A landscape that's changed forever

The collapse of Lehman has changed Wall Street forever. What about the firms that service the Street? Susan Beck reports

The mantra of responsible investors is diversify. Don't be too heavily committed to one sector or one type of investment. A balanced portfolio is the key to success. In the good times, you won't get the spectacular results but in the bad times you'll avoid painful losses.

But many of the top US law firms have ignored - even flouted - that rule. Few firms are as focused on one sector as the big Wall Street law firms are on financial institutions. In past downturns, no one questioned that the premier firms would fare just fine. They were too prestigious, too wealthy, too strong. But this downturn, everyone agrees, is different. This time, should the big New York law firms be worried?

In the short term, the financial meltdown is likely to be a boon for these firms. Many have been tirelessly handling crisis assignments: the Wachovia-Citibank-Wells Fargo saga; the sale of Bear Stearns and Merrill Lynch; the dismantling of Lehman Brothers; the conversion of investment banks to bank holding companies.

But months and years from now, when the dust settles, what kind of work will be left on the new Wall Street, and will the remaining clients be willing to pay top-tier rates approaching $1,000 (£660) an hour? The American Lawyer, Legal Week's sister title, interviewed more than 15 law firm leaders and consultants to get their views. Some see a dramatic and fundamental shift in the landscape for law firms, -predictions that happen to justify their long-term strategies. Others predict business mostly as usual - at least for -themselves.

One person who sits at the eye-popping-change end of the scale is Peter Kalis, the chairman of K&L Gates. "The metaphysical question is whether you can have bulge-bracket Wall Street firms without Wall Street," says Kalis. "The capital markets, when they rebound, will no longer have the margins they once did. Like night follows day, they will not be willing to pay premium rates."

Lacking diversity

Kalis maintains that competitive firms will have to be diversified across countries, currencies, practice areas, and industries. He says that Wall Street firms will suffer for their lack of diversity. "We will see the proposition that Wall Street firms did not have to do international build-outs to be fallacious, and they will be exposed for not being sufficiently diversified," says Kalis, whose firm has grown to 1,500 lawyers in 28 offices on three continents over the past decade.

On the other extreme is Simpson Thacher & Bartlett, which has 80% of its lawyers in New York, many doing work for Wall Street institutions. Simpson certainly hasn't had an easy time of it this year. Lehman is gone, and its marquee private equity clients are hurting. Chairman Richard Beattie recognises the severity of the situation - "I strongly suspect we have got a rough period of time ahead" - but sounds unruffled. He sees the markets turning around within a year or two, and does not expect big changes ahead for his firm and its closest competitors.

"I do not think [the market changes] will impact fees," he says. "The M&A work will come back, and Goldman Sachs and Morgan Stanley will be advising the companies doing M&A, and I do not see the fees being different... The private equity firms will be back. They are sitting there with huge piles of money." In the meantime, Simpson will be kept busy by, among other things, representing the US Department of the Treasury as it manages the $700bn (£466bn) bailout fund.

Some of his peers disagree. Mel Immergut, chairman of Milbank Tweed Hadley & McCloy, expects clients to drive harder bargains on fees. "With the consolidation going on, there will be increased pressure on fees that comes with increased buying power," he says. "At the high end of the fee scale, we will have to prove ourselves even more." He also believes that New York firms will need a varied practice to thrive. Their success, he says, will be "largely dependent on the amount of diversification they are able to achieve".

Consultant Ward Bower of Altman Weil concurs. "Some firms, particularly in New York, will probably come to the conclusion that there is some value to diversification in practice areas and geographically, so that they will be less exposed. It will fuel some law firm consolidation."

Evan Chesler (pictured), the presiding partner of Cravath Swaine & Moore, stresses that firms do not need lots of offices to be diversified. "It is too easy to confuse geography with geographic reach," he says. "It is not the same thing." Cravath has 97% of its lawyers in New York, as does Cahill Gordon & Reindel. Wachtell Lipton Rosen & Katz outdoes both, with 100% concentration in Manhattan.

Although Cravath has just one small outpost in London, the firm is highly diversified, Chesler maintains. "We certainly do Wall Street work, but we always have done work for companies not on Wall Street, companies that make things and are located all around the world, and will continue to do so."

Even before the drama of September, many New York firms were feeling the pinch of a slowing economy. Dan DiPietro of Citi Private Bank recently reported that, in the first half of 2008, the most profitable firms were the ones hardest hit by the slowdown. They saw a steeper drop in revenues and hours worked, and a larger increase in expenses than their less profitable rivals. Hildebrandt consultant James Jones, who worked with DiPietro on this survey, predicted that profits at New York firms would be down 5%-15% for the year.

Will meltdown-related work save them? DiPietro says that although there's been a "flight to quality in this turmoil", it is unclear how long this will continue. "There is no way to predict what kind of transactions will be happening [in the future]," he says. "Financial institutions will make money, but in different ways in the next five years."

Consultant Peter Zeughauser does not see trouble for the big New York firms as a whole, but says they will have to adapt to new ways of doing business. For example, if they did work for Merrill Lynch, they'll have to get used to Merrill's new owner, Bank of America (BofA) Corporation. "BofA has been a very sophisticated buyer of legal services," he says. ("Sophisticated" usually means "demanding"). "BofA is a different kind of client than Merrill Lynch ever was."

The Charlotte-based bank keeps an exacting leash on outside counsel and requires that a significant number of women and minorities staff its matters. The company's detailed rules for outside counsel, which are available on their website, might send shudders down the spines of some high-end lawyers. For example, forget about billing for conflicts checks, and get used to -discounted fees. One partner whose firm does work for BofA chuckled as he wondered aloud how Wall Street firms will react when BofA "applies the thumbscrews".

It's an awkward time to suggest this, but in the end, the market will provide the answers. Clients may not reach for the thumbscrew if they think they really need a particular firm; firms, even famously independent ones, may bend if they think they need the work. "There will be a Wall Street, and [it] will need lawyers," says Chesler. "The best lawyers will be in demand for the most demanding situations and clients."

And then there's everyone else who will have to cope with the economy's collateral damage. "The top New York firms will continue to be successful," says Francis Milone, the chairman of Morgan Lewis & Bockius. "They are not where they are by accident. People are kidding themselves if they think they will fall on hard times."

It is 'the rest of us' who will have to change, "and maybe that's a good thing," he says. Now that the easy times are over, we will see who's got the right DNA to evolve.