Beginning to emerge are lessons from the implosion of Dewey.
I’ve believed, and written, for some time that the root causes of the failure, which is massive, spectacular, tragic, and utterly unnecessary, were self-inflicted: Unintentional suicide by drug overdose, if you will.
The question that matters for those of us left standing is what can we learn from this? And in particular, I’ve had any number of calls and emails in the past few weeks from journalists at places ranging from The New York Times and The Wall Street Journal to The Financial Times, The Times of London and the more usual suspects such as ALM, Law360, and Bloomberg, asking me if Dewey’s impending dissolution holds potential lessons for the industry as a whole or whether it was an aberrant outlier.
I wish it were Answer B, which would be comforting and reassuring and allow us all to get back to our knitting without a hiccup, but I’m convinced it’s Answer A.
I’ve written earlier about what I believe the root causes to be, which are, in a nutshell:
- Debt and more debt
- Guarantees and more guarantees—especially to “legacy” or incumbent partners
- 20:1 or greater compensation ratios of the highest-paid partners to the lowest-paid partners
- A culture of the haves and the have-nots
Now, thanks to impressive and industrious reporting from many of the media identified above (especially Peter Lattman of the NYT and Ashby Jones and Jennifer Smith of the WSJ, who’ve been covering this story continuously), we have great additional insight into the thinking within the firm, and it’s become as clear as ever could be in matters as contentious as this that the troubles date at least to the 2007 Dewey Ballantine/LeBoeuf Lamb merger, if not earlier.
In this deeply revealing WSJ interview with Marty Bienenstock and Charles Landgraf, we see how far back the systemically dangerous practices went:
Mr. Bienenstock: At the time of the merger, a lot of partners on both the Dewey and LeBoeuf sides were given four-year contracts because Steve Davis wanted to make sure that the business generators remained in place for four years.
Some people’s contracts guaranteed money no matter what the firm’s income was. Other deals were contingent on the firm’s income. Laterals were attracted and also had other types of contracts. Some were guarantees; others were based on projections of income; others were a little of both.
Separately today, we get confirmation in Peter Lattman’s NYT piece “Assigning Blame in Dewey’s Collapse” of something we’ve heard previously, namely that Steve Davis had enormous ambitions for the newly merged Dewey LeBoeuf, and that he was in a hurry to realize them:
His goal, he would say, was to become the next Skadden, Arps, Slate, Meagher & Flom or Latham & Watkins, two profitable large firms with strong international networks. Together, LeBoeuf and Dewey created a firm with offices in 26 countries and $1 billion in revenue that Mr. Davis thought had the global reach and diverse practice to withstand a recession.
It did not. The merger, which closed in October 2007, was reached as credit markets were beginning to seize up. Less than a year later, the financial crisis would cripple the international economy. To keep important partners from leaving, Mr. Davis had handed out dozens of four-year contracts, creating onerous compensation commitments.
Mr. Davis had also projected a 25 percent increase in partner pay in 2008 over 2007, according to a January 2009 internal memo sent from Mr. Davis to the partners. Instead, Dewey’s profit in 2008 dropped 15 percent. “In hindsight, our 2008 targets proved to be overly optimistic,” Mr. Davis wrote.
The January 2009 memo chafed some partners in another respect. The executive committee — the 24 senior partners who oversaw the management of the firm alongside Mr. Davis — had established a bonus pool to reward top-producing partners in 2008. Many of those top producers sat on the executive committee.
“We were in the middle of the worst economic crisis since the Depression and these guys were reserving bonuses for themselves,” said a former junior partner. “Whatever happened to shared sacrifice?”
A shared sacrifice ethos did not exist at Dewey. Mr. Davis subscribed to a “barbell” compensation system. On one end were the so-called rainmakers with big books of business who were lavished with multimillion-dollar, multiyear guarantees. Dewey’s stars were paid as much as $10 million a year. (Mr. Davis himself earned about $4 million a year, but cut his 2011 salary to $300,000.)
On the other end of the barbell were partners who worked on the court cases and deals brought in by the rainmakers. These partners were paid about $300,000, creating a dynamic where the highest-paid partners were making 30 times more than the most junior ones.
At Skadden, by comparison, the highest-paid partner makes no more than five times the lower-paid ones. One former partner called the arrangement “something closer to feudalism than a true partnership.”
Let’s do a quick point-counterpoint with a brief quote from Bienenstock in the WSJ: Asked how it could be that “the firm has missed its revenue targets for each of the last four years,” Bienenstock replies (emphasis supplied):
But basically I don’t want to point a finger at any single part of the firm that wasn’t performing. You want to remember the time. In 2008 and 2009, every Wall Street law firm suffered, had layoffs and delayed their new associate start dates, so I don’t think this is a matter of pointing fingers.
I think the world changed after the merger in October of 2007, and maybe some of the contracts given to people were not as prudent in the new world. And no one saw the new world coming.
Marty Bienenstock is nothing if not smart, but it’s re-writing history to say that “no one saw the new world coming.” Economists and analysts of many stripes were warning we were in an unsustainable credit bubble—some were even sharp enough to position themselves to profit from it. Indeed, far closer to home, permit me a moment’s self-indulgence while I point out that I forecast just such a thing in April 2007 right here on Adam Smith, Esq., and reconfirmed it in January 2008 (“The Upcoming Banana?”).
Be that as it may, 99 other AmLaw 100 firms were faced with the same reality and we’re not writing post-mortems on those 99 as well.
The point is simply this: Here we see in plain sight all the toxic ingredients that would later coalesce into the irresistible centrifugal forces tearing the firm asunder:
- Not just cautious, limited, performance-based grants of compensation, but widespread, promiscuous grants—many without regard to individual or firm performance;
- The seeds of a haves/have-nots culture being sown;
- Confirmation, indeed celebration (the “barbell” compensation ideal) of a culture that rejected the notion of “shared sacrifice” as quaint fogeyism;
- And perhaps most damningly of all, the headlong pursuit of audacious ambitions (the next Skadden or Latham) through toxic, corner-cutting, intrinsically short-term thinking and behavior.
It also appears that Steve Davis may have learned the wrong lesson early in his tenure as chairman of LeBoeuf Lamb:
He made his mark quickly. During his first year in charge, he recruited Ralph C. Ferrara, a former top lawyer at the Securities and Exchange Commission, away from Debevoise & Plimpton. LeBoeuf caused a stir in the corporate law world by agreeing to pay Mr. Ferrara about $2 million a year and assuming responsibility for his pension of roughly $15 million.
Mr. Ferrara’s hiring turned out to be a coup for LeBoeuf. It raised the firm’s profile in Washington, where Mr. Ferrara was based, giving it a strong foothold in defending S.E.C. enforcement cases and securities class action lawsuits.
“Steve had early, great success with Ralph’s hiring,” said a managing partner at a big law firm who spoke on condition of anonymity. “And what can happen when you have an early success is that it can give you a false sense confidence about what you’re capable of doing.”
Compounding all of this was the air, and the reality, of great secrecy created by Joel Sanders, the CFO, Steve (“the Sicilian enforcer”) DiCarmine, the executive director, and Steve Davis.
The firm’s culture of secrecy initially masked the extent of its troubles. Beyond the figures cited in the magazine, details of Dewey’s financial picture were hard to obtain, even by its own partners, some former partners said. Rather than a traditional law partnership, with lots of committees and collective decision-making, Dewey was run more like a corporation, these people said, with Steven Davis, the chairman, playing the role of a powerful chief executive officer. Working closely with Davis were Stephen DiCarmine, executive director, and Joel Sanders, chief financial officer. Neither DiCarmine nor Sanders responded to calls seeking comment.
Typically, Davis and Sanders were the ones who presented financial information to the partnership. It couldn’t be determined to what extent the three men shared information with their executive committee, which generally numbered around 30 people.
The firm’s bond offering in March 2010 – for $125 million – was unusual for a major law firm, and was apparently not widely known by Dewey partners. Some only learned about the transaction when it surfaced in news reports the next month. “I read about it in the papers,” said one former partner. “And I certainly didn’t sign off on it.”
Meanwhile, here on Adam Smith, Esq., a “very angry” “European partner” [at Dewey] commented:
As European Partner I can tell you that the misrepresentation of revenues (which brings the misrepresentation of profits, financial position, ppp …) was served also internally to the “partnership”. I never saw a balance sheet or a proper statement of account and, obviously, a balance sheet was never presented for approval (and thus “approved”) by the partnership. When I asked, the answer was that it can’t circulate because there are people who sent it to the media … the number were showed in a slide and commented by the Chairman and the CFO to the annual meeting only. It should be noted that the final numbers (revenues) as presented in the slide were the aggregate of the revenues of each office. Thus, each office managing partner (which means basically the whole ExCom members) was able to see if the number of his/her office were correct or not …
Similarly, no one was aware of the outrageous salaries paid to people as Sanders and diCarmine to name a few and no one (within the so called “service partners” not close to the management, as I am) was aware that there were around guaranteed contracts for 100 people.
You can’t make this stuff up. Partners who can’t be trusted to see financial information because, they are insultingly told, they might leak it to the press? A historic bond offering which partners learn about through newspaper reports?
Now, I love Justice Brandeis as much as the next fellow, but his “sunlight is the best disinfectant” remark is suffering chronic fatigue syndrome. I will however invoke The Principle of the securities laws of the US, which is disclosure.
The core question all this secrecy inevitably poses is, “What have you got to hide?”
I wish we were done here but we’re not.
Permit me to point out a sort of magical thinking—I’m not sure how else to characterize it—that seemingly infected decision-making at the firm. To wit, enormous stock was put on projected and budgeted financial results, to which reality evidently had to take a back-seat. Consider this deeply revealing colloquy from the WSJ. Asked “There’s been a lot of talk about why Dewey failed. What’s your take on what happened, and who bears responsibility?” Bienenstock replied (emphasis mine):
[…] But there were several things that led to problems that led to the result we had. For one thing, the projection of revenues for last year fell $30 million short in December. So instead of earning $820 million we were closer to $790 million for 2011. So the net income was $250 million instead of $280 million.
The second factor: The firm had a $100 million revolver from a group of lenders that was due to mature in April of 2012. In order to maximize our ability to roll the revolver over for 2012, the firm was advised not to bring the draw back up to $100 million. At the end of December, the revolver had been paid down to about $30 million, but we were advised to draw it back up only to $75 million, not all the way to $100 million.
So between the $30 million revenue shortfall and the $25 million of unavailable credit, we were looking at a working capital contraction of $55 million. This is why people weren’t paid.
WSJ: So is it safe to assume you were using the credit line to pay partners, at least in part?
Mr. Bienenstock: Look, money is fungible.
Move to strike as non-responsive. I leave it to my adroit readers to deconstruct all that’s off-key about this exchange, but we can start with the pluperfectly straightforward observation that Marty does not deny money from drawing on credit did end up being distributed to partners, one way or another. To be sure, “money is fungible” is a short and snappy, and generally indisputable, observation, but in this context it obscures more than it reveals.
The premise of his answer is that despite the firm’s finding itself $55-million short of what it projected it was going to have on hand they could still plan to pay partners out of profits they never made: “I should point out that the firm put a plan in place to deal with the shortage of payments to partners. Jeff [Kessler] and Charley spearheaded a plan in which money would be paid off over a six or seven year period, starting in 2014.”
Forgive me, but there’s a reason the famous metric is called Profits per Partner. (a) You can’t pay partners (in aggregate) more than the firm’s profits, and (b) partners, and profits, come dead last in line after absolutely everything else has been paid for.
Yet we find the same magical thinking expressed differently when the topic of the widespread guarantees comes up:
WSJ: To what degree does the executive committee bear responsibility for the firm’s failure?
Mr. Bienenstock: The chairman had the right to give contracts, and both the executive committee and the entire firm knew of the contracts that were given to the partners, because the compensation committee, a subset of the executive committee, knew each year how much it could allocate to contracts. At firm wide partnership meetings the contracts were always spoken of. So the situation was known to all partners. [This has been flatly contradicted by many individuals in many forums over the past couple of years, individuals who presumably have no desire to portray themselves as naive or incurious.—Bruce]
Again, I think that if Steve is guilty of anything, it’s the crime of optimism. Whether he misled people—I’m sure some people would argue that he did—but I’m not going to take a position before we have the results of our investigation. But nobody said that the contracts should have been stopped. They were known about and spoken about openly. I don’t recall in the four years that I was there that anyone ever raised their hand and said, “Let’s terminate the contracts” or anything like that. Most of the partners with the contracts were highly respected, they were wanted by other firms, and the numbers were market numbers. Many of us were offered comparable deals before we came to Dewey.
Mr. Landgraf: I think certainly in the case of contracts for laterals [or partners hired from other firms], the lateral contracts are something we’re looking at. Whether all the contracts were the subject of full discussion or simply known as a technique that was used…..is still being reviewed. But the technique of using guarantees of all forms, especially in the recruitment of laterals and retention of key business users, is pretty widespread throughout the industry. [So if something is “still being reviewed,” it’s not yet established, and to say something is “pretty widespread throughout the industry” begs the question how many people knew exactly what about it, internally.]
To recap: We have a fatal intersection of
- Extreme and urgent ambition
- Pursued by high-beta, high-risk compensation practices
- At (admittedly) a terrible time in the macroeconomy for such aspirations
- Through high-handed and unilaterally designed and imposed means kept assiduously secret from the partnership at large
- Instilling a culture of fear and an “in-crowd/out-crowd” mentality
- Fueled by a consistent half-decade track record of overestimating results and underdelivering on performance
- Causing resort to incurring long-term liabilities to fund short-term outlays.
Yes, we appear to have some lessons here, Dear Reader.
My next column will look at what they knew and when they knew it.