Second thoughts in the Second City?

Second thoughts in the Second City?
November 2015

Vincent Sergi joined Katten Muchin Rosenman in 1974 as part of the upstart firm’s inaugural associate class. He went on to become chair of its commercial finance group, and in 1995, he took the reins as managing partner.

Sergi’s personal rise coincided with a remarkable run of head count growth at the firm.

In just 21 years, Katten went from nonexistent to the sixth-largest firm in Chicago. With 254 lawyers here in 1995, it reached a size unmatched by much-older peers including McDermott Will & Emery (founded here in 1934), Sonnenschein Nath & Rosenthal (1906) and Schiff Hardin (1864), to name a few, according to the 1995 Chicago Lawyer law firm survey.

After its breakneck sprint to the top tier of Chicago’s legal market, Katten’s growth curve by 2008 resembled virtually every other large Chicago firm. That is to say, it went into reverse.

The number of lawyers fell, and more so in Chicago than elsewhere.

Since topping out in 2008 with 312 lawyers in Chicago, Katten’s local office shrunk 16 percent by the beginning of this year, based on 2015 Chicago Lawyer survey data, to 263 lawyers — just nine more than it reported 20 years earlier. Meanwhile, the firm as a whole has lost only 7 percent of its lawyers since 2008.

Katten is not an aberration. It is typical among the city’s largest firms.

At all but one of the 10 largest firms in Chicago Lawyer’s 2008 survey, the number of lawyers in Chicago fell further than the firm as a whole. On average, the Chicago offices of those firms shrunk 19 percent since 2008 while head count at those firms as a whole declined by only 4 percent.

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The trend is most dramatic at DLA Piper, which has seen its Chicago office head count shrink by 31 percent while it is virtually unchanged firmwide. The firm did not respond to a request for comment.

At three firms — Mayer Brown, Jenner & Block and DLA Piper — head count losses at the Chicago office have been so steep that they reported fewer lawyers this year than in 1995.

Fifteen years of job growth washed away in roughly five.

The exodus has been swiftest atop Chicago’s legal market, but it has not been confined there. The top 50 firms in Chicago in 2015 reported 14 percent fewer lawyers than the top 50 firms in 2008.

Even if they were aware Chicago offices had dwindled since the recession, law firm consultants expressed surprise at how sharply they had fallen compared to the decline at those firms writ large. There is no indication that Chicago’s legal economy has drastically underperformed.

“I think these statistics are amazingly interesting,” said Kay Hoppe, president of consultancy Credentia Inc.

“Why would their Chicago offices shrink more rapidly than other places? I don’t know the exact answer,” said Kent Zimmermann of The Zeughauser Group.

The trend appears to be the result of a wave of factors, some of which crashed into the legal market around 2008, others of which have lapped ashore over decades — having more to do with the natural life cycle of professional services firms in a global economy than structural changes in the legal market.

As Katten’s Sergi explains it: “It seems very natural that you end up starting a firm in a certain location and your growth starts to come from elsewhere at a certain point.”

Whatever the cause, the effect is being felt by a wide range of legal market participants. Nearly 800 fewer lawyers work at the city’s 10 largest firms and 1,300 fewer work at the top 50. The average first-year associate class has been cut in half, reverberating all the way down to law schools who must scramble to find alternative sources of employment for thousands of students. And commercial landlords are beginning to feel the squeeze as firms downsize office space.

Into this void have stepped out-of-town law firms including Kansas City, Mo.-based Polsinelli, Miami-based Akerman and others. These firms spot an opportunity to grow practices the city’s largest offices do not cater to — either out of unwillingness or inability, depending on the importance one places on profit margin.

And therein lies the rub.

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Despite the loss of so many top-flight legal jobs here, the city’s largest firms are more profitable than ever. Profit per partner at these firms has grown 13 percent on average since 2011. Gross revenue has grown by 12 percent on average, according to The American Lawyer.

The relative decline of the Chicago office at these firms is a story about two things: What is happening at offices in other cities and what is happening here. The out-of-town story is simple: That’s where they see the most growth opportunities.

The local story is more complicated, but one thing is clear: There will not be a Chicago renaissance anytime soon. Growth at the city’s largest firms has flatlined.

Chicago, whence they came

The city’s legacy law firms began to nationalize decades ago and the majority of them have now opened offices internationally.

As Linda Doyle recalls, McDermott was already pushing against calling Chicago its “home office” when she joined as an associate in 1999. Now the firm’s chief human resources officer, Doyle has been instrumental as the firm has grown through lateral hires in other cities.

Since 2010, the firm has opened offices in Frankfurt, Germany, Seoul, South Korea, Paris and, most recently, Dallas. This year alone, the firm has brought on 33 lateral partners. The most in any one city came in Dallas with 12.

Chicago Lawyer surveys show McDermott’s local office dipping 7 percent from the end of 2008 to the end of 2014. The firm provided figures that show a 13 percent decline both in Chicago and firmwide from the end of 2008 through mid-September.

“Obviously our strategic growth (has been) outside the U.S.,” Doyle said. “And to be a large, multinational law firm serving large, multinational companies, you need to invest in both coasts, in the middle and around the world. And we’ve done that.”

McDermott is by no means the only one.

Six of the 10 firms involved in this analysis responded to a request to detail which of their offices had grown the most by lateral partner hires in the past two years. All six, including Kirkland & Ellis, Sidley Austin, Jenner & Block, Katten, McDermott and Seyfarth Shaw, listed cities other than Chicago.

Kirkland added 12 partners in both New York and Houston, compared to eight in Chicago.

Sidley added 22 partners in New York since 2013 and has added 80 lawyers in Dallas and Houston since 2012. Since 2008, the firm has opened four offices in what Larry Barden, the chair of the firm’s management committee, called key markets: Palo Alto, Calif., Houston, Boston and Century City — a second office in Los Angeles.

“Our approach to growth in terms of head count has always been to make sure we’re attracting top talent and bolstering our strength in areas where we’re seeing increased client demand,” Barden said in a provided statement. “Across all of these offices, we have added to our capabilities in several practice areas, among them M&A, private equity, capital markets, energy and life sciences.”

Katten grew more in Houston than anywhere else, adding 16 lawyers since the office opened in 2013, Sergi said. In that same time, the firm added 10 partners in New York, five in Washington, D.C., five in Chicago and three in London. The firm also opened an office in Shanghai in 2012, which has eight lawyers and legal assistants.

Sergi said the firm’s Houston office typified the firm’s demand-led approach to growth.

After having success building an environmental regulation practice in the nation’s capital, the firm saw an opportunity to service those same clients — mostly energy companies — in their Houston locations. Specifically, it would provide them with a workplace safety practice and litigation capabilities. That model has proven successful, Sergi said, with clients including Chevron Corp. and DuPont.

“We’re not really focused on geography as much as we are on clients asking us to be closer to where some of their business hubs are,” Sergi said.

Seyfarth takes a similar approach and has been most recently focused in Australia, adding nine lateral partners to offices in Sydney and Melbourne since 2013. In the same time, the firm has added four partners each in New York, Los Angeles and Boston.

“Australia remains one of the most robust and dynamic markets for workplace-related legal work,” Stephen Poor said in a release announcing its Australian office opening.

Jenner & Block is the only firm that expressed an explicit strategy that focuses on growing the firm in places other than Chicago.

The firm has grown its New York office to more than 70 lawyers and has more than 40 lawyers in California, managing partner Terry Truax said. This year, it opened a London office.

“That’s a reflection of where the market has moved,” Truax said. “We are very much focused on pushing our front door into different forums. Because we believe that’s going to allow us to better service our client base and that’s of course what we’re all about.”

Something below the sky is the limit

Ward Bower, a consultant at Altman Weil, said these firm’s growth outside of Chicago can be partially explained by the fact that they are going to the hottest legal markets in the country: the East and West Coasts and Texas.

“Texas was hot as all get-out up until about a year ago,” he said.

But that doesn’t necessarily explain the entire reason these Chicago offices have shrunk more quickly than their firms overall.

Bower said he has seen similar growth trajectories at firms that were founded in cities including Cleveland, Pittsburgh and Philadelphia. As those cities’ economies cooled between the 1970s and 1990s, firms such as Jones Day, Reed Smith and Duane Morris began to grow elsewhere.

“I think that might be true to a degree for Chicago even though it’s been a pretty robust legal market,” Bower said. “It may be that for those firms on this list, the prospects for growing in Chicago may be daunting compared to the prospects of growing in cities where they’ve not yet established offices.”

But that does little to explain why these Chicago offices have shrunk as much as they have.

Jenner & Block’s Chicago office had 33 percent fewer lawyers in this year’s survey compared to 2008. DLA Piper, 31 percent. Mayer Brown, 30 percent.

The Zeughauser Group’s Zimmermann said it is not because Chicago is a “low-priority” legal market; far from it.

“It’s been a very busy year on the law firm merger front,” he said. “There have been more mergers involving Chicago announced this year than involving any other city, period.”

Instead, consultants said smaller Chicago offices are most likely the result of a shifting strategy at Big Law firms. They are less interested today in providing all practice groups to all clients and are more dedicated to particular groups that are the most profitable.

“The large law firms used to do everything,” Credentia’s Hoppe said. “And now, companies are commoditizing work and it’s being sent to a variety of different places.”

To compete for talent, law firms have become more focused on profitability, said Ronald Nye, managing partner of recruiting firm Major Lindsey & Africa’s Chicago office. That means targeting work that commands the highest billing rates. If there are practice groups or lawyers within an office who aren’t cutting it, they may get cut or they may choose to move to a new firm.

“There are very good lawyers at those firms who can’t charge their clients at the highest rates,” Nye said. “So part of the movement you see in Chicago is to more middle-market firms where they can get rate relief, give their clients rate relief and be at firms where their practices fit better.”

Chicago’s largest firms spent decades building practice groups that they now may view as non-essential, Hoppe said. Because they have been here longer than anywhere else, there may be more room to cut, especially in practices including estate planning, real estate and, in some cases, labor and employment.

“We’re in a different game now,” Hoppe said.

Leaders at the firms interviewed for this article — McDermott, Jenner, Katten and Sidley — demurred when asked which, if any, practices they had cut back on since the recession.

McDermott’s Doyle said her firm’s Chicago office decline mostly consisted of trimming associates as client demand for younger lawyers slowed.

“We have certainly limited our investment in certain practice groups, but we didn’t have any commodity practices we needed to shed,” Doyle said. “Which was good.”

Katten’s Sergi said the firm’s Chicago office has historically focused on practices such as corporate transactions and securities; litigation of all types; real estate; financial services; commercial finance; and trust and estates. He said the firm views that diversity as a strength.

“We certainly focus more on what we’re good at,” Sergi said. “But we happen to be good at other things that may not demand rates or fees that aren’t as high as others. And that doesn’t mean they’re not valuable. And that doesn’t mean we’re not able to restructure groups that aren’t as profitable.”

Gretta Rusanow, head of advisory services at Citi Private Bank Law Firm Group, said it’s clear that firms have strategically trimmed their practice groups.

“You’ve only got to look at the math of it,” she said. “What else causes the contraction?”

While firm leaders may be shy about discussing specifics, Rusanow said trimming practices that are in decline is a feature common to financially stable firms.

“The most profitable firms who report (financial data) to us don’t try to be all things to all people,” she said.

“They tend to have built a go-to brand name in one or two or maybe a handful of practice areas. And they absolutely have built that reputation as being the go-to firm for those specific practices.”

If law firms’ real estate decisions are indicative of their future head count plans, the shrinking trend does not appear to be changing anytime soon.

Jon Milonas, a vice president at CBRE Inc. who represents law firms in lease negotiations, said many Chicago firm’s growth projections over the next five years are smaller than their projections leading up to the recession.

Firms including Winston & Strawn, Kirkland and Jenner have sublet space and Kirkland has exercised options to give up partial or full floors, he said.

Now arriving: Polsinelli, Akerman and others

Meanwhile, Polsinelli, a firm that opened in Chicago in 2006 with six lawyers, plans to move into about 120,000 square feet of space in the office tower rising just west of the Chicago River at 151 N. Riverside Plaza.

While the recession threw Chicago’s oldest firms into decline, it sped up growth at Polsinelli.

“The recession impacted us positively,” said Tony Nasharr, the office’s managing partner.

As the city’s largest firms cut associate classes and “service partners,” Nasharr said the lateral partner hires he recruited often came to Polsinelli seeking a wider support staff. In some cases, he recruited partners from the largest firms on the basis that offices at their current firm in, say, Germany or Dubai, were not helpful to their practice.

Today, four of the firm’s practice group chairs are in Chicago.

Andrew Douglas joined from Seyfarth and leads the firm’s employee and executive benefits group. Matthew Murer came from Foley & Lardner to chair Polsinelli’s national health-care practice, which is a key focus at the firm. Mary Clare Bonaccorsi chairs the health care litigation group, joining from Bryan Cave. And Eric Greenfield, who joined from Greenberg Traurig, is the vice chair of Polsinelli’s real estate practice.

“Chicago is a deep talent pool for Polsinelli,” Nasharr said. “And whether it be health care or labor and employment or tax or life sciences or technology we can find the caliber of lawyer we need in Chicago. And so the growth here is dictated not really by the needs of the Chicago office per se, but by the needs of our individual practice groups.”

Another firm, Akerman, has had similar success since opening an office here in February last year. It now has around 40 lawyers. The office’s managing partner Scott Meyers said the growth has come more quickly than the firm expected.

“If anything, we expect that pace might even increase,” Meyers said. “Because as you attract more people you create a critical mass which strengthens the gravitational attraction of the office.”

Hoppe calls all this a “stratification” of the legal market. The competition for the highest-tier legal work will continue to be smaller and more well-defined, causing the number and size of firms in those areas to shrink. Other firms will grow. And some lawyers and law firms will be left behind.

“The stratification that was predicted is happening with great speed and great definition,” Hoppe said. “And the key is to figure out where you fit. Because there aren’t enough chairs for everybody.”