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“If the performance in the first quarter continues, the firm will not be able to survive in its present form.” The managing partner of a large Washington, D.C., firm issued that grim warning to his colleagues on April 3, 1993, in the wake of the last national recession. Law firms shared in the boom of the 1980s, and then felt the pain when the nation’s economy deflated in the early 1990s. Sound familiar? It is. In the current economic slump, several large law firms are reliving the traumas of the recession that gripped the country just more than a decade ago. Then, as now, partners awoke after an expansion binge — fueled by overheated markets — to the realization that they had overextended their firms. Then, as now, firm managers laid off associates, shrank or shuttered satellite offices, and “refocused on core strengths.” It’s not clear that the current recession will shake the law firm world as roughly as did the recession of the early ’90s, which led to several firm dissolutions. Indeed, some firm leaders say they see significant distinctions between the two downturns. But if the recent spike in layoffs and the uptick in partner defections are any indication, history may be repeating itself. For the most fiscally unfit firms out there, that could mean there’s worse to come. And if the economy is in fact poised to emerge from recession, as some Nasdaq prospectors now claim, firms that cut back aggressively over the past year may soon pine for their discarded “overcapacity.” “What has gotten firms into this box again is a fear among law firm leaders to say, ‘Look guys, it’s time to take a little less money this year,’ ” says James Jones, a law firm consultant and former Arnold & Porter managing partner. “ That’s not a very popular thing to do. But there is such a thing as a business cycle, and sometimes profits go down.” GROUNDHOG DAY In the January/February 1991 issue of The American Lawyer, then-editor Steven Brill wrote that the steep drop-off in the hostile takeovers, leveraged buyouts, and real estate speculation that had kindled the bonfire of the ’80s would lead to “a thinning of the ranks of top-tier-earning associates.” Layoffs — some purely economic and others based “strictly on performance” — were already occurring nationwide. Brill anticipated more, and observed that at least some of the firings followed “shortsighted overhiring of not fully qualified people during boom times — thus allowing the firm to say, truthfully, that the cuts are the result of performance reviews, not lack of business.” Of course, he noted, “had business kept up, they would have been content to keep these mediocre performers doing mediocre work at high billing rates.” Brill also forecast a decline in the hiring of new recruits, and a more sober, deliberate policy on compensation. “This market will distinguish more precisely between the stars and nonstars and reward them accordingly.” He was certainly right about the layoffs. But his trust in the rationality of the legal market was misplaced: Many firm leaders proved unable — or unwilling — to restrain their compensation and hiring committees when the Internet ignited the broader economy in the late ’90s. “In ’91 and ’92, there was a lot of panic that set in,” recalls Jones, who was leading Arnold & Porter at the time. “A lot of associates were shown the door.” But when the economy got back on track in the latter half of the decade, “firms had to come back into the [employment] market when it was decidedly a seller’s market, and they had to pay real premiums,” Jones points out. Firms may now be “on the verge of making some of the same mistakes.” The premiums firms paid for associates peaked during the salary wars of 2000, after Silicon Valley’s Gunderson Dettmer Stough Villeneuve Franklin & Hachigian famously jacked salaries for first-year recruits to $125,000. Virtually every major U.S. firm soon followed suit in a feverish bid to compete for talent amid the dot-com gold rush. At the same time many firms, from San Francisco-based Brobeck, Phleger & Harrison to D.C.-based Arnold & Porter, also grew dramatically. The combination of more lawyers and higher salaries has proved difficult to manage. “Firms have stretched themselves to the limit,” says Peter Pantaleo, CEO of D.C.-based Verner, Liipfert, Bernhard, McPherson and Hand. In Pantaleo’s view, the current downturn will hit some firms harder than past recessions as a result. Clients’ relentless pressure to hold down legal costs has made it impossible for most firms to offset higher salaries with fatter fees, Pantaleo notes. So firm management has looked to “elasticity in productivity” — meaning more work from the rank and file — in order to prop up profits. But with associates’ annual billable-hours requirements already hovering around 2,000 hours at most major firms, “there is no more elasticity there — people are at the end of their endurance,” Pantaleo says. Add to this picture the fact that at least some major firms have racked up substantial debt, throw in the drop in demand for some legal services, and you have at least a few firms “in very dire circumstances,” he says. “The salary wars are an example of ego replacing economics as a way of making decisions.” Verner Liipfert is in some ways a case in point: The current leadership is now straining to regroup as a leaner, lobbying-focused enterprise after recent expansion efforts and poor controls on costs and collections proved economically calamitous. But Pantaleo says the firm is not strapped with debt. PLAY IT AGAIN If the much-publicized layoffs last year at Silicon Valley’s Cooley Godward made the firm the poster child for law firm retrenchment in the current recession, Latham & Watkins enjoyed the same role 10 years earlier, when it famously cut 43 associates. “We were too narrowly based in the late ’80s,” recalls John Walker Jr., who was Latham’s managing partner at the time and is now a senior partner. “We had a much smaller base of productive partners, and we made a big bet” on clients such as junk bond flameout Drexel Burnham Lambert Inc. and LBO hawks Kohlberg Kravis Roberts & Co. When work in that sector of the economy dried up in 1990, the firm’s profits sank. Today, of course, the firms that are “too narrowly focused” are the ones that bet too heavily on dot-com companies. Walker nonetheless says he believes the current economic situation is actually quite different from the one he battled through. “The nature of the early ’90s recession was really kind of one-dimensional. It was a debt problem. The whole economy was overleveraged,” says Walker. The current downturn, he suggests, is a more complex combination of a cyclical slump in corporate profits, a depression in the tech sector, the recessionary effects of Sept. 11 on specific industries, and the persistent stagnation of the Japanese economy. Whether a more-complex recession is better or worse for law firms remains to be seen. But Walker’s experience surely offers useful lessons for today’s managers. “We took a hit” for laying off associates, and “found out it was a mixed thing to do for the firm. We’re not going to do it this time because we’ve structured ourselves so we don’t have to,” he says. In 1993, the firm retooled its partnership compensation scheme to encourage more partners to generate business. The firm diversified its service offerings, adding more intellectual property and litigation expertise. As a result, Walker says, “We’re getting through this quite nicely. The bottom is a lot higher.” He has no illusions about the future of the legal market, however. “You could write a short one-act play right now,” says Walker. “In four years when the next boom hits, somebody in a boardroom in New York will have the bright idea of raising associate salaries, and this will all happen again.”

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