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With its head start in the Bay Area, Shearman & Sterling was poised to take the lead among New York firms in Silicon Valley. Instead, it stumbled and is scrambling to recover The mood had turned tense in the private room at Morton’s of Chicago-The Steakhouse. The half-dozen Shearman & Sterling partners who had gathered in downtown San Francisco on this evening in the spring of 1995 fiddled nervously with their sharp knives. Shearman & Sterling’s Bay Area strategy had come under attack. The dinner had been planned as a regular meeting of West Coast partners. Before the gathering, corporate partner Michael Kennedy had circulated a memo detailing how the firm’s San Francisco office needed to retool itself to become a more credible player in the technology arena. At Morton’s, the young partner pushed his plan. The main problem, he argued, was that the San Francisco office lacked a local, corporate client base, relying instead on national institutional clients, like investment banks. He dismissed the prevailing wisdom that as local companies matured, they would naturally dispense with local firms and flock to more sophisticated New York lawyers. Too many in-house lawyers came from these local firms, he pointed out, and the Silicon Valley firms would eventually “migrate up the quality chain.” Because Shearman had historically acted “above it all,” he wrote, “we simply are not connected.” Kennedy’s solution: create a group of lawyers focused on start-up companies and consider offering discounts or flexible fees to attract this work. If the firm didn’t do these things, Kennedy warned, it would never succeed. Normally, Kennedy is brash and blunt. On this night, with a few drinks under his belt, the then 35-year-old lawyer was even less diplomatic than usual. Although some partners thought Kennedy had good ideas, there was no consensus in favor of his plan. “I didn’t think it was realistic with the limited resources we had at the time,” recalls William Hinman, who had recently come out from New York to head Shearman & Sterling’s San Francisco office. Two years later, a frustrated Kennedy was gone, defecting to Brobeck, Phleger & Harrison. (He has since hopscotched to Wilson Sonsini Goodrich & Rosati.) Shearman & Sterling’s San Francisco office continued to roll along, bustling with finance and underwriting work. Although it hadn’t made a huge splash in the Valley, it seemed to be doing all right. In the fall of 1998, the firm, finally ready to present itself as a bona fide Valley player, took the crucial step of opening an office in Menlo Park. And then the wheels fell off. Since the start of this year, the Menlo Park office has been decimated by defections. Four partners — the entire partner team in Menlo Park — switched to the Silicon Valley offices of competing firms, including Davis Polk & Wardwell and Simpson Thacher & Bartlett. Shearman & Sterling should have run circles around its Manhattan competitors in the Valley. It’s been in the Bay Area for more than 20 years, having opened in San Francisco in 1979. It stocked its San Francisco and Menlo Park offices with exceptional talent. But today, with Silicon Valley indisputably established as a major economic center, this proud firm is scraping egg off its face and scrambling to rebuild. Meanwhile, Davis Polk and Simpson Thacher, which have been in the Bay Area less than a year, confidently cruise forward, bolstered by the experience and know-how of Shearman & Sterling refugees. What happened to Shearman & Sterling is a lesson for every firm ogling the Valley. The advice in Kennedy’s memo is as sound today as it was in 1995: Silicon Valley is different. Even if a Valley office is busy with lots of New York-style finance work, it will have a hard time gaining credibility, attracting laterals, and holding on to its lawyers unless it gets hooked into the scene that revolves around advising companies and start-ups. If a firm can’t be flexible and open-minded enough to make that a priority and devote the considerable resources necessary to support such a plan, it won’t fully capitalize on the Valley’s opportunities. “It’s too bad,” says William Kelly, who ran Shearman & Sterling’s San Francisco office in the early 1990s and is now at Davis Polk. “If you look at the talent that has been in that office and how long they’ve been there, [Shearman] had an opportunity for an absolutely breakout practice.” But it isn’t easy for any out-of-town firm to appreciate the Valley’s daunting challenge, especially New York firms that are convinced they know it all. Says Kevin Kennedy, a young partner — not related to Michael Kennedy — who left Shearman & Sterling and joined Simpson Thacher in August: “This has got to be the most difficult market in the world for any New York firm to crack.” A New York lawyer visiting Silicon Valley for the first time might feel as if she’s been whisked back to an episode of the old television show Green Acres. The area’s equivalent of Main Street — the commercial thoroughfare called El Camino Real — offers little more than a motley collection of businesses, scattered like trinkets from an unfashionable charm bracelet. A walk along El Camino from downtown Menlo Park to Shearman & Sterling’s office passes by a mattress discounter, a car wash, and a dance studio. It’s a far cry from Shearman’s headquarters in midtown Manhattan. From a purely financial point of view, Shearman & Sterling’s offices in San Francisco and Menlo Park aren’t failures. For years, San Francisco has been among Shearman & Sterling’s three most profitable offices, and some years topped the charts with profits per partner of close to $2 million, according to several former partners. (The firm disputes that profitability figure, but declines to provide specifics.) Lawyers in those offices were flooded with more work than they could handle, focusing on investment banking clients like The Goldman Sachs Group, Inc., and Morgan Stanley Dean Witter. But the lawyers strained under the workload. “We needed lateral partners and transfers from New York,” says one partner who was billing 3,000 hours a year. “New York was not responsive.” Shearman & Sterling’s New York management denies that it neglected the Bay Area. Managing partner Whitney Pidot acknowledges that the Bay Area offices were competing for resources with other major initiatives, such as expansions in Europe and Asia, but contends that the Bay Area offices “were getting their share of attention.” The personnel numbers tell a different story: Since 1995, Shearman & Sterling has added more than 175 lawyers in Europe and Asia, mostly lateral hires. During that time the Bay Area offices hardly grew at all, expanding from 25 to only 33 lawyers. (A firm spokesman said senior partner Stephen Volk was unavailable for comment, traveling and working in Europe.) Frustration over staffing led to a major loss at the start of 1995, when San Francisco star litigator Tower Snow, Jr., jumped to Brobeck. (Within three years Snow would become chairman of that firm and redefine it as a technology leader.) Around that time, the Valley’s technology sector shifted into high gear. At Shearman & Sterling, young corporate partners like Michael Kennedy chafed to do more company-side work. Valley firms generally prefer company work — whether for start-ups or publicly held corporations — because it moves them closer to the local action. It enables a lawyer to develop that all-important network of contacts that drives a successful practice in the Valley. Shearman & Sterling could boast of some major company-side clients — such as Silicon Graphics, Inc., and Adobe Systems Incorporated — and it was happy to see new corporate clients come in the door. But it was reluctant to sacrifice underwriting work to make a major push for company business. “I don’t think there was any edict, implied or real, that discouraged company-side work, especially for public companies,” says one former partner. “At the same time, did the firm have a strategy that said: ‘Let’s turn down some underwriting work; we need to do whatever it takes to get [more company work]‘? … That would be a foreign thought [to the firm].” Figuring out the right mix of company and underwriting work wasn’t easy, says Hinman, the former managing partner of the Bay Area offices. “That was a constant question we were always asking ourselves,” he says. And back at Shearman & Sterling’s Lexington Avenue headquarters, management seemed pleased with the existing strategy, according to several partners. “Everybody saw the strong profits,” remarks one. “If it’s not broke, why fix it?” Still, one enterprising young partner took the initiative to build a start-up practice on his own. Soon after he made partner at the end of 1998, Kevin Kennedy prepared a 15-page memo describing his plan. “I really thought it was important to be full-service,” says the 34-year-old lawyer. By then, the firm’s leaders, including Hinman, were more receptive to a start-up practice than they had been four years earlier, when Michael Kennedy had floated similar ideas. The start-up craze was in full swing, and Kevin Kennedy got the green light. “The reaction at the end of the day was, ‘Whatever it takes,’ ” Kennedy recalls. He says he quickly lined up about a dozen stripling businesses as clients, including iSyndicate, Inc., a San Francisco outfit that aggregates and resells content for Web sites, and ManageStar, a Walnut Creek, California-based company that runs an Internet auction site for building management services. The new practice was “ successful beyond my wildest expectations,” Kennedy says. In the fall of 1998, around the time that Kevin Kennedy was launching his start-up practice, Shearman & Sterling opened its Menlo Park office with Hinman, Kevin Kennedy, and two other corporate partners. The move gave Shearman & Sterling two offices in the Bay Area. During 1999 and early 2000 both were flush with underwriting and corporate finance work, leaving little time to cultivate company-side clients, aside from Kevin Kennedy’s start-up endeavor. During the first half of 2000, Shearman & Sterling led the nation in representations of underwriters in securities offerings (based on number of offerings), and the Bay Area offices were shouldering a backbreaking load. According to Thomson Financial Securities Data, Shearman & Sterling advised underwriters in 27 IPOs that went to market from January to mid-August of this year. Nearly half — 13 — involved Bay Area companies, like Pets.com, Inc. and Evolve Software, Inc. At one point Menlo Park partners Kevin Kennedy and Alan Denenberg juggled 20 offerings between them, sharing only a half-dozen associates. “It was insane,” says one former Shearman & Sterling lawyer. “We didn’t have resources to execute our strategy.” Former partners debate how much office head Hinman deserves the blame for the problems. “Bill is a terrific lawyer but not a very effective manager,” says one former partner. He and others fault Hinman for not insisting that the office get more resources and for not realizing that the Valley required a different approach. “He was charged with the responsibility for educating people [back in New York] about the [Silicon Valley] market. I don’t think he was doing it,” says one former partner. Hinman says he often asked New York for partners and associates, but didn’t get them. “It was very disappointing,” he says. Shearman & Sterling managing partner Pidot denies that the firm held back resources. “We did produce people,” he says. “And in some cases our proffered staffing was turned down.” Pidot faults Hinman for not building the office through lateral hires, noting that that is how most of its non-New York offices have expanded. “Part of our strategic plan is to hire locally,” says Pidot. “That was not achieved.” Hinman says he had talks with several strong candidates, but they declined to come to the firm. He notes that without a critical mass in the Valley, it was hard to attract laterals. To be fair, all out-of-town firms have struggled to lure big-name corporate partners away from Valley competitors. (Litigators and other specialists are easier.) You can count on one hand the number of corporate stars who have made such a jump. In this market, Cooley Godward and Wilson Sonsini carry more clout than any New York firm. And the local stars are paid very nicely, thanks to whopping equity stakes in clients. The first outward sign that Shearman & Sterling’s Menlo Park office might be in trouble came last January, when Davis Polk snagged Bill Kelly just a few months after it opened its Menlo Park office — right next door to Shearman & Sterling’s. Kelly had left Shearman on good terms in 1994 to become general counsel of Silicon Graphics. He rose to senior vice president of business operations and enhanced his enviable network of Valley contacts. When he decided to return to private practice, he talked to Shearman & Sterling but chose Davis Polk. “When they could not get [Kelly] to come back, you had to think to yourself, Why would a lateral come if our own guy won’t come back?” says one former Shearman & Sterling partner. Kelly says that his decision had more to do with what Davis Polk had to offer than what Shearman & Sterling didn’t have. He declines to elaborate, but Davis Polk does appear to be treating Silicon Valley as a priority. In March litigators Dean Kristy and Susan Muck left Shearman & Sterling’s San Francisco office for Brobeck. But the big seismic shocks came a few months later. In June 39-year-old M&A partner Christopher Dillon decamped for Gunderson Dettmer Stough Villeneuve Franklin & Hachigian, one of the more adventurous Valley firms that caters to start-ups. That same month Alan Denenberg, 40, announced he was joining Kelly at Davis Polk. Both young stars were cornerstones of Shearman & Sterling’s Valley strategy. What happened next is a matter of dispute. Pidot says that Shearman & Sterling decided to replace Hinman as head of the Bay Area offices. Hinman says he had already decided to leave. “I told them at the beginning of this year I was very unhappy with the level of support [the office was getting] and I was thinking of leaving the firm… . They asked me to stay and serve as head of worldwide technology for the firm. To say they decided to replace me is completely incorrect.” In any event, in June the firm dispatched New York partner Peter Lyons, the cohead of its worldwide M&A group, on a salvage mission to head the Bay Area offices. The next month, Hinman and Kevin Kennedy announced that they were leaving for Simpson Thacher. All of the departed partners avoid talking about work that has followed them away from Shearman & Sterling, but a few underwriting assignments have moved, as well as matters for drugstore.com, inc., German software company SAP Aktiengesellschaft, and some of Kevin Kennedy’s start-ups. It’s not clear whether Davis Polk and Simpson Thacher have game plans for the Valley that are dramatically different from Shearman & Sterling’s. But at least they’re working from a clean slate and have promised that Silicon Valley will get lots of attention. Shearman & Sterling isn’t giving up. By diverting the talents of a high-profile partner like Lyons, the firm has shown that Silicon Valley is now a priority. (It’s not clear, however, how long he’ll stay: The 45-year-old partner says he’s committed to staying in the Bay Area until the end of next summer. Beyond that, he doesn’t know.) The firm also uprooted Bruce Czachor, a partner in its Toronto office, to serve as co-managing partner of the Menlo Park office. In addition, it rushed out two more partners and six associates from New York. One partner and four associates are relocating from San Francisco. The real proof of its long-term plans lies in a new lease for 33,000 square feet of exorbitantly priced space on Marsh Road in Menlo Park. It has room for 80 lawyers, and Lyons says Shearman & Sterling plans to fill it. Lyons admits the firm made mistakes. “I think it’s fair to say we probably should have put more resources opposite the opportunities,” he says. “We should have been more aggressive about lateral hiring in the local market.” He stresses that the firm is now “actively in the market.” He also states that he believes the office needs a “reasonably healthy diet” of start-up work, and has been doing more this year. Back in New York, management attempts to shift to Hinman most of the blame for past problems. At least five years ago, Pidot says, “the firm gave our local management a mandate to expand on the West Coast. In hindsight, we should have sent out new management and additional resources earlier.” Hinman counters that if the firm was unhappy with his leadership during his five-and-a-half-year tenure as office head, they didn’t tell him. “Never once … did they express any unhappiness with our rate of growth,” he says. Another former West Coast Shearman & Sterling partner backs up Hinman. “I never heard some mandate that said, ‘Please grow bigger, and we’re disappointed that you’re not growing bigger,’ ” says this lawyer. Even one Bay Area lawyer who is critical of Hinman says it’s unfair, not to mention poor form, for New York to make him the scapegoat. This partner points out that the firm certainly acted as if Hinman was doing a great job. When his five-year rotation as West Coast managing partner ended in 1999, the firm reappointed him. And at the start of 1999, Hinman was promoted to Shearman & Sterling’s elite “leadership class” of compensation. “If they were unhappy with him, why on earth did they promote him?” the partner asks. After stumbling so badly, can Shearman & Sterling finally “get it” in Silicon Valley? And if it does, is it too late? “When [Steve] Volk gets committed, he is a formidable competitor,” says one former Shearman & Sterling partner. “[But] it’s not so easy to come out here and say, ‘The real lawyers from New York are here! Please dispatch with Wilson and Brobeck and Cooley.’ ” Another former partner contends that Shearman & Sterling will prevail in the end: “ They are not quitters, and they are not losers,” this partner says. “They will succeed. It will just take a while.” Meanwhile, senior management might dust off some old memos.

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