Get Comfortable with Uncomfortable
WE HEAR THE ROLE of the GC is changing - that’s certainly true, but the way businesses work is also changing. Many newer businesses are breaking th...
But the undisputed giants of the professional services world have once again set their sights on the legal market. This time, they mean business: Both PricewaterhouseCoopers and Ernst & Young are looking to build leading global law firms within the next five years. Deloitte and KPMG have also been bolstering their legal services offerings by making hires across the United Kingdom, Germany and Asia.
The expansion drive is already well underway. In February, PricewaterhouseCoopers successfully applied for an "alternative business structure" (ABS) license—a new regulatory structure that allows U.K. businesses to offer legal services. The following month, it acquired a boutique Canadian law firm.
EY's growth has been even more spectacular. The firm hired no fewer than 250 lawyers in 2013—increasing its total attorney head count by almost 30 percent, to 1,100. Last year, it launched legal services in 29 countries, including Australia, China, Japan, Mexico and 14 separate African countries—more than doubling its coverage to 52 international jurisdictions from 23. Ernst & Young has started 2014 on the same track, hiring a series of partners from top international firms—including one from elite Magic Circle member Freshfields Bruckhaus Deringer. Ernst & Young's global legal services head, Cornelius Grossmann, says the firm aims to be in more than 80 jurisdictions by 2020.
"We're building rapidly and ultimately want to be in every mature [market] and relevant emerging market," says Grossmann, who formerly spent 10 years as a partner at German independent firm Luther and New York's Donahue & Partners, which is allied with Ernst & Young. "We want to at least double or triple in size by 2020. That's pretty bullish, but we think it's achievable."
At the beginning of 2013, Ernst & Young's management launched what it called "Vision 2020"—a strategy designed to transform the firm into "the leading global professional services organization." Grossmann says that law is a vital part of the firm's plans to offer multidisciplinary services to clients.
Ernst & Young's legal services offering broadly falls into three practices—transactional, commercial and employment—while it also has a strong industry focus on financial services and banking. Grossmann says that the firm's legal arm, EY Law, offers specialist services such as intellectual property, information technology and real estate in more mature markets, particularly in western Europe. (Ernst & Young did not respond to requests to name clients or discuss legal matters that it has handled.) The sheer size of the accounting firm's client base, however, means it has no plans to build a stand-alone litigation practice.
"Litigation is very dangerous for us," Grossmann says. "If it's a nice big case, it's very unlikely that Ernst & Young has nothing to do with the opponent." The firm will enter into litigation for clients as an "after-sales service" where a deal that Ernst & Young acted on enters into dispute, he adds, but the firm will "stay out of litigation, to the extent that we can."
Having kicked off a European expansion drive five years ago, Ernst & Young already has about 900 lawyers in the region—including more than 150 in France, more than 100 in the Netherlands, about 90 in Spain, and 70 in Russia and the CIS. Grossmann describes Europe as the "clear center of gravity" for Ernst & Young's legal services, but admits that the U.K. is an "important gap" in its network.
It's a gap Ernst & Young is working on filling. In September, Phillip Goodstone, the former corporate managing partner at top 25 U.K. firm Addleshaw Goddard, will relaunch the firm's legal services practice in the country. Goodstone will be joined that month by former Berwin Leighton Paisner finance head Matthew Kellett and Freshfields Bruckhaus Deringer corporate partner Richard Norbruis, who will lead Ernst & Young's global financial services and transactional law practices, respectively. Grossmann says the firm is unlikely to compete with the Magic Circle and other elite international law firms on transactional matters for the foreseeable future. "We have to be realistic," he says. Instead, Grossmann says Ernst & Young will target the more vulnerable midmarket firms.
In addition to the U.K., the firm is planning significant growth in Asia. Last December, Ernst & Young hired Herbert Smith Freehills energy partner John Dick to create a legal services offering in Singapore. Then, in February, it became the second of the Big Four to launch a Chinese legal practice by acquiring 40-lawyer Shanghai firm Chen & Co., which also has offices in Beijing and Hong Kong. The move followed Deloitte's establishment of its own Chinese arm in early 2013 with hires from several domestic firms. The seven-lawyer Qin Li Law Firm doesn't bear the Deloitte name, but practice leader Patrick Yip and partner Clare Lu are simultaneously partners at Deloitte, and the firm's website links to those for Deloitte China and Deloitte Legal. Deloitte declined to comment for this article.
For the accounting firms, an ABS license has seemingly become a crucial passport to the U.K. legal market. In February, PricewaterhouseCoopers—which in 2013 generated revenues of $32.1 billion, making it larger than the world's top 18 law firms combined—became the latest business to successfully apply for an ABS license. Shirley Brookes, the U.K. senior partner of PricewaterhouseCoopers's law firm arm, PwC Legal, has said the move will be "rocket fuel" for the firm's expansion plans, which include doubling its global legal revenues to $1 billion over the next five years. Revenues of $1 billion would have placed PwC Legal in the global top 30 last year, according to The American Lawyer's 2013 Global 100 survey.
(PricewaterhouseCoopers declined requests for an interview for this article. A source at the firm said that the presence of the word "American" in The American Lawyer's title had spooked senior management due to the U.S. blanket ban on accounting firms providing multidisciplinary services to audit clients post-Enron.)
PricewaterhouseCoopers may soon be joined by Ernst & Young and KPMG, which are both in discussions with U.K. regulators over possible ABS moves. PricewaterhouseCoopers has structured its legal services business as a stand-alone ABS, PwC Legal, which is then owned by the accounting firm. According to three former partners of each firm, Ernst & Young and KPMG are considering a far more extreme option: converting their entire businesses to ABSs. Both Grossmann and KPMG's head of indirect tax, Gary Harley, say that firmwide switches to ABS are possible, but add that no final decisions have yet been made.
Converting to ABS would also allow the Big Four the option to acquire a U.K. law firm. The ABS structure has already been used for several law firm acquisitions in the U.K.: Australia's Slater & Gordon, which in 2007 became the world's first publicly listed law firm, got its ABS license in 2012 and has acquired five U.K. personal injury and consumer law firms in the last 16 months, including two in the U.K. top 100. PricewaterhouseCoopers has shown an appetite to grow its legal services offering through acquisition, having snapped up 37-lawyer Toronto-based immigration firm Bomza Law Group in March.
Grossmann says a U.K. deal is "absolutely not the focus right now," but former Big Four partners say they would not be surprised if the accounting firms sought to acquire a U.K. law firm, pointing to PricewaterhouseCoopers's April acquisition of management consulting firm Booz & Company (now Strategy&), itself a billion-dollar business, as a clear demonstration of the buying power of the Big Four.
Interviews conducted with 20 former partners of accounting firm legal arms give some indication of the challenges the Big Four will face in hiring the lawyers necessary to achieve their strategic goals. Most questioned whether a top law firm partner would actually want to join an accounting firm, which they said many would see as a retrograde step, while several said they experienced a feeling of isolation upon moving from a law firm to an accounting environment.
"At a law firm, everything is geared toward advising clients on the law—everything else works to support that practice," says one former Ernst & Young partner. "At an accounting firm, everything is geared toward tax and accountancy—law is the support practice. That sounds obvious, but it took me by surprise and took some getting used to."
Grossmann allows that a certain degree of culture shock is inevitable when partners transition from a law firm environment, where they are "the most important people in the room," to working as part of a wider team across various service lines. "It's about the mindset—you have to buy into the strategy," he says. "Mistakes have been made in the past, but our strategy today is that [legal services is] an equal member in a multidisciplinary team. We're not an add-on."
But as any managing partner of a large international law firm will attest, actually ensuring that partners work seamlessly across departments is easier said than done. It's even more challenging for accounting firms with legal practices, since some accounting departments—such as insolvency, forensic accounting and litigation support—receive significant volumes of referrals from law firms. Five former partners at legal arms of the Big Four said they were overlooked for legal assignments by their own colleagues in those departments, who feared losing law firm referrals.
Grossmann admits that such internal friction is "sometimes an issue," but says it usually stems from individual partners looking out for their own personal books of business. He adds that Ernst & Young is "fine with that tension" from a strategic perspective, as the accounting firm would not expect law firm clients to feel threatened if it started offering legal services. "Besides," he says, "law firms will always need the Big Four and we all have legal practices, so they'll have to pick one of us."
KPMG's designs in legal services are less grand than those of PricewaterhouseCoopers and Ernst & Young. When it launched KLegal, its now defunct legal arm, in 2000, KPMG sought to build an independent, full-service law firm. Harley says that approach was "practically the antithesis" of KPMG's revised U.K. legal services offering, which operates as part of the accounting firm's tax and pensions department. The current 50-strong team, which comprises one of the country's largest tax litigation practices, expects to generate revenues of between 8 million to 10 million pounds ($14 million to $17 million) in the current fiscal year. (KPMG did not respond to requests for client names.) It was boosted this January by the hire of DLA Piper corporate partner Nick Roome, who now heads KPMG's legal services team in Manchester, England.
The accounting firms' previous push in legal services was doomed as much by a lack of integration as Sarbanes-Oxley, Harley says: "Legal was seen as an adjunct—it was bolted on, not integrated." KPMG is determined not to repeat that mistake. "We're trying to resist the temptation to do a bit of everything everywhere, and focus on building strength in areas where it makes sense to have an integrated offering," Harley says. Although KPMG's legal practice is largely focused on tax and pensions, the firm has in the past two years expanded into other areas that overlap with its tax business, such as corporate, commercial, immigration and employment.
But putting its legal services practice within the accounting business has created some minor regulatory complications for KPMG. Because KPMG does not yet have an ABS license, any solicitors joining the firm have to suspend their practice license. They can still provide legal advice to clients, but aren't able to take part in "reserved legal activities" such as litigation or handling probate or notarial work.
"Not being regulated does put some restraints on what you can and can't do, but the reality is that we're not competing with law firms here," Harley says. "We're trying to provide an integrated offering to our clients, and this hasn't stopped us from doing that very successfully so far."
In some respects, the timing of these developments is surprising. If anything, the regulatory environment for accounting firms is worse today than it was a decade ago. In 2016, the European Union will introduce new rules that enforce even tougher restrictions on accounting firms than Sarbanes-Oxley, prohibiting them from providing almost any nonaudit services to European audit clients—even tax. The new rules also require European-listed companies and financial institutions to switch to a different audit firm every 10 years.
Grossmann admits that Ernst & Young is "not happy" with the new legislation, but insists that the resulting upheaval—combined with the pressures that law firms are already feeling from clients—will also present an opportunity for picking up new clients. "A fluid market is a great opportunity for a new and growing business," he says.
But significant portions of the market will be off-limits as prospective clients for lawyers at the Big Four. Audit work generates between 26 percent and 37 percent of the Big Four's U.K. revenues, according to the firms' most recent accounts.
(PricewaterhouseCoopers's U.K. audit business produced revenues of 963 million pounds, or $1.65 billion, in 2013—37 percent of its total U.K. revenue of 2.62 billion pounds, or $4.5 billion.)
Grossmann says that Ernst & Young audits about 35 percent of all U.S. Securities and Exchange Commission-registered companies in the United States—those for which EY Law would be unable to act under Sarbanes-Oxley—but that figure "dilutes quickly" once you leave the U.S. market. He estimates that fewer than 10 percent of clients in Germany, Switzerland and Austria, for example, would be off limits to EY Law.
"It is still a disadvantage, but top law firms probably can't act for about 10 percent of the market due to conflicts, so it's really not that different," he says. "Sometimes we lose great clients because Ernst & Young is the successful winner of an audit [contract], but then we just cheer for the auditors and look for new clients."
The Big Four haven't even been able to escape the long arm of U.S. regulation in Asia, with an SEC administrative law judge ruling in January that each of their Chinese arms should be suspended from auditing U.S.-listed companies for six months. The judge said they "willfully" failed to cooperate with SEC investigations of securities fraud at certain Chinese companies. The suspensions are under appeal.
But Grossmann is convinced that Ernst & Young and the other accounting firms can succeed, despite the challenging regulatory backdrop. "The rules haven't changed," he says. "What has changed is that we've learned how to deal with the rules. When Sarbanes-Oxley hit, we didn't know what else was coming—we just knew that we lost a significant part of our business"—that is, the ability to provide legal advice to audit clients of the firm. "We are now rebuilding in an environment where we know where the no-go zones are," he adds. "We wouldn't be so bullish about expanding if we weren't really convinced that this is a model that works and that interests our clients."
It's easy to dismiss the accounting firms' previous foray into the legal services market as a failure—and a costly one at that. Ernst & Young had invested huge sums in building up its U.K. law firm, Tite & Lewis, and had to write off 22 million pounds ($38 million) when the practice separated from the accounting firm's legal network in 2003, according to two former Ernst & Young partners with knowledge of the situation. "EY spent a lot of money on recruitment and then closed the whole thing down," says one former Ernst & Young partner. "They made quite a mess of it."
But that would overlook the fact that, before the Sarbanes-Oxley legislation pulled the rug from underneath their feet and effectively rendered their business model obsolete, the Big Four had successfully built independent law firms that were established members of the U.K. legal midmarket. Both KLegal and Garretts—the legal arm of Arthur Andersen—had even gotten so far as to break into the U.K. top 100. KLegal posted U.K. revenues of 41.5 million pounds ($71 million) in 2003, according to U.K. publication The Lawyer, while Garretts brought in 37 million pounds ($63 million) and had created an international network composed of leading local practices such as Beiten Burkhardt in Germany, Spain's Garrigues, Rajah & Tann in India, and 1,150-lawyer French tax specialist Fidal.
For midmarket law firms and even international giants such as Baker & McKenzie and DLA Piper, the Big Four accounting firms make daunting competitors. They have global networks comprising hundreds of offices; global brands that are far stronger than those of any top law firm; much greater sophistication in technology, training and business support; and client lists that dwarf even those of the largest law firms. The Big Four are simply in a different league when it comes to scale. Baker & McKenzie, the world's largest law firm by head count, has just over 4,000 attorneys worldwide. Deloitte has almost that many staffers in South Africa alone. Law firm partners often comment on how, as the legal market continues to consolidate and becomes increasingly dominated by a smaller number of larger firms, it will come to more closely resemble the accounting sector. They may be more right than they imagined.
Author: Published July 30th 2014 by Chris Johnson, Chief European Correspondent, www.americanlawyer.com