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McKee Nelson has struck again. Last week, the raptor-like tax and capital-markets boutique snared yet another marquee partner from a much larger and more established competitor. This time, it’s Edward De Sear, chairman of the top-ranked structured-finance team at Orrick, Herrington & Sutcliffe, who has opted to take the McKee Nelson gamble. He’s leaving behind 650-lawyer Orrick to join a three-year-old firm with 90 lawyers. The news of De Sear’s move ricocheted through the clubby structured finance and securitization bar last week. One practice head at another leading firm in the arena simply said, “I’m stunned.” De Sear, 56, is just the latest in a string of deft lateral hires by McKee Nelson. The fledgling D.C.-based firm has relied heavily upon such acquisitions since it was launched in late 1999 by a pair of King & Spalding tax partners armed with a loan from accounting giant Ernst & Young. Since then, the firm has aggressively pursued — and landed — senior tax and capital-markets partners with substantial books of business from firms such as Dewey Ballantine; Miller & Chevalier; Sidley Austin Brown & Wood; Stroock & Stroock & Lavan; and now Orrick, Herrington. Competitors grumble that McKee Nelson is wooing rainmakers with “baseball contracts” — lavish employment deals guaranteeing above-market compensation for several years. And some partners at other firms question whether McKee Nelson’s revenue can ultimately support those arrangements. McKee Nelson’s co-founder and chief executive partner, William Nelson, confirms that some laterals have received guaranteed contracts, but he says they’re justified by the business the partners have brought to the firm. And he insists that partner draws in 2002 were covered by fees, not bank financing. The firm’s numbers are remarkable. In 2002, McKee Nelson generated $75 million in fee income, Nelson says. And according to sources with knowledge of McKee Nelson’s finances, the firm’s 36 partners earned an average of about $1.2 million in profits. To be sure, that average is skewed by a handful of very highly paid rainmakers. First-year partners at the firm reaped profits of around $400,000, according to Nelson, who would neither confirm nor deny the average partner profit figure. Still, such numbers are impressive for a venture that was started from scratch three and a half years ago. THE BIG IDEA McKee Nelson was formed during what seems like another era. Swaggering Big Five accountants believed it was just a matter of time before they added legal advice to the list of consulting services they could sell to their public company audit clients. A lot of big-firm lawyers were anxious about their chances against such well-financed competition. The regulatory barriers that prevented lawyers from going into business with nonlawyers would inevitably fall, many predicted. The day of the multidisciplinary practice, or MDP, was dawning. Today, after the Enron Corp.’s collapse, Arthur Andersen’s decimation, and the ensuing regulatory backlash against auditors’ conflicts of interest, the prospect seems more remote. But in 1999, it beckoned alluringly to Nelson and his longtime friend and colleague, William McKee. The unlikely duo first met in a contracts class at the University of Virginia School of Law in 1969. Bill McKee, then a long-haired 25-year-old who had just graduated from Harvard Law School, was the eager new professor. Will Nelson, who had played starting center for three years on the football team at Mississippi State before coming north for law school, was the decidedly underwhelmed 1L. But the two hit it off, and within a few years, they literally wrote the book on partnership taxation: Their treatise on the notoriously complex subject remains the industry standard. Both later did stints in government. McKee was tax legislative counsel at the Treasury Department from 1981 to 1983. Nelson served as chief counsel at the Internal Revenue Service from 1986 to 1988. And as partners at King & Spalding, they built a lucrative and high-profile tax practice. Yet when William Lipton, Ernst & Young’s vice chairman for tax services, approached them in the spring of 1999 with an idea for launching their own firm — to be linked with E&Y — they leapt. “We had both been at King & Spalding a very long time, and had built our careers there,” says the 56-year-old Nelson. “But we were beginning to come to work a little bit later every day.” Adds the 59-year-old McKee, “The opportunity to have an alliance with a global powerhouse was hard to pass up.” Ernst & Young agreed to lend McKee and Nelson the money to launch a new law firm, dubbed McKee Nelson Ernst & Young. They quickly lured top-tier tax lawyers to the venture, including Gerald Kafka, head of the tax litigation group at Dewey Ballantine, and John Magee, chair of the tax practice at Miller & Chevalier. Magee brought a cadre of tax litigators and a pipeline of big-ticket tax cases for clients such as the Dow Chemical Co. With roughly 30 tax lawyers on board in 2000, the firm pulled in $26 million in revenue. “While we did lose money overall [in 2000],” Nelson recounts, “our revenue per lawyer was $850,000 or so, which ain’t bad.” Even as the startup gained momentum, however, it became clear that McKee Nelson was not going to be able to work hand in glove with Ernst & Young as originally planned. In 2000, in the face of fierce opposition within the bar to the notion of MDPs, the American Bar Association opted against lifting the rules that restrain lawyers from going into business with nonlawyers. Not long after, Ernst & Young made clear that it wanted to recoup the money it had lent the firm. “The MDP project did not materialize in this country,” says Nelson. “We decided we needed to stick to our knitting.” By May 2001, the Ernst & Young name was gone from the law firm’s stationery, and McKee Nelson had swapped its E&Y loan for a fresh line of credit from London’s Barclays PLC. Ernst & Young and McKee Nelson still maintain an “alliance,” and the two firms do refer some client work to each other, partners at McKee Nelson say. As the original MDP vision dimmed, McKee Nelson moved aggressively to expand the firm’s law practice. “We had absolutely blue-chip tax lawyers,” McKee recounts. “The next step was to get into nontax work, so we went after securitization.” SECURITY BLANKET Securitization is a financing technique that involves moving a cluster of assets held by one owner — say a stack of home mortgages held by a bank — into a separate corporate entity, which in turn issues securities to investors. The investors’ money flows back to the original owner of the assets, and the investors reap whatever cash those assets spin off over time. The technique emerged in the early 1980s and is now commonplace in U.S. capital markets. Car makers securitize auto loans, home lenders securitize mortgages, banks securitize credit card receivables, David Bowie famously securitized the proceeds from future sales of his music. Virtually every Wall Street bank now participates in the industry. Many of these deals are public and registered with the Securities and Exchange Commission. Other, similar financing structures are one-off, private arrangements. A few, such as the ultra-aggressive off-balance-sheet deals engineered by Enron, stretch the boundaries of law and accounting. All involve tax issues. For a law firm made up of very bright tax lawyers, securitization was a logical practice to target. As they had done with former Miller & Chevalier partner Magee, McKee and Nelson scouted out a known-quantity partner in the field who boasted a substantial — and portable — book of business. And they got him. John Arnholz, now 44, was the leader of the structured-finance group in the D.C. office of Brown & Wood, which in early 2001 was in the midst of a merger with Sidley & Austin. Arnholz had built a practice around residential mortgage securitizations. He boasted close relationships with clients such as Lehman Brothers, which remains a wellspring of deal work for McKee Nelson, according to partners within the firm and competitors. Arnholz’s move to McKee Nelson in May 2001 shook up the structured-finance bar. Then, as now, a handful of firms dominated the public securitization market. Among them were Cadwalader, Wickersham & Taft; Orrick, Herrington; and Arnholz’s Brown & Wood. Securitization leaders at some of these firms say they were startled to see a well-known player at a top securitization firm jump to a startup run by tax lawyers. But Arnholz now says he saw a chance to work without the kind of institutional weight that burdens most large firms. “This is as close to the way law ought to be practiced as you can get,” Arnholz says. “It’s completely nonbureaucratic. Sure, there are some cultural issues” that arise when you bring partners from different firms together, “and sometimes there’s too much work. But I don’t know if I could work at another large law firm again.” With Arnholz and his team on board, McKee Nelson moved quickly to win over other rainmakers. Last year, for example, the firm landed Reed Auerbach and Robert Wipperman, leaders of the securitization practice at Stroock & Stroock in New York, another perennially top-ranked structured-finance firm. At the same time, McKee Nelson opened its own New York office, which now houses 20 lawyers. Again, McKee Nelson had found in Auerbach, Wipperman, and their team a lucrative practice propelled by a zealous business-getter: Auerbach is well-known within the industry for his work on student-loan securitizations for Sallie Mae. And again, McKee Nelson gambled correctly that the clients would follow the lawyers. Industry league tables illustrate the point. According to data from Thomson Financial, McKee Nelson represented underwriters in more publicly registered debt securitizations in the first quarter of this year than any other law firm. During the same quarter last year, McKee Nelson ranked 14th on that list. “By and large, we have not adopted a ‘build it and they will come’ strategy,” says Nelson. “We have tried to hire whole practices, with business, so there’s very little ramp-up cost” to finance. “When someone joins up,” he adds, “we try to be sure they just have to turn the meter on.”

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