A New York Times Editorial, 5/7/2012: “The Cautionary Tale of Dewey & LeBoeuf”

GUEST: Mark Zauderer
AIR DATE: 07/28/2012
VTR: 05/10/2012

I’m Richard Heffner, your host on The Open Mind. And my guest is a distinguished member of the bar I’ve called upon often over recent years to help me – and my viewers – parse more and more of the legal conundrums that surface ever more frequently in our own times.
 
Mark Zauderer is a well known New York trial and appellate attorney who has long represented major corporations and prominent individuals in financial and commercial litigation in federal and state courts throughout the United States.  And it seems we’ve talked together here about everything law-related from cameras in the courts and law firms’ forced retirement practices, to neuroscience and the law.

  But perhaps the Open Mind conversation my guest and I had at this table four years ago – titled “The Law…fitting a profession into ‘the business model'” – is the one that most closely relates to what brings us here today in mid-Spring, 2012 to record a discussion of what has seemed for some time now to be a running, almost a daily, New York Times story… as Peter Lattman’s report headlined “Dewey & LeBoeuf Crisis Mirrors Legal Industry’s Woes”, James B. Stewart’s titled: “Dewey’s Fall Underscores Law Firms’ New Reality”, and, of course, even a Times editorial earlier the week we record this program: “The Cautionary Tale of Dewey & LeBoeuf”.

  It begins: “The law firm of Dewey & LeBoeuf was created in 2007 in the largest merger of law firms in history.  Last week it encouraged all of its partners – quote – “to seek out alternative opportunities”[ – end quote, end the law firm, too]”.
  “The firm is falling apart,” the Times editorial continued, “because of financial problems after overpaying star partners, gross mismanagement and other factors.  But its troubles are only an extreme version of those facing many other firms.”

 And that, I guess, is what I ought to ask my lawyer fiend Mark Zauderer, who is so pre-eminently a lawyer’s lawyer, having represented for decades major law firms and their partners in disputes within the profession.

The question then: ARE many other law firms facing such problems?  And if so, what happens to the profession – or is it now: “to the business”? That’s my question, what do you think, Mark.

ZAUDERER: Well, I’m glad you’ve reprised this topic and let me say at the outset, because I am involved in aspects of the situation, I won’t comment directly on the Dewey situation, but as you are correct, the situation at that firm really illustrates something that’s important to us that’s occurred over the last few decades as there have been changes in the law profession, changes in society and a confluence of factors that have brought about very significant changes in the legal profession.

And I think to understand it … again … we have to go back some decades or even more to picture in our mind’s eye a profession of law which is very much like a medieval guild. It was a system with values from those who grew up in it, people generally felt that their most important compensation was the respect they got in the community, not so much how much money they made.

And just like doctors and other professionals, this was a reward in itself for a practicing professional.

A number of changes occurred at the same time. Business changed. The clients whom these law firms served. Businesses became what we now call “multi-national”. Transactions were cross-border transactions. And there both was a need by these businesses and an opportunity for law firms to get together to work on transactions that not only transcended state borders but international borders … that required and promoted the growth of law firms.

Now law firms were once home-grown entities. We can go back to the days of Abraham Lincoln when he would try cases for a major corporation as the only lawyer. The world’s changed.

Law firms in New York, for example, were generally home-grown entities. People knew each other, they went from law school to careers as associates and ultimately partners, knowing each other, understanding each other.

And relatedly their compensation was generally what they call “lock-step”. People progressed throughout the profession, earned more as they got more experience and garnered the loyalty of clients.

Now, as the law firms grew, they grew largely by aggregation. The firms became multi-city firms to serve clients that were perceived to have needs in many different cities and in many different countries.

The law firm model became more … a so-called “business model” which I feel and many feel is a poor template for a professional organization.

So lawyers’ compensation, lawyers’ worth was largely judged by people, who in a management committee, perhaps in a different city, who knew very little about the lawyers in the other cities except statistical data. The number of hours they work, the dollars and cents they bring in from clients.

And, by the way, let me say, I have a very high respect for lawyers in, in many of these firms, in all these firms … there are some very, very fine lawyers.

The issue that we’re really talking about is, to some extent, out of the control of the lawyers, because the firms have grown like this.

So, where we once had small groups of lawyers who knew each other and were loyal to each other, we now have firms that have been put together as agglomerations of lawyers, groups of lawyers who are very much like free-agents in sports and if they’re not happy with the firm, they, they can leave.

And then we have other factors, of course … the fact that lawyers have greater expectations in recent decades than before about their compensation.

Many of them have, have gotten more than comfortable. Many of them saw the earnings of their colleagues or clients in investment banking firms and thought … “you know, I should be earning something approximating that, too”.

And so, so this, this confluence of factors have produced many of the things that we see in law firms today.

In particular, let me give you if I may, a little arithmetic model that we understand about law firms that really illustrates what’s happened to so many of these law firms.

And I remember being involved in the … what was the first prominent case of this type of a law firm collapsing … the Finley Kumble case …

HEFFNER: You mean there have been many?

ZAUDERER: There have been a number, yes. And there have been several prominent ones in recent years. And you have in each of them, the same phenomenon. You have the kind of growth that I’ve just alluded to.

And then you have by those managing the firms, a desire to expand the firm, which takes money. And to do this you often have to attract lawyers who have a following of clients, i.e. dollars for the firm.

So, many, as entrepreneurs do … many managers of law firms will have the firms borrow money which in essence finances the promised payments to these star partners who are expected to bring business.

And it’s a bet, it’s a gamble. Now what happens and what happened in 2008 … we had a shift in the economy. And these law firm problems have often tracked shifts in the economy.

So you have a diminution of the gross income of the firm along with the recession. Now why is that so significant? If you think of a law firm as an economic model, a typical large firm may operate on a 30% profit margin.

That is for $100 that it takes in, the first 70% pay overhead. They pay the expenses of the associates’ hours, the staff, the rent, the electricity, everything else. So the 30% … the thirty dollars is what the partners take home.

HEFFNER: No bad.

ZAUDERER: Depends on how big … how many hundreds we’re talking about in this model. Now if that $100 suffers a diminution of 15% … say a 15% drop you can survive. Well, what happens? The $100 becomes $85 … so you have a fifty, not a fifteen, but a fifty percent reduction of the profit margin.

So, for example, the partner earning $500,000 is now on average earning $250,000. Or more to the point, the partners who were bringing in the business … who, let’s say, are earning $2 million dollars are now earning $1 million dollars with that diminution of profits and they get restless.

And they say, “Why should I be working at a firm where I’m earning half and, you know, I’m bringing in all the business and I can do better elsewhere”. Because that partner probably came to that firm from another firm under similar circumstance. So the free agent game goes on.

So, these are all the factors that contribute to the situation and like, when you have dry leaves … a spark can set it off. Well, a downturn in the economy can do that.

And then you get an implosion effect in law firms. When the partners with the business start leaving for more attractive situations, it only accelerates because that reduces the income, they tend to take their, their following, their clients with them. Because these are the people the clients generally know.

So, it’s a kind of death spiral. You’ve got this toxic brew of factors that can throw a firm into a death spiral. Again, I’m talking generally now … there have been several firms that have experienced this.

Finley Kumble was the first example and was an interesting one because at Finley Kumble the firm had done just this, just this … I think in 1987 it owed about $70 million dollars to its banks. They invested in some former Senators, former Governor, former Mayor … promised them very high salaries and then the, the gross income declined and things went on from there. We can talk about that if you like. But I don’t want to filibuster.

HEFFNER: No, it’s not a matter of filibustering at all. It is a matter of expanding upon, as you have, the business model. As businesses go “belly-up”, law firms do then because they’ve become businesses.

ZAUDERER: Yes.

HEFFNER: And what do your … their fellow professionals think about this. Where does it end?

ZAUDERER: Well, nobody knows. I suspect that, as a result of some of the recent failures or near-failures that we’ve seen, the smart people within these law firms and they certainly have smart people and good people and very ethical people … this is not a question of, you know, bad ethics or bad lawyers. It’s a question of bad business in many respects. Ahemmm …

HEFFNER: Excuse me, what do you mean “bad business”? The model …

ZAUDERER: The model … bad business planning. Bad business planning. It’s common to businesses to take risks. But law firms have generally been more conservative, not been entrepreneurial businesses in that sense.

They have not typically borrowed a lot of money. If the income was down, they allowed themselves, the partners did, to take reduced income.

But, let, let me give you an example of why it’s a bad model or a manifestation of it.

A large law firm may say, “Well, our profits were X this year. Well, we want to increase our profits by 5%.” They just decide that in advance, because they want to show they’re a profitable firm and everybody will hopefully make more money and if you’re a profitable firm you can attract people with business. If you’re not, you won’t attract them in a competitive environment.

So, now they back into them and say, “Well, in order to make 5% more, that means … we’re a firm let’s say that bills by the hour … which is a typical model. So we’re just got to do the arithmetic. That means we have to have so many lawyers, billing so many hours at such-in-such a billing rate per hour.

So you have to gamble that you’re going to have the work or require the lawyers to put in more work on the cases they have, assuming there’s work to be done, in order to bring in the income to meet that 5% goal. And there’s a lot of pressure on the lawyers in these firms to do that, of course. That’s a whole other, other subject.

When I started practicing … over 40 years ago … and I was a young associate, we didn’t even know how many hours we billed. I mean we could have added that up from our daily submissions, but when we had our annual reviews from the partners, they didn’t show us the data or, or in most instances comment on it, if you were busy.]

You know today, associates in law firms typically have goals, quotas in some case, or in a, in a sense, their bonus, their compensation is tied to hours because they have to hit a certain tier of hours in order to qualify for a bonus.

So, you know, that’s … one can say that’s, that’s a bad business model if you start with the assumption that you have to make more money and then gear everything to that, there can be many consequences of that.

And I think clients also are putting pressure on law firms. To some extent now and I haven’t mentioned this … but I think one could conclude this from what I’ve observed if you accept it.

Laws firms have done this to themselves. You know clients in some respects and some instances are less trusting of law firms, they put more pressure on them in terms of billing … they’re no longer willing to pay for what’s called the learning time of associates.

The firms have very, very fine, able young lawyers coming out of law school, joining the firms, but they’re not efficient yet. They’ll be, they’ll be given research assignments … some of them are superb. They’ll go with the senior lawyers to court or to a deposition … in, in the days of, of yore … the time was billed to clients and clients didn’t fuss about it.

Clients will now sometimes say to lawyers … I only want one person at a deposition … or two people in court … whatever the circumstance is … they’ll say we won’t pay for more. And firms are less willing to absorb the time by sending the associate, which in part, while helping … is a learning experience for the lawyer.

HEFFNER: You’re talking about cure, perhaps … remedy … but imposed … I sense from the outside from the clients …

ZAUDERER: To a great degree.

HEFFNER: … is there no mechanism within the … and now I’m using the word very carefully … in quotes, within the “profession”?

ZAUDERER: Ah, I think … the profession is addressing this in some ways.

HEFFNER: Through what mechanism?

ZAUDERER: They’re becoming more efficient. They’re making fee arrangements now with clients that will reduce the fee to the client, in many cases, with an incentive for the law firm for success. You know, much like a, a business device.

Example … large firms are more willing to take a case on a partial contingency … right … instead of billing on an hourly basis, there’s a success fee component in it. “We’ll, charge 75% of our normal rates, but if we get a recovery for you, if you’re suing, we’ll get X percent of the recovery in addition.”

Sometimes that’s done on the reverse side … representing a client who is sued … a firm may say, “We will agree that … here’s a number … if we can save you money on the defense side … we’ll get a piece of what we save you.” And other creative arrangements. Sometimes reduction for volume of business. Things to make the cost less for the client and still be profitable for the law firm by building in efficiency.

So those are some of the tools, plus I think the, the education programs … you know we have continuing legal education in the profession it’s required in New York State and, and many other states.

Many of the programs are dealing with law firm management. You know, how to do things efficiently, how to do … get the best result for the client without wasting money or resources.

HEFFNER: You say, how to do things efficiently. Is it a matter of efficiency?

ZAUDERER: To a great extent it is. Of course that can mean less profits for the law firm.

HEFFNER: Yeah, well I wonder about that.

ZAUDERER: Fewer hours. But law firms will try to work with clients to make a bargain, which, which places some risk on the law firm, reduced fees during the course of a case, but with an incentive, as I say, if there’s a result achieved. And for some that’s very satisfactory. Clients feel that aligns the interest of the lawyer with the interest of the client, rather than having at least a perception that the lawyer’s interest is just to keep working and is less concerned about the result.

I don’t believe that’s true. I think most lawyers want to get the case done, get it done efficiently, want to please the client to get the next matter.

HEFFNER: Mark, are … can you compare this with other societies? And the practice of the law. I mean is, is … is it impossible because of the way we have made the law into, perhaps a business?

ZAUDERER: My impression is there have been differences, but in foreign countries the practice of law is going the way of the practice of law in the United States. And partly because the law firms have become multi-national.

A large law firm today may have an office in 25 or more cities. Law firms that have over 3,000, 4,000 lawyers.

There are some differences, but the … what I think they share in common, the common thread is a, a model which is premised more on what we’ve talked about as, as a business model.

HEFFNER: Okay, let’s go back to this question of “profession”. Suppose you approached it from that end … there’s something different, isn’t there between a profession and a business?

ZAUDERER: I believe that. I do.

HEFFNER: Okay, now … how would that work out if you used … if you went back to the notion of a profession.

ZAUDERER: Ah, for one thing … I think the firms ought to pull back on the way they compensate their lawyers.

HEFFNER: The way or the amount?

ZAUDERER: The, the way. The way meaning, don’t compensate a lawyer so heavily just based on the business they bring in. Create a culture where everybody benefits the whole, so that everybody has a greater stock in say … in the success of the whole organism, not just the individual lawyer.

Ah, that was the model at one time. And as I said earlier, there was what was called “lock-step” compensation earlier.

HEFFNER: MmmHmm.

ZAUDERER: You know, we’ve seen this … if I may just talk about a parallel profession … in, in the accounting profession as well.

I remember seeing a commercial for one of the big accounting firms during the Super Bowl. And it said, it gave the name of the accounting firm … it said “We are in the business of accounting”. And I thought to myself, why are they identifying themselves so thoughtfully and carefully … they’ve put together this whole ad and paid a couple of million dollars for it … to call themselves “in the business of accounting”, why don’t they say, “We’re in the profession of accounting, serving businesses”.

You know, I think that’s an instance where somebody has, you know, lost their compass in my, my opinion.

But in the accounting profession, take the Enron case which brought about the demise of Arthur Anderson, which was Enron’s auditors. It’s been widely written that they failed to catch what was going on in Enron and, of course, there was a law suit against them. They ultimately went, went down, they were destroyed for a number of reasons.

But it illustrated how that firm had changed. Whereas the founders of the firm, I guess Arthur Anderson and company … individuals … once had a compensation system which gave every relationship partner, that is a partner that oversaw a client’s account … closer to lock step compensation and, and if the firm was profitable everybody earned well. In other words, a rising tide raises all boats.

Firms have followed the compensation model of “who is your client, how much revenue did it generate?” What does that do? It means consciously or unconsciously the professional, be it an accountant or a lawyer, who overseeing the client relationship will lose independence. Because that person’s own financial interest is at stake.

An accountant, even one who is well-meaning and ethical is going to be in a different situation in terms of retaining independence if his or her compensation is solely determined by that client’s business. Because what if we lose the client, what if we displease the client … now compensation is down.

HEFFNER: Now you’re talking about accountants.

ZAUDERER: Accountants.

HEFFNER: But exactly the same thing has been said …

ZAUDERER: … it’s similar …

HEFFNER: … about lawyers.

ZAUDERER: And I agree with that. It’s, it’s influence the law, the law firm and lawyers as well.

Again, I, I want to just stress that I have an extremely high regard for lawyers because I think if you take any value … you know, in any profession … in any group of people … if you think … if you were to plot how people rate on any value, integrity, skill, anything. I think people fall on a bell curve. You’re going to have … on intelligence … people … a small number at the low end, a small number at the high end … great number in the middle.

And I think the center of that bell curve … if you, if you impose it … superimpose it on values that are important in the legal profession that, that bell curve falls pretty high. The whole curve is over here … integrity, skill … but at the lower end are those whom we may disapprove of and the higher end are those we have the highest respect for.

So I have a very high regard for lawyers, but I think that as a result of circumstances, many of which are beyond their control, but many of which they have contributed to, they’ve put themselves in this situation with all the pressures we’ve described.

HEFFNER: Many years ago when The Open Mind had just begun, WGBH, the educational station in Boston asked me if I would come up during the summer, when it wasn’t on the air, and do a program. I said, “Sure, but it would have to be called something else, and I called it Search for Truth”.

And I remember one of my guests was the great Paul Freund and he came on and he said to me after the program, he said, “Mr. Heffner you’re very naïve … you think the law is a search for truth. It’s not. It’s a search for victory in the courtroom. Or a conquest.”

And I wonder whether that marks a difference that is important here. That if the dollars mean so much that you’re not looking for truth, but for dollars … how can you do other than end up the way a number of firms are ending up today?

ZAUDERER: Well, I, I think that does conflate two different principles. The first that you refer to is really our adversary system …

HEFFNER: MmmHmm.

ZAUDERER: … which has nothing to do with dollars.

HEFFNER: Doesn’t it?

ZAUDERER: Well, the premise is … it, it can … I mean if it’s abused by a lawyer that just wants to drag on a case. But, you know, everyone is familiar with the theory … it’s been in place in our system for hundreds of years … which is a well-represented client on each side of a controversy … the lawyer represents him … presents the best case and somebody decides .. a judge or a jury.

But you’ve really raised a new topic which is very, very interesting … and that whole process is being questioned and economic support of it, because of the cost of litigation.

And new techniques have emerged in the field of litigation which have proved very effective and very healthy for clients. One is mediation. That has experienced an enormous growth of popularity and acceptance, when it was once looked askance at as something that was a waste of time.

And the concept of mediation is, you don’t win or lose, all or nothing by it … an adversary contest … with the intervention of a third person. You talk about your disputes, you have the person do in discussion with the parties … not only the lawyers, but getting the principals involved so they can hear the other side’s problems.

Often, you know, often behind disputes … this is only one aspect of law … we have corporate deals and other things … but we’re talking about litigation … there’s a tremendous emotional component. And I’m not just talking about domestic relations cases, I’m talking about business cases because the people behind these cases are people. They may have the office of Vice President or CEO and they carry with them all of the feelings of that all of us have … they feel they’ve been mistreated and in mediation, we get them together.

HEFFNER: You know, I have people with feelings who are waving their hands at me … say “Good-bye” because your program time is over. Therefore, you have to stay where you are and let’s pick up right here in the next program.

ZAUDERER: Very well, thank you.

HEFFNER: Thanks. And thanks, too, to you in the audience. I hope you join us again next time. Meanwhile, as an old friend used to say, “Good night and good luck.”

And do visit the Open Mind Website at thirteen.org/openmind to reprise this program online right now or to draw upon our Archive of 1,500 or so other Open Mind and related programs. That’s thirteen.org/openmind.