Law Firm Reports on Revenues and Profitability: A Radical Proposal

Seattle Transit System 32 Year Net Loss & Prof...

Seattle Transit System 32 Year Net Loss & Profit History (Photo credit: Oran Viriyincy)

Law firms’ profitability and revenue stream which infect the trade press at this time of year is a reflection of the profession’s hubris in boasting about how much money it makes on the backs of their (frequently cash strapped) clients.  The principal creator of this villainy may very well be Steve Brill, the initial publisher of The American Lawyer and who some 30 years ago, invented the AmLaw 100.  A casual observer might wonder why private partnerships publicize their personal financial information.  I doubt that very many law firm partners distribute to the press or otherwise publish their own personal tax returns or post them on their Facebook sites.  But why would law firms  stick it in their clients’ faces that law firm partners or a particular law firm is making oodles of money, when the clients, who fill their coffers, are on austerity budgets?  Who would expect that before engaging a physician, you first asked him or her how much money he or she makes every year.  The result of law firms crowing about the wonderful profitability the firm is realizing, often exaggerated by legerdemain, smoke and mirrors (which those of us who advise law firms can see right through) is just plain pissing  clients off.  Lexis/Nexus recently conducted a survey and found that 58% of in house general corporate counsel believes that their outside lawyers are just making too much money.  And, what is their reaction?  For those firms not willing to assume the financial risk on legal engagements, clients are cutting hourly rates and taking more work in-house.  The demands for reduced hourly rates by clients is only emboldened by the otherwise inexplicable compulsion by law firms to boast about how much money they are already taking out of their clients’ pockets.

A significant parenthetical to some of the examples of the creative dexterity to which firms resort to artificially inflate their profitability is instructive:  First, we have all known for years that the so-called “Profits per Equity Partner,” the purported gold standard, is adroitly manipulated by most reporting firms by simply dubbing some lowered paid partners to “non-equity partners,” without in any way affecting the actual earnings of such partners or their roles or status within the firm.  Rather, by eliminating the lower earning partners from the metric, the PPP number is – poof  — inflated.  Reporting for 2009 provides an added level of prestidigitization. During a difficult year for the profession as a whole, with decreased revenues and wholesale elimination of timekeepers, we have seen so  many firms report that despite such reduced gross revenues, profitability has nonetheless increased.  However, there is no mention made of the fact that the differential is caused by the elimination of salary expenses and personnel, while bills rendered by the firm for work already done by such timekeepers as well as work already in progress (WIP) yet to be billed will yield revenues, the so-called “ramp down effect.”  Yet, long term effects of ramp downs can have staggering negative consequences.

Financial accounting for law firms is governed by applicable generally accepted auditing standards and generally accepted accounting standards, adopted from time to time by the American Institute of Independent Certified Public Accountants.  As we all know, footnotes to income, balance sheet and profit and loss statements are an integral part of any financial statement.  Yet, it is virtually unheard of for any law firm to release its full financials or the required footnotes. In many instances, lawyers are fully aware of the fact that release of partial data, including the failure in particular the integral footnotes may constitute material and actionable omissions.  Despite such knowledge, the release of financial data by law firms with material omissions is pandemic.

There is no federal, state or regulatory requirement that firms boast about their profitability or slink in shame when their numbers are off.  So, just don’t do it.  Let the American Lawyer magazine say what it might, but, in the end, it simply won’t matter if you don’t report to them.  The only people who should see  law firm revenue and profit numbers are partners, their accountants,  the firms’ and partners’ bankers,  potential lateral partners,  the IRS and clients who require such disclosure prior to engaging their services. And each should be held to confidentiality requirements.  For those who suggest that declining to participate in this perp walk might adversely affect recruiting, bear in mind that just like the market for legal services is purely a buyers’ market, so too is the market for lateral partners and young lawyers.

The bottom line and our radical proposal is to simply stop this chicanery and flouting of plumage. Let that which is private remain private and remove revenue and profitability numbers from public discourse until some rule, regulation or governing requirement compel disclosure and if that ever that becomes the case, require uniform reporting consistent with AICPA standards.

© Jerome Kowalski, February 2010, All Rights Reserved.

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