When is a law firm not a law firm?

That sounds like the setup to the driest joke of all time. In fact, it’s the subject of serious debate within the industry.

Take Norton Rose. This summer the London-based firm will finally secure a long-sought-after American deal, when it combines with Fulbright & Jaworski to create a 3,800-lawyer, 55-office giant that will rank among the world’s 10 largest law firms by revenue and second to only Baker & McKenzie by attorney head count.

The move marks the latest step in a remarkable transformation for Norton Rose. Less than a decade ago, it was in danger of sliding into insignificance. While the firm was a major competitor to the Magic Circle as recently as the early 1990s, a series of ill-judged strategic decisions left it floundering in an increasingly competitive midmarket.

That all changed in 2009, when a resurgent Norton Rose announced that it would combine with Deacons, one of Australia’s largest firms. Just over 12 months later, it garnered more headlines by pulling off a three-way tie-up with Canada’s Ogilvy Renault and South Africa’s Deneys Reitz. In early 2012, it added another top Canadian practice, Macleod Dixon.

The moves have catapulted the firm onto the global stage. In The American Lawyer’s 2010 Global 100 survey, which ranks the world’s 100 largest law firms by revenue, Norton Rose placed 67th. This year, it was 14th, with revenues of $1.32 billion—an increase of 175 percent in just two years. With aggregate revenues of around $2 billion, the new firm, Norton Rose Fulbright, would have ranked sixth—ahead of Magic Circle firms Linklaters, Allen & Overy, and Freshfields Bruckhaus Deringer.

On paper, it should be celebrated as one of the legal industry’s great modern success stories. But not everyone is convinced. Some would argue that Norton Rose isn’t a law firm at all, thanks to its use of a little-known corporate holding structure called the Swiss ve­rein. Put simply, a verein allows participating members to join forces yet retain their existing forms. So, while each of the group’s six firms now practice as Norton Rose Fulbright, they remain distinct legal entities and are not financially integrated.

Norton Rose is not alone. Almost every major cross-border law firm merger of the past three years has utilized the verein, including the tie-ups that created Hogan Lovells, King & Wood Mallesons [see "Today, Asia. Tomorrow. . . ?], Squire Sanders, and SNR Denton. Baker & McKenzie and DLA Piper are also structured as vereins.

It’s easy to see why the structure is becoming so popular. Combining through a verein separates liabilities and removes many of the common hurdles to large-scale combinations, such as balancing disparate profitabilities or the complex and potentially costly reconciliation of contrasting tax, accounting, and partner compensation systems. (This is a particular challenge in transatlantic tie-ups, with U.S. firms generally operating on a cash-based accounting system on a calendar fiscal year, and United Kingdom firms typically utilizing an accrual-based setup with a fiscal year that ends April 30. There is also the matter of squaring U.S. firms’ predilection for more performance-based partner compensation systems with the U.K.’s traditional lockstep approach.)

A verein structure also permits greater flexibility for future expansion, with the option for new members to join the group. It is highly unlikely that Norton Rose could have successfully completed five substantial deals in the space of just three years through conventional mergers. "A full financial merger is a hugely time-consuming and distracting business," says Norton Rose’s global CEO, Peter Martyr. "With a verein, we could focus on business immediately."

But many in the market oppose this new breed of bolt-on behemoths, claiming that they are little more than glorified alliances with shared branding. Indeed, the very word verein suggests as much—it means "club" or "association" in German. K&L Gates chairman Peter Kalis, one of the most outspoken critics of vereins, once famously described them as "Noah’s Ark" mergers. "A merger is when two become one, not when two become two," he said.

In an attempt to resolve this contentious issue, we set out to investigate the ways in which vereins compare to other large international firms, and to assess the impact their structure has—if any—on their ability to operate in an integrated fashion and to serve their clients.

First, we had to define what it means to be a unified firm. After extensive discussions with strategy consultants and leaders at 30 of the world’s largest law firms, we drew up a 13-point checklist to zero in on the key aspects of firm integration. The list covers areas such as unified strategy, management, profits, compensation, referral work, branding, and cost-sharing. (For the full list, and the results for a selection of international firms, see "The Integration Checklist.") 

Using the checklist to compare vereins and other large international firms makes for some interesting results. It may come as a surprise, given the fervor surrounding the subject, to learn that the vereins are collectively able to answer yes to practically every question.

In fact, there is only one point on the integration checklist that a verein firm could not legally comply with: the presence of a unified global profit pool. This is the sole structural limitation of vereins under Swiss law. (The verein itself is registered under Swiss law. The various member firms retain their existing registrations and remain subject to the local regulations of each of the jurisdictions in which they operate.) The only other rule that is forced upon a verein is the requirement to form a vorstand—essentially a board of directors. Every other aspect of how a verein firm is organized is defined by its own strategic and management decisions—not by any restrictions inherent to the structure.

"It’s like joining a golf club," says Aster Crawshaw, a partnership expert at U.K. law firm Addleshaw Goddard. "You have to comply with the club rules, but if something isn’t covered by those rules—like other sporting interests or the allocation of profits between law firms—then you can just get on with it."

Even the loosest of the verein and verein-type firms we surveyed, CMS Legal, still has a lot in common with other global firms. A group of 10 European law firms, bringing together firms such as the U.K.’s CMS Cameron McKenna and Germany’s CMS Hasche Sigle, CMS Legal is structured as a European Economic Interest Grouping, or EEIG. (EEIGs do not separate out the respective members’ liabilities, but are otherwise very similar to vereins.)

Established in 1999, CMS has a single overarching constitution and governance structure, with a global executive committee that determines firmwide budgets and strategy, but each of the 10 member firms have almost complete autonomy to run their own business and control aspects such as finances and staffing.

"Everything we do is focused on our clients," says CMS group chairman Cornelius Brandi. "The more it comes to internal issues, the less integrated we are, but we don’t believe that is important."

What separates CMS from a mere alliance network, Brandi adds, is a combined practice and sector group structure that runs across each of the 10 firms, with single leaders at a global—rather than regional or member—level.

A progressive shift away from country or region-centric structures to a more practice and sector-driven approach has been one of the biggest organizational changes among Big Law firms over the past 20 years. Every traditional partnership firm we surveyed had such a structure in place. But then so do all of the verein firms. (Hogan Lovells and DLA Piper are two slight exceptions. Both have aligned practice and sector groups, but Hogan Lovells has global coheads split between its U.S. and international arms for three of its largest groups—corporate, dispute resolution, and finance—while DLA has separate U.S. and international coheads for all of its sectors and practices.)

CMS and the vereins also have common IT and conflict checking systems, and global brand names that are identical in all jurisdictions, except when that is not permitted because of regulatory constraints. (Norton Rose previously utilized a series of regional monikers—Norton Rose Australia, Norton Rose Canada, and so on—but following its latest merger in June will be known as Norton Rose Fulbright worldwide.) Even the fact that verein members remain separate legal entities is not so different from supposed "single" partnership firms. Regulatory constraints within certain jurisdictions, such as Hong Kong and Japan, mean that traditionally structured firms often are made up of several distinct partnerships. K&L Gates’s own website states that the firm is composed of "multiple affiliated entities," for example, including no fewer than eight different partnerships around the world, a separate holding company that maintains its Moscow office, an Italian association, and a joint venture in Japan. The key, Kalis says, is that such local requirements typically do not preclude partners from also being part of—and sharing profits through—another common legal entity.

Kalis is right. While vereins are free to operate almost as they choose, there is still one significant difference that separates them from traditional partnerships: the existence of multiple profit pools. The relative importance of a global law firm having one profit pool, and of all partners having a direct stake in the wider firm’s performance, represents the very heart of the verein debate. Potential cost savings aside, the core benefit to merging two law firms is the ability to offer a deeper and broader service to clients. If partners aren’t working together seamlessly, then that advantage is lost.

"The problems of the verein structure are very real and limiting," says Reed Smith global managing partner Greg Jordan, whose firm uses a traditional partnership structure. "The incentives for partners to share work across country lines are much less direct as the financial benefits flow to where the work is done. It’s just fundamental human nature."

But it’s another popular misconception that vereins can’t share profits. It is true that the verein itself cannot generate or distribute profits, but there are no restrictions on the member firms directly sharing profits as they see fit. Doing so could undermine their status as independent legal entities and potentially expose them to various additional tax liabilities, however. A U.S. firm that transferred profit across a transatlantic verein might find itself facing a tax bill in the U.K., for example.

Verein firms therefore typically choose to share costs instead, which Alan Hodgart, managing director at Huron Consulting Group, says produces "essentially the same" end result. "Profit is directly influenced by costs, so if you can move that cost around, then you effectively are sharing profit," he says.

Say you have two law firms in a verein, which for the sake of simplicity both have revenues of $100 million and costs of $50 million. Left to their own devices, each firm will generate a $50 million profit. But if firm A transfers $10 million of cost—in return for work it had referred across the verein to firm B, perhaps—then firm A’s profit will rise to $60 million.

Once mockingly referred to as "McBaker" in reference to its loose and sprawling structure, Baker & McKenzie now actually provides one of the clearest examples of how a verein can effectively replicate the workings of a single profit pool. The original law firm verein, having converted back in 2004, Baker is notoriously sensitive about its structure. The firm declined all interview requests for this feature and did not respond to the survey. But five current and former partners with knowledge of the situation confirm that the firm operates with a single virtual profit pool and is entirely centrally financed. Baker’s Chicago base is the only part of its 72-office network that has a treasury function, meaning that it is solely responsible for managing the firm’s finances. All of the revenue it generates worldwide is pooled in Chicago. The profits are then redistributed to each office at the end of the fiscal year, with the exact allocations determined by a highly complex formula. At this point, Baker’s system differs from those typically seen at most international firms. While most vereins have chosen to ape traditional partnerships by introducing a single worldwide partner compensation system, Baker allows its offices free rein over how partners are paid. The global giant’s compensation system has been subject to constant review over the past 15 years, however, and in 2011 the firm introduced a new central profit pool to further encourage integrated behavior. This new pot of funds is primarily used to reward work to develop the firm’s relationships with the 150 or so clients that are part of its decade-old key client program, with bonuses determined by a global compensation committee.

Introducing a partner compensation system that incentivizes and rewards "one-firm" behavior can help mitigate—and even overcome—many of the potential weaknesses associated with a verein’s lack of financial integration.

When its merger took effect in May 2010, Hogan Lovells immediately began a transitional period that would see it adopt a single firmwide partner compensation system within two years. The biggest changes occurred at the legacy Lovells partnership, which progressively moved away from its modified lockstep to adopt an entirely new compensation system that more closely mirrored Hogan & Hartson’s existing merit-based model. This process reached a successful conclusion last May. Partners are now evaluated against the same metrics worldwide, with compensation based on a range of financial and nonfinancial contributions, including business and client development, the sharing of contacts and work, and marketing. The process is managed by the global management committee and board.

"We have as close a degree of financial integration as we are able to achieve—that has always been a priority," says Hogan Lovells co–CEO Warren Gorrell. "Everyone benefits from work won for the firm, which is really important. Partners don’t sit around thinking about our structure any more than they did before the combination."

Our decision in 2011 to treat vereins as single entities for the purpose of our Am Law 100 and Global 100 surveys generated considerable controversy. In an essay ["Grand Illusion," May 2011], K&L Gates’s Kalis wrote that in doing so, we had "undermined" the value of our rankings. He raised some interesting points: Would a truly merged firm take five years after its formation to implement a unified strategy, as was the case between DLA’s U.S. and international partnerships? (DLA has since hired Tony Angel, the highly regarded former managing partner of Linklaters, and tasked him with helping to resolve its long-running integration issues.)

But a general debate about vereins and their treatment as single entities rather misses the point. The fact that a firm is a ve­rein actually tells you almost nothing about its structure and the way it operates. A verein could be anything from a very loosely affiliated group of firms to a tightly run business that is virtually indistinguishable from a traditional partnership.

SNR Denton’s global chairman, Joe Andrew, stresses that he is neither a proponent nor a critic of the verein, adding, "It’s just a tax-advantage tool we happen to be using right now."

Shortly after the formative combination of Sonnenschein Nath & Rosenthal and London-based Denton Wilde Sapte in late 2010, the firm established a committee, led by general counsel Josh Koski and composed of a number of tax and corporate partners, that regularly reviews whether the verein is still the most suitable structure for the firm. So far, they’re convinced that it is. (SNR Denton announced in December the arrival of two additional members to its verein: European firm Salans and Canada’s Fraser Milner Casgrain. The new firm, Dentons, will boast 2,500 lawyers across 79 offices.)

That’s not to say that integrating verein firms is an easy task. Rewiring a partnership’s cultural mind-set can take considerable managerial effort and time. One former London-based Norton Rose partner, who left the firm last year, says that—during his tenure, at least—it was proving tough to break down a pervading "them and us" culture between the group’s various members. "It can be hard to align performance with strategy at a verein," he says. "People still think in terms of profit blocks, no matter how much internal marketing you do." (Norton Rose declined to respond to this point.)

Any difficulties that exist are largely born of management and culture, however—areas that can be challenging for many firms. Those with pure lockstep systems, where partners are compensated solely based on seniority, can struggle when older partners see their billings diminish, while it could be argued that an "eat-what-you-kill" approach is far less likely than a well-run verein to result in partners openly sharing work and clients. Ann Bruder, general counsel at Fortune 500 steel manufacturer Commercial Metals Company, says she actively avoids eat-what-you-kill firms in favor of those "whose model is more aligned with client value."

And being a single partnership is no guarantee of integration. White & Case has always existed as a unified worldwide partnership, but following a four-month review by McKinsey & Company in 2008, the firm underwent a substantial internal reorganization in an attempt to resolve integration issues that were based around an outdated office-centric approach. "We were a single LLP but had been operating more on an individual office basis," recalls White & Case London office head and global executive committee member Oliver Brettle. "Large international clients don’t think that way—they want a seamless service across entire regions, not just local markets—so moving from location to practice lines in 2008 was an important step in our development."

The vereins all argue that their internal workings have no impact on their ability to service clients. Of much greater importance, they say, is the way in which they present themselves to—and interact with—those clients.

Hogan Lovells, for example, has integrated client teams and common client relationship management policies across its U.S. and international arms. London-based co–CEO David Harris says the practice "gives a strong message to clients about seamless operation across offices and practice areas."

Squire Sanders, which combined with U.K. firm Hammonds via a verein in 2011, meanwhile, has implemented a system under which it sends single invoices to clients, regardless of which offices or member firms were involved in the work. According to global CEO Jim Maiwurm, Squire Sanders was also the first verein to have a global professional liability insurance policy. "We’re strongly disinclined to let our structure get in the way of operating as an integrated law firm around the world, and the combination of the right compensation system and the ability to share costs means it doesn’t have to," he says.

If being a verein does automatically lead to a less integrated service, clients don’t seem to have noticed. We surveyed in-house counsel across the Fortune 500 and a range of big private companies to get their take on vereins [see "What's All the Fuss About?," opposite]. Three-quarters of the 450 respondents hadn’t even heard of the term "verein." Over 90 percent said they do not take a law firm’s structure into account when selecting outside counsel.

Vereins also feature prominently in the 2012 Acritas global elite brand index. The rankings are based on feedback from more than 1,000 international in-house counsel, who were asked which firms they would be most likely to use for major cross-border matters. Baker & McKenzie heads the list, as it has in each of the five years that Acritas has published a global ranking. DLA, Hogan Lovells, and Norton Rose each placed inside the top 10, while King & Wood Mallesons and CMS both made it into the top 20.

The global legal market is changing faster than ever before. Spurred by the deepest recession in a generation, consolidation is sweeping the industry. The relative ease with which firms can join together using a verein means that not only is the structure becoming more popular, it is actually helping to drive that change.

Vereins and verein-like firms already constitute five of the world’s 25-largest law firms by revenue, according to our most recent Global 100 survey ["The Hustlers," October 2012]. Five years ago, there was just one verein on our list: Baker & McKenzie, with the U.S. and international arms of DLA Piper still appearing as separate firms. Three new verein-type firms joined our rankings in 2012: Squire Sanders, SNR Denton, and CMS. As the market continues to evolve, there will likely be more.

Most of the vereins that currently exist are still relatively new. Norton Rose and SNR Denton have both signed agreements with firms that haven’t taken effect yet. Even DLA, which combined back in 2005, has only recently set about tackling integration in earnest. It’s still too early to judge whether they will each prove a long-term success. But one thing is for sure: The success or failure of these firms will have little to do with the fact that they’re vereins.