Footing the Bill for Pensions?

Jennifer Smith of the WSJ reports, Footing the Bill for Pensions:

Retirement should be a happy time for a generation of baby boom-era lawyers near the end of their working lives. Less joy may await the partners they'll leave behind.

At some of the country's top firms, younger lawyers will foot the bill for deluxe pension plans that could drag down their own earnings for years to come.

These pensions are largely unfunded: there is no money saved to pay retirees. Instead, most law firms with such plans pay the benefits as they go, using a portion of their current profits.

Partners at some elite firms are often entitled to between 20% to 30% of their peak pay after retirement—in many cases, for life, according to partners and law firm consultants. For the most profitable firms, that could mean payments of $400,000 to $600,000 a year per retired lawyer.

Many law firms have moved to phase out unfunded pension plans. But those that haven't must pay them at a time when the corporate legal industry is finding it harder than ever to boost earnings. While law-firm profits are slowly improving after the recession, earnings have lagged behind previous years. Firms are under mounting pressure to lower their billing rates.

Given those conditions, "it creates a significant burden on the younger partners," says Dan DiPietro, chairman of Citi Private Bank's law-firm group.

The pension plans were devised decades earlier when life expectancy was lower and firms had fewer partners. That was before tax law changes in the 1980s made other retirement options more attractive for lawyers and law firms. But these pensions are still offered by a core slice of the most profitable law firms in the country, such as Gibson Dunn & Crutcher LLP and Davis Polk & Wardwell LLP.

Few attorneys will complain as long as profits keep up. The trouble starts if payments to retirees grow faster than profits.

"It's a real problem in this environment for a law firm to pay 10 or 15 cents out of every dollar of revenue to partners who have retired from the law firm," says a senior partner at one firm with a generous pension plan.

Some managing partners at elite firms that still offer generous pensions say that such plans help build loyalty and retain top talent. "Partners take comfort in the fact that it is there. I think it's an important part of our culture," said Kenneth Doran, managing partner at Gibson Dunn & Crutcher.

The pensions often come on top of other retirement programs, such as 401Ks, in which participants save for their retirement by putting away a portion of their earnings on a tax-deferred basis (often with a company match). Some firms also have profit-sharing plans.

In its own way, the future liabilities for some top law firms mirror similar problems across the U.S. Benefits promised in more stable economic times seem increasingly unsustainable today. From General Motors Co. and AT&T Inc. to cash-strapped local governments employing public workers, pension liability is becoming a growing concern as the retiree pool swells.

"It's the same thing you had with pensions in the private sector, where it was all defined benefits and companies were going bankrupt," says James Jones, a former managing partner at Arnold & Porter LLP who is now a senior fellow at Georgetown University's Center for the Study of the Legal Profession.

Among law firms, hefty pension obligations also can jettison potential mergers or compound financial woes. For instance, some blamed the 2009 collapse of the Philadelphia firm Wolf, Block, Schorr & Solis-Cohen LLP—which followed a failed merger attempt in 2008—in part on its leadership's refusal to scale back their unfunded pension plan.

At Gibson Dunn, partners who serve there for 20 years get a retirement benefit at age 60 that pays out 20% of their top compensation. At current profits, that could amount to $500,000 a year for eight years or life—whichever is longer. Surviving spouses would get the remaining benefit should a partner die before the eight years are up.

Gibson Dunn reported record earnings in 2011, with gross revenue of $1.7 billion and average profit per partner at $2.47 million. Mr. Doran says his firm guards against burdening active partners with "runaway obligations" by capping pension payments at 6% of the firm's net income.

Just how large such obligations loom is difficult to determine. U.S. law firms don't disclose financial details. Few lawyers feel comfortable discussing the subject of partner retirement benefits.

Top firms with unfunded pensions include Cleary Gottlieb Steen & Hamilton LLP; Cravath, Swaine & Moore LLP; Debevoise & Plimpton LLP; Fried, Frank, Harris, Shriver & Jacobson LLP; and Milbank, Tweed, Hadley & McCloy LLP, according to data compiled by the American Lawyer magazine. Those firms declined to comment.

According to one estimate by law firm consultant Peter Giuliani, the current pension liability at a typical large New York firm with an unfunded plan could amount to $200 million—if the firm had to make the total payout today.

His calculations are based on a firm of 175 partners with an equity stake and average annual earnings of $2 million per partner, with about 20% of the partners near retirement age. The pension would pay out over two decades. That liability could be much higher at the most profitable firms, according to several people with knowledge of finances at some top law firms.

Some firms have moved to prune their plans, by shrinking benefit amounts or lowering caps that limit retiree payments to a certain percentage of profits. But getting rid of unfunded pension plans altogether can be a difficult proposition.

"In a law firm, you have to get a majority vote of the partners to get it done. In some cases it's a supermajority, so 75% to 80% would have to support it," says Mr. Giuliani. "If 25% have an entitlement they don't want to give up, there is no way of doing it."

One firm that discarded its unfunded pension plan is Akin Gump Strauss Hauer & Feld LLP. The firm set up a funded plan, where money is socked away today to pay for future benefits, and now provides individual retirement plans that are owned by the lawyers, says chairman R. Bruce McLean.

"We paid out the people who were entitled to benefits under the old unfunded plan," Mr. McLean says. "It's a great benefit…The difficulty is that at some point in time, some percentage of your income is siphoned off at the top."

The economics of pensions will hit law firms hard over the next decade. Why? Because a lot of partners are going to retire at a time when profit margins are contracting. Law firms are struggling to cope in an environment where the financial services sector is shrinking. As those Wall Street bonuses get pruned, it will impact top law firms too.

But what really gets me is partners retiring based on a percentage of peak day earnings. That's insane and if I was a young lawyer at one of these top firms, I wouldn't be too happy knowing I'd have to foot the bill for their lavish retirement. by the way, the same thing is going on at top accounting firms.

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