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Corporate law departments in companies large and small find themselves under intense pressure to cut their expenses, particularly for outside legal services. In part, this reflects a growing imbalance between rapid and significant increases in law firms’ rates, and what clients are willing to pay for their services. The rate growth, in turn, is a product of increased overhead owing in large measure to intense competition among firms for top talent. Until recently, the principal effect was to transfer this cost pressure to outside law firms, including through demands for discounts from “rack rates,” especially in commoditized practice areas; economy through “convergence” policies that give all outside work to fewer firms providing some discount based on volume and presumed efficiencies from knowing a business; and generally increased attention to alternative billing arrangements that both reduce amounts and increase the predictability of legal services expenditures. These are healthy market forces at work. Today, however, the corporate discussion seems to be shifting from “How much does it cost?” or “Can we do it in-house?” to “Can we do without it?” This is likely to be seen later as a costly strategic mistake by U.S. and foreign companies. In a very real way, “doing without” results in a cost-shifting exercise by corporate financial managers from today’s profit-and-loss sheet to tomorrow’s stockholders. By reducing today the legal spending that is essential to effective risk and liability management, companies and their owners will pay in the future many times over for hidden risks and liabilities that can come to fruition after today’s “savings” have been booked. The thinking that produces this result fails to account for critical differences between mere legal compliance and adroitly managing � in part with legal service resources � corporate risks and strategic interests. Two examples indicate benefits that may be lost Here are two simple illustrations: Company A, dependent on developing and exploiting its intellectual property, decides to forgo bringing a relatively difficult and complex affirmative infringement case against one of its competitors because the cost is high and the outcome uncertain. The cost of prosecuting the claim is saved. But what is likely lost is maximizing the ability to defend that intellectual property in the future. Moreover, the company may quickly acquire a reputation as a pushover with respect to defending its intellectual property, thus inviting other infringers. Perhaps not bringing the case is a good strategic decision, but cost should not be the defining element of that judgment. Company B does substantial business with governments in parts of the world in which corruption is woven into the fabric of commerce. To save legal fees, the company forgoes a joint internal audit and legal department effort to evaluate compliance with the Foreign Corrupt Practices Act and raise internal awareness regarding compliance in this area generally. The cost of inside and outside counsel and other resources needed to carry out the evaluation is saved. At the same time, however, the likelihood that the company will encounter FCPA problems in the future is significantly increased. Moreover, if those problems arise, the lack of preventive attention to them will make it appear to enforcement authorities that the company did not take its compliance seriously. While to some companies the cost of paying fines and penalties may not justify the front-end investment that more aggressive risk management would require, the equation may change when the very real risks to corporate reputation, shareholder value and management careers are factored in. Cost-savings choices that shortchange reasonable risk management are particularly bad business now because the trend in the enforcement environment is going the other way. Business-crime enforcers and government regulators with strong criminal and civil penalties at their disposal and aggressive enforcement goals have more resources than at any time in the past. Previously, businesses and their leaders were primarily prosecuted for crimes that carried traditional indicia of criminal activity, including a demonstrative intent to do wrong. Today, though, reams of federal regulations governing conduct across the spectrum of commercial activity regularly become the basis for criminal investigations and prosecutions. Furthermore, many of these are true minefields of potential liability because what regulations proscribe or demand is often not at all clear and can be the subject of great debate among experts. While such circumstances may lend themselves to providing a strong due process defense, that is little comfort to the company, executive or board member who suffers through a long period of investigation and allegations, often in the public eye. The risk also goes well beyond just the risk of penalty for legal liability. Errant corporate practices present real risks to revenue, such as when a foreign entity is acquired based on revenue assumptions that are ignorant of corrupt arrangements with customers or other third parties. Likewise, even relatively isolated corporate misconduct can greatly impair a corporate reputation. This would be problematic for any company, but it can be devastating to those for which corporate reputation is a critical asset. This is especially true, for example, for financial institutions, consumer products businesses and other concerns that view public and/or governmental trust as an important element of their business. So why is there such pressure on management to pay less for legal services if the level of risk is rising? Much of the pressure to cut legal spending comes from in-house counsel’s finance department colleagues. Chief financial officers and their subordinates are not foolish, just squeezed. The amounts spent on legal services are never popular in a corporate culture that, quite appropriately, supports activities that contribute directly to the bottom line and disdains seemingly unproductive cost centers. Moreover, the substantial cost of Sarbanes-Oxley Act compliance and associated aggressive � and expensive � work by outside auditors has eaten up a large portion of whatever tolerance exists for spending corporate funds on compliance. This statute was as much a solution to congressional political problems as it was a fix for businesses’ financial reporting shortcomings. It is having the presumptively unintended consequence of seeming to occupy the compliance and risk management field. Its technical, check-list-like approach to risk management and compliance has sucked much of the air out of companies’ self-initiated efforts to meet obligations to shareholders to run the corporation well with regard to risk management and liability avoidance. One-size-fits-all Section 404 review is replacing more targeted, and arguably more effective, industry-specific compliance practices. Because the cost of Sarbanes-Oxley compliance has grown so huge, spending for other kinds of risk-management activities, including legal counsel, is being curtailed. Large law firms with the resources to help manage these risks in a sensible way are already rather busy helping to clean up, after the fact, messes that might have been avoided with more aggressive risk-management and compliance efforts. That is not to say that the big law firms cannot do a better job of pricing their work and managing their legal services projects with greater efficiency. They can. Indeed, they must do so. To do otherwise is simply to ignore the forces at work in the legal services market. Companies get what they pay for in legal services That said, companies tend to get what they pay for when it comes to purchasing legal services. Companies benefit most from legal advice based on specialized training, expertise and judgment gained through long experience. These services have substantial value to companies doing deals and fighting legal battles worth great sums of money, the most important of which can determine a company’s survival. This is the reason that corporate clients seek out the best lawyers in a competitive market and are willing to pay premium rates for their services. Applying such expertise and judgment to risk management would be better viewed as wise investment than as discretionary spending. To the extent that pressure to rein in legal spending forces both corporate legal managers and their outside counsel colleagues to focus on managing the cost of services better and to be more efficient, it is a positive development. In that vein, flat fee and other alternative billing arrangements can have great value in promoting efficiency, managing overall costs and assisting in predictable expenditures for given projects. However, when that pressure moves to the level of forcing companies to curtail expenses that, in the judgment of company lawyers and corporate risk managers, are appropriate and necessary to the company’s well-being, the welfare of shareholders is being put at risk unnecessarily. In-house legal leaders need to have a permanent seat at the executive management table and a voice equal in weight to financial managers when it comes to managing risk and the expenditures attendant to it. Board members, particularly on the audit committee, have a duty to ensure that systems and controls that reasonably address and manage risk are in place and utilized. All executives and directors should be concerned with the effect on the bottom line, where short-term savings that make for a good quarter can produce significant long-term risk to revenue, corporate reputation and, not least, shareholder value. This article originally appeared in theNational Law Journal , a publication of ALM. � George J. Terwilliger III is the global head of the white-collar practice group in the Washington office of White & Case. He previously served as a federal prosecutor, as well as U.S. attorney and deputy attorney general of the United States.

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