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Big Law Profit Plunge Looks Like Precursor to Another Good Year

Aug. 18, 2022, 9:30 AM

Welcome back to the Big Law Business column on the changing legal marketplace written by me, Roy Strom. Today, we dive into first-half financial results for Big Law firms. Sign up to receive this column in your inbox on Thursday mornings.

One question I’ve asked lawyers is whether Big Law’s outstanding financial performance in 2021 was a historical anomaly or the result of a secular shift that bolstered large law firm business prospects.

Most people I’ve spoken to believe the former.

The typical story is Big Law benefited from unprecedented financial conditions caused by the response to the pandemic. The industry’s biggest profit machine—teams of lawyers working on M&A and capital markets transactions—went into hyperdrive. As that machine winds down, Big Law will go back to its more routine, longer-term trajectory.

That camp will likely see Big Law’s first-half financial results as evidence in support of their beliefs.

But it’s more complicated than that.

Evidence exists that the large firm business model is healthier than ever.

Here’s what is happening.

Law firm rosters swelled to meet a crest in demand last year.

With the tide flowing back out, those lawyers are less productive and their larger salaries, plus the return of normal business expenses, are weighing on profit margins, according to reports this week from Wells Fargo Legal Specialty Group and Citi Private Bank, which track law firm financials.

The bottom-line hit is large. Wells Fargo said net income margins decreased 14.3% from the same year-ago period. Citi says growth in expenses (up 14.7%) far outpaced revenue (5%) during the first half.

If those figures persist for the full-year, it will be the biggest drop in Big Law profits in at least a decade.

Still, even with the drop, profit margins would be higher than they were in 2019.

Wells Fargo’s report showed net income margins through six months of this year were 31%. That compares with 28.5% in the first six months of 2019.

Average lawyer productivity—the number of hours billed per lawyer—is also up from 2019, according to Citi Private Bank, despite retreating from highs set last year.

It’s important to note this is occurring against the backdrop of stagnant demand. Wells Fargo says demand—hours billed—fell .5% in the first six months compared with the year-ago period.

What’s even more telling about the longer-term prospects for Big Law finances is that firms were still able to achieve significant rate increases despite that falling demand. Wells Fargo says standard rates increased in the first half by nearly 6% compared to last year’s period.

“Some people have seen the report and interpreted it as doom and gloom for the industry,” said Joe Mendola, senior director of sales for Wells Fargo Private Bank Legal Specialty Group. “I don’t see it that way.”

I’d speculated that windfall profits could lead to prolonged rate pressure for law firms. But that broke my own rule: Never underestimate Big Law’s ability to raise rates.

The fact that rate increases were so strong, even as demand subsided, shows law firms still have significant sway over pricing.

Viewed from a longer-term perspective, comparisons against 2021 aren’t that relevant. Law firm partners will keep the profits they booked during an unprecedented year. And their ability to continue to raise rates will leave them positioned to capitalize even more on any increase in demand over the second half of the year.

There are positive signs on that front. The economy seems to be avoiding a recession. There was an unexpected surge of dealmaking activity in August. And courtrooms are back in action, providing a needed boost for litigation practices.

This year won’t match the last, Mendola said, but that doesn’t mean it’s all downhill from the top. Another strong year will bolster an argument that the large firm business model is performing as good or better than ever.

“2022 may end up being the second-best year the legal industry has ever had,” Mendola said.

Worth Your Time

On Tesla: Tesla Inc. has parted ways with David Searle, the law department leader heading an internal inquiry into purchase orders at the electric vehicle maker, Brian Baxter and Ed Ludlow report.

On the NRA: A once-floundering lawsuit seeking the return of hundreds of millions in donations to the National Rifle Association of America is back on track after the plaintiffs found new lawyers at the last minute. I wrote last week about the tortured history of this lawsuit, and an attorney I asked for an expert opinion on the case ended up being hired by the plaintiffs.

On Laterals: Lateral moves often beget more lateral moves, and Justin Wise reports law firms will struggle to keep hold of their new stars after the pace of hiring doubled from that of just five years ago.

On Law Firm Ownership: California is taking center-stage in the battle over reforming rules prohibiting non-lawyer ownership of law firms, Sam Skolnik reports. The state is set to vote this month on legislation that would allow California to test new models, just after the American Bar Association urged states against loosening law firm ownership restrictions.

That’s it for this week! Thanks for reading and please send me your thoughts, critiques, and tips.

To contact the reporter on this story: Roy Strom in Chicago at rstrom@bloomberglaw.com

To contact the editors responsible for this story: Chris Opfer at copfer@bloomberglaw.com; John Hughes at jhughes@bloombergindustry.com