Chris Rushton, formerly Singapore managing partner, became operations partner, and Stephen Gillespie became strategy development partner. Just two years later, at the beginning of 2005-06, global loans head Mike Duncan took over from Brayne, while Gillespie moved across to a firmwide strategy role.

“It’s not always crystal clear that you’ve got somebody with all the skills to manage all the constituencies, so you come up with different arrangements,” says Morley, defending the move.

This sort of fudge is not unheard of at other firms: Clifford Chance experienced similar indecision when it brought in Robert MacVicar and Tim Plews to run the London banking practice in January 2003. However, in a tacit admission that Clifford Chance’s two-headed experiment was a failure, it was junked earlier this year when sponsor finance specialist Mark Stewart replaced the pair.

However, what is inexplicable is why there was not one clear candidate for running a banking practice that three years ago was at the top of its game. Gillespie, who has just quit for Kirkland & Ellis, was seen as a contender by some, but others thought his temperament too volatile. Gillespie was overidentified with the leveraged finance group, dubbed ‘B3’, which did not endear him to the other powerful constituency within the banking group, the global loans team, dubbed ‘B1’.

The reshuffle a year ago has left Duncan and Rushton as group leaders. They provide management ballast, but it is unclear what sort of leadership they offer. Together they are so underplayed as to be verging on the colourless; passion is not much in evidence. Duncan is one of the leading lights in global syndicated lending, with a burgeoning sideline in Islamic finance. He is an all-rounder whose clients include HSBC and ABN Amro, but who also has a following among corporates such as TeliaSonera, Rexam and BAA.

Rushton, meanwhile, had run Singapore with considerable success. “He’s effective,” says a partner. “From a management perspective, he’s ensuring the machine functions.” His role is to be the administrative partner, although on 44 points it makes him an expensive one.

At no other major banking practice does a managing partner do next to no fee-earning and next to no client work. “If you don’t do fee-earning you lose visibility within the partnership,” admits one A&O partner. However, another defends Rushton’s role. “You can look at whatever points he’s on, but there are plenty of [cost] efficiencies he’s brought in which make up for it,” says the partner.

However, A&O partner Robin Harvey argues that he and his partners do not need management as such. “Partners at A&O don’t need to have somebody coming in and telling them what to do,” he says. “Everybody’s self-starting.”

Harvey’s comment underlines the fact that many A&O partners mistake micro-management with leadership. It cannot be coincidental that A&O’ s standing as the number one banking firm has been eroded steadily over the past couple of years, and in two key areas where it has traditionally been market leader: projects and leveraged finance.

In 2004-05, A&O’s projects group lost £5m after partner take. At the time the firm blamed the exchange rate, with projects head Graham Vinter quoted as saying: “The group works in pounds, but mostly bills in dollars.”

If that is the case, then it was strange that the banking management did not see the bigger picture earlier. Linklaters took an axe to partner headcount, while Clifford Chance redeployed fee-earners around the network, but A&O was late in the day in considering options such as running deals out of Dubai – one of the offices that bills in dollars.

The extraordinary outcome was this: management, in consultation with the projects partners, decided to dock points not because of partner underperformance, but because of market conditions. (This logic does not seem to apply to New York, which continues to lose millions a year.)

Instead of culling partners, it was decided to reduce the number of equity points by 172 – helped by the retirement of another senior projects partner Alex Pease, which also brought another 50-odd equity points back into play.

Indeed, one A&O source argues that the points-docking exercise was a knee-jerk reaction. “Morley panicked,” he claims. “He said, ‘you have to do something about this.’ A lot of banking partners felt projects was being subjected to harsher treatment than corporate.”

However, the points reduction did not affect the leading lights, Graham Vinter and Anne Baldock, which raised some eyebrows internally. A&O sources claim that the most recent financial year has seen the group bounce back. “The individuals concerned are all still here,” says a banking partner. “I’d expect within six months to a year they’ll be back to a position that they would have been in – it’s a temporary suspension, with the benefit of hindsight.”

Group divide

Perhaps the monster fees A&O earned first on Marconi in 2002-03 and on Drax in 2003-04 blinded the management to the structural problems in the firm. It is only now that A&O partners admit that they are overcompartmentalised. Morley says: “We’re arguably a little silo’d – there’s more convergence in financial products and we’re working to break down those barriers.”

Nowhere has this been more evident than in the tensions between leveraged finance and global loans.

It is only in the Canary Wharf office that there has been any effective crossover between the two groups, with leveraged buyout (LBO) partners Jackie Evans and Ian Borman sitting with Stephen Kensell and George Link. Notably, this has translated into the global loans partners handling leveraged work.

However, the divide between the global loans and leveraged groups has bedevilled internal organisation for years.

Duncan claims: “Our internal groupings can give false impressions of silos.” But that optimistic view is not borne out by his colleagues. The divide between the groups has never been fully resolved, although the move to the new building in Spitalfields is being touted as the answer to the problem.

Nor did the banking management grapple with the hole in its sponsor finance coverage. Tony Keal had made enough enemies for A&O not to mourn his exit, although his departure for Simpson Thacher last autumn meant the wholesale loss of the firm’s biggest sponsor finance client KKR. Harvey is now the only finance partner with any private equity following, with a lock on the PAI financing work.

Several partners argue that the departures will make things easier in the future. “The big advantage with Tony and Stephen having gone is that the finance practice will probably gel better rather than having a leveraged finance silo,” says one. “That will stop some of the turf wars.”

For the moment, Harvey and new private equity partner Derek Baird have been tasked with getting in more sponsor work. However, there is still an ingrained reluctance to court private equity clients too much. “Markets do tip,” warns Kensell.

“Does it help a banking practice to have a strong private equity practice?” asks leveraged finance head Tim Polglase. “It creates problems. But a good private equity practice is a good thing for the firm, even if it is at the expense of a pure leveraged finance practice.”

Another banking partner is even more sceptical. “Clifford Chance certainly has a nice offering on sponsor coverage,” he says, “but there’s a perception that they’re going over to the dark side on sponsors.”

Inevitably, Clifford Chance partners disagree. Says one: “One of the messages we’ve had from sponsors and banks is that A&O on leveraged are rather set in their ways because they haven’t been seeing much of the sponsor side. You can’t be trying to get the deal you wanted to get two years ago.”

A&O’s weakness on the sponsor side has not gone unnoticed by its banking clients. “The relationship with the financial sponsors is key,” says one client, outlining what he sees as the firm’s key weakness. “All deals that firms do are multi-treed deals and the financial sponsors will say [who they want].”

Belatedly, A&O has begun to address this by tasking Harvey and Baird with the specific objective of building up sponsor relationships (see news story, page 3). But it is not just the sponsor side that needs work. Several banking partners admit that A&O has let certain bank relationships slide. “We need to re-engage with a number of clients,” confesses one partner, echoing several of his colleagues.

On the credit side, A&O maintains an excellent relationship with JPMorgan Chase, mostly through Polglase, as well as with investment bank Mizuho.

But there is plenty of work to be done with three other major institutions. Polglase points to Royal Bank of Scotland (RBS), Barclays and Deutsche Bank as three banks that A&O needs to focus on.

Deutsche has been effectively colonised by White & Case, with Linklaters making a strong showing.

A&O has had a patchy relationship with RBS ever since a senior banker fell out with Keal several years ago. LBO partner Andrew Bamber has worked with the bank, but RBS now mostly uses Ashurst‘s Mark Vickers and Helen Burton and Clifford Chance’s James Johnson.

Meanwhile, A&O is currently focusing on shoring up its relationship with Barclays Capital (BarCap). Historically, that relationship was not helped when A&O fell out with the bank over its financing of Candover’s acquisition of Belgian company Ontex four years ago. According to several sources familiar with the situation, A&O pitched for the deal with a fee quote that overran substantially. But bad blood was caused, say the sources, not by the cost overrun – an occasional hazard of the trade – but by A&O’s rigidity in dealing with the matter. It led to a distinct cooling off of relations.

BarCap and A&O declined to discuss Ontex on the record, but one A&O partner says: “We’ve had our ups and downs [with Barclays] over the years. It didn’t help with the leveraged team but we drew a line under it. These things happen in relationships, but the key thing is to sort it out.”

A major beneficiary of BarCap’s work has been Clifford Chance; and furthermore A&O has to cope with Ashurst’s increasing visibility. BarCap has traditionally chosen between Clifford Chance, Linklaters and A&O, but it opted for Ashurst on the £1.85bn AA buyout. “The guys at Ashurst have done some great work,” says a BarCap source.

The job of building up the Barclays relationship has gone to the man widely tipped to be the next leader of the banking department, Kensell, who has been based in Canary Wharf for four years. There are some promising footholds: Kensell has a good power base in the global loans group and the firm is also strong in the real estate finance section.

However, Kensell – who is one of the few banking partners not to exhibit any signs of complacency – may have a long way to go to get A&O partners’ names known. One banker interviewed by The Lawyer could reel off several names at Clifford Chance and Linklaters, but could only offer up Morley as a contact name at A&O.

A tough future

“Our vision is to remain at the top of the game by concentrating more on our strategic clients, continued development of our people and always with a keen eye on profitability,” declares Duncan.

But even with a strong financial performance this year, with banking group turnover up 13 per cent to £218m from £193m (in the period from March 2005 to March 2006) and profitability up 20 per cent to around £27,000 per point, A&O banking partners are facing ever-increasing competition in London. Their market share is under attack not just from Clifford Chance, but from ambitious outfits such as Linklaters, Ashurst and White & Case. It is going to take a lot more than a new seating plan in the new building to heal the fractures in the group – or, indeed, build a sponsor practice from scratch. Hard work ahead.

 A&O partner departures

Vanessa Blackmore to Sullivan & Cromwell, May 2006
Michael McDonald to Cleary Gottlieb Steen & Hamilton, May 2006
Stephen Gillespie to Kirkland & Ellis, May 2006
Chris Watson to Dechert, February 2006
Franco Vigliano to Ashurst, January 2006
Chin Chong Liew to Linklaters, December 2005
Jonathon Nabarro to Weil Gotshal & Manges, December 2005
Clive Wells to Skadden Arps Slate Meagher & Flom, December 2005
Thomas Werlen to Novartis, September 2005
Tony Keal to Simpson Thacher & Bartlett, September 2005
Justin Jowett to Cadwalader Wickersham & Taft, August 2005
Julian Tucker to Shearman & Sterling, March 2005
Angus Duncan to Cadwalader Wickersham & Taft, March 2005
David Harrison to Berwin Leighton Paisner, March 2005
Stuart Harray to Russell McVeagh, March 2005
Andrea Arosio to Pedersoli e Associati, February 2005

 The lockstep

Allen & Overy’s (A&O) lockstep is the longest in the City, running from 20 to 50 points over 15 years – plus a two-year wait as a non-equity partner. On current form, A&O partners will be in their very late 40s, if they are lucky, before they reach plateau.

Central management has become aware of a certain amount of unrest, say insiders. In December, senior partner Guy Beringer sent round a quarterly email to the partnership suggesting that A&O put aside extra points to benefit key laterals, who in hindsight may have come in at the wrong level. The note clearly referred – although not by name – to members of the Norton Rose four.

Because A&O had essentially matched what they were getting at Norton Rose, the four were despatched to the lower levels of the lockstep, despite the fact that their peers were higher up the ladder. The Lawyer can reveal that Beringer and managing partner David Morley originally wanted to set aside 40 points for that. After strenuous objections by some partners, that was reduced to 20 points.

Accordingly, as The Lawyer revealed last week, from the beginning of the financial year partner Robin Harvey was moved four points (the equivalent of two years) up the lockstep to 28 points, while leveraged finance head Tim Polglase rose two points to 32.

“Robin and Tim had their points adjusted because where they were on the lockstep didn’t reflect their seniority,” says one banking partner. “It has everything to do with equality of esteem – being valued to the same extent as your peers.”

Several A&O partners argue that it was not a defensive move. However, the fact was that the timing of the original email was a month after the departure of Clive Wells – himself one of the Norton Rose four – to Skadden Arps Slate Meagher & Flom.

While the departure of Tony Keal had been telegraphed for months, that of Wells was unexpected, say insiders.