05.03.12

Dewey & LeBoeuf Near Collapse—Are Other White Shoe Law Firms In Peril?

It would be the biggest law-firm collapse in history, writes Dan Slater. Management experts point to a deadly combination of general economic malaise and the firm's particular mismanagement.

When Aaron Sorkin conjured Sam Seaborn, the fictional White House staffer in The West Wing, he wanted to invest the character, played by Rob Lowe, with a distinguished pedigree. So Seaborn graduated magna cum laude from Princeton, edited the law review at Duke, and cut his teeth at a famous law firm, Dewey Ballantine.

In the late 1990s when The West Wing was conceived, it was an obvious choice: Dewey, a powerhouse in corporate law since the presidency of Teddy Roosevelt, had 500 lawyers in offices around the world. It was spoken of in the same breath as other old-line New York firms, many of them recognizable to the general public, such as Cravath Swaine & Moore, Sullivan & Cromwell, and Debevoise & Plimpton. 

A few years later, Hollywood came calling. Dewey's opulent offices in midtown Manhattan were used to shoot scenes for the George Clooney legal thriller Michael Clayton. In 2007, Dewey's dominance was only expected to grow when it pulled off the largest law-firm merger in history, joining ranks with LeBoeuf, Lamb, Greene & MacRae, creating a 1,300-lawyer firm with annual revenues of about $1 billion.  

But it could all be over soon, as the news came in over the past week that the firm, now known as Dewey & LeBoeuf is flirting with ignominious collapse. Dewey’s demise has many wondering what's next for the embattled law-firm industry, and whether other “white shoe” giants, previously thought to be immune from recessionary strain, could also fall. 

"We've seen some prominent firms fail in recent years," says Peter Zeughauser, an adviser to law firms. He cites Coudert Brothers, Heller Ehrman, Howrey, and Thelen. "But Dewey has an incredible legacy. In many ways, this is a first – at least for this era." Zeughauser, a former general counsel, says a failure by Dewey would be the largest law-firm collapse in history.

What brought Dewey down, law-firm management experts say, was a deadly combination of general economic malaise and the firm's particular mismanagement. The problems began when the 2007 merger with LeBoeuf went from being a great idea to a horrible one: practically overnight, the ensuing financial crisis flattened demand for legal services. In 2010, the firm's chairman, optimistic about a recovery, began recruiting scores of rainmakers from other firms – so-called lateral partners – by promising huge pay packages that Dewey could not afford. 

Not surprisingly, Dewey's partnership was divided over the wisdom of these hires.

"Normally, when new star talent is recruited, everyone in the partnership bears equal risk," explained Zeughauser. "But what happened at Dewey is that partners at the higher end of the pay-scale demanded guarantees on their money. That transferred all the risk to the people at the lower end of the pay scale, creating huge pay disparities."

Dewey was not alone among firms of its ilk in going after star hires. American Lawyer magazine, the law-firm industry's leading trade publication, reported that 2011 "was the year that partners jumped back into the lateral market with full force." Dewey, having hired 33 new partners in the 12 months ending September 30, 2011, ranked ninth, among top-gaining firms, in lateral-partner hires. American Lawyer cautioned, however, that 2011’s "uptick in lateral churn does not mean the boom years are back ... In many cases, it's cherry picking, as firms try to counter a stagnant economy by poaching top performers from rivals." The hiring binge, American Lawyer wrote, “was driven by desperation, not a thriving economy.”

"The only thing holding many large firms together now is money. No shared history. No shared values. Money by itself is weak glue."

In October of 2011, Dewey announced it had compensation commitments it could not meet. Slashed pay led to lawyer defections. Since January, at least 85 of Dewey's 300 partners have left. Last week, the Manhattan district attorney launched a criminal investigation into alleged wrongdoing by Dewey's former chairman, Steven Davis, in his management of the firm. On Friday, Dewey told its incoming class of summer associates, scheduled to begin in a matter of weeks, making more than $3,000 per week, that the summer program was cancelled. On Monday, Dewey advised its partners to begin looking for work elsewhere.   

"If the economy had clipped along, like in 2006 and 2007, Dewey management might have looked wise," said William Henderson, a law professor at Indiana University who studies the business of law firms. "But with the downturn, the pay guarantees essentially sheltered some new hires at the expense of the rest of the rank and file partnership." 

Historically, in order to afford those $3,000-per-week salaries for first-year attorneys with no experience, and to keep rainmaking partners happy, law firms have been, like some of the Wall Street institutions they service, heavily leveraged entities. The difference is that, in law, the leverage is not financial but human. Banks gamble on investments, while law firms gamble on people. In a sense, it’s all the same: if business is good, leverage pays off.

It's best, Henderson says, for a firm to grow organically, nurturing its own talent rather than paying high prices for rainmakers who might not make it rain. But under pressure, many firms are giving up on organic growth and turning to a lateral-hire strategy in the downturn. "Lateral partners seem like the cure," Henderson says. "As a result, the only thing holding many large firms together now is money. No shared history. No shared values. Money by itself is weak glue."

Some brand-name firms, like Latham & Watkins, have done well with lateral hires by vetting them carefully and being cautious with pay guarantees, says Zeughauser, the law-firm adviser. "But it's always risky. Law firms are just fragile. In a consolidating industry, even the strongest of them won't be around forever. Dewey proves that." 

The legal press has compared Dewey's situation to the 1987 collapse of Finley Kumble. It was that year ironically, that American Lawyer published the first edition of its now heralded law-firm rankings, the Am Law 100, and ranked Finley Kumble #2. By year's end, the firm folded, in part because of rich guarantees to star laterals.

Twenty-five years later, 11 of those original AmLaw 100 firms are now extinct.