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Philadelphia-based Pepper Hamilton and Arent Fox Kintner Plotkin & Kahn of Washington, D.C., have broken off talks in what would have been the largest merger of two American law firms this year. Executive partner James Murray of Pepper Hamilton said Oct. 5 that merger talks broke off almost two weeks earlier, but he declined to specify why. “Chances are slim that a merger of equals like this is going to work out,” Murray said. “The surprise should be when one of these actually does happen. The result is disappointing, but it was also the right decision for us.” Pepper Hamilton has 425 lawyers; Arent Fox has 300. Sources said Pepper officials were concerned that Arent Fox attorneys were not unified behind the firm management’s strategic vision. Sources noted that Arent Fox had tried and failed to complete other mergers during a two-year quest during which managing partner Christopher “Kit” Smith focused most of his time on finding a dance partner for the firm. Arent Fox flirted at least once before with a midsized Northeastern firm. Last fall, the firm confirmed that it was discussing a merger with Boston’s 225-lawyer Brown Rudnick Freed & Gessmer. But those discussions fell through. “Part of it for us is that we’re not sure it’s a good time for anyone to be doing a merger with the economy the way it is,” Smith said. “We have partners all over the map on that subject. “It would have been the largest [law firm] merger this year, and when you have two firms of this size talking, there are a number of issues: personal, structural and practice group issues. And you have to remember, we’re a partnership, not a corporation where a CEO is making all the decisions. We were not prepared to go forward considering all the circumstances, not least of which is the economic disturbance caused by the events of Sept. 11. And mergers bring with them a lot of costs.” Smith said the firm’s partners would head to a retreat in Hershey, Pa., later this month to discuss past and possible future merger negotiations with other law firms. Another source familiar with the Pepper situation, though, cited practice conflicts, incompatible financials and the pending departure of at least nine attorneys from Pepper Hamilton’s intellectual property group in Washington as reasons for the failed negotiations. Talks began in early summer and would have produced a firm with more than 700 attorneys in more than 10 offices. But sources said attorneys from both firms were told late last month that the negotiations had ended. It appears there were client conflicts that hindered negotiations. Arent Fox handles a good deal of bad faith claims work. A source familiar with the situation said Pepper Hamilton soured on that practice because of its heavy representation of insurance companies. Murray, though, said practice conflicts like that one did not squelch the deal. “Some people were concerned about that one, and other conflicts as well,” Murray said. “But I think that the leadership of both firms felt they could work through that.” Arent Fox, sources said, was also disappointed after reviewing Pepper Hamilton’s financial information. But Murray again shot down that theory, saying that financials for the two firms were compatible. He also said that those numbers are always exchanged at the beginning of negotiations and that the Pepper-Arent talks went on for several months after financials were disclosed. According to the latest version of The American Lawyer‘s AmLaw 200, which compiled financial information for firms during 2000, Arent Fox’s profits per partner was listed at $400,000, while Pepper Hamilton’s was $365,000. But Pepper, which was listed as having 100 more lawyers than Arent Fox, had a larger gross revenue ($145 million) than its potential merger partner ($119 million). Those numbers appear comparable on the surface when the difference in billing rates between the two markets — Washington’s is generally higher than Philadelphia’s — is considered. Smith agreed with Murray’s assertion that the practice conflicts and financial compatibility issue did not break the deal. But he acknowledged that the conflicts would have to have been resolved for the two sides to move forward. GROUP DEPARTURE From Pepper’s perspective, what could emerge as a larger story than the failed merger is the loss of its entire IP group in Washington, with most lawyers moving on to Cleveland-based Baker & Hostetler. John Weber and Gilberto “Ybet” Villacorta are seen as the two headliners of Pepper’s Washington-based IP practice group. Villacorta confirmed that the nine-attorney IP group hired a legal headhunter shortly after merger talks began and shopped around the Washington market. “The merger talks precipitated that move because it was something we were not sure we wanted to do,” Villacorta said. “There was a split of opinion in the group as to whether it would be the right thing for us. And you hate to do things out of necessity, so we wanted to have some other options.” Weber, three other partners, four associates and a patent agent decided to head to Baker & Hostetler, which does not have an IP presence. Villacorta said he had a different philosophy from his colleagues about where he wanted to practice. He said he did not close the door on being part of a possible Pepper-Arent merger, which would have created a 300-attorney Washington office. But when the deal fell through, he said, he was not interested in staying at Pepper and rebuilding the practice — something he did a few years ago when a key partner defected to Boston’s Hale & Dorr. At the end of the month, Villacorta will join Katten Muchin & Zavis, which already has an established IP group of more than 15 lawyers. He said he hoped to take a few associates with him, but Chicago-based Katten Muchin has promised to hire a few to work with him. For his part, Weber said there was not “much linkage” between the Arent Fox talks and the departure of his group for Baker & Hostetler. “I’ve had relations with Baker & Hostetler for a long time; they just stepped up their courtship during the merger talks,” Weber said. Sources said Weber and Villacorta accounted for almost half of Pepper’s Washington office business. Villacorta said the firm would clearly have to target some practice groups to rebuild what is now a 30-attorney office, which still has a presence in real estate, litigation, labor and employment, and some other transactional practice areas. “We lost two productive partners and the people who support them,” Murray said. “It’s something that happens in this marketplace. It was apparent to me that they made their decision while the discussions were ongoing and not afterward. “Our IP group is still very strong. We still have 25 lawyers remaining [in offices outside Washington]. This will have more of an effect on our Washington office. And we’ll do what we always have done when something like this happens: We’ll restock. But I don’t think it’s imperative that we have an IP practice in Washington.” Arent Fox used to have the dominant regional real estate practice, a field that was hit hard by the recession of the early 1990s and never fully recovered. The firm still lags behind Washington competitors in profits per partner, but sources said the firm had taken steps to close the gap. One of those steps has been to look for a merger partner. There are obvious geographic and practice synergies that would have made such a union attractive to both sides. From Pepper’s perspective, an Arent Fox merger would have helped the firm meet two major strategic objectives: obtaining a New York presence and expanding its Washington office. While Pepper has a New York site, no single attorney is solely situated there. Arent Fox has a 40-attorney Manhattan office. As for Washington, Pepper had 40 attorneys there, but Arent Fox has 260. When looking at practice area strengths and weaknesses, Arent Fox is a typical Washington firm with deep government relations and regulatory groups that include former U.S. Sens. Dale Bumpers of Arkansas and John Culver of Kentucky. It also has strengths in health care (particularly with U.S. Food and Drug Administration matters), real estate and a 50-attorney intellectual property group. Sources familiar with both firms said Pepper would have welcomed such additions, particularly the IP and government relations strength. Pepper would have offered Arent Fox its powerful corporate and securities practice, led by firm chairman Barry Abelson’s highly profitable venture capital group. The firm also has an extremely strong commercial litigation group. With 125 more lawyers, Pepper Hamilton is 30 percent larger than Arent Fox. But the economics of the two firms appeared to be similar. And while about half of Pepper Hamilton’s lawyers are in Philadelphia, the rest are scattered among 10 other offices: Berwyn and Pittsburgh; Cherry Hill and Princeton, N.J.; Wilmington, Del.; Tyson’s Corner, Va.; Detroit; and the aforementioned New York and Washington sites. That would also seem to be appealing to Arent Fox, as Smith had said that one of the major reasons the firm had looked at merging was to expand geographically — both nationally and internationally. Arent Fox has an office in Bucharest but has only one American lawyer stationed there. But potential mergers between relative equals are always difficult to achieve because of the all-important power issues. What is the new firm’s management structure? Who’s going to run it? How many seats on the management, executive and compensation committees should be dispersed to each side? Do the respective firm cultures mesh? And what will the new firm name be? Murray, though, said that from his perspective, none of those power issues were deal breakers. From Pepper’s perspective, an Arent Fox merger would have helped the firm meet two major strategic objectives: obtaining a New York presence and expanding its Washington office. Pepper would have offered Arent Fox its powerful corporate and securities practice, led by firm chairman Barry Abelson’s highly profitable venture capital group.

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