Firms Hunting for Stars Re-examine Partner Compensation

It's easy to understand the resistance to change. The most profitable firms don't often lose partners to other firms. That's never happened at Simpson Thacher (2006 profits per partner of $2.5 million), says managing partner Philip 'Pete' Ruegger III. Like Cleary's Walker, Ruegger says that Simpson's compensation system is designed to promote the institution over the individual, with benefits accruing to both. Simpson's bedrock clients, like The Blackstone Group L.P. and Kohlberg Kravis Roberts & Co., are clients of the firm, not of any individual partner, so all partners have a stake in the revenue they generate.

'Life would go on,' says Ruegger, about the possibility of losing a partner to another firm because of Simpson's compensation system, which, according to competitors, has a spread of less than 4:1. (Ruegger would not comment on the firm's spread.) 'We'd be disappointed, but we wouldn't change our structure.'

The Lateral Market

Maybe not, but there is evidence suggesting that even the firms with the highest profits per partner are becoming increasingly vulnerable to the lateral market. Partners now make moves that might have once been unimaginable. Two-and-a-half years ago, star securities litigator Ralph Ferrara left Debevoise & Plimpton for a partnership at LeBoeuf, Lamb, Greene & MacRae LLP, a firm historically not in the same universe as Debevoise in profitability. Last fall, Steven Lofchie, an expert in broker-dealer regulation, opted out of the lockstep compensation system of Davis Polk & Wardwell for Cadwalader, Wickersham & Taft LLP, a firm that is known for compensating partners for their business-generating prowess. And earlier this year, Roger Meltzer left Cahill Gordon & Reindel LLP, ranked sixth in PPP, for DLA Piper, which ranks 49th in PPP ' but which has a spread of around 10:1 among equity partners.

None of these laterals would comment on compensation, but it's clear that several firms in The Am Law 100 are now deploying high-spread compensation systems specifically designed to reward their most valuable partners with more money than they could earn at even the most profitable low-spread firms. Firms have upped the difference between their highest- and lowest-paid partners to 10:1 ' or even more. And some of those firms have the capacity to pay partners as much as or more than the best-paid Cravath or Simpson partner.

Banker-Like Compensation

Traditionally, when the most profitable firms have lost star partners, it hasn't been to other firms, but to other industries, frequently the financial world. In 2000 Cravath M&A rainmaker Robert Kindler went to Chase Manhattan Corporation (now JPMorgan Chase & Co.) to become an investment banker. (Kindler has since moved on to Morgan Stanley.) In 2005 the leader of Davis Polk's M&A group, Dennis Hersch, followed Kindler to JPMorgan Chase. Last year Alan Schwartz left Simpson for the First Reserve Corp., a private equity firm. And in February, executive compensation expert Adam Chinn gave up his guaranteed millions as a partner at Wachtell, Lipton, Rosen & Katz to join Centerview Partners LLC, a newly formed investment banking boutique. Even the most profitable firms don't try to keep partners who are lured by the riches of financial institutions, which can easily pay them more. 'We can't and we don't compete [with investment banks],' says Chesler.

But now a few of the highest-paid partners at firms further down The Am Law 100 profitability chart are receiving more banker-like compensation ' thanks to extreme spreads in the partnership, which often includes equity and nonequity tiers. That's the case at Latham & Watkins LLP, which ranks at the bottom of the first quintile of The Am Law 100 in profits per partner. In a modified lockstep system, Latham equity partners receive between 300 and 900 points. Income partners are given as few as 60 points on top of their fixed salary, according to a former partner. (The value of each point is determined by the profits available.) Bonuses, which are handed out in addition to the points, put even more distance between the highest- and lowest-paid Latham partners. Robert Dell, Latham's chairman and managing partner, won't reveal the firm's spread, but he says that 15% of the firm's profits are allocated to bonuses, which is an attractive selling point for laterals, especially those who know they can bring business to Latham. A top performer at Latham can now earn more than $5 million, according to a recruiter familiar with the firm. (The firm declined to comment on the figure.)

Reed Smith managing partner Gregory Jordan also says that the firm's ability to pay more at the high end has helped in lateral hiring. 'When we find a lateral that fits in our firm, we've been able to meet the compensation requirements even when our competition has a higher ranking in the PPP,' says Jordan. 'We don't really stop at the name of the firm.' Reed Smith, which had a 16.8:1 spread in 2005, recently brought in partners from firms with higher average profits per partner, including Lee Zoeller, who chaired Dechert LLP's state tax practice, and corporate partner Kevin Hall, from Linklaters LLP.

At Hogan & Hartson LLP, the spread in 2005 was even higher ' 20:1. J. Warren Gorrell Jr., Hogan's chairman, says that's the result of the firm's growth into markets and practice areas with different rate structures. There's more variation in the profits that partners generate, he says, and the spread simply takes that into account. 'We've had [a large spread] for a very long time,' says Gorrell. 'The fact that it drags down our PPP is not such a big deal.' Especially when top partners can be amply rewarded. Gorrell, like Reed Smith's Jordan, says that the flexibility of his firm's spread helps in lateral hiring. He declined to cite examples, but last year Hogan brought in senior M&A partner Jonathan Coppin from the London office of Shearman & Sterling LLP, a firm that has traditionally had higher profits per partner than Hogan. (Coppin declined to comment on his compensation.)

Small Top Tiers

In most firms with high spreads, the top tiers are very, very small. At DLA Piper, for example, the highest-paid partner ' product liability litigator Amy Schulman ' earned $5.75 million last year, according to a DLA partner who spoke on background. Another partner, San Diego-based patent litigator John Allcock, made $5 million. But according to this partner, below those two, the drop is significant, with the lowest-paid equity partner making $425,000. Schulman and Allcock declined through a DLA spokesperson to comment on their compensation, but joint chief executive Francis Burch Jr. says that if the firm's three highest-paid partners were not included, the spread would be around 7:1, not 13.5:1. (Burch declined to confirm the identity of the highest-paid partners or their compensation.) At Sheppard, Mullin, Richter & Hampton LLP, where the spread is 19.6:1, a single lawyer ' Los Angeles-based antitrust and IP litigator Joseph Coyne, Jr. ' is alone at the top, according to Guy Halgren, the firm's chairman. After Coyne, who confirms that he made $5.4 million last year with the help of a contingency fee case, the next-highest-paid partners made around $2.1 million. Partners at the bottom of the scale made around $300,000.

Among many firms in the upper echelon of profitability, that's exactly the sort of inequality that lockstep and low spreads are intended to avoid. Proponents of small spreads say that they foster a culture that eases the pressure on individuals, which helps keep partners on board even if they could make more elsewhere. 'If you think you're making enough, you weigh the other things,' says Cleary's Walker.

But there's also a financial risk analysis that often keeps partners put. Lawyers are risk-averse. So many partners who could jump from a lockstep firm to a more eat-what-you-kill shop and make $4 million to $5 million for a year or two hesitate when they're offered no guarantees beyond that. Between that option and a guaranteed multimillion-dollar salary until they retire at their lockstep firm, 'many will chose the latter,' says legal recruiter Arthur Schwartz of Klein Landau & Romm.

Still, it may be a mistake for firms with low spreads to be complacent ' especially if they begin to lose ground to competitors. They only have to look at the experience of certain Magic Circle firms, some of which have extremely low spreads of 2.5:1. After Clifford Chance's merger with Rogers & Wells in 2000, for example, most of the American partners were slotted into Clifford's lockstep system. Some stars from Rogers & Wells were kept off the lockstep ' yet the firm still lost many of them, including Kevin Arquit to Simpson Thacher and Steven Newborn to Weil, Gotshal & Manges. (In December 2005 Clifford Chance partners voted to amend the firm's system by introducing three different lockstep ladders, which would take into account different markets, but a Clifford Chance spokesperson declined to specify to what degree the new system has been implemented.) American firms are luring away some of the best talent at other lockstep British firms as well. Last year, for example, Kirkland & Ellis brought on such high-profile London partners as the Linklaters private equity duo of Graham White and Raymond McKeeve and Allen & Overy LLP finance ace A. Stephen Gillespie. In recent years some of the Magic Circle firms have responded by taking steps to boost their profitability. Linklaters, for example, asked a 'significant' number of underperforming partners to leave, according to the firm's U.S. managing partner, Paul Wickes. Since the restructuring ' and despite its lockstep compensation ' Linklaters in New York has attracted lateral partners from White & Case, Shearman & Sterling, and Latham & Watkins.

Shearman & Sterling may provide a cautionary tale of what happens to firms with low spreads that can't pay at the top of the market. Last year Shearman increased profits per partner 19% to $1.65 million, but over the years it has not kept pace with its peers in the New York elite. In 2000 the firm ranked 13th in PPP; this year it ranks 22nd. During Shearman's slide down the profitability chart, it has lost a raft of partners. Shearman asked some to leave, according to a former partner. But not all defections were planned, including the loss of such stars as antitrust partner Steven Sunshine to Cadwalader (he's now at Skadden, Arps, Slate, Meagher & Flom); tax litigators B. John Williams Jr. and Alan Swirksi to Skadden; and asset management partner Barry Barbash to Willkie, Farr & Gallagher LLP. As it lost ground in the profitability ranks, Shearman did not significantly adjust its 4:1 spread ' and, says a former partner, lawyers with portable business realized that they could make more money elsewhere. (Shearman declined to comment for this story.)

A Clear Lesson

If firms continue to employ a narrow spread, the lesson is clear: Make sure the PPP stays high. If Cravath didn't make so much money, would its partners stick around? 'I don't know the answer to that,' says Cravath's Chesler. 'I think there is more glue than just the money.' But he hopes he doesn't have to find out.

Andrew Longstreth writes for The American Lawyer magazine, an A&FP affiliate publication.

Cleary Gottlieb Steen & Hamilton LLP managing partner Mark Walker is old school when it comes to partner compensation. He sees no reason to change Cleary's seniority-based lockstep scheme, in which the spread between the highest- and lowest-paid partner is less than 3:1. It's a no-hassle system ' no long meetings explaining bonus decisions and no disputes among partners over credit for bringing in business. And it is the foundation of Cleary's culture, Walker says, which emphasizes the collective over the individual. If the firm is not a magnet for hot lateral candidates who want to be paid like A-Rod, that's okay with Walker. 'My view is that if someone says I'm not going to Cleary Gottlieb because [another firm] is guaranteeing me a salary of X, then they don't belong at our firm anyway.'

That's a common sentiment among the most profitable firms in The Am Law 100, where old-fashioned compensation systems remain firmly in place. Leaders of firms such as Debevoise & Plimpton LLP; Cravath, Swaine & Moore LLP; and Simpson Thacher & Bartlett LLP say they don't see a need to adjust their pay scales to accommodate star partners. With profits so high at those firms, even low spreads ' frequently less than 4:1 ' give few partners reason to complain. 'We look at ourselves all the time,' says Evan Chesler, presiding partner of Cravath, a firm with a spread of 3:1 (and profits per partner of $3 million in 2006). 'There's not been any serious consideration to change our lockstep system.'

Resistance to Change

It's easy to understand the resistance to change. The most profitable firms don't often lose partners to other firms. That's never happened at Simpson Thacher (2006 profits per partner of $2.5 million), says managing partner Philip 'Pete' Ruegger III. Like Cleary's Walker, Ruegger says that Simpson's compensation system is designed to promote the institution over the individual, with benefits accruing to both. Simpson's bedrock clients, like The Blackstone Group L.P. and Kohlberg Kravis Roberts & Co., are clients of the firm, not of any individual partner, so all partners have a stake in the revenue they generate.

'Life would go on,' says Ruegger, about the possibility of losing a partner to another firm because of Simpson's compensation system, which, according to competitors, has a spread of less than 4:1. (Ruegger would not comment on the firm's spread.) 'We'd be disappointed, but we wouldn't change our structure.'

The Lateral Market

Maybe not, but there is evidence suggesting that even the firms with the highest profits per partner are becoming increasingly vulnerable to the lateral market. Partners now make moves that might have once been unimaginable. Two-and-a-half years ago, star securities litigator Ralph Ferrara left Debevoise & Plimpton for a partnership at LeBoeuf, Lamb, Greene & MacRae LLP, a firm historically not in the same universe as Debevoise in profitability. Last fall, Steven Lofchie, an expert in broker-dealer regulation, opted out of the lockstep compensation system of Davis Polk & Wardwell for Cadwalader, Wickersham & Taft LLP, a firm that is known for compensating partners for their business-generating prowess. And earlier this year, Roger Meltzer left Cahill Gordon & Reindel LLP, ranked sixth in PPP, for DLA Piper, which ranks 49th in PPP ' but which has a spread of around 10:1 among equity partners.

None of these laterals would comment on compensation, but it's clear that several firms in The Am Law 100 are now deploying high-spread compensation systems specifically designed to reward their most valuable partners with more money than they could earn at even the most profitable low-spread firms. Firms have upped the difference between their highest- and lowest-paid partners to 10:1 ' or even more. And some of those firms have the capacity to pay partners as much as or more than the best-paid Cravath or Simpson partner.

Banker-Like Compensation

Traditionally, when the most profitable firms have lost star partners, it hasn't been to other firms, but to other industries, frequently the financial world. In 2000 Cravath M&A rainmaker Robert Kindler went to Chase Manhattan Corporation (now JPMorgan Chase & Co.) to become an investment banker. (Kindler has since moved on to Morgan Stanley.) In 2005 the leader of Davis Polk's M&A group, Dennis Hersch, followed Kindler to JPMorgan Chase. Last year Alan Schwartz left Simpson for the First Reserve Corp., a private equity firm. And in February, executive compensation expert Adam Chinn gave up his guaranteed millions as a partner at Wachtell, Lipton, Rosen & Katz to join Centerview Partners LLC, a newly formed investment banking boutique. Even the most profitable firms don't try to keep partners who are lured by the riches of financial institutions, which can easily pay them more. 'We can't and we don't compete [with investment banks],' says Chesler.

But now a few of the highest-paid partners at firms further down The Am Law 100 profitability chart are receiving more banker-like compensation ' thanks to extreme spreads in the partnership, which often includes equity and nonequity tiers. That's the case at Latham & Watkins LLP, which ranks at the bottom of the first quintile of The Am Law 100 in profits per partner. In a modified lockstep system, Latham equity partners receive between 300 and 900 points. Income partners are given as few as 60 points on top of their fixed salary, according to a former partner. (The value of each point is determined by the profits available.) Bonuses, which are handed out in addition to the points, put even more distance between the highest- and lowest-paid Latham partners. Robert Dell, Latham's chairman and managing partner, won't reveal the firm's spread, but he says that 15% of the firm's profits are allocated to bonuses, which is an attractive selling point for laterals, especially those who know they can bring business to Latham. A top performer at Latham can now earn more than $5 million, according to a recruiter familiar with the firm. (The firm declined to comment on the figure.)

Reed Smith managing partner Gregory Jordan also says that the firm's ability to pay more at the high end has helped in lateral hiring. 'When we find a lateral that fits in our firm, we've been able to meet the compensation requirements even when our competition has a higher ranking in the PPP,' says Jordan. 'We don't really stop at the name of the firm.' Reed Smith, which had a 16.8:1 spread in 2005, recently brought in partners from firms with higher average profits per partner, including Lee Zoeller, who chaired Dechert LLP's state tax practice, and corporate partner Kevin Hall, from Linklaters LLP.

At Hogan & Hartson LLP, the spread in 2005 was even higher ' 20:1. J. Warren Gorrell Jr., Hogan's chairman, says that's the result of the firm's growth into markets and practice areas with different rate structures. There's more variation in the profits that partners generate, he says, and the spread simply takes that into account. 'We've had [a large spread] for a very long time,' says Gorrell. 'The fact that it drags down our PPP is not such a big deal.' Especially when top partners can be amply rewarded. Gorrell, like Reed Smith's Jordan, says that the flexibility of his firm's spread helps in lateral hiring. He declined to cite examples, but last year Hogan brought in senior M&A partner Jonathan Coppin from the London office of Shearman & Sterling LLP, a firm that has traditionally had higher profits per partner than Hogan. (Coppin declined to comment on his compensation.)

Small Top Tiers

In most firms with high spreads, the top tiers are very, very small. At DLA Piper, for example, the highest-paid partner ' product liability litigator Amy Schulman ' earned $5.75 million last year, according to a DLA partner who spoke on background. Another partner, San Diego-based patent litigator John Allcock, made $5 million. But according to this partner, below those two, the drop is significant, with the lowest-paid equity partner making $425,000. Schulman and Allcock declined through a DLA spokesperson to comment on their compensation, but joint chief executive Francis Burch Jr. says that if the firm's three highest-paid partners were not included, the spread would be around 7:1, not 13.5:1. (Burch declined to confirm the identity of the highest-paid partners or their compensation.) At Sheppard, Mullin, Richter & Hampton LLP, where the spread is 19.6:1, a single lawyer ' Los Angeles-based antitrust and IP litigator Joseph Coyne, Jr. ' is alone at the top, according to Guy Halgren, the firm's chairman. After Coyne, who confirms that he made $5.4 million last year with the help of a contingency fee case, the next-highest-paid partners made around $2.1 million. Partners at the bottom of the scale made around $300,000.

Among many firms in the upper echelon of profitability, that's exactly the sort of inequality that lockstep and low spreads are intended to avoid. Proponents of small spreads say that they foster a culture that eases the pressure on individuals, which helps keep partners on board even if they could make more elsewhere. 'If you think you're making enough, you weigh the other things,' says Cleary's Walker.

But there's also a financial risk analysis that often keeps partners put. Lawyers are risk-averse. So many partners who could jump from a lockstep firm to a more eat-what-you-kill shop and make $4 million to $5 million for a year or two hesitate when they're offered no guarantees beyond that. Between that option and a guaranteed multimillion-dollar salary until they retire at their lockstep firm, 'many will chose the latter,' says legal recruiter Arthur Schwartz of Klein Landau & Romm.

Still, it may be a mistake for firms with low spreads to be complacent ' especially if they begin to lose ground to competitors. They only have to look at the experience of certain Magic Circle firms, some of which have extremely low spreads of 2.5:1. After Clifford Chance's merger with Rogers & Wells in 2000, for example, most of the American partners were slotted into Clifford's lockstep system. Some stars from Rogers & Wells were kept off the lockstep ' yet the firm still lost many of them, including Kevin Arquit to Simpson Thacher and Steven Newborn to Weil, Gotshal & Manges. (In December 2005 Clifford Chance partners voted to amend the firm's system by introducing three different lockstep ladders, which would take into account different markets, but a Clifford Chance spokesperson declined to specify to what degree the new system has been implemented.) American firms are luring away some of the best talent at other lockstep British firms as well. Last year, for example, Kirkland & Ellis brought on such high-profile London partners as the Linklaters private equity duo of Graham White and Raymond McKeeve and Allen & Overy LLP finance ace A. Stephen Gillespie. In recent years some of the Magic Circle firms have responded by taking steps to boost their profitability. Linklaters, for example, asked a 'significant' number of underperforming partners to leave, according to the firm's U.S. managing partner, Paul Wickes. Since the restructuring ' and despite its lockstep compensation ' Linklaters in New York has attracted lateral partners from White & Case, Shearman & Sterling, and Latham & Watkins.

Shearman & Sterling may provide a cautionary tale of what happens to firms with low spreads that can't pay at the top of the market. Last year Shearman increased profits per partner 19% to $1.65 million, but over the years it has not kept pace with its peers in the New York elite. In 2000 the firm ranked 13th in PPP; this year it ranks 22nd. During Shearman's slide down the profitability chart, it has lost a raft of partners. Shearman asked some to leave, according to a former partner. But not all defections were planned, including the loss of such stars as antitrust partner Steven Sunshine to Cadwalader (he's now at Skadden, Arps, Slate, Meagher & Flom); tax litigators B. John Williams Jr. and Alan Swirksi to Skadden; and asset management partner Barry Barbash to Willkie, Farr & Gallagher LLP. As it lost ground in the profitability ranks, Shearman did not significantly adjust its 4:1 spread ' and, says a former partner, lawyers with portable business realized that they could make more money elsewhere. (Shearman declined to comment for this story.)

A Clear Lesson

If firms continue to employ a narrow spread, the lesson is clear: Make sure the PPP stays high. If Cravath didn't make so much money, would its partners stick around? 'I don't know the answer to that,' says Cravath's Chesler. 'I think there is more glue than just the money.' But he hopes he doesn't have to find out.

Andrew Longstreth writes for The American Lawyer magazine, an A&FP affiliate publication.