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Matthew Larrabee, the 52-year-old litigator who chairs Heller Ehrman, prides himself on his ability to diplomatically answer the most sensitive questions. Has the firm in recent years nudged some shareholders out of the partnership and into positions such as special counsel? “There are some folks that have [had] a change in status based on what is going on in their practice and their life,” Larrabee says rather succinctly. Did the firm recently revise its egalitarian compensation system to show greater deference to business generators? “There has been a philosophical adjustment to how we reward our people. We are allocating more to our biggest producers,” he responds quickly, in a relaxed tone.
But during an interview in early March at Heller’s San Diego office, it was a fairly innocuous question that appeared to dismay Larrabee, causing him to fall silent, a perturbed look on his face. What accomplishment, he was asked, was he most proud of? “I’m proud,” Larrabee eventually said, “[of] having the shareholders rally around what we are doing to make us a more competitive business.” Larrabee’s three-year tenure as chair hasn’t been defined by accomplishments as much as by the departure of “shareholders” (Heller’s word for partners). In fact, Larrabee’s visit to the San Diego office came almost a year to the day after the office’s former managing shareholder, Stephen Ferruolo, left with another shareholder and five associates to open an outpost for Goodwin Procter. Their departure was quickly followed by an announcement that the San Diego-based cochair of the firm’s intellectual property transactions group was joining Ropes & Gray in New York. By the end of 2007, San Diego’s corporate practice, which once numbered 25 lawyers, was down to about 15. Across the firm, 25 shareholders left in 2007, 16 of them for other firms. Some of the departures could be described as mutual, resulting from the firm’s efforts to boost its profits per partner. But among the departing shareholders in 2007 were also key business generators and practice group leaders, including Patricia Gillette, cohead of the firm’s employment group, who moved her $5 million practice to Orrick, Herrington & Sutcliffe; and Jerry Marks, a securities litigator and managing shareholder of the Los Angeles office, who left for Milbank, Tweed, Hadley & McCloy with at least $6 million in business. And since Larrabee’s reelection to a second three-year term as chair last December, the pace of the departures has not abated. So far this year, more than 16 shareholders have left Heller, including Ginger Dreger, a $6 million life sciences shareholder who joined Goodwin’s Silicon Valley office, and P. Peter Benudiz, a Los Angeles shareholder whose real estate and hospitality practice has generated as much as $8 million in past years. Nor was partner head count the only statistic in decline at the San Francisco-based firm. In a year that saw the firm’s Bay Area brethren post some impressive financial gains, Heller reported a 3 percent decline in both gross revenue ($491 million in 2007) and profits per partner ($1.005 million). Additionally, the firm’s revenue per lawyer-traditionally a strong metric at Heller-fell by 5 percent, to $805,000. According to two former partners, Heller, which last year laid off 65 members of the firm’s support staff, missed internal budget projections by 15 percent. Larrabee insists that the 2007 drop was an aberration, not an indication of a flaw in the firm’s business strategy. Heller’s corporate practice, he notes, generated $210 million last year-a 5 percent increase from 2006 and the department’s best-ever posting. Larrabee attributes the overall downward spike to the settlement of several cases that were big revenue generators for the firm’s mainstay litigation practice. “This is not spin. This is the same thing I tell people internally. It is the same thing I tell people externally,” Larrabee says. In December 2006, for instance, the firm settled a matter related to the Parmalat Finanziaria SpA bankruptcy for Deloitte & Touche LLP. Two months later, Microsoft Corporation settled an Iowa state antitrust class action in which Heller was cocounsel with Sullivan & Cromwell. In March 2007, the firm settled a case for Genentech Inc., and in June for Azul Systems. That same month a federal court dismissed a case stemming from the involvement of longtime Heller client Ernst & Young L.L.P. in the AOL LLC-Time Warner Inc. merger. The conclusions of these cases were coincidental and abrupt, and management could hardly be expected to have planned for all of them. The harder question is why the pipeline wasn’t stocked with new matters. Heller Ehrman has always marched to its own beat. But its current troubles, say former shareholders, have come as the firm’s leadership implemented a series of changes designed to help Heller keep up with competitors. In 2003, in an attempt to build a corporate practice that would match the luster of its litigation reputation, Heller acquired the 60-lawyer Venture Law Group-a move that was in many respects an initial admission that substantive change was necessary at the firm. Then in recent years, as the firm saw the profitability gap between it and peer firms grow, Heller’s leadership began paring down the partnership, focusing on core practices and rejiggering the compensation structure to reward business generators. The hope, Larrabee says, is that these adjustments will make Heller more competitive without sacrificing the culture that held the firm together. “Being competitive economically concerns us, and I think for that very reason we have changed over the past few years,” he says. Whether the changes will improve the firm’s financial performance over the long term remains to be seen, but the short-term results have not been promising. And in the meantime, they have upset some longtime shareholders-many of whom are now former shareholders. Heller Ehrman traces its roots back to the law practice that San Francisco attorney Emanuel Heller established in 1890. A time line decorating the walls of some firm offices notes that following the San Francisco earthquake, the Heller family home served as the temporary headquarters for Wells Fargo Nevada National Bank, then Heller’s most important client. More than 100 years later, in 1987, the firm opened a Los Angeles office to service, among others, Wells Fargo & Company. Heller was on the move in the 1980s and 1990s. The Los Angeles opening followed new offices in Seattle and Palo Alto, and was in turn followed by new branches in Singapore, Washington, D.C., and New York. Today, the firm’s 611 attorneys practice at 14 offices worldwide, in cities from Shanghai to Madison, Wisconsin. As Heller sought a national and international platform, the firm’s unique culture seemed to be an asset. Partners refer to themselves as “shareholders,” and in the past they took more pride in their collegiality than their books of business. This was reflected in the firm’s compensation decisions, in which, historically, Heller gave less weight to business generation than peer firms. “They had a little of that California hippie vibe: ‘It’s not all about the money, relationships are important,’ ” says a former attorney at the firm who asked not to be identified. “ [Heller] marketed itself as the alternative for sane, smart people.” Lateral candidates, for instance, typically met with no fewer than 25 shareholders during the recruiting process. “Heller was always different from most other firms [when it came to] ‘lifestyle’ or ‘soul,’ ” says former shareholder Patricia Gillette. This “soul” may partly explain why after 2000 the firm was never quite able to match the profitability of other Bay Area firms, such as Orrick and Morrison & Foerster. In 2001, for example, Heller’s profits per partner ($645,000) were $120,000 less than Orrick’s and $30,000 less than MoFo’s. (Heller traditionally fared better in the RPL rankings, where it was often at or near the top of the Bay Area rankings.) But for a while, the firm’s own exceptional growth appeared to be enough to satisfy shareholders. In 2005, the firm’s profits per partner reached $885,000, an increase of $240,000 in four years. Heller was by then two years into a major push to redefine its corporate practice and improve its profitability. The firm has always brandished its reputation as a top-flight litigation shop, representing large corporate entities such as Altria Group, Inc., Merck & Co., Inc., and all four of the major accounting firms in high-stakes matters. Its corporate practice, despite strong client relationships in the life sciences and hospitality industries, was, comparatively speaking, an afterthought. “I think it is fair to say that [Heller] has struggled some to build a full-service corporate practice to match [its litigation department],” says Chuck Fanning, a San Francisco-based legal recruiter at Major, Lindsey & Africa, who has represented some of the departing Heller shareholders. “The corporate folks they do have are first rate, they just need more of them.” The firm opened a New York office in 1999; it’s now Heller’s second largest, with 98 attorneys, but has not become the hoped-for center of a strong corporate practice. (In June, Larrabee will relocate there, arguing that New York “is a logical place for me to be as we focus on growing on the East Coast and internationally.”) In 2003, in a bold move to build the corporate practice, Heller acquired the Venture Law Group, a Silicon Valley-based firm that represents emerging growth companies. The VLG attorneys, along with 14 corporate lawyers from the San Diego office of Brobeck, Phleger & Harrison who also joined Heller in 2003, were supposed to give the corporate practice greater heft. Heller’s leadership contends that they did just that. “It has absolutely been a success,” says Barry Levin, the former firm chairman who engineered the deals. “Those acquisitions have been great additions to Heller Ehrman. We are not simply representing technology companies, but becoming a part of their growth into larger companies. It has been a part of what has helped us expand into new places and attract new people.” Since the addition of the VLG and Brobeck attorneys, revenue from corporate matters has jumped more than 60 percent, according to firm management. Additionally, the firm provided a list of companies-including Yahoo! Inc., Seagate Technology LLC, and Symantec Corporation-for which it handles both litigation and corporate work. “There are synergies. There are situations where our corporate lawyers are in boardrooms, and that produces a need for securities advice, corporate governance advice, and litigation,” says Larrabee. But former shareholders say the VLG and Brobeck acquisitions didn’t live up to expectations. “In supporting the merger with the Venture Law Group, my thinking was if we bring some more corporate lawyers it would bring us the critical mass. But all they were interested in was doing private company and venture capital work,” says Ferruolo, the former San Diego managing shareholder who left Heller in 2007. Another former shareholder says the firm’s strategy was flawed from the beginning: “That was not the way to build a corporate practice because what you get is mostly cheap work.” Former Heller lawyers also contend that there is little connection between the corporate work of the laterals and the firm’s traditional litigation work, leaving a split between Heller’s two most important practices. Two years after Levin’s corporate department acquisitions, Heller’s leaders considered a merger that might have transformed the firm. But their sense of Heller’s uniqueness-the very quality that some shareholders say has been lost in the last couple of years-kept the firm from making a deal. “There was a lot of pride attached to the culture and the name,” says a former shareholder. In 2005, San Francisco-based Heller and Boston-based Goodwin Procter held exploratory talks. But Goodwin insisted on conditions that Larrabee, who was by then Heller’s chair, wouldn’t agree to. According to a former shareholder, Goodwin wanted Heller to cut head count by 150 attorneys, to boost billable hours, and to eliminate the firm’s “student government” management structure. (Larrabee says that as a rule he does not answer questions about merger discussions, but a Heller insider describes the former shareholder’s description of Goodwin’s terms as “exaggerated.”) Merger thwarted, Goodwin went on to open four offices in California, luring away four Heller shareholders in the process. Heller, meanwhile, ended up making some of the very changes Larrabee had rejected when Goodwin proposed them. The firm had been shaken by both the VLG acquisition and the merger talks, with shareholders becoming acutely aware that Heller was not keeping pace with other national firms. So the policy committee began implementing new strategies. “The business is evolving and the culture is not the same,” says Larrabee. “We have changed a lot in the last three years. We are now really focused on the businesses we are extraordinarily good at [and] investing a little less in some other things.” While still billing itself as a full-service shop, Heller has sought to focus on a select group of core practices: antitrust, real estate and hospitality, corporate and IP work for emerging companies, insurance recovery, and securities litigation. Heller has also held exploratory talks with several potential merger partners. The firm changed its compensation structure-which once gave a great deal of weight to factors such as citizenship, collegiality, and quality lawyering-to grant more credit to business generators. One former shareholder describes the change as boosting business generation from 50 percent to about 80 percent of the analysis used by the ten-member compensation committee to determine compensation; Larrabee denies the process is that formulaic but admits that business generation “went from important to very important.” Heller also pushed out struggling shareholders. Of the dozens of departures from Heller over the last three years, about 40 percent were by what firm leaders call “mutual arrangement.” Another 15 shareholders accepted early retirement or a demotion to a counsel position. “For a long time, Heller was operating under the big-tent mentality of ‘there is room for all good lawyers.’ As long as you are a good lawyer, everything is fine,” says Peter Zeughauser, a Newport Beach, California-based law firm consultant and contributor to The American Lawyer. (Zeughauser’s firm is a marketing consultant to Heller, and one of his partners worked at Heller for several years.) “Now they are trying to hone their practices in a strategy that will enable them to succeed over the long haul.” Within the firm, some have welcomed Larrabee’s aggressive focus on business. Eight Heller shareholders interviewed for this article expressed their support. “No matter how good your culture, that is not enough to guarantee a successful business that will thrive over time,” says Kenneth Chernof, a Washington, D.C.-based litigation shareholder who sits on the policy committee. “The right thing is to find a balance, and that is really hard to do.” Adds another Washington, D.C.-based attorney, who did not want to be identified: “As a young shareholder who has brought in business, I think you have to reward people who have shown an ability to bring in work. You have to do it carefully, though. There are people who have been here a while and the firm has to show them that their loyalty and service is valued.” But other shareholders are voting on Heller’s new strategy with their feet, and they’re voting no. Their reasons for leaving vary. Some say Heller’s culture was destroyed by the new policies. Others say that despite the revamped compensation structure they still weren’t making enough money. But mostly they say Heller is a firm without a strong sense of direction. Since the 2003 acquisition of the Venture Law Group, former shareholders say, Heller’s evolution has been a series of missteps, of which the firm’s current efforts are just the latest. “I, like many others, lost confidence in where the firm was going,” says a former California shareholder. “I think it wasn’t just the financial issues. [It] wasn’t clear how they were going to turn the negatives into positives.” Former Heller attorneys say that confidence in the firm and a commitment to its culture is what kept many shareholders with portable business there when Heller’s profits were eclipsed by those of other firms. But once Heller changed its priorities, there was less reason to stay. “Now that they have made money [their] number one [priority],” says one former Heller lawyer, “I don’t know why they are surprised when people leave to make more money.” Bruce Jenett, a Silicon Valley-based shareholder who cochaired Heller’s life science practice for seven years, says he made the move to DLA Piper for new opportunities-but adds, “Financially, things were very attractive.” One former shareholder admits that when the invincibility of Heller’s culture cracked, firm leaders were in a no-win situation. They had to compromise the culture and channel more cash to business generators in order to try to keep up with other firms, even though that was a competition they were bound to lose. Larrabee disputes that his efforts to make the firm more business-minded have resulted in a diminution of the firm’s culture and a rush of shareholders seeking the highest bidder. “We are not at the top of the profit chain and so when people come here they are almost always really talented people turning down more money someplace else,” Larrabee says. He asserts that the firm’s culture is still the major draw for laterals. Intellectual property litigator Kevin Culligan, who joined Heller as a New York-based shareholder in June 2007 with three other partners from King & Spalding, agrees. “You spend a lot of time at work and working hard,” Culligan says. “To do it in a place were people are truly cooperative and interested in making life easier makes all the difference in the world.” Larrabee also points to the success of the firm’s year-old London office as a sign of Heller’s new direction. Several practice areas called on Heller’s policy committee to open the firm’s first European office. The committee agreed to the proposal, asked a handful of U.S. shareholders to relocate, and brought aboard three new lateral partners from Wilmer Cutler Pickering Hale and Dorr. After the London office’s opening in March 2007, Heller attracted an additional lateral partner from Wilmer, as well as a partner from Sidley Austin. Steven Koppel, the New York-based shareholder who is responsible for lateral recruitment, says Heller plans to keep adding talent in core practice areas-although only one lateral shareholder has joined the firm so far in 2008. (Heller has also announced that Nick Seddon, a former partner at DLA Piper, will become a regional managing shareholder for Heller in Asia this summer.) “I have been a partner at more than one law firm. This is a great place,” Koppel says. “I am not going to feel bad because we had a hiccup of $30,000 in profits per partner. Not that we don’t want to do better. We do want to do better. And we will.” But the question isn’t so much whether Heller can do better, it’s how long shareholders are willing to wait for it to happen. E-mail: [email protected]. Headed Out In the last year, Heller has lost a number of key practice leaders. In order of departure: Stephen Ferruolo: Cochair, corporate/VLG practice group. Left in March 2007. Harry Rubin: Cochair, intellectual property transactions practice group. Left in March 2007. Patricia Gillette: Cochair, labor and employment practice group. Left in October 2007. Margaret Mann: Cochair, restructuring and insolvency practice group. Left in January 2008. P. Peter Benudiz: Cochair, real estate practice group. Left in February 2008. Paul Davis: Cochair, patents and trademarks practice group. Left in March 2008. Thomas Donnelly: Cochair, environmental practice group. Left in March 2008. Marc Schildkraut: Cochair, antitrust and trade regulation practice group. Left in April 2008.

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