Big Firms and The Wizard of Oz: Who's Behind the Curtain of Your Bill

by Tricia Steele on Apr. 23, 2017

Other Ethics   General Practice Other  Education 

Summary: Analysis of profit models, perverse incentives and conflicts of interests within big firm business models.

Big Firms and The Wizard of Oz: What is Behind the Curtain (and your Big Firm bill)? 

The litany of perverse incentives inherent in modern Big Firm business models which generate profits based on billable hour quotas and leveraged hierarchy has been well covered and discussed in academic journals and within the boardrooms of Fortune 500 corporate clients, but despite the noticeable conflicts that exist, the most sophisticated and successful corporations continue to rely almost exclusively on Big Firm brands to service their transactional and compliance needs, whether due to relationships, risk intolerance or just because it's "the way things have always been done."

However, a slow shift is occurring within the entrenched tradition of "blank check" legal engagements, as CEOs and Corporate Directors are beginning to refuse terms that cross the line of economic sensibility and ethical service.  One focal point recently emerging as a line clients draw with their law firm engagements pertain to junior associates and whether they will be tolerated on deal teams or billed at historically high rates. The increase in first year salaries created a new dialogue shedding light on what has historically been well-kept secret of Big Firm corporate law- an issue pertinent to prospective clients and law students alike, that is, the unique costs associated with training and educating a corporate lawyer and how these costs are predominately paid by the client. 

In the wake of the recent salary increases, Bank of America's global general counsel published a letter to its lawyers, stating "we are aware of no market-driven basis for such an increase and do not expect to bear the costs of the firms’ decisions." The letter challenged their law firm to "maintain a true partnership that meets their reciprocal needs—thoughtful, strategic, and cost-competitive representation at rates and alternative billing arrangements that are attractive to our counsel,” and closed the letter stating "they would entrust their work to recipients of the letter based on their legal expertise and entrepreneurial instinct." In increasing numbers, clients are refusing to pay for work done by their highly paid for junior lawyers, and for good reason. Reasons which have nothing to do with the intelligence or aptitude of the junior corporate associate, but have everything to do with mismanagement of attorney talent and the inherent bent in modern legal education towards preparing students almost exclusively for careers in litigation. 

There is no simulation for the pressure of closing a billion dollar deal in a compressed time frame. The deal     terminology is foreign and the pace is lightening fast, a narrow window of opportunity exists to absorb the substance of the transaction and the context of your role in the “big picture” of the project. Even the brightest and hardest working corporate associates cannot make up for the steep learning curve they face during their first few years on the job, yet the bottom-heavy profile of the Big Firm model means corporate sections train their associates "under fire" during times sensitive transactions, often with little guidance and ill-defined goals, leaving junior corporate associates, accustomed to being 'shining-stars' in all their endeavors, feeling demoralized and wondering why they are having such a difficult time navigating this unfamiliar terrain.

This distortion is most true in corporate sections due to the fact that law schools predominately builds skill sets more suited for litigators (case law analysis, legal research and citation methods, writing structured memos, motions and briefs) and lack training aimed at equipping graduates with the skills necessary to function as business lawyers, comprehend a business transaction, draft transactional documents or assess optimal corporate structures. 

The newly minted corporate associate may arrive the first day at work with an impressive degree from one of the finest law schools in the country, however, their real legal education has only just begun. This means client's transactions serve as "training ground" for junior associates, with step-by-step guidance by senior attorneys, who typically end up rewriting the novice's work before it goes out.  Depending on the section's work load, clients may find themselves spending hours dealing with junior associates directly, followed by frustrated calls to the senior Partner on the deal as issues arise which the associate cannot manage.

Ironically, Big Firm corporate associates are usually billed out at higher rates than their classmates in other sections due to market demands. Associates are typically encouraged to bill all their time, leaving the decision up to the partner to determine if the client is cost-sensitive enough to require writing off a portion of the junior associates time.  How frequently this happens is unknown, however most junior attorneys are able to check their "realization reports", and a survey of first and second year attorneys reported their surprise that over 95% of the billable time had been labeled as "realized," meaning not only was it billed, it had been collected by the firm. This level of realization explains how firms pay such exorbitant salaries in the face of such inexperience.

This tradition became an acceptable 'norm' and was more palatable (and rational) under the initial Cravath lock-step philosophy of training home-grown corporate associates who stayed on as partners. Clients could justify the expense as an investment in the future relationships with the firm as these associates would be their "go to" attorneys of the future. However, the trend toward lateral hiring at the partner level slowly decreased the probability that such home-grown trainees would ever become career attorneys at their firm of origin. Thus began a myopic, 'immediate gratification,' view at both the associate and partner level which prioritized current earnings over the long-term vision of the the original Cravath model aimed at cultivating the current human capital existing within the firm community.

There is a direct correlation between the shift in focus away from training homegrown attorneys to maximizing the immediate profits generated from hiring large classes of junior associates in the form of increased billable hour quotas. The largest firms tend to view junior associates as fungible commodities used for less sophisticated, hour-heavy work such as document review which requires less supervision, allowing Partners to spend more time developing business. Lateral hiring at the partner level creates a culture in which partners lack motivation to invest time training lawyers they assumed would gone in 2-4 years, leaving many junior associates without the real career skills necessary or appropriate to command the rates being charged or to advance at the firm. Likewise, as junior associates saw their improbable longevity at their dream firm and were tasked with hours summarizing contracts and other mind-numbing work, this generation of newly-minted talent was underutilized, grew disillusioned with the practice of law, lacked motivation to invest in the firm and instead focused obsessively on associate salary and bonuses evidenced in the 'Above the Law' and 'Greedy Associates' blogging culture.  

On the subject of associate compensation, a few remarkable trends have emerged which say more about the firm's corporate ethics than whether associates are overpaid. First year associates at at the highest paying AMLaw averaged a starting salary of $82,000 in 1992 (adjusted for 2016 inflation) compared to $180,000 in 2016. The significant increase is driven not by an increase in value-added, but on what the market supports. As firms are loathe  to absorb any added expenditures due to the impact on Profits per Partner and corresponding rank in peer reviewed journals, the premiums get passed down to the client in the form of higher rates, or perhaps the costs are shifted such that client's bills are tagged with reallocated over head expenditures to cover the loss. What is unclear is why cost-shifting is justified or even necessary given that billable hour quotas more than cover associate salaries in multiples with ratios of profits per partner (PPP) to associate salary of 8.8 to 1 using the combined average of PPP at AMLaw 100 ($1.6 million) up to 36.6 to 1 at the firm with the highest PPP ($6.6 million at Wachtell, Lipton, Rosen & Katz in 2016). 

Finally, the math does not support the myth that all elite firms are exclusively comprised of premier talent. There are only so many top 10 law school grads on the market each year, far fewer than get hired at prestigious firms. As top law firms grew in size, especially during boom economies, standards for first year hires slacked under the weight of client-matter volume, meaning the 5-Star firm a client believed they were hiring for its impeccable talent pool was actually dipping deeper into class rank and GPA, bringing on less "superstars" and more "worker bees" to fill their first year classes. Not only can worker bees do document review like the best of them, the knowledge that the partnership would remain primarily a pool of lateral hires with valuable books of business eased this transition at firms which would not have dreamed of hiring the same students years ago.

In sum, before you sign that large engagement letter, be sure to ask "who's behind the curtain of your brand name firm (and the expensive bill)" waiting beyond the rainbow of all the firm has promised?

For a more detailed discussion on the topics discussed herein, see further The Cost of a Corporate Legal Education and Behind the Rankings.

Tricia Steele Boutros is a Prinicpal Partner at SL Global Partners.

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