Allen & Overy’s (A&O) New York derivatives risk management business is the latest venture launched with New York senior partner and derivatives star Dan Cunningham in mind.
The beginning of a credible but costly American dream for A&O began in February 2001 when it hired Cunningham from Cravath Swaine & Moore.
Back then nothing came cheaply in New York – especially when Cunningham was believed to have been the first partner ever to have left the white-shoe firm for a rival.
And decamping to an English magic circle upstart made it all the more dramatic, with Cunningham arriving on a price tag far above what A&O’s lockstep could offer at the time.
His base earnings at Cravath exceeded the top of equity at A&O (£1.1m back then) by around $1.35m (£930,000 in 2001). He also had to give up his generous but non-transferable Cravath pension scheme entitlement of around $540,000 (£372,000 in 2001) per year.
A&O, desperate to bring Cunningham on board, proposed to broker a special deal for him that would see him gain part ownership in a derivatives-focused business. According to a memo sent to A&O partners at the time, Cunningham was guaranteed a top-of-lockstep position, separate significant payments to reimburse him for his lost pension and, crucially, a 15 per cent interest in a proposed new derivatives venture to compensate him “for the shortfall in annual earnings” he would suffer by leaving Cravath.
The memo continued: “This interest may prove worthless, but is capped in value at $15m [£10.35m].”
With the original derivatives business, Derivative Services, proving unprofitable, Cunningham now also owns an equity stake in A&O’s new derivatives e-business docGenix, which launched last week, as reported by The Lawyer (1 September).
DocGenix follows directly in the footsteps of Derivative Services, which launched on 11 September 2001, just a few months after Cunningham joined. Its first product, ‘netalytics’, assesses certain risks relating to standard International Swaps and Derivatives Association (ISDA) documentation. With Cunningham being a US counsel to the ISDA, he was a natural fit to work with Derivative Services.
Cunningham’s 15 per cent equity stake is yet to earn him any cash: docGenix has just started up and Derivative Services, which currently has 53 subscribers, has so far posted significant operating losses every year since its inception. After heavy initial investment in the products, losses ran to almost £1.5m in 2002; £584,000 in 2003; £217,000 in 2004; £55,000 in 2005; and £265,000 in 2006.
The figures reveal a significant investment by the wider A&O partnership in the business. But Derivative Services is not a law firm with a law firm business model, explains A&O partner and head of e-business Jonathan Brayne.
“Like other online businesses we’ve chosen not to distribute profit, but rather to reinvest profit and cashflow in new businesses,” he explains. “After netalytics, CSAnalytics was launched in 2003, diligence in 2006 and docGenix in 2008.”
Some of this is now beginning to pay off. For while Derivatives Services is still posting an operating loss, most recently it turned over more than $3m (£1.68m) in subscription fees, while the subscriptions by themselves have been profitable since 2005. However, investment in new ventures such as ‘diligence’, has continued to swallow up the turnover.
Brayne says: “[Cunningham] hasn’t taken cash out of the business, but he has an equity stake in an enterprise that counts 65 per cent of top derivative houses in the world as its customers. That has to have value.”
Cunningham declined to comment, but despite his remuneration falling short of initial estimates, he is clearly committed to A&O for the long haul.
After seven years the magic circle firm’s plateau profit share increased to £1.65m at the 2007-08 year-end, while the average figure at Cravath for the 2007 calendar year was also £1.65m.
While ;Cunningham ;may, ;by comparison, be out of pocket now, if he ever decides to cash out, ultimately his shares in Derivative Services and docGenix may prove financially valuable after all.