Bonuses, Layoffs, Money, Partner Issues, Partner Profits

More Internal Documents from Simpson Thacher

By  
on

Last week, we shared with you a very interesting internal document from Simpson Thacher & Bartlett: a collection of notes or informal minutes from a June 2009 partners’ meeting. The notes discussed attorney headcount, possible layoffs, and compensation, among other subjects.
Today we have even more deliciousness for you: an internal memorandum from executive committee chairman Pete Ruegger to the executive committee, transmitting the complete minutes of the June 8 partners’ meeting. As it turns out, the version of the meeting notes that we previously published was accurate, but not complete.
Here’s an excerpt to whet your appetite. If you think that a return to the heady days of 2007 is just around the corner, as the economy improves and Wall Street strengthens, think again:

• As we dig out of the recession, hopefully with increased utilization and decreased headcount, we should do better in 2010 and beyond, but we do not think our gross revenues and premiums are going to return to 2007 levels and our net income is unlikely to return to 2007 levels in the next couple of years.

As the matrix shows, if we can get our average hours back up over 1800, we can still have a $1M+ [partnership] point at 88% realization. But, Simpson Thacher and our peer firms are going to be less profitable businesses than they were. Pricing and margins are going to continue to be challenging. At least in the short to mid-term.

Indeed. Additional analysis and the complete documents, after the jump.


In his memo to the other members of the executive committee at Simpson Thacher, dated September 30, Pete Ruegger highlights some statements from earlier in the year:

We are going to need to continue to be extremely circumspect in making new partners, and we need to continue to have partners take advantage of our very attractive retirement benefits that commence at age 55. In an environment in which net income is falling and the point is falling, point dilution compounds the negative impact.

Did you catch that, Simpson associates gunning for partner? The firm plans to be stingy when it comes to partnership promotion, at least for the time being. Unless you are a superstar of superstars, you might want to start thinking about other opportunities.

Obviously, with a declining point, everyone is going to do less well. We think we need to continue to improve the relative fairness among partners. We think we need to adhere more closely to the 1999 guidelines, which will mean more “holds” and more “downward adjustments” of points. We are currently planning to accelerate the compensation process to November/December and postpone the new partner process until after the compensation process so that we have a clearer picture of partners, points and prospects, before we add new partners.

Sponsored

This change in the timing of the new partner announcement has apparently come to pass. Check out the News and Events page on the STB website. In 2008, new partners were announced on December 2. This year, we’re already at December 14, and no partner election announcement has been made.
Simpson has a “modified lockstep” compensation system for its partnership, in which partners get more points as their seniority grows, but subject to holds or downward adjustments for less productive members. Working within the parameters of this system, Ruegger identifies some ways to keep partner payouts high while preserving fairness among the partners:

Applying that statement, I think we should (i) continue to identify early retirement candidates; (ii) identify several adjustments downward from the 3.25 and 2.875 levels; (iii) identify a handful of additional holds at 2.5; and (iv) identify a few holds at 2.125. Doing that, and taking a similar approach in the next two or three years, would hold point dilution to ½ of one percent or less over the next couple of years.

This completes the interesting stuff from Ruegger’s memo to the executive committee. Now let’s turn to the new portions of the June 8 partnership meeting memo (“new” = not included or discussed in our prior post).
As previously discussed in these pages, hours are down all over the place. Over 20 percent of ATL readers expect to bill less than 1700 hours this year, according to our recent survey. Simpson is feeling the pain too:

[F]or the first 5 months of ’09, we are running at 1530 annualized average hours. [May’s client hours per day were at a 1669 annualized average hour pace.] If we run at the May pace for the next 7 months, we will be at 1612 average hours for the year. Obviously, this is not the 1850/hr pace we would consider healthy.

Recall, however, that this was the state of affairs back in June. We hear that things have picked up at 425 Lexington since then.
It’s not just the billable hours that are suffering. Rates are feeling the pressure too:

Sponsored

• First, Pricing: As you are all aware, our pricing power is diminished. In more and more areas, clients are seeking discounts or other billing arrangements. On new business pitches, discounts are routinely being sought.
• In 2007, our realization was 110%; in 2008, our realization was 97%; for 2009, we originally budgeted 93%, and we are now running at a realization of around 89%.
• We want incremental business and we are realistic about what is needed to obtain attractive incremental business. We think we are value-added and should be paid as a top-tier firm with top-tier talent, but we need to be competitive with rates. We are giving discounts on some litigation; we are giving discounts on bank and investment bank house account matters; we give busted deal discounts; we are willing to fix fees. If a particular partner rate or particular class rate is a sticking point, we can discount those rates to be competitive. We can quote a blended rate. In brief, we are flexible on rates and want to do what we need to do in order to expand our share of the high-end business out there.

This is all good news for STB clients. If you’re thinking of retaining the firm, the foregoing is information you should know. The firm is “let’s make a deal” mode. In fact:

• We considered lowering our rates, but rejected that idea since we are collecting 100% or close to 100% on a high percentage of our business and are able to provide a discount on most of the rest of our business. We think lowering our rates would have a substantial negative impact on our revenues.

Since Simpson, unlike certain other major firms, hasn’t slashed associate base salaries, it seems sensible for them to keep rates where they are. But raising rates, which has actually happened in the past year, may be a tough sell for 2010.
The memo then gets into some fairly micro-level detail about profitability. It’s interesting, but there really isn’t much we can add to it. Read about it in the full document below (under the “Profitability” bulletpoint).
After predicting that revenue and profits won’t return to 2007 levels “for the next couple of years,” the notes size up some of Simpson’s competition:

• There may be exceptions to these general statements. Weil Gotshal, with its bankruptcy practice, may have an up year; some litigation boutiques may be exceptions to the general rule, but the high-end, full-service firms are not going to escape the change in pricing that has occurred [that includes S&C, Cleary, Davis, Skadden]. [So, we need to get used to being a less profitable business than we were.]

In sum, the business of law ain’t what it used to be. This grim reality affects not just law students and associates, who face vastly diminished job opportunities and partnership prospects, but also partners, at a top-tier firm like Simpson.
Get used to it. Because it’s probably a trend that’s here to stay.
Read the complete STB documents below.
P.S. By the way, we don’t mean to pick on Simpson Thacher; we welcome interesting internal documents from all major law firms. Please feel free to submit them via email. Thanks.
Earlier: A Fly on the Wall at 425 Lex: Inside a Simpson Thacher Partner Meeting
SIMPSON THACHER & BARTLETT — INTER-OFFICE MEMORANDUM
CLIENT NO.: 099999
MATTER NO.: 0921
To: Executive Committee
Date: September 30, 2009
From: Pete Ruegger
Re: Guidance to Compensation Committee
We have agreed to meet with the Compensation Committee in October to provide them with “guidance” as to how they should administer the compensation process in November/ December. I would like the Executive Committee to arrive at a unanimous view, but failing that, I hope we can develop a majority view.
I think our guidance should be that which we agreed to at the May 27 Executive Committee Retreat (Attachment A) and as communicated to the partners at the June 8 partners meeting. See my statement on compensation starting on p.5, including:
“We are going to need to continue to be extremely circumspect in making new partners, and we need to continue to have partners take advantage of our very attractive retirement benefits that commence at age 55. In an environment in which net income is falling and the point is falling, point dilution compounds the negative impact. Obviously, with a declining point, everyone is going to do less well. We think we need to continue to improve the relative fairness among partners. We think we need to adhere more closely to the 1999 guidelines, which will mean more “holds” and more “downward adjustments” of points. [Emphasis added] We are currently planning to accelerate the compensation process to November/December and postpone the new partner process until after the compensation process so that we have a clearer picture of partners, points and prospects, before we add new partners.”
Applying that statement, I think we should (i) continue to identify early retirement candidates; (ii) identify several adjustments downward from the 3.25 and 2.875 levels; (iii) identify a handful of additional holds at 2.5; and (iv) identify a few holds at 2.125. Doing that, and taking a similar approach in the next two or three years, would hold point dilution to ½ of one percent or less over the next couple of years.
Attachment B is the Hersch Base Case circulated at the last Executive Committee meeting, adjusted for the approach outlined above.
I do not think we should propose zero growth in points or zero dilution. I think that sends a message that the higher compensated partners are pulling up the drawbridge and are going to offset the point growth contemplated by our compensation system with freezes or structural adjustments. I think we can achieve the results described in Attachment B within the confines of our existing compensation system.
____________________________________________
6/8/09 Partners Meeting
• On Wednesday, May 27, we had an Executive Committee Retreat at the exotic 30J location. All of us have been dealing with the profound recession that commenced in the summer of 2007 (notwithstanding, its official beginning in December of 2007). The financial meltdown was exacerbated by Lehman’s bankruptcy in September of last year and we have been dealing with the dramatic fall off in financial transaction activity that followed Lehman’s bankruptcy. Obviously, we have endured some very slow months in the last quarter of last year and January and February of this year. March showed improvement; in April, we dipped and in May we resumed our upward trend. So far, for the first 5 months of ’09, we are running at 1530 annualized average hours. [May’s client hours per day were at a 1669 annualized average hour pace.] If we run at the May pace for the next 7 months, we will be at 1612 average hours for the year. Obviously, this is not the 1850/hr pace we would consider healthy.
• Our litigation activity is good. Our credit activity, with all the restructuring, is good, and in capital markets, the green shoots are sprouting, so our new matters have picked up significantly. M&A activity in the United States continues to be at very modest levels (levels not seen since 2002). The M&A slowdown is affecting all law firms used to having big M&A shares, and we are no exception. And, in private equity, for all the reasons described by Glenn Hutchins and by our friends at Blackstone and KKR, transactional activity continues to be very slow and is expected to continue to be slow for at least the medium-term.
• It was in that context that we met twelve days ago to review where we are and what actions we should take on pricing, attorney headcount, and partners and points.
• First, Pricing: As you are all aware, our pricing power is diminished. In more and more areas, clients are seeking discounts or other billing arrangements. On new business pitches, discounts are routinely being sought.
• In 2007, our realization was 110%; in 2008, our realization was 97%; for 2009, we originally budgeted 93%, and we are now running at a realization of around 89%.
• We want incremental business and we are realistic about what is needed to obtain attractive incremental business. We think we are value-added and should be paid as a top-tier firm with top-tier talent, but we need to be competitive with rates. We are giving discounts on some litigation; we are giving discounts on bank and investment bank house account matters; we give busted deal discounts; we are willing to fix fees. If a particular partner rate or particular class rate is a sticking point, we can discount those rates to be competitive. We can quote a blended rate. In brief, we are flexible on rates and want to do what we need to do in order to expand our share of the high-end business out there.
• We considered lowering our rates, but rejected that idea since we are collecting 100% or close to 100% on a high percentage of our business and are able to provide a discount on most of the rest of our business. We think lowering our rates would have a substantial negative impact on our revenues.
• If you need to provide a discount or quote more flexible terms to get business or protect business, speak to Alan or Peter. Also, if you need help fashioning a proposal, speak to them.
• [We expect our diminished pricing power will last for a while – certainly into 2010 and probably beyond.]
• Headcount: We continue to be oversized relative to demand in New York corporate, particularly among the younger classes and in California corporate. We have been working closely with Personnel and have aggressively been moving out underperformers and people who have been passed over for partner. We have had 55 departures year-to-date, and including departures for Fellowships, expect to have 90 departures by the end of July. For the calendar year, after factoring in arrivals, we will shrink by 35 to 40 attorneys in 2009, and with our small summer class converting to a small arrival class in 2010, we are on track to shrink by 35 to 45 additional attorneys in 2010 and by an additional 50-60 attorneys in 2011. Obviously, we could “right size” faster if we implemented a lay-off (100 attys). And, we could target the younger corporate classes in New York and the younger classes in California. However, none of the top-tier firms has engaged in lay-offs. We do not want to be the first top-tier firm to engage in lay-offs. From a financial point of view, given the market practice that has developed, with respect to severance, the cost savings produced by a lay-off, as opposed to our aggressive performance-based reductions, is modest [no savings this year / $30K per/point next year]. [The course we are on produces a 100 attorney reduction over a two-year period/ probably only 75 down from today’s headcount.]
• The course we are on does produce irregular class sizes – large 2007 and 2008 classes and small 2010 and 2011 classes. We recognize that will present some issues.
• Also, we need a great deal of help from the partnership in order to achieve the reductions we need. We need help finding job opportunities for more senior associates; we need partners to take on added work so we can move out some of the senior associates; and, we need partners to submit reviews, including reviews when performance is below the desired level. [And, we need support in enforcing deadlines.] [Mary Beth will talk more about that in a few minutes.]
• Profitability: We are going to be less profitable in 2009. Here is a revised matrix with average hours and realization as the two axes. This matrix factors in the elimination of bonuses in classes 2005-2009 and some other expense reductions. In this revised budget, we budget 88% realization. We had originally budgeted a point just shy of $900K. That was based on 93% realization and 1550 average hours. We are currently at 89% realization and 1530 average hours annualized – that would produce a $780 accrual point. As you see, at 88% realization, we would need 1650 hours to reach the budgeted accrual point of $897K. As you know, our cash results are running way behind our accrual results. If activity picks up, cash collections are expected to continue to lag. So, we could be headed for a cash point that is considerably lower than the accrual point – possibly $100K. Here’s the cash point for the last 10 years [SLIDE]. If we were to have a cash point in the low 800s, down 1/3 from our 2007 peak, I think we have to say that that would not be a disastrous result in the worst recession in our lifetime and taking into consideration what has happened to some of our clients and the severe downturn in corporate activity, particularly M&A and private equity. If we were to have a cash point that begins with a “6,” I think that would be very unfortunate but is in the realm of possibility. Let’s not let that happen.
• As we dig out of the recession, hopefully with increased utilization and decreased headcount, we should do better in 2010 and beyond, but we do not think our gross revenues and premiums are going to return to 2007 levels and our net income is unlikely to return to 2007 levels in the next couple of years. As the matrix shows, if we can get our average hours back up over 1800, we can still have a $1M+ point at 88% realization. But, Simpson Thacher and our peer firms are going to be less profitable businesses than they were. Pricing and margins are going to continue to be challenging. At least in the short to mid-term.
• There may be exceptions to these general statements. Weil Gotshal, with its bankruptcy practice, may have an up year; some litigation boutiques may be exceptions to the general rule, but the high-end, full-service firms are not going to escape the change in pricing that has occurred [that includes S&C, Cleary, Davis, Skadden]. [So, we need to get used to being a less profitable business than we were.]
• Again, what are we doing about the expense side of the equation? You will see from the 5-month numbers that our expenses to date are below last year. We, as you know, have eliminated lots of costs. As I mentioned, our revised budget eliminates bonuses for the younger classes (2005-2009). As previously mentioned, we are about to have a staff reduction for unnecessary positions [some secretaries, some receptionists, some people in duplicating].
• Partnership: We have an extraordinarily talented partnership. I think we have the best partnership of any firm, particularly when it comes to the breadth of our talent. I don’t think any firm is as outstanding as we are in as many complementary areas. We have been around 125 years, and I think we will continue to be among the top handful of competitive high-end firms, as long as there are high-end law firms.
• Compensation: Our modified lock-step compensation system serves us well, helping to create the sharing and collegial team approach that enables us to deliver quality legal service across our substantial band of talent to our sophisticated clients.
• Obviously, outside of litigation, restructuring and real estate, our average partner hours are way below where we would like them to be. The demand for our services is below what we would like. We have experienced ebbs and flows before – times when litigation carried us; times when M&A outperformed; times when private equity generated huge premiums. Currently, in corporate, and particularly in M&A, we are in a trough.
• Our compensation system is based on the long haul, not the snap-shot approach. But, our overall business is smaller than it was in 2007 and seems to be more similar in size to our business in 2005 when we were 23 partners smaller than we are today. We are going to need to continue to be extremely circumspect in making new partners, and we need to continue to have partners take advantage of our very attractive retirement benefits that commence at age 55.
• In an environment in which net income is falling and the point is falling, point dilution compounds the negative impact. Obviously, with a declining point, everyone is going to do less well. We think we need to continue to improve the relative fairness among partners. We think we need to adhere more closely to the 1999 guidelines, which will mean more “holds” and more “downward adjustments” of points.
• We are currently planning to accelerate the compensation process to November/December and postpone the new partner process until after the compensation process so that we have a clearer picture of partners, points and prospects, before we add new partners. We would still plan on new partners being added effective Jan. 1, 2010.
• As you all know, the key variable to our business is revenues. Our costs have been whittled down. And, at this point, are mostly fixed. If we can add to revenues, we can add to net income. I think our business development efforts have never been better. We need to keep at it and add incremental revenue. Our business environment has never been more competitive. We need to win that new business. We want to emerge from this recession with bigger and better market share than we have ever had.
• [The Executive Committee is focused on all of the matters that all of you are worried about. We need to communicate better. In that regard, we will schedule a partners retreat, probably in New York, certainly in the next 8 months, if not sooner.]
• Again, we are going through an unprecedented challenging time. We have a strong and talented partnership – we will get through this.

Bonus Time

Enter your email address to sign up for ATL's Bonus & Salary Increase Alerts.

Topics