Trouble ahead or back to normal? What to make of the law firm profits report

(Reuters) – Sometimes there’s nowhere to go but down.

The nation’s biggest law firms hit stratospheric levels of revenue and profits in 2021, but a new report by the Thomson Reuters Institute indicates 2022 will likely be a return to earth.

My question for legal consultants: How worried should firms be about a crash landing?

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The institute on Monday released its latest Law Firm Financial Index (formerly known as the Peer Monitor Index), which is based on real-time data drawn from major law firms. The Thomson Reuters Institute is part of the same parent company as Reuters.

The report, as my colleague Karen Sloan noted, analyzes quarter-over-quarter changes in rates, demand, productivity, expenses and other factors that influence law firm profitability, crunching the numbers to come up with a composite score.

The latest results are striking – but not in a good way. The first three months of 2022 extend what’s now a three-consecutive-quarter decline. According to the report, the Q1 composite score of 46 is the lowest it’s been since the third quarter of 2009.

For longtime legal chroniclers like me, 2009 is a scary point of reference. More than 3,000 lawyers lost their jobs that year as dozens of elite firms imposed far-reaching layoffs. Bonuses across the Am Law 200 were slashed and incoming associates had job offers rescinded.

Is that where we’re headed now?

Unlikely, legal consultants told me. As Hildebrandt Consulting Chairman Brad Hildebrandt said, “This report is being turned into a little too much gloom and doom.”

Last year’s record-setting revenue and profits “were an aberration that is probably not going to be repeated — though it could be at some firms,” said Hildebrandt. Instead, he sees the latest numbers as heralding a “return to a more traditional growth pattern.”

Still, there are reasons for caution.

The index showed that rising expenses are eating away at profitability. In part, said consultant Lisa Smith, who heads the Washington, D.C., office of Fairfax Associates, that’s because the 2022 numbers are being compared with the first quarter of 2021, when everyone was working from home on the cheap.

Recruiting, office expenses, marketing and business development were all low last year but have since rebounded — and then some.

A spike in associate salaries is also a major factor, with the going rate for first years at top firms hitting $215,000 not counting bonuses, which can add $20,000 or more.

According to the report, associate compensation year-over-year has jumped 17% at Am Law 100 firms.

(For some real-world context, federal district court judges currently make $223,400 — just 4% more than the Big Law base salary for brand-new lawyers– which strikes me as unseemly, but I digress.)

Smith noted that there has “been some softening of demand,” in certain practice areas. “But keep in mind it’s from an incredibly high prior level,” she added.

Notably, the report found M&A in the first quarter was down 5.7%. “That’s certainly a driver of work,” Smith said, but also pointed out that the fall-off mainly affects a select subset of firms that get the lion’s share of that business.

Overall, however, demand was up 2.7%, fueled by an uptick in litigation, corporate, real estate and labor and employment work.

That’s certainly an encouraging sign for most firms. Still, it’s easy to see potential dark clouds ahead with inflation and interest rates on the rise, the stock market in bear territory and global uncertainty amidst the conflict in Ukraine and ongoing pandemic.

“I don’t know where we’re headed, but it’s probably not in a good direction,” Indiana University Maurer School of Law professor William Henderson, who studies the legal profession, told me.

Henderson also believes firms learned some hard lessons from the widespread associate layoffs of 2008-2009. “When the market rebounded, they had big holes in their talent,” he said. Trying to fill those gaps was difficult, he said, adding that he’s heard firm leaders pledge they “won’t make the same mistakes as 2008.”

In the meantime, Zeughauser Group consultant Kent Zimmermann suggests firms brace themselves for turbulence — and make proactive cuts now.

The strongest firms “going into a down economy tend to be the strongest coming out the other side,” Zimmermann said in an email.

In practical terms, that means firms should move now to shed people, practices and offices that lose money or otherwise chronically underperform.

After years of highly unusual revenue and profitability spikes, Zimmermann added, there’s “nowhere to go but down for some firms.”

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