Freshfields’ smoke and mirrors puts PEP at magic million mark

As readers may be aware, 2007 is The Lawyer’s 20th anniversary year. It’s an occasion that has prompted a great deal of trawling through back issues, searching for trends that point to the development of the UK legal market.

Few things highlight the growth of the market as well as money. Way back in the 1990s, the emergence of the first £500,000 partner job offer was big news. Last week showed how much things have changed when the benchmark for top City partner remuneration was firmly set at £1m.

True, Linklaters was the first of the four global elite firms to hit a seven-figure average profit per equity partner (PEP) when it posted £1.06m last year.

But last week Clifford Chance managing partner David Childs announced a PEP of £1.02m, shortly followed by Freshfields Bruckhaus Deringer chief executive Ted Burke declaring £1.04m. Both confirmed that the market has moved on.

The £1m PEP benchmark is not only a hugely significant psychological benchmark. More importantly, it marks a profound market shift in the international fortunes of the UK’s top firms.

“What we’re seeing is the magic circle firms go up the global league tables in terms of PEP,” says one senior City partner. “To some extent this is down to the dollar depreciation, but a lot is down to revenue and profit growth. Partners look at relative prosperity, not absolute targets.”

A Freshfields partner adds that “not a single partner” he knows thinks it important to get above the £1m PEP level, adding that “getting to £1bn in revenues” didn’t register either. “What people want is continued growth,” he says.

But it’s hard to believe that the highly competitive partners at Freshfields, or Clifford Chance for that matter, haven’t been casting an eye over Linklaters’ PEP performance with just a hint of envy.

As Childs puts it: “Partners care about comparability with peer firms.”

Which makes it even harder to ignore the nagging suspicion that there’s just the tiniest bit of manipulation going on with Freshfields’ figures. As Allen & Overy senior partner Guy Beringer might tell us, his firm is the only one of the magic circle that is an LLP, and therefore required to disclose figures (although Linklaters has just converted).

In other words, Freshfields can say more or less what it likes. (Beringer, however, believes he’s already said all he wants to say about PEP and preferred not to comment.)

Freshfields confounded the market’s expectations by hitting the £1m benchmark not next year, after the firm has slimmed down, but in the same year it completed one of the biggest restructurings ever seen in the City.

Smith & Williamson partner Colin Ives says: “It’s understandable to a degree, but it’s sometimes better to accept difficult news than pursue PEP, particularly when the market was already expecting bad news.

“All firms need to be aware of market perception, but the changes for Freshfields are generally viewed positively for the future, and surely the future is more important than PEP to a lateral? Next year the £1m-plus PEP would have been expected and delivered. That’s a powerful message.”

Something in the region of 100 partners exited Freshfields’ former all-equity partnership last year via early retirement, redundancy or high-tailing it elsewhere.

The firm’s PEP is based on an average of 474 equity partners over the year and a net profit of £491m. And this is the nub of the great Freshfields £1m PEP mystery.

What has Freshfields done with the cost of that restructuring? Does its PEP figure reflect what’s left before or after that has been taken into account?The firm’s finance director Laurence Milsted says the PEP is an “accurate reflection” of the profit the business has produced, which has then been split between the partners that produced it.

But sources say that because Freshfields has to pay certain partners an additional share of profit by way of compensation, £1.04m is not necessarily what partners have taken home.

Freshfields has paid the partners that have left their profit share, plus any additional payments, out of profit as a below-the-line cost. A perfectly fair accounting treatment and one that allows it to post a PEP above £1m.

In reality, though, the PEP for ongoing partners at Freshfields will be below the magic million thanks to what Jomati consultant Tony Williams calls “the pay-off kicker”. Some kick.