Law firms require outside directors. Heresy you say? Yes, but they really, really need them. The bigger and most successful firms need them the most but almost any sized firm could use the expertise that an outsider would bring. Why? 

Dewey & LeBoeuf represents today’s most convincing argument, but going all the way back to Finley Kumble’s demise in the late 1980s, major law firms, and many not-so-major firms, have failed to manage risk. This failure occurs in part because the governance structure of virtually all law firms excludes outside perspectives.

Here are three recent examples.

•    Dewey guaranteed compensation to a number of its partners, guarantees that wound up being paid from the shares of existing partners when profit growth didn’t meet projections. Assuming there will never be periods of revenue downturns is highly risky.

•    Howrey opened a number of European offices, failing to consider that European conflict procedures would slow revenue growth. The firm bet that contingent fee earnings would only create higher and higher peaks rather than understanding that valleys almost always follow peaks.

•    Thacher Proffitt & Wood grew incredibly fast from 2002 through 2006 on the strength of mortgage-backed securities deals and other structured finance transactions. When this market collapsed in 2008, the folly of the firm having all its eggs in one basket became clear, as it did for those who bought only technology stocks in 1999 ahead of the dotcom crash.

These three firms represent examples of businesses that failed to manage risk. A similar trend marks other law firms that have failed. The managing partners of these firms may have been extremely capable, but their governing committees were composed of partners with training and work experiences similar to their own. There were no outsiders asking tough questions about the risk inherent in particular strategies. Of course, the more traditional explanations, such as a breakdown in the collegiality among partners or the concentration of decision-making among just a few partners, may have contributed to the demise of these firms as well.
 
Obviously, there is no single action that will result in law firms eliminating the potential risks to their businesses. However, the probability that risk could be managed more effectively would increase with the inclusion of non-lawyers from outside the firm as voting members of a firm’s governing committee.

Outsiders are more likely to ask probing questions designed to protect a firm as opposed to safeguarding individual practices or partner interests. By contrast, partner members of the governing committee have an inevitable concern that their compensation will be reduced or their practice areas penalized if they challenge proposed actions.

Law firms are very traditional organizations. To the authors’ knowledge, no firm has added outside members to its governing body. In normal times, this conservative bias would leave the status quo untouched. But the implosion of so many firms proves these are not normal times. Firms are experiencing intense competitive pressure, encouraging those with vision to seek ways to differentiate their firms from the pack. Adding outside members to a law firm’s governing body would attract clients and potential clients that would view the law firm as more sophisticated and more likely to operate with a greater awareness of prudent business practices than its peers.

Adding outside members could also strengthen the confidence partners feel in their firm, thereby lessening the fundamental risk of partner departures. In one sense, adding outside members would signal to the partners that the old methods of managing are no longer sufficient for continued success. The firm would, in essence, be saying, “We are different and we are going to manage differently.” In another and perhaps more important sense, the outside members could counteract skepticism about management’s actions as expressed by the inevitable sub-groups of partners who wonder about those who make up the governing body.

A perfect example involves decisions that governing members make about their own compensation. A compensation subcommittee of the board composed mostly of outside directors charged with establishing compensation for the other board members could effectively address this concern. Overall, the partners would have greater confidence that management is focusing on solid business principles without being unduly influenced by individual partner self interest. In addition to gaining greater confidence about the direction of the firm, partners would have greater stability not for just themselves but for everyone who works at the firm.

Managing partners and their governing body members are often so consumed with day-to-day matters that they may miss opportunities that could make their firm more successful. The demands of maintaining their individual practices and addressing partners’ interpersonal issues also divert them from tackling risk and strategic issues facing the firm. An outside member of the governing body can bring an independent mindset that could provide the perspective necessary for the firm to meet its goals and objectives.

Is it really necessary to add a voting nonlawyer to a firm’s governing committee?  Why won’t an adviser sitting in on board meetings do just as well? About 10 years ago, one of us convinced our managing partner and another member of the executive committee to include an outside consultant at the monthly meetings for a year. The consultant was smart and experienced enough to contribute to many of the issues that arose in the course of the year. But the committee members knew they didn’t really have to pay attention to what he said, because they recognized that he didn’t really have a constituency within the firm. Partners outside of the committee failed to ask what this outsider’s point of view was about any issue before the committee. In one sense, he didn’t matter. At the end of the year, the firm ended this test relationship.

Managing partners may be loath to invite an outsider to participate in the governance of their firms. They could perceive this action as a reduction in their power to lead the organization. But the inclusion of a nonlawyer outsider would be a brilliant example of anticipating what a firm needs, a critical trait of a true strategic thinker. The managing partner would know she was serving the partners’ interest, expanding the attractiveness of the firm to its clients, and enhancing her his or her personal prestige.

Paul Bellows has worked with law firms since 1981, recently as chief operating officer for a 500+ lawyer, nine-office firm.  He holds a MBA from The Wharton School and developed his leadership expertise as a U.S. naval officer. He and Al are partners in Leadership Alternatives, LLC, a law firm consulting company. He can be reached at Pbellows@Leadership-Alternatives.com.
 
Al Conti worked with law firms since 1973, serving in executive director/COO roles with a major New York firm, several large multi-office regional firms, and in-house with a Fortune 20 company managing its corporate legal department.  He also spent eight years with one of the Big Four public accounting firms. He and Paul are partners in Leadership Alternatives, LLC, a law firm consulting company.  He can be reached at Aconti@Leadership-Alternatives.com.