Biglaw

The Accidental Ponzi Scheme

How LeClairRyan grew itself into bankruptcy.

By  
on

LeClairRyan, once a 400-attorney firm with offices across the country, has filed for bankruptcy. The filing has been expected ever since the firm’s dramatic, highly public meltdown began in July with the departure of its founding partner, Gary LeClair, which I’ve been tracing in this column for the past month.

For this last of three pieces about LeClairRyan, I spoke with former firm partners who were there for a key transitional point in the firm’s management culture. The portrait they painted was one of a firm culture that shifted from openness to secrecy, and from meritocracy to patronage, and from smart growth to a desperate search for cash to cover for past mistakes. But more than anything, the story that starts to emerge is one that reads more like that of a would-be emperor imperceptibly and unwittingly transforming into an ersatz Bernie Madoff. Gary LeClair aggressively pursued growth for his firm, at first for its own sake, but later because that growth may have been all that was keeping the firm afloat. When that unsustainable growth stopped, the wheels came off, and the knives came out.

 The Golden Era

Business was booming throughout the legal industry in the mid-1990s, and LeClairRyan was taking advantage. According to former partner David Nagle, Gary LeClair was successfully growing his firm by luring over young business generating partners from throughout Virginia with his mantra of “mutual trust and respect.” A primary selling point was a transparent, open compensation system. “It had one of the most appealing and novel approaches to compensation, called the ‘consensus exercise,’ where all of the equity partners essentially took the total compensation budget, calculated by Gary, and submitted their own charts as to how it should be divided amongst the various partners.” While not binding, this open forum for discussion made sure every equity partner felt heard, and understood why final compensation decisions were made.

Another former partner, John Fitzpatrick, referred to the LeClairRyan of the 90s as a “true meritocracy,” one where the people who produced got rewarded for their effort, far better than they would have at older firms that were more interested in maintaining the older partners’ salaries.

The tech bubble collapse of 2001 was what first put those ideals to the test. Both Gary LeClair and the firm he built relied heavily on servicing entrepreneurial tech companies. LeClair’s book was reportedly decimated, seemingly overnight, and the firm’s financial bedrock was shaken. Firm lawyers, including LeClair, who once commanded top-tier compensation, faced a far more uncertain future.

In response, the old open-compensation system was progressively closed, and compensation decisions were increasingly vested in the hands of LeClair and his compensation committee. Per Nagle, “we went from a real meritocracy, where compensation was based on full disclosure of numbers, to a system that, by the time I left, had evolved where there was very little input from anyone beyond the core leadership group, and there was very little tolerance for dissent or desire for disclosure.”

Sponsored

With decisions now made behind closed doors, the mutual trust LeClairRyan was built on started to erode. A perception began to arise that LeClair and his favored lieutenants were keeping their salaries buoyed by the profits of more productive partners. Not only did the move toward a functionally closed system make lawyers, who are skeptical by nature, concerned about what was happening with compensation, but it seems that it contributed to driving away lawyers and practices that were profit centers for the firm. When rainmakers don’t see the benefits of their own hard work and growth, they become poised to leave for a new firm more willing to pay them what they’re worth. LeClairRyan found itself vulnerable to the same poaching of profitable attorneys it had been so successful at just a few years earlier.

The Band-Aid of Growth

Rather than make the hard choices such as cutting unproductive partners’ salaries (or his own), LeClair instead made a play for growth. In the short term, the plan was to take in existing practices, bringing in new profit centers to shore up declining profits elsewhere. In the long term, the hope was to expand the firm’s national footprint and top-line numbers to entice a fat corporate buyout once state bars began to allow non-attorney ownership of law firms.

The long-term plan fizzled when the predicted sea change in legal ethics rules never came to pass. But the short-term effects of this rapid expansion were also more detrimental than helpful. LeClairRyan expanded aggressively, bringing in small practices with questionable profitability on guaranteed, multi-year salary contracts. Small offices are notoriously expensive, and rarely benefit from the economies of scale that larger law firm satellites enjoy. LeClairRyan’s top line kept expanding, as did Gary LeClair’s empire, but expenses kept pace, and in some cases exceeded the new revenue brought in.

In the last few years, it appears LeClairRyan found itself chasing endless cash infusions to cover the losses its prior decisions had wrought. The ill-fated preferred stock plan, discussed in my last column, kept funds flowing for a while on the promise of a big payout once the firm was bought out. LeClairRyan received a $20M cash injection when it announced its partnership with alternative legal services provider UnitedLex, which I profiled previously. That partnership is now listed as being owed $8M plus interest in LeClairRyan’s bankruptcy schedules.

Sponsored

I don’t believe Gary LeClair set out with anything but the best of intentions in mind. But by the end of the road, LeClairRyan stumbled into being both the perpetrator and the victim of an inadvertent Ponzi scheme. It made bad decisions that cut into its profits, and so made more bad decisions to bring in new sources of funding to cover the shortfall. Then it needed more funding to replace the new funding it brought in, and on, and on, until the company had grown itself into a sudden and thunderous collapse.

Why This Matters

These past few pieces have been close to my heart. I manage a law firm that, up until a few weeks ago, I would have considered a peer of LeClairRyan. I needed to understand why and how such a seemingly forward-thinking firm, one that in some respects seemed to be a model of the forward thinking and experimentation that I champion, could go so wrong so quickly.

While we’ve only gotten a glimpse of the problems LeClairRyan faced, it’s apparent now that their biggest enemy was ignoring an unsustainable present by hoping for a possible future. A firm that doesn’t compensate and retain its dollar-producing partners isn’t going to last. Accurately valuing and pricing the contributions, both monetary and intangible, of each partner is more crucial than ever in a legal market poised for further contraction and more ruthless competition. Similarly, a firm needs confidence in the good faith of its leadership, and leaders need to earn that over time. A partnership needs to know that its leaders will make the tough choices — even when those choices are unpopular or difficult. Some decisions have to be made behind closed doors. When those decisions spawn fear and skepticism, rather than trust, nothing good can or will follow.

LeClairRyan forgot the lessons it built itself on, and died as a result. The only question remaining is how many of us left behind will learn from this collapse, and how many will continue marching proudly toward catastrophe.

James Goodnow

James Goodnow is an attorney, commentator, and Above the Law columnist. He is a graduate of Harvard Law School and is the managing partner of NLJ 250 firm Fennemore Craig. He is the co-author of Motivating Millennials, which hit number one on Amazon in the business management new release category. You can connect with James on Twitter (@JamesGoodnow) or by emailing him at James@JamesGoodnow.com.

Topics

, , ,