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Due Diligence Failures Leave Lateral Hires At Risk By Andrew Strickler

Law360, New York (April 01, 2014, 7:20 PM ET) — BigLaw partners considering lateral moves are failing to review records or even speak with a firm financial officer before making the leap, an oversight that could leave them ill-prepared for financial woes if their new firm founders, experts say.

Although high-profile bankruptcies like Howrey LLP’s and Heller Ehrman LLP’s have injected some discipline into the lateral market, far too many partners are still “totally cavalier” when it comes to learning about a firm’s financial health or even reviewing the partnership contract, said Jon Lindsey of attorney search firm Major, Lindsey & Africa, co-author of the 2014 Lateral Partner Satisfaction Survey.

The analysis of 1,775 partner responses reveals “shockingly inadequate” habits when it comes to learning about a firm’s spending habits as well as partners’ potential liability for major office leases and bank loans.

According to the survey, just 40 percent of lateral candidates met with or spoke to a financial officer before they signed on. Less than a third made contact with a benefits manager, and just 36 percent said they reviewed a firm loan document, lease or other financial statement.

Perhaps most troubling, Lindsey said, was the failure of nearly 40 percent of partners to review their firm’s partnership agreement before joining.

If those lawyers “were counseling a client who was considering an investment in a real estate or oil and gas or other partnership, and neglected to look at that fundamental document, multiple alarm bells would go off and malpractice insurers would expire of apoplexy,” the report states. “Leaving aside the very small number of large law firms which have no written partnership agreement, it still leaves well over one-third of all lateral partners who leapt before they looked.”

Despite the lack of research, the survey found, the lion’s share of partners — 86 percent — said they had adequate and accurate information about their firm’s financial health. Nearly four in five said they felt they knew what they needed to do about the compensation system.

The report says that for many attorneys, the high level of confidence is apparently borne out of a review of media reports “and having one or more of the firm’s partners reassure them that the firm was in good financial shape.”

Lindsey said more partners should overcome whatever personal reservations they may have and glean what they can do about bank covenants and major lease obligations.

Firm managers “might think you’re being exceptionally thorough, but I don’t know that many lawyers get criticized for being thorough,” he said.

The issue of firm accounting practices and debt was stirred up again last month by the specter of Dewey LeBoeuf LLP and criminal charges filed against Chairman Steven Davis, Executive Director Stephen DiCarmine and others for alleged fraud committed as the firm tried to stay ahead of creditors and partner guarantees before its implosion in 2012.

Among the report’s other key findings was an overall high level of satisfaction partners had in their current role. Fifty-two percent of lateral partners indicated they were “very satisfied” in their current firm, and an additional 33 percent said they were “somewhat satisfied.” Less than 4 percent of respondents reported being not at all satisfied.

Data pointed to firm culture as a key driver of lateral moves as well as levels of satisfaction. More than 40 percent said not liking their former firm’s culture was the reason they left, compared to nearly 33 percent who cited compensation.

Anticipated compensation at a new firm ranked sixth in importance for partners in the selection of their current firm, following other considerations such as the personality of partners and practice area support.

Michael Allen, managing principal at Lateral Link Group LLC, said that many partners should be more disciplined about their financial due diligence but cautioned against enquiries that go too far afield of a partner’s individual capital stake in the partnership.

“A lot of partners should be doing more than they are, but those kinds of questions … aren’t going to be well- received,” he said.

Instead, Allen said, a lateral should weigh how much capital the firm will require and ask if the firm uses partner contributions for routine day-to-day capital or for more troubling uses such as paying down debt.

A failure to have that information could lead to a bad professional move, as well as complications around seeing that money again when the partner decides to leave.

Beyond the “doomsday” scenario of a bankruptcy, “the real risk is they don’t look at this beforehand because in their mind, they think it’s the last firm,” Allen said. “Even if the firm doesn’t go belly up, they don’t know the restrictions on getting their capital back.”

–Editing by Jeremy Barker and Christine Chun.