Page numbers correspond to pages in the offering memo (not the PDF document):
1. Page 21: “It is worth noting that as a result of the 2007 merger, LLGM brought its operating expertise to the DB model, providing for noticeable improvement in financial results.”
Duly noted. Alas, there are probably some legacy Dewey people who wish the legacy LeBoeuf people, including former chairman Steven Davis and former executive director Stephen DiCarmine, had left their “operating expertise” behind.
2. Pages 23-24: The firm brags about how, after the merger, it “eliminated 300 attorneys, as well as 300 redundant staff positions in accounting, IT and human resources. These steps have resulted in substantial, positive contribution to net income in 2009.”
The firm “eliminated 300 attorneys.” It sounds so wonderfully clinical, as if the firm had excreted them out. Or maybe vaguely militaristic, as if Steve DiCarmine had called up his cousin and issued some hits.
By the way, cross-reference these pages with exhibit 6.4, the income statement on page 54 of the offering memo. Dewey & LeBoeuf saw fee revenue dive between 2008 and 2009, from $955 million to $809 million. How did it reduce the impact to its bottom line? Through the touted attorney and staff layoffs. The line for total compensation for associates went from $245 million in 2008 to $184 million — a sizable dip, about 25 percent. Total salaries and overtime for legal assistants and other staff also fell, from $106 million in 2008 to $84 million in 2009 — a decline of 21 percent. The firm’s operating income, or “Excess of fees collected over operating expenses,” declined from $318 million to $279 million — a significant drop, but percentage-wise, a mere 12 percent dip. In other words, the Dewey partners protected partner profits at the expense of associates and staff (shocking, I know).
3. Page 25: Some observers have wondered which law firms (other than Dewey) were involved in this placement. On this page, the offering memorandum states as follows: “The Note Agreement, to be provided under separate cover, has been prepared by Bingham McCutchen. The company requests that Chip Fisher of Bingham McCutchen serve as investors’ special counsel for the Notes.”
(I’m not a securities lawyer, so I don’t know the significance of this fact. Please feel free to enlighten me.)
4. Pages 41 and 42 discuss partner capital accounts and contributions. Here’s the relevant discussion:
Query whether the following language accurately stated how things worked at Dewey, given the compensation guarantees: “The Firm does not employ an incentive compensation plan, but to the extent earnings exceed plan, partners share proportionately.” As we have previously discussed, some sources claim that at various points in the firm’s history, 80 percent of the profits were going to 10 percent of the partners. That doesn’t sound like pro rata sharing to me.
5. Page 55 contains the consolidated cash flow statement for the post-merger Dewey & LeBoeuf:
The story this table tells is pretty straightforward. Well before the troubles that surfaced in the past few months (for which some blame the media), they have been borrowing for years to pay their partners at Dewey & LeBoeuf, digging themselves a deeper and deeper hole.
In 2008, net cash provided by operating activities amounted to $273 million. In 2009, this figure went down to $245 million. Considering that late 2008 witnessed the fall of Lehman Brothers (Dewey’s neighbor at 1301 Avenue of the Americas), followed by a credit crisis, this dip is understandable.
But take a look at the line for partners’ drawings and distributions in 2008: a whopping $339 million. In other words, in 2008, the firm paid out to partners about $66 million more than it earned in cash from its operations. It bridged that gap partly by taking $36 million out of its cash and partly through short-term borrowing of $39 million.
Then look at 2009. The firm’s net cash from operating activities dipped to $245 million, but the firm still sent almost that much out the door as partners’ drawings and distribution ($243 million). It spent another $9 million on repayment of partners’ capital and another $6 million on repayment of partners’ current accounts. So, once again, it resorted to short-term borrowing, this time in the amount of $42 million.
Giving the state of Dewey & LeBoeuf’s finances at the end of 2009, is it any surprise that they had to turn to the bond markets in 2010? It certainly was, as Carlyn Kolker of Bloomberg noted at the time, “a rare action by a U.S. law firm.” But given how Dewey was paying out to its partnership as much money or more money than it was making through its operations, it might not have had much of a choice.
Why was Dewey paying out so much in partner drawings and distributions in the first place? My best guess: the guarantees. The more-common law firm model is to borrow money through a revolving credit facility over the course of the year to fund operations (especially in the early months), collect money from clients, pay down the revolver (periodically and then completely), and then distribute what’s left to the partners as profit, in proportion to their partnership points or shares. Dewey had a different model: pay tons of money to partners, both legacy and lateral partners, pursuant to guaranteed contracts, and then borrow — first from banks, and later from the bond markets — to make up the difference between partner payments and operating income. Suffice it to say that the Dewey model turned out to be suboptimal.
The guaranteed contracts, worth as much as $6 million a year for a few partners, might rank the same as equity does in most corporate bankruptcies: at zero.
“It could be argued by other creditors that partners’ pay is a return of equity,” said Chip Bowles, a bankruptcy lawyer with Bingham Greenebaum Doll LLP in Louisville, Kentucky. That would demote Dewey’s partners below trade creditors, he said.
The firm’s lenders, including JPMorgan Chase & Co. and Citigroup Inc., and its bondholders might recover only about half their money in a liquidation, based on trading prices and estimates of how much the firm has to pay its debts. Dewey’s banks and bondholders rank equal in payment priority, according to a 2010 bond memorandum obtained by Bloomberg.
On the next page, we’ll share with you some reader analysis of the offering memo….