The Dewey collapse is a fairly typical story of greed, too much leverage, and borrowing against uncertain future earnings destroying a company. Its also a great example of cargo cult thinking. Law firms see their clients merging and think: we need to get bigger too. Thus, there has been a huge trend in law firm mergers the last couple of decades. Yet, law firms as businesses bear almost no resemblance to the sort of traditional companies that benefit from mergers. There's very little economics of scale in a law firm. They have little to no physical capital, and almost all their value is wrapped up in their people, who are only there as long as it suits them.[1] And legal ethics rules penalize larger firms, because they impute conflicts of interest for every lawyer onto the whole firm.
The only value to merging beyond a certain size,[2] is for the managers and administrators, who can use the mergers as an opportunity to funnel more profits up to themselves. At Dewey, Di Carmine and the CFO, two non-lawyer administrators, were making over $2 million per year. They also had golden parachutes and clauses saying they could only be fired if they committed crimes. Their justification for all that was of course the role they played in the merger. Its notable that at lockstep firms, where partner pay is based strictly on seniority, and there is not a huge incentive for partners who take on managerial roles, merger mania has not taken hold.
The collapse is also a wonderful example of how intelligent people can make dumb decisions based on the narratives they create for themselves. Prior to the merger, LeBouef & Lamb was financially sound, while Dewey Ballantine was facing declining revenues. The folks pushing the merger, Davis and the consultants, painted this narrative of LeBouef merging its way into a prestigious brand, and Dewey shoring itself up with a profitable marriage-partner. Of course in hindsight the narrative was ridiculous. The pedigree of the brand wasn't particularly valuable in the end, and LeBouef was not large enough to successfully absorb an ailing firm that was almost as large as itself.
[1] Law firms face a more extreme version of the "talent exodus" problem that plagues tech companies. At a firm, almost all of the value of the business is wrapped up in the partners. If they leave, they take their billings with them and your bottom line is in trouble overnight. The top partners might want to stick with the firm through a rough patch, but they have an enormous game-theoretic incentive to jump ship because if the firm does implode, the folks that don't leave will be left holding the bag.
[2] Practice areas ebb and flow, so you need enough lawyers to support diversified counter-cyclical practices and to be able to cross sell clients internally. The point of diminishing returns for that are probably a quarter of the size Dewey ended up after the merger.
There are marketing reasons for law firm mergers. Law firms make money by having the biggest/richest clients who pay multimillion legal bills. The idea is that these clients want to hire the "best" law firms, and they determine the "best" by looking at which firms are the biggest/richest/hired by other big clients. This logic says that if your competitor firm becomes larger, you need to get larger too in order to appear competitive to clients.
In reality clients are probably smart enough to realize bigger != better, but it's not just pure cargo cult thinking that leads to firms trying to stay large.
Compare this with the world of advertising, where you have three major holding companies controlling most of the market, but each company runs dozens - if not hundreds - of independent agencies.
Fascinating. In this game, the side that buys a rainmaker can never win. They can only buy the prestige that comes with a higher top line, but do nothing for their bottom line.
This was an amazing story. Lots of professional services firms get too wrapped up in profit sharing and infighting when they get too big. Look at Accenture and Arthur Andersen breaking up.
You have a lot of good points on the nature of law. If you're selling billable hours, it is very hard to scale up. Profitability is still per partner. You can find ways to charge more money, or increase the worker bees per partner, but that's about it. Some firms find a way to leverage the connections between partners (think McKinsey, but not a law firm) but that's rare.
The partners and worker bees can leave at any time leaving behind very little IP.
This is why these firms rarely trade at high multiples, and frequently stagnate post-IPO.
> “Rather than speak openly with creditors about mounting debt and shrinking revenue, the defendants began deliberately manipulating the firm’s financial statements,” said Richard Frankel, who heads the FBI’s criminal division in New York, in a statement. “They backdated checks, changed write-offs and even misappropriated loan payments as revenue. All in an elaborate attempt to cover up the increasingly dire situation.”
> Aviva Life & Annuity Co. has sued Davis, DiCarmine and Sanders, alleging they induced the insurer to buy $35 million of secured notes in April 2010. Des Moines, Iowa-based Aviva said Dewey kept its debt secret from partners to avoid the “possibility of a mass defection” of lawyers.
Nice. Sounds like an average "rainmaker" partner at a law firm clears north of $2mil/year with sign-on bonuses and multi-year contracts; and you can be a prima-donna and complain with the management and throw your weight around.
Very unlike an engineering company where you have to keep your head down and do the work. Good for them.
Law firms don't have "management" like a typical company. Partners are shareholders, not employees, and the power structure is based on who originates the most business, not on who holds what title. "Management" can be a pretty thankless job under those circumstances.
It's not that different than engineering. For the associates, it's 2400-3000 hours a year billable. They work from when they wake up until they go to bed.
If they're lucky enough to make it to partner, they frequently still have huge billing expectations. If they don't pull in clients, they're gone. And if there is a down year before they make it to partner, they can easily get sacked. 80% of law grads are clawing to get these jobs, and the ones who don't wind up underpaid with massive debt.
Compare this to engineering... The median workers do well. The lifestyle isn't that awful. The CEO and top salespeople are still the best paid people in most technology firms.
Odd how lawyers did not stick to the basic rule of letting off steam/having arguments face to face or by phone! Reminds me of the e-mail banter between bankers in London when they were basically fiddling the LIBOR rates. Perhaps it takes a generation to fully understand a new communications technology.
Even before I clicked the link, I knew it would be by Matt Levine. He writes excellent Bloomberg View pieces. He formerly wrote for dealbreaker.com, a snarky site that covers the travails and misdeeds of Wall Street.
Whenever I read a story like this I inevitably remember Greenspan. Its always good to start with an extreme to begin with whats wrong with most systems today.
As he once said - there shouldn't be any law against financial fraud; as the markets themselves will take care of that.
And he himself got away with all the mess by saying there was a flaw in his model of the world.
Dye and his group should have left the week Davis shafted him out of the leadership position. Their insurance specialty would have been successful wherever they went, and D&L would have failed earlier. Since they didn't leave, Davis was really borrowing trouble in going ahead with the merger that he had justified as somehow taking their place.
The Dewey collapse is a fairly typical story of greed, too much leverage, and borrowing against uncertain future earnings destroying a company. Its also a great example of cargo cult thinking. Law firms see their clients merging and think: we need to get bigger too. Thus, there has been a huge trend in law firm mergers the last couple of decades. Yet, law firms as businesses bear almost no resemblance to the sort of traditional companies that benefit from mergers. There's very little economics of scale in a law firm. They have little to no physical capital, and almost all their value is wrapped up in their people, who are only there as long as it suits them.[1] And legal ethics rules penalize larger firms, because they impute conflicts of interest for every lawyer onto the whole firm.
The only value to merging beyond a certain size,[2] is for the managers and administrators, who can use the mergers as an opportunity to funnel more profits up to themselves. At Dewey, Di Carmine and the CFO, two non-lawyer administrators, were making over $2 million per year. They also had golden parachutes and clauses saying they could only be fired if they committed crimes. Their justification for all that was of course the role they played in the merger. Its notable that at lockstep firms, where partner pay is based strictly on seniority, and there is not a huge incentive for partners who take on managerial roles, merger mania has not taken hold.
The collapse is also a wonderful example of how intelligent people can make dumb decisions based on the narratives they create for themselves. Prior to the merger, LeBouef & Lamb was financially sound, while Dewey Ballantine was facing declining revenues. The folks pushing the merger, Davis and the consultants, painted this narrative of LeBouef merging its way into a prestigious brand, and Dewey shoring itself up with a profitable marriage-partner. Of course in hindsight the narrative was ridiculous. The pedigree of the brand wasn't particularly valuable in the end, and LeBouef was not large enough to successfully absorb an ailing firm that was almost as large as itself.
[1] Law firms face a more extreme version of the "talent exodus" problem that plagues tech companies. At a firm, almost all of the value of the business is wrapped up in the partners. If they leave, they take their billings with them and your bottom line is in trouble overnight. The top partners might want to stick with the firm through a rough patch, but they have an enormous game-theoretic incentive to jump ship because if the firm does implode, the folks that don't leave will be left holding the bag.
[2] Practice areas ebb and flow, so you need enough lawyers to support diversified counter-cyclical practices and to be able to cross sell clients internally. The point of diminishing returns for that are probably a quarter of the size Dewey ended up after the merger.