False Sense Of Security Still Prevalent Among Law Firms

In spite of overwhelming evidence that the booming economy enjoyed practically uninterrupted for the past 20 years has ended, at least for the near term, many law firms are still optimistic of their 2009 prospects.  I beg to differ.  I believe 2009 will start a strong shift in the make-up of many law firms due to the lack of any planning for the economic conditions.

Who can blame attorneys for being optimistic?  Regardless of the economy since at least the early 1980′s, lawyers have enjoyed consistently increased business and profits.  This has led to a complacency and a denial of the economic conditions that are facing the country.

Law firms aren’t alone.  In fact, the “big three” auto makers (Ford perhaps excepted) are acting out of a similar denial as they attempt to scare Congress and the President into paying for their internal problems.  Who didn’t see the failure of GM coming?  Was no one noticing the extravagant pensions being offered to the employees?  Did anyone who dared notice believe the ever slimming margins would cover the ever growing benefits?   Not likely.  As the Legislative and Executive branches delve deeper into the phantom pockets of our tax base, a  nice summary of the fallacy of “avoiding acting like Herbert Hoover” has been inked in an opinion piece by Todd J. Zywicki in the Wall Street Journal.

Law firms, though not nearly in the long-term slide as the domestic auto industry, is more sensitive to this economic downturn than many attorneys would like to admit.  Many firms have been spoiled by margins that exceed 50% without spending more than a passing glance at the indicators that led them to such bounty.  The issue isn’t so much a drop-off in business, though some firms who specialize in areas that are in the midst of collapse will certainly feel the pain.  Rather, the issue is how firms will retain good talent, retain their expected incomes and avoid layoffs of associates.

These are regular issues for most industries but are foreign to the mid-size law firm.  Many firms pride themselves in their “family” atmosphere, which includes the bratty sibling rivalries that are tolerated when times are good.  Salary incongruousness may seem a bothersome itch when profits are high, but once the deadwood becomes heavy the scratching becomes intolerable.  Some may panic to find their balance sheet showing a loss without ever seeing it coming.  Drastic change is put into place – at a time no worse to prepare.  No more is it wise to visit a market when hungry than to suggest change while in the midst of a spiral.

Yet our economy has afforded all of us time to prepare.  It was suggested by many (myself included as far back as March) that our economy was in for some hard times.  Firms with the foresight and gumption to plan and hold timekeepers accountable for providing not only quality service to their clients but ensuring prompt billing and payment for the betterment of the long term financial health of the firm are in a position now to profit over the firms who were complacent.

It’s not too late, however.  Many firms are just now seeing the first bumps in the road.  It is my opinion that the economic downturn is just now really beginning to hit middle America.  The massive layoffs (over 533,000 in November) are an indicator that the many months of body blows caused by the collapse of the credit and housing markets (not so unlike what happened in the late 1920′s, speaking of Herbert Hoover) are finally taking its toll.  The question now is, where is the bottom?

No one knows.  That is a troubling concern that should make you want to hug every dollar your firm receives and not let go of it.  In times such as these, power goes to those who hold cash.  This may change if our government attempts to over-spend its way out of our economic downturn (thereby devaluing the dollar, leading possibly to hyperinflation combined with stagnant productivity – a prescription for the “d” word), but as of right now, many believe that the economy should rebound sometime in 2010.

In my opinion, firms need to pay more attention to the profitability of each fee earner and place more emphasis on marketing activities and their key profit drivers.  Please feel free to email me (by clicking here) if you would like some ideas on how to not only retain your current income, but increase profits during an economic downturn.

Is Suspension Of Mark-To-Market Rule Irrelevant?

Good counter-argument to what former FDIC chairman Isaac and Newt Gingrich have said regarding the role of mark-to-market accounting rule:

Even if mark-to-market rules are suspended immediately, it won’t change the makeup of a company’s balance sheet. Investors have decided that these assets are toxic and no matter how a bank accounts for them in its books, that sentiment isn’t likely to change unless investors see some proof that the instruments are actually undervalued.

Read more here.

On the other hand, there is the other argument:

“For almost every bank, especially the regionals, what they’ve taken the biggest hit on is mark-to-market securities,” said (Joshua Siegel, managing principal of Stone Castle Partners, a private equity group). “This is what they needed to do first – not cut a $700bn check. They first need to take the pressure off earnings.”

For now, it appears the SEC is moving towards suspending the rule.  In the meantime, it was announced Tuesday that “managers could use their own judgment when valuing securities in illiquid markets, which means they can use measurements other than actual market prices.”  The revised rule can be read by clicking here.

I am not sure that sort of ambiguity is what is needed to help this crisis.  Perhaps a sane rule that doesn’t devalue assets based on immediate marketability would help investors better than leaving the valuation to the whim of the managers.  Further, taking the point of Phil Izzo from the Wall Street Journal’s “Real Time Economics” Blog, is it too late for the change to make a difference in the current crisis?  Can you really go back and increase the value of assets that you have already deemed toxic and worthless and expect anyone in the market to trust it?

Opinions on mark to market are strong and more and more people are speaking out on it:

• Jeff White, Financial Post; “Mark To Market Madness”
• The Motley Fool, “Mark-to-Market Accounting Basics”
• Andrew Willis, Globe And Mail, “Making the case for mark-to-market Rules”
• Joshua Boak, Chicago Tribune, “Critics Say Accounting Rule Off Mark”
• Floyd Norris, New York Times, “Mistakes Of Past Live Again”
• The Economist, “Fair Cop:  Fair Value Accounting Becomes A Political Issue”

Amlaw Daily: Profit Down in 2008

AmLaw Daily reports that during the first two quarters of 2008, “profit margin compression–that is, expenses increasing faster than revenue–was the greatest it’s been in the last eight years.”  The Wall Street Journal Law Blog takes a look at the highlights of the report:

• Too many lawyers:“Because law firms continued to add lawyers to their ranks despite the drop-off in demand,” writes [Citi Private Bank’s Dan] DiPietro, “firms experienced a slowdown in productivity comparable to the second quarter of 2001 and lower than every other second quarter between then and now.”
• Unproductive lawyers, beware: Among other things, DiPietro advises firms to “consider sending a tough message to unproductive lawyers at every level,” and to “conduct a systematic expense review to eliminate redundant or nonessential support staff and functions.” As for hiring in a soft economy, he writes: “[I]t’s particularly important to vet candidates to differentiate between laterals who are looking to move because they’re not happy and those who are looking to move because their firms are not happy.”
• Associate bonuses (a/k/a “The elephant in the room”):DiPietro is paring back earlier estimates for 2008 profits-per-equity-partner. “[W]e now believe PPEP will be flat, or even down by as much as 10%, in 2008,” he writes. “The top-tier firms will have an even tougher year, with profits down by 5-15%. Our reason for providing a range is that there is an elephant in the room: How will firms, particularly the top-tier firms, handle associate bonuses this year? The rational approach would be to pare them back, but, while lawyers display rationality and dispassion in the practice of law, they have exhibited ‘irrational exuberance’ on this issue in the past.”
• Most profitable firms hit hardest:Demand drop-off and expenses were accelerated at a more rapid pace at the top firms, writes DiPietro. He explains that top-tier firms tend to rely on high-end private equity deals, securitization, and structured finance, and have more financial service clients. Now, with those markets in decline, top-tier firms “are paying the price,” and the practices that firms typically rely on in a downturn, such as restructuring, bankruptcy, and litigation, haven’t helped “cushion the drop-off in transactional work.”
• A silver lining?“A bad year (and the numbers suggest 2008 will be even more trying than 2001, when partner profits were down slightly),” writes DiPietro, “will enable firms to take steps that partners would resist in a good year-winnowing out unproductive lawyers and applying greater discipline to expense control.”

 What can law firms take from this report?  Measure performance.   Of Counsel Consulting was created to help firms perform better.  Whether you need help in determining your profit drivers, need help in measuring them, or need help in implementing technology to make you more efficient, Of Counsel Consulting can help.  For more information, call (205) 588-4OCC (4622).