The reaction to my last column on the developments at Dewey has been as strong as to any piece I can remember writing in the near-decade Adam Smith, Esq. has been around. But for those of you who may be feeling overdosed on Dewey coverage, events are not letting the topic die—to the contrary, the firm’s own statements seem almost perversely designed to deepen the mystery.
On Wednesday of this week Steve Davis and other members of Dewey leadership gave what The Wall Street Journal described as a “pep talk” to the partnership. Normally such events are par for the course and completely unremarkable, but Dewey continues to break the mold in unexpected ways. We already knew that associate bonuses for 2011 were going to be delayed (the payment date now appears to be not later than May 31), but the truly shocking news was more than halfway into the story, reported in deadpan style. After the requisite anodyne statement (“We are producing the best work in the history of the firm and producing some of its strongest ever results,” Mr. Davis said, according to the statement. “The overwhelming majority of our partners are excited about our future.”), here was the critical disclosure:
Meanwhile, questions among current and former partners continue to swirl about the firm’s finances. Dewey & LeBoeuf reported $935 million in revenue in 2011, according to the American Lawyer. But three former partners said the partnership was told the firm took in roughly $780 million last year.
Partner Richard Shutran, co-chair of the firm’s corporate practice and a member of the firm’s operating committee, said the American Lawyer uses different metrics to measure firm revenue than those used in general budget calculations.
“They’re just not comparable numbers,” Mr. Shutran said. “That’s something people like to pick on.”
Robin Sparkman, the editor-in-chief of the American Lawyer, said Dewey & LeBoeuf’s numbers were given to them by the firm’s management.
$935-million vs. $780-million, or more or less a 20% difference. “Holy smokes,” one of the printable reactions I’ve heard to this, hardly does the disclosure justice. If Dewey had reported the $780-million figure to the American Lawyer, they would have ranked #30 on the AmLaw 100, not #22. Need I point out that a firm reporting such an abrupt drop in revenue (from over $900-million the prior year) would invite intense scrutiny—deservedly so?
In response to my original piece, a few wise and experienced practitioners in workouts and restructurings reacted more or less along these lines (I paraphrase): The liabilities are always larger, the profits smaller and the problems deeper than first appears when the mess develops. We may be beginning to see how true that is.
What could possibly be going on here?
A brief detour into Accounting 101:
Essentially all law firms are on cash basis accounting, under which the rules for revenue recognition are as simple as could be: Revenue is considered to be earned only when the cash for goods sold or services delivered is collected, regardless of when the sale was made or the work was performed. For firms on a calendar year fiscal year, this means annual revenue consists simply and only of all cash collected from clients between 12:00:00 am on January 1 and 11:59:59 on December 31. I told you it was simple.
Occasionally, however, firms toy with “modified cash basis accounting.” The goal can be as innocent, and even as salutary, as trying to make financial statements more accurately reflect “real” firm performance, but once the door has been opened to exercising judgment over how to categorize the classification and timing of revenue and expense items, it can be become too easy to submit to temptation.
I’m not a psychiatrist, but I’ve read a fair amount on how people who go astray—from gamblers doubling down on their bets in the hopes of making it all back and walking away, to Bernie Madoff—begin by wandering just ever so slightly outside the lines and end up irretrievably far from the reservation.
Back to Dewey. How could this ~20% difference have possibly arisen?
So far, the entire substance of their public explanation consists of Mr. Shutran’s remark that $780-million and $935-million are “just not comparable numbers.” Indeed they are not. So far is this from an explanation, Mr. Shutran has simply reaffirmed and amplified the disconnect he was presumably asked to explain.
The $780/$935 disconnect fairly begs someone to pose the classic cross-examination dagger: “Are you lying now or were you lying then?”
Well, what are we getting so excited about? What does it matter?, some might conceivably ask. It’s just a ratings table in a magazine.
Wrong, and wrong. It matters enormously: To Dewey’s lawyers and staff, to our profession, and to our clients and the public good we supposedly have an obligation to uphold.
First, the annual AmLaw list has been, for three decades, the Bible of US law firm rankings. You are all welcome to retire to the anteroom and debate among yourselves whether it should be, but without doubt it is. Everyone knows it’s the scorecard of record—not some fringe beauty contest—and call me old-fashioned enough to be alarmed if I think a firm has grossly overstated its bedrock ranking metric.
If a firm were to do so, it would go far beyond just good sport, fun and games poking a stick in the eye of the competition; it would be an offense against the very rules of the game as it’s been played for three decades. Don’t care for the game? Welcome to the big leagues; this is what you signed up for, so play fair. Cynics, disagree; I draw the line.
[Now is not the time to debate the fluidity of the reported AmLaw PPP figures, because that long-running and fundamentally unresolvable conversation started before the first PPP results were even printed and will, it's safe to predict, continue after everyone reading this has retired. That's precisely why the auditability of the PPP numbers is not the same as the reliability of the Annual Revenue numbers; the latter is, to repeat, the bedrock ranking metric which is supposed to be impossible to game.]
Second, Dear Reader, we dare not forget we are dealing with a law firm here, composed of professionals presumably deserving of being held to a higher standard than the rough and tumble of the commodities trading pits, the Fulton Fish Market, or 47th Street diamond dealers. But we don’t even have to hold law firms to a superhuman standard; we hold public companies to an entirely human standard every day, called Rule 10b-5. Woudn’t a public company’s revenue, uh, miscalculation, to the tune of 20% (one figure for external consumption, one for internal) state a prima facie case of securities fraud?
Ed Reeser (disclosure: a friend), one of the masters of proper and improper accounting for law firms, has penned a lengthy additional comment to my original article describing modified cash basis accounting and how it can go wrong. He also published a four-part series last year in the Daily Journal going into more detail, for those in the audience wanting a more advanced tutorial on all this.
Fundamentally, this is simple stuff. Basic questions deserve answers. What we’ve been told so far does not add up.
These are the questions I posed to the firm’s executive director yesterday morning by email, followed late in the afternoon with a phone call. I think they’re simple questions capable of simple answers:
- Is the firm on cash-basis accounting?
- How exactly is revenue measured? From what start date to what end date?
- If the firm uses “modified” cash-basis accounting, what “modifications” exactly are made to revenue recognition assumptions?
- Which set of figures do you use in disclosures to and discussions with your banks and other lenders?
- Finally, have there been discrepancies in past years between figures the firm has reported to The American Lawyer and internal figures?
No response from Dewey.
Again, folks, these are not abstruse or complex questions. They’re law firm finance 101. It would be a matter of minutes to answer them if there are legitimate and straightforward answers. Sometimes silence just means silence (Occam’s Razor), but in this case I have to believe it speaks more loudly than any response.
Actually, while Dewey hasn’t responded to me, they have responded to the world, as it were, as reported in The AmLaw Daily, “Dewey Officially Doing Damage Control.” There, we learn:
- Michael Sitrick—a public relations specialist once labeled the “Ninja Master of the Dark Art of Spin” by Gawker—is helping Dewey navigate what has become a media minefield, including helping firm leaders shape their response to what they contend is an inaccurateWall Street Journal story posted online in the wake of a regular monthly partners meeting on Wednesday meant to rally the troops.
- Dewey also took issue in the statement with what it described as mischaracterizations about the firm’s finances being made in the press by former partners, claiming that “some people feel compelled to strike out at an institution that lays them off or [makes] changes with which they don’t agree.”
- In another sign that a counteroffensive is under way, Davis gave a lengthy interview to Fortune for a story the magazine posted online Thursday. In the article, Davis disputed that Dewey is in dire financial straits, and maintained that Dewey is at no risk whatsoever of violating the covenants that govern its sizable debt. “Those rumors are utterly and completely bogus,” Davis told Fortune.
Hiring a “spin master” will surely help clear everything up forthwith. Aren’t you relieved Dewey has taken this bold step in the right direction, towards transparency and clarity?
As for disgruntled former partners’ “strik[ing] out at [Dewey],” I frankly wasn’t aware that was where the action is; by far the most damning commentary has come from within the firm so far as I have tracked it. Perhaps the next well-crafted statement coming the firm will enlighten us on this angle.
But the core assumption of this ad hominem attack (that’s what it is, and resorting to ad hominem attacks generally means a response on the merits would be awkward) is that anyone who has the effrontery to question the wisdom, or simply the veracity, of the firm’s reassurances must have it in for them. This strikes me as flatly mistaken: I don’t know of anyone, including all who have reported on this sorry saga (most definitely including yours truly) who is “against” the firm or wishes anything other than a happy resolution and a collective sigh of relief across the board.
Finally, the referenced Fortune interview includes these highlights (apologies for the extended excerpts but I’m trying to give a representative flavor of the piece):
Davis defends the decisions he and his management team have made. He has answers for why the recent departures of dozens of talented lawyers won’t have a lasting effect on the law firm’s performance. If you’re willing to let him, he’ll even do a good job of convincing you that they knew things were about to get a little hairy inside the offices on 6th Avenue. What he didn’t know: that The New York Times, The Wall Street Journal, and legal blogs would pounce on the developments and blow them up into a full-fledged crisis. “Nothing these days remains confidential,” he says a little ruefully. “Every decision we make seems to be occurring in a total fishbowl. I had a call from a journalist yesterday asking what time our monthly partners’ meeting was today. I almost said, ‘You might as well come, as it sounds like you’re going to hear about it anyway.’ That never would have happened in the old days.” Welcome to tomorrow, Mr. Davis.
[Recurring to the original Dewey/LeBoeuf merger:] The goal was a simple one: to create a global platform that could serve the myriad needs of an increasingly globalized U.S. clientele (as well as cross-border needs of a growing roster of foreign clients.) Never quite mentioned in the same breath as their more “elite” counterparts like Cravath, Swaine, & Moore or Davis, Polk & Wardwell, the lawyers at the two combining firms decided that if they couldn’t grow their way to elite status, then they were going to merge their way there.
[This required some fundamental changes to their business:] “Law firms of this sort operate much more like big businesses than they used to,” says Davis. “While there are good things about that, like the fact that we can provide legal services to GE in Russia, there are the not-so-good things as well. Like the fact that 1,100 lawyers can’t sit around the same table like we used to 35 years ago when we’re dealing with internal or external pressures.”
Well, there’s that, and more. One fundamental change in the way the firm has operated since the merger is that they moved away from the traditional lockstep compensation approach — where partners are basically paid in terms of tenure — and toward a star system in which the top moneymakers can out-earn their colleagues by a ratio of up to 10-to-1. Davis says the extremes shouldn’t define the system, though, and that the more “normal” band is about 6-to-1. Still, it must chafe to be the guy who’s earning the “1″ and knows it. Hard to see oneself as a “partner” of the “6s,” let alone the “10s.” [Now we're getting somewhere.]
[Finally, the most telling point of the interview:] I point Davis toward a quote from a former partner in The Wall Street Journal: “Management tried to make the firm a Skadden or Cravath overnight. They tried to take Dewey away from its roots and make it into something it was never going to be.”
“That’s my favorite criticism during this whole time,” he says. “When Jennifer Smith of The Wall Street Journal called to ask me how I would respond to it, I wondered whether it was a trick question. Why is that goal a bad thing? We put this firm together and our fundamental objective and priority was to create an elite global law firm. We are closer to that today than we have ever been. And how did we lose sight of our ‘roots’? If the implication is that we were mediocre and should have simply accepted our mediocrity, then I don’t agree with that.”
Bingo. Davis may here have revealed more than he intended: “Ambition is a good thing; don’t blame us for trying.”
I stand second to none in admiring ambition, striving, and setting up challenging aspirations. But there are intelligent, honest, strategically and culturally sound ways to try to get there, and there are tempting shortcuts that can undermine the very foundations of the firm you’re trying to transform. This is what Davis doesn’t seem to grasp.
Skadden and Cravath (and S&C, Davis Polk, Simpson, Cleary, and you can name many others, including the cheaply maligned Willkie [in the Fortune piece, courtesy of the pugilistic Rich Shutran]) did not become who they are overnight. They were built as durable and enduring institutions over decades—make that generations—adhering to core non-negotiable values of mutual respect, comity, and, most important of all, a shared long-term commitment to the greater good of the firm. No star systems, no 10:1 compensation ratios, no richly rewarded laterals-with-guarantees, no stealing borrowing from the disenfranchised at the bottom to line the pockets of the in-crowd at the top.
Alex Novarese, editor-in-chief of Legal Week, writes:
the unhappy combination of aggressive expansion, high debt and outsized pay for ‘star’ partners that currently ails Dewey has repeatedly been shown to be a risky way to do legal business.
And the fragility of this model is all the starker in the individualistic US market, given the ease with which departing partners can take clients with them. High growth strategies are inherently volatile – that has been proved time and again in law and numerous other industries. Making it work requires sophisticated management, strong balance sheets or a lot of fortune. There aren’t many neutral observers arguing that Dewey has excelled at the former two, and luck always runs out in the end.
All the evidence points precisely to this bedrock failing: Dewey’s senior management bet on a high-risk strategy in an effort to leapfrog what it takes to join the ranks of the elite, super-prestigious law firms. It takes hard work, day in and day out, with eyes kept assiduously focused on the long-run greater good of the firm. There are no shortcuts.
Dewey’s trajectory over the past few years reminds me too much of a star college athlete aspiring to the NBA or the NFL who chooses steroids over the path of relentless practice, conditioning, and training. It’s certainly possible it will do the trick, but we all know that’s not the betting line on our hypothetical star. The probabilities just don’t work out that way in reality.
There may still be time to change things. But judging by available evidence, if this plane crashes—with all the devastation to innocent bystanders that would entail—the accident investigation will conclude that the crew flew it into the side of the mountain.