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Wednesday, January 25, 2006

Are Big Firm Lawyers Engaged in Market Deception?

Last year, there were some accusations that law schools are engaged in various modes of accounting flimflammery in order to elevate their rankings in the US News.  (For purposes of this post, I'm remaining agnostic on the merits of that controversy.)  When I was in law school and while I was practicing, I often heard some lawyers lament the same pernicious influence on law firm culture posed by the American Lawyer 100 survey of the economic health of big firms. 

As a result of the AmLaw100, it is said, firms have become more ruthless bottom-line oriented.  Thus, most firms except those at the very top have a desire to increase the appearance (and actuality) of profits per partner to enhance their reputations with clients and each other; those at the very top, by contrast, may have an incentive to downplay their profits per partner so that their clients don't think they're being fleeced with particular vigor.

I only have one source for the question in the title, though I think it's a reliable one, but I thought I'd see if the question's proposition could be advanced by lawyers or prawfs who formerly lawyered, and perhaps our faithful readers who are journalists might wish to delve into this further.  Apparently firms bring their audited  financial statements to Citibank and they can find out how they are doing vis-a-vis certain other firms.  If Citibank is accessing the major firms' statements, then it is in a position to check the statements found in AmLaw 100, and apparently it has done so.  What I also heard is that of the 100 firms in the AmLaw100, about 70 are misrepresenting their stats. There are purportedly documents out there to this effect.  If true, it's time for, um, truth on the market.

Posted by Administrators on January 25, 2006 at 08:59 AM in Current Affairs | Permalink


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Dan: I won't rule out an associate considering PPP in choosing a law firm, but we're talking about someone ruling out a $400k PPP to interview at a $1.2M PPP (or vice versa for lifestyle reasons), rather than choosing a $1.35M PPP over a $1.3M PPP. It seems implausible that a firm is manipulating their PPP by a factor large enough to be material to these sorts of decisions. (And any law student whose choice of firm depends on a small-percentage difference in PPP is likely to be switching firms eventually anyway, because it's unlikely that someone that oblivious will have the set of political skills needed to thrive in a high-PPP environment.)

Posted by: Ted | Jan 25, 2006 10:29:39 PM

I don't know that "rumor" you are referring to, but Citibank long ago courted law firms for banking business and began to collect data for peer comparisons on a variety of economic measures. No one has the breadth of data that Citibank has. The data are presented without the names of other firms but you can tell roughly who is in your peer group and discussions may provide other hints. Firms that want continued access to the data have an incentive to keep doing business with Citibank. So the service is a good "binder" for Citibank.

I don't consider these to be "audited financials" in the sense that public companies have audited financials. There are no independent auditors roaming the halls of the firm. There are no investors making decisions on the basis of the data. By the way, there are other data collections, including the annual Altman Weil surveys, which you can find in any large law school library.

I also doubt that there is fraud on the market here. Laterals know how to ask about PPP; they often negotiate specific ranges of draw for the first few years; they ask about recourse, debt, etc. I'd be disappointed to hear that law students consider these published PPP numbers to be material to their choices. The American Lawyer said in print that they'd like to move to the revenue/lawyer ratio, which they think is less susceptible to manipulation. Don't doubt that some firms might actually downplay their public PPP number, by the way.

Posted by: lpt | Jan 25, 2006 9:07:02 PM

What is the source of this Citibank rumor? Why would law firms have audited financials? Who would audit them? Why would they all go to Citibank? Why would Citibank do this? I'd love some more explanation on this.

Posted by: Matt | Jan 25, 2006 4:41:15 PM

Don't you think it's possible that someone who's considering moving to another firm as a partner might limit which firms she considers based on reports of PPP? I know I would consult AmLaw in that situation. Perhaps others would too.

Posted by: Dan Markel | Jan 25, 2006 3:18:33 PM

Prospective partners don't care what the American Lawyer number is, they care what they're going to make, and that's a negotiated figure (be it of guaranteed minimums or of shares). Inflated PPP numbers can only hurt that negotiation. A PPP number is relevant for internal firm politics of setting financial goals and evaluating managing partners (and for measuring one's self-worth versus similarly-situated classmates, as seems to be the case), but it sounds like firms rely on Citibank, rather than American Lawyer, for the important decisions. A senior associate should look at the American Lawyer statistic, but only as supplemental information to gather a probabilistic sense of whether the firm is likely to pull up the partnership ladder and change the rules of the game after they show up -- and even then, the politics can shift over the course of the short partnership track without warning. (And none of the firms I interviewed with when I moved back to DC mentioned their PPP to me.) It seems exceedingly unlikely that the American Lawyer numbers can be fudged so much as to make a material difference in someone's decision in either event.

Posted by: Ted | Jan 25, 2006 3:09:48 PM

I can only say what Irell did to publicize its profitability of luring young associates; it's possible that their strategy for luring lateral partners or senior associates may involve revelations of PPP. Btw, Vault is only one possible measure of what counts as prestige. It's always seemed inadequate by my lights. A better one, I suggest, is looking at where the top grads of Yale, Stanford, Chicago and Harvard go to practice (including a former Easterbrook clerk like Ted). With all due respect to V/E and H/K, my anecdotal experience indicates Irell did much better at those national schools in recruiting.

Posted by: Dan Markel | Jan 25, 2006 2:55:06 PM

"It was my impression that Irell did publicize its profitability during recruiting, not with exact PPP reports, but with proxies, such as: we pay associates more than virtually anyone else."

Telling associates that they'll be paid more than anyone else isn't a wink-nudge proxy for PPP statistics, _it's telling associates that they'll be paid more than anyone else_. Which is what prospective associates care about. Publicizing the $270k payouts for senior associates tells one nothing about PPP numbers. Recall that your original thesis is that law firms are manipulating their PPP scores for recruiting purposes. If law firms aren't actually using PPP numbers, but are instead using "proxies," such as lockstep associate salaries and summer associates that are verifiable, where's even the theoretical deception?

If you look at the national Vault prestige surveys of 15,000 associates, Irell suffers in comparison to other seven-digit PPP shops: associates perceive Irell (#58, $1.5m PPP) as between Vinson & Elkins (#51, $685k) and Holland & Knight (#63, $425k), which is absurd by any quantitative measure. Irell's reputation is regional.

Posted by: Ted | Jan 25, 2006 2:37:32 PM

This discussion is going far away from the point of the post. Let me just respond to one thing. It was my impression that Irell did publicize its profitability during recruiting, not with exact PPP reports, but with proxies, such as: we pay associates more than virtually anyone else. Come enjoy our lush summer program, etc. Firms like Quinn Emanuel, during its robust growth in the late 90's, would do the same thing, by giving summer associates a 10K bonus in addition to the crazy salaries then. I don't think Irell's reputation was suffering at all, or lagging behind its profitability--but how would one measure this off the cuff anyway? Then, Irell was known, along with Munger, as the go-to place in SoCal. And it still is today I think.

Posted by: Dan Markel | Jan 25, 2006 12:47:45 PM

My point about Irell is the opposite: its PPP (and quality) outstrip its perceived reputation. If PPP correlated with reputation, a firm like Irell would have a great deal of incentive to publicize its PPP to demonstrate that it merited more prestige.

Hiring: If one lurks through the law-student and law-firm-associate boards, there's lots of discussion of first-year salaries and bonuses, lots of discussion about Vault rankings, lots of discussion about QoL and hours, and next to none about PPP. (Heck, there's irrationally little discussion about senior associate salaries, which is the financial element most likely to make a difference to a law student's life ten years down the line.) When PPP is discussed, it's just as likely to be as a inverse proxy for QoL.

That a Wachtell or Cravath is a relatively safe bet to have a high PPP ten years down the line doesn't change the competitive and dynamic marketplace that most law students' choices for firms are in. The most popular boutiques when I was in law school are now all branch offices of gigantic firms. And Wachtell and Cravath were known as the top of the hill long before American Lawyer quantified their profits.

Posted by: Ted | Jan 25, 2006 12:37:52 PM

Ted asks "What client chooses their law firm based on PPP?"

Is anyone aware of any empirical research on the question of why clients choose their lawyers, and particularly why large institutional clients choose their firms?

Posted by: Eric Fink | Jan 25, 2006 12:35:17 PM

Ted, these are useful points, and I'm not endorsing the rationality of the market, just suggesting how its forces might unfold in some cases. As I mentioned in the post, some firms with high PPP might actually face the threat you mention. But the fact that firms don't advertise their PPP doesn't mean that general counsels at corporations don't know what the relative PPP's are, since they are often firm refugees themselves. And PPP is not the only info AmLaw provides; perhaps other information is instructive to the buyers of law firm services. (You also mention Irell, where both of us once worked. I'm quite certain that its high reputation was fed in part by its profitability, and that lots of people were lured there, especially as associates, because of its profit sharing plan for mid and senior-level associates.)
As to recruiting, you're right that it's a long window of time, and therefore imperfect information susceptible to chane, but that doesn't mean the information is useless. Students today who see Wachtel at the top of the charts have a good reason to think that if they make partner there ten years from today, they'll be at or near the top of the heap--I'm quite sure that my classmates at least considered this information when choosing firms, even if they didn't rely on it exclusively.

Posted by: Dan Markel | Jan 25, 2006 12:11:09 PM

"On the second point, the market is two-fold: one, the recruiting of (or defection of) lawyers to firms from schools or other firms; the second market is clients choosing firms based, in part, on the relative "success" of firms."

1) Even associates who choose firms based on accurate PPP are making a huge mistake. You might as well accuse firms of misrepresenting their horoscope or phrenology. There are only a small minority of firms whose partnership structure and profits look anywhere near today the way they looked in 1996, when those on the cusp of partnership today were making their initial decisions. There's no reason to think the 2Ls of 2006 are going to be able to use PPP information to predict their 2016 prospects. Prospective partners are presumably working from information more specific and detailed than the American Lawyer.

2) What client chooses their law firm based on PPP? The evidence that this is simply not so can be found in firm advertising: if clients were making their choices based on PPP, then firms would publicize their PPP, rather than leave it buried in the American Lawyer. Even firms like Irell, that don't have nationally-known brand names and thus could hypothetically benefit from using PPP as a signal don't mention PPP anywhere on their web site. PPP sure wasn't mentioned in any beauty-contest packet I put together. I have to think that PPP is actually a client-relations problem, because it's hard to have a seven-digit PPP and then ask for a 10% bump in hourly rates. Far more likely a client would use PPP to ask for a haircut (cf. one notoriously tight-wadded retailer that purchases more than its share of legal services) than to pick between firms.

Posted by: Ted | Jan 25, 2006 11:45:14 AM

Ted, on the first question, I'm not sure what the scope of the allegation is, but I suspect that it's more than just "gaming." It's a fair point about manipulation within the rules, and I guess we'd need more info to know. On the second point, the market is two-fold: one, the recruiting of (or defection of) lawyers to firms from schools or other firms; the second market is clients choosing firms based, in part, on the relative "success" of firms. It seems plausible that some clients may think, well, these guys at firm X are doing well, they must be doing something right for their existing clients. My post, I should add, is more to ask a question than it is to lauch a "J'accuse." I don't have sufficient information for that, but I wonder if it's out there and if others could add to it.

Posted by: Dan Markel | Jan 25, 2006 11:19:07 AM

Also, what's the "market" being deceived in market deception? Who's investing based on AL PPP figures?

Posted by: Ted | Jan 25, 2006 9:41:56 AM

Are we talking "deception" or gaming the American Lawyer methodology USNWR-top-law-school style (or, as is alleged in an allegedly defamatory book, Trump/Forbes-400 style)?

1. Partners can manipulate the AL rankings by creating various tiers of partnership that affect the rankings but not the underlying economics.

2. Law firm accounting of PPP is different than GAAP of income. The latter doesn't allow income-smoothing through use of reserve funds, while law firms can do that to protect individual partner cash flow, save for a rainy day, or to allow a managing partner to appear to have increased PPP consecutive years. If Citibank is measuring the latter, and American Lawyer is reporting the former, this might account for the entire difference.

Posted by: Ted | Jan 25, 2006 9:40:28 AM

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