About.com defines "cautionary tale" as "a traditional narrative, e.g., a fable, proverb, or urban legend with a moral message warning of the consequences of certain actions, inactions, or character flaws," and cites the following example: "King Midas is a cautionary tale demonstrating the pitfalls of unbridled greed."
To most of us, King Midas represents "the man with the golden touch," but the power bestowed upon him by the gods had a negative side. Yes, it turned simple twigs and stones into valuable gold, but it also turned his food, water and even his lovely daughter into the hard, cold metal, illustrating the lesson all of us must learn at some point in life: Anything taken to extremes can have unintended consequences and often leads to serious problems.
This is what happened to Dewey & LeBoeuf. The law firm that traced its roots back to 1909—when three Harvard Law School graduates founded the Wall Street firm of Root, Clark & Bird—had many outstanding successes, and employed scores of legendary attorneys did not contemplate carefully enough the potentially negative aspects of some of its practices and ended up taking many of those practices to unprecedented extremes. They were no longer functioning in the world of "standard operating procedure." They had crossed over into the world of excess, thereby providing the rest of us with some very important lessons.
Transparency, Communication, Fairness
One of the most essential lessons is the importance of openness and communication. After the firm’s fortunes started spiraling downward and its internal practices became grist for public discourse, it became clear that deals had been made with banks, existing partners and newly-hired lateral partners, the specifics of which were known to just a handful of people. One of the reasons most law firms have so many committees is to prevent just this kind of situation. This is the way the political process, academia and most other businesses function too. It has to do with basic "checks and balances" and is an extremely valuable tool that helps keep individuals and institutions out of trouble.
In Dewey’s case, the practice that went most unchecked was the issuing of an unusually large number of compensation guarantees. Though much has been said about the guarantees the firm issued to attract lateral partners, they were not the only or perhaps even the most glaring misstep management made. Indeed, it is important to remember that the lateral partners firms find most desirable are usually happy at their present firms, and therefore typically require some assurances that they will be treated fairly in a new system. Such assurances often take the form of a compensation guarantee and, if anything, Dewey’s collapse has made those guarantees more common, not less so.
Much more damaging to the fabric of the firm were the guarantees Dewey issued to entice existing partners to stay, especially since most of them appear to have been struck "in the dead of night," shielded from the visibility of the rest of the firm. In and of themselves, guarantees of a certain amount of compensation for a reasonable period can be appropriate in any business setting, however, Dewey continued to offer them long after its financial condition became precarious, guaranteed some with actual letters of credit, attached no performance benchmarks to them, and offered them for unusually long periods of time.
As one law firm chairman told us: "At the end of the day, it matters who performs and who doesn’t. And compensation levels should reflect that." Absent those standards, there will be a lack of fundamental fairness that can prove corrosive to a firm’s culture. Another firm leader put it this way: "Everyone should have skin in the game, be expected to play by the same rules and deliver equally challenging results."
If firm leaders are contemplating paying over market—either in actual dollars or extended guarantees—to retain or attract new talent, they need to consider the potential damage to the firm and partnership as a whole if the new relationship does not work out and they should have the institutional fortitude to recognize when a particular transaction is out of reach for their firm. If guarantees are offered, they should be of a limited, reasonable duration with clearly articulated performance metrics. The firm should also establish the conditions under which they can terminate the guarantee, claw back monies already paid or make a downward adjustment of the compensation if agreed-upon projections are not met. As Thomas S. Clay, a principal at Altman Weil, put it: "We recommend only one to two years for a guarantee. And those should have some performance component." Remember the lesson learned from King Midas: Turning things into gold is fine, as long as it’s not taken to extremes.
Lateral Hiring Adds Depth and Value
As with guarantees, lateral hiring is also being looked at with fresh eyes and being improved by firms and partners. It is a valuable and effective way for law firms to add depth to existing practices, bring in new practices and add geographic reach. Partners who make such moves are able to expand their practices, provide more services to their existing clients and reach new markets. And it is increasingly popular: In the 12 months ending Sept. 30, 2011 (the most recent data available), 2,454 partners left or joined AmLaw 200 firms, a 22 percent increase from the previous 12-month period. But lateral hiring must, like all other important business transactions, be done only after sufficient due diligence and with appropriate safeguards in place.
Ideally, the lateral partner process should be self-selecting, with the partner and the firm believing that joining forces will produce significant opportunities for both. Once this is determined, the more intensive due diligence should begin. All information in the candidate’s lateral partner questionnaire should be evaluated carefully. "We no longer wait for the third, fourth or fifth meeting," a managing partner told us. "We need to see behind the curtain as soon as possible, after the first meeting in most cases." If the lateral candidate objects to completing the necessary authorizations, consider it a red flag. As Elliott Portnoy, Global Chief Executive of SNR Denton, explained: "Intense due diligence, client references, lengthy written submissions by laterals, and rigorous checking of every data point by our firm and the search firms with whom we work are the new normal."
Both Sides Want to See the "Books"
For their part, lateral partners have, as a result of the collapse and much-publicized financial pain suffered by the Dewey partners, become more circumspect in their negotiations with potential firms. Before Dewey, many lateral partners typically ranked culture, compensation and platform as the most important considerations when making a move. Though the former items remain on the radar, there is a renewed focus on the future firm’s financial stability.
In the past, law firms were the only party to a lateral transaction that conducted real financial analysis, largely by having their accounting people review and model the information supplied in the lateral partner questionnaire. Now the door swings both ways: Lateral candidates are asking to see prospective firms’ books. They want to know the firm is financially sound, has minimal long-term debt, the extent of any other unfunded obligations, as well as its capital structure and capital account requirements.
Though far from universal, an increasing number of partners are requesting this information, as confirmed by Joseph Leccese, chairman of Proskauer:
Candidates, at least the ones firms like ours are interested in, are putting less weight on short-term factors, like adding another dollar to next year’s compensation and the strategic flavor of the month, and far more emphasis on the indicia of long-term strength and stability that contribute to ultimate career success. They’re looking for a consistent firm trajectory based on fundamentals, including basic financial strength, an absence of debt and a palpable sense of mutual respect and partnership culture that allows firms to see their way through the inevitable financial cycles.
As Bruce MacEwen, president of Adam Smith, Esq., told The New York Times, "[Dewey] was an example of Mismanagement 101 across the board. They had a mismatch of assets and liabilities. They took on a massive amount of long-term debt, but their assets were short term." This may sound like business-speak, but it is the type of language those entrusted with running a law firm, or those considering joining one, need to understand. Lateral partners who aren’t able to easily decipher all the different columns and numbers should have a knowledgeable recruiter and/or financial advisor go through the books with them.
Partners considering lateral moves are also analyzing prospective firms’ partnership agreements much earlier in the process. They are reviewing carefully the definition of "equity partner" and whether there are any "look see" periods during which their performance will be evaluated before they are admitted to the partnership. In addition, firms are increasingly making incoming partners, at least at the outset, "at will" employees, representing a significant change from the past.
It’s a Business
Lawyers relish the brotherhood (and sisterhood) of the law, but Dewey and others before it have taught us that lateral partners need to enter their negotiations with "eyes wide open" and investigate the "numbers behind the news." It is nice to be friends with the lawyers you’re going to work with, but that shouldn’t keep a lateral candidate from asking tough questions. Nor should it stop firms from performing the requisite due diligence by carefully reviewing the lateral partner questionnaire. Firm managers also need to remember to involve the entire executive committee and, when possible, the larger equity partnership in the discussion. Firm leaders, or the practice leaders tasked with the responsibility, should be ready to explain what they’re doing and why. After all, equity partners have a right to know what is being done with their money and they might know things about the candidate that were not uncovered in the firm’s research. Even if they do not contribute any new information, it is important that they be included in the process and be made aware of the details of the package being offered.
Dewey was a story of excess and a lack of controls. The behavior was, in some instances, so egregious that it provided other firms with a startling example of just how wrong things can go without a system of checks and balances. Law firm managers and partners need to remember that law is a business—not a terribly complicated business, but one that requires vigilant management, open communication, transparency, due diligence (on both sides of the lateral process), and basic fairness to everyone who calls (or wants to call) the firm their home.
Lawrence N. Mullman, a partner at global legal search firm Major, Lindsey & Africa, can be reached at email@example.com.