Last week, I attended the LMANJ city group's session on "Teachable Moments from Dewey," a presentation taking place in New York that we were remotely accessing. Our speakers were Bruce MacEwen, founder and President of Adam Smith, Esq and Sara Randazzo, a reporter with American Lawyer.
While I've been watching the Dewey coverage with interest, I haven't gotten as involved as some in the details, so it was a fascinating presentation. Bruce said that it's been a topic of near obsession among his readers for the last few months - he started writing an analysis of this in March.
As Bruce and Sara spoke, I took notes all over the handouts that we'd been given, so I'll try to make sense of them here!
Bruce began with a slide on what Dewey did wrong - the collapse of the firm didn't happen out of the blue. And since other AmLaw firms survived, this isn't about the recession either. Dewey had:
- Shocking levels of debt.
- Revenue misrepresentation: they lied to American Lawyer. Bruce commented that it's possible that other firms are doing this, but it's never come to light.
- Guarantees upon guarantees: No tie to performance.
- 20-to-1 partner compensation ratios: inordinately high - not a partnership.
- Haves and have-nots: the firm had become this culture.
- Extreme secrecy: you can get away with a lot and people will trust you. But they lost people with their extreme indulgence in secrecy.
The next slide focused on the firm's debt, with a chart showing the obligation and the amount:
|2010 Bond Issue||$150-million|
|Revolving bank debt||$75|
|Guesstimate of other debt||$25|
|Subtotal, "hard" debt||$250-million|
|Deferred comp owed partners||$150--$250-million|
|Subtotal, "soft" debt||~$275-million|
Bruce said that he'd never seen a firm with more debt, though they may be out there. What's wrong with debt? It's more toxic to law firms than corporations. The answer is timing - law firms have short term assets and long term liability. This same kind of timing mismatch was seen with Lehman Brothers, Bear Stearns, and the S&L Crisis in the 80's.
The presenters then spoke about the revenue misrepresentation - Sara said that to pay partner profits, they would have to borrow from the next year, and this was a cycle that just kept continuing. Law firm accounting is done on a cash basis. Dewey was doing their accounting on 12 months of cash plus whatever accounts receivable were on the books. The problem is that you can't stop doing this, so you have to do it again the following year, or you'd have a ten month year.
The firm also made guarantees upon guarantees:
- 97 in total
- 57 to incumbents, 40 to laterals (59%/41% split)
- Many dating to 2007 Dewey Ballantine/LeBoeuf Lamb merger
- Annual Total: ~$175-million
- Firm's average annual profits, 2008 - 2011: $240-million
- "Have's": $1,800,000/year on average
- "Have-not's": $325,000/year
Dewey had 20:1 partner compensation ratios:
- Actually, 25:1
- Mort Pierce, the $8-million/year man
- Average partner sans guarantee: $325,000
- But isn't Derek Jeter well-paid (to paraphrase Jeffrey Kessler, the sports lawyer of "barbell" comp fame)? Yes, but:
- Divorced from performance (individual or firm)
- Promiscuously awarded
In terms of the Have's and Have-Not's, the presenters shared this slide:
- Mortgaging the firm's future
- Trashing those who departed
- Claiming "there will be no impact on revenue"
- "Whatever else this was, it wasn't a partnership" -- Fran Musselman, bankruptcy trustee, Finley Kumble
Compounding all of this was the extreme secrecy:
- The two Steve's and their henchman
- "The Sicilian Enforcer"
- Audited financials embargoed
- Almost any financials embargoed:
- "They might leak to the media"
- The PowerPoint 5-second rule (Bruce referenced this later, saying that they might show a PowerPoint slide of the financials, but they'd only leave it up for five seconds.
- Almost any financials embargoed:
- Bottom line: If you act like you have something to hide, it might be because...(you do!)
Bruce said that the firm would consciously send uninformed underlings to critical meetings so that they could say they didn't know.
The Wall Street Journal put together a graphic of partner departures by month, showing how the partners were abandoning ship, which the presenters shared with us. In 2012:
- January: 9
- February: 8
- March: 22
- April: 40
- May: 126
- June: 1
Bruce also pointed out that Dewey was not doing so well before the bubble. Four years before everything "hit the fan," Dewey's revenue wasn't looking so hot. Also telling was their net income before the merger, which was similarly in a decline. But the most shocking graphic for us was the net income versus partner distributions - Dewey was always giving more to the partners than the firm was earning. It's not a game you can play forever, but they kept hoping that they'd be able to make it up the following year.
It's generally believed that Dewey failed because of bad management. Back in March, Bruce said:
Judging by available evidence, if this plane crashes - with all the devastation to innocent bystanders that would entail - the accident investigation will conclude that the crew flew it into the side of the mountain."
People thought, at the time, that he was being too harsh. But it turns out that there really was nothing fundamentally wrong with the plane - it was pilot error.
Sara added some of her own comments, saying that as this was all taking shape, she would ask the partners questions, and they would tell her that she probably knew more than they did. She heard this over and over - this all speaks to the extreme secrecy.
The firm said again and again that it wasn't going to file for bankruptcy, and when it eventually did, they waited for a holiday weekend to announce it. This was deliberate on the PR side - they waited to announce this until 9am on the Memorial Day Monday. However, there were indications that they'd been thinking of doing this since April. On April 2nd, the firm hired bankruptcy counsel. Dewey's counsel is insisting that this bankruptcy will be different.
Sara also commented on the PCP - Partner Contribution Plan. Dewey insists that the partners owe them, while the partners think that they're owed. Dewey wants the partners to pay and agree to wash their hands of this. Dewey owes money to recruiters, landlords, pension agency, a former associate, the representative for a malpractice case, and more.
The firm has already spent $7.3 million in the first weeks of their bankruptcy - paying lawyers for bankruptcy and some staff. They estimate that spending $24.8 million will bring them to August 1st, when they hope to have an agreement with the partners. There are a lot of moving parts, and they want things to move quickly. Dewey is paying $935/hour to their bankruptcy counsel, Al Kogut, and almost as much per hour to their communications firm.
Bruce said that there is a lot of bad blood, and the reports from former partners have been consistent that aside from their monthly draw, they haven't been paid in 12-18 months. He added that an unidentified group of partners went to the Manhattan DA a few months ago, and that investigation has yet to be closed. Bruce said that you wouldn't go to the DA to rat on your partners unless there is a lot of bad blood. He thinks it's unlikely that the bankruptcy will conclude quickly. He said that a partner in San Francisco has filed a fraud suit against some of the partners, which is more evidence that there's a lot of tension there.
As you can imagine, there were a number of questions from those in the audience for Bruce and Sara:
- Question: Is there a risk for firms who are taking on Dewey partners?
- Answer: Bruce said that if they reach the agreement, it will get rid of the liability of the partners. However, there could be risk. As far as contingency plans, he's not sure what to suggest to firms other than getting rid of them. He added that the Coudert decision in New York could be applicable to Dewey.
- Question: Would they comment on the firm's PR strategy?
- Answer: It was an interesting couple of months. Looking back, the firm was very careful, but they would regularly say that things were one way when they were really another. He commented on the "free to leave" memo, which everyone interpreted as the firm advising people to leave. The PR response to that was that they weren't encouraging people to leave, but were instead telling them that they weren't liable. They tried to spin it, and carefully chose their words. However, everyone stopped believing them after that. The firm also employed the "Friday news dumps," where they tried to release all news late on Friday night, but the reporters wised up to this and would just wait for them.
- Question: Why didn't the firm self-correct?
- Answer: Two theories - the haves and have nots - the have nots were in the dark. They didn't know the severity of the issues. Steve Davis revealed the extent of the guarantees back in October at an all-partner meeting, and people have said that you could have heard a pin drop in the room. People didn't know. The other reason was fear - they didn't want to challenge these people. The lawyers would say that it wasn't their job to run the firm - they were just there to serve their clients. Sara added that there was also the issue of full time management versus management plus practicing law. Steve Davis would constantly re-elect himself to run the firm, even several years ahead of his term being up. He was a full-time manager.
- Question: Can you talk more about the lawsuit out of San Francisco against senior management?
- Answer: The partner was a lateral hire, who was asked to give $1.8 million - this went in one door and out the other. He says he was lied to when they were recruiting him. This could bring other things to light during the bankruptcy.
- Question: Are there any analogies to Brobeck?
- Answer: Bruce says he knows a bit about Brobeck, Howrey and Coudert. What they have in common is enormously overweening ambition. You've got to be realistic about what you can achieve. He believes at some point they were culpable, but we'll see whether it's criminal, or was just poorly run.
- Question: Should we be worried about our jobs?
- Answer: Very large law firms aren't joined at the hip like banks are. A fall like this takes months of laying the groundwork, whereas a trader can press a button and move money immediately. Everyone in the industry is currently hyper-sensitive to the warning signs. When Bruce made his comment in March, most people were not alarmed. People will now be scrutinizing bad news much more closely.
- Question: What role did the original merger have? They never seemed to integrate or get along.
- Answer: It was a huge role. Not only were both firms in New York, but they were within a half a block of one another. They had two of everything for a while. If you merge two firms in two cities, you have to end up with one center of power to have a merger. But here, they had two firms so close, with strong (different) cultures and they both wanted to retain them. That's when the guarantees started - they paid people who weren't supportive of the merger to stay with the firm. At the end, three out of five guarantees were to incumbent partners. If you could make a principled argument (and Bruce doubts it) for guarantees to laterals, that still wasn't the issue here.
- Question: It appears that the firm was financially mismanaged - were marketing and business development also sub-optimal?
- Answer: One of the things that we hadn't talked about is that the firm wanted to be the next Cravath or Skadden...while Steve Davis was the managing partner. This kind of ambition takes decades though, and you can't do it by shortcuts. Dewey was giving mixed and confusing messages to the market - are they a solid New York firm or a Simpson Polk wannabe? They tried to push this through lateral hires.
- Question: Is Dewey an outlier, or the first of several firms to fall?
- Answer: Bruce said he won't mention Dewey and another firm in the same sentence. But, a lot of the things that Dewey did are things that other firms do, with perhaps the exception of lying to the American Lawyer. Bruce had suggested that the American Lawyer audit firms' financials, but that would be hard. What Dewey was doing wrong was all of the things that Bruce mentioned earlier, and doing all of them to an extreme degree - this leaves no margin for error. It raises questions, and once these are raised, it's difficult to get them out of people's minds. Trust is gone, and once that happened, it's extremely difficult to recover. He doesn't know if another firm is doing all of those things, or to the extreme that Dewey was.
- Question: Didn't people know what was going on?
- Answer: The firm claimed to have a system of checks and balances, but it's hard to say to what extent people knew. There were people in various positions, but they were all on the same team. Power was held very tightly.
- Question: Will anyone go to jail?
- Answer: Bruce said he has no idea what the Manhattan DA is up to because his office is leak proof. He's like to see more of what was going on come to light. He's not sure how that will happen without subpoenas, etc. The law talks about those who "knew or should have known." Bruce said that senior leadership knew or should have known, and he'd like to see people questioned.
- Question: Doesn't this underscore that lawyers are lousy businessmen?
- Answer: Yes. McKinsey has a rule of thumb that managing a professional services firm, like a law firm, is five times more complex per dollar than managing a trucking company, for example. It's not a part time job, or a time for "on the job" training. If a CEO of a company said he was "just not that into management," as a law firm managing partner is quoted as saying, he would be out of a job by lunchtime. Bruce added that Jack Welch can't build a jet engine, but no one questions that that means he can't run GE. He summed it up by saying that lawyers think they can do everyone else's job, and no one can do their job.
- Question: Why did LeBoeuf merge with Dewey? If Orrick had so conspicuously passed on a merger, what did LeBoeuf see?
- Answer: LeBoeuf wasn't purer than the driven snow, but not on the same scale as Dewey. Bruce said he had met Steve Davis once, socially, and though he doesn't really know him, he can see how someone who's in a big hurry to be Cravath could see this as a good idea. Sara said that it's interesting that there are still disputes today over how much of Dewey's problems were known to the LeBoeuf side. They're still bickering over this, and she wonders whether some of it is because they saw what they wanted to see and the merger was done so quickly.
- Question: Should Citi have known something was going on?
- Answer: Bruce said that he doesn't know Dan DiPietro, but yes, they should have known. There were audited financials prepared every year, and if Citi didn't see those, he's not sure who the audience for them was (there were no financials prepared for 2011). That would have gotten his attention if he was a lender. Sara said that she found out that Citi sold off their debt before the bankruptcy. There are four banks, and all but JP Morgan sold off their debt before the bankruptcy - hedge funds have the debt now.
- Question: Would they agree that the most profitable firms in the AmLaw are led by a staff of professionals?
- Answer: Bruce said that he thinks that's right. That would be a sign that we're becoming adults in this area. Bruce said he's not sure what else has to happen before lawyers realize that they can't do everything.
Having not paid too much attention to the situation with Dewey prior to this presentation, I was incredibly intrigued by Bruce and Sara's comments, and will be following this much more closely in the future!