At the University of Virginia School of Law in the 1990s, Saul Levmore would illustrate in his corporations courses the stupidity of making a hostile bid by auctioning off sealed plastic bags filled with money that symbolized target companies. Levmore warned students that the winner would overpay -- the winner's curse, the economists call it -- and the students always ended up proving him correct.
Levmore moved to the University of Chicago in 1998, and if he's still hawking bags of money, law firm managers would do well to head to Hyde Park to sit in on his class.
Instead of thinking of the bags as corporations, the lawyers should see them as potential lateral hires with enticing books of business. In both cases, good due diligence is difficult if not impossible to perform; it may even be harder in the case of lawyers. Public companies at least have audited financial statements; individual attorneys or small groups of them do not.
That may be the primary lesson from the collapse of Dewey & LeBoeuf LLP. In 2007, Steven Davis, then the chairman of LeBoeuf, Lamb, Greene & MacRae LLP, combined it with Dewey Ballantine LLP. It was a risky move for the head of a firm whose core clients were insurance companies and utilities, especially since Dewey was teetering after a failed merger with Orrick, Herrington & Sutcliffe LLP. In one fell swoop, Davis dramatically increased the risk profile of an institution in a conservative business with conservative clients that would seem to have been poorly equipped to make such a move.
Davis acquired a single business with employees, audited financials and real estate, but in another sense he had picked up a whole group of businesses, some more stable than others, all run by people who could leave at any point. Indeed, many already had left; Dewey partners voted on the Orrick deal with their feet. Among the defectors were Michael Aiello, who's now the head of the corporate department at Weil, Gotshal & Manges LLP, and Adel Aslani-Far, now a global co-chair of M&A at Latham & Watkins LLP.
The departures should have underscored the risks of a radical change in strategy for a large law firm and the stiff challenge in integrating Dewey & LeBoeuf's 1,300 lawyers in 25 offices. But instead of spending a few years knitting together the two predecessor firms, Davis almost immediately started using them as a platform to acquire more partners, many of whom received guarantees that the firm eventually had to borrow to fund. That debt is the proximate cause of the crisis the firm currently faces.
Davis wasn't alone in dipping into the lateral market. Indeed, one argument for law firm mergers is that they allow the combined firm to spread the costs of lateral hiring and geographic expansion across a larger number of partners. Davis apparently loved that bet, because he made it every time he hired a lateral partner, which he did with dizzying frequency. Last year, Dewey brought in 37 laterals. That's a lot of bags of cash to buy at auction, especially during a severe recession in the demand for legal services.
Dewey couldn't call up a prospective hire's clients and ask them for their opinion of the lawyer; it often couldn't even verify what the lawyer said about his billings and his client list. If Dewey wanted a lawyer for his book of business, it was essentially bidding on a bag of money whose value it had to estimate.
Davis was also betting on his ability to remake both his old firm and Dewey Ballantine by moving the merged entity dramatically upmarket. That's hard enough to do over the course of a generation, and perhaps impossible over the shorter term. But numerous other firms harbor the same ambitions. Law firm managers often talk about expanding and doing higher-margin work; they almost never talk about providing services more efficiently.
There are smart ways to hire laterally. Firms may need a specific expertise with an ascertainable value -- an antitrust partner who bills 2,200 hours a year and will keep three associates busy with Hart-Scott-Rodino filings; a Foreign Corrupt Practices Act counsel who bills 1,800. Some firms may be able to avoid giving guarantees to some lawyers. But in handing a rainmaker a guarantee, you're buying a bag of money. Levmore wouldn't let his students overpay by too much in order to learn their lesson. Davis didn't have that protection.
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