Legal Village

A dark mood on Wall St

Posted 16/09/2008 by Anthony Lin

The world's leading law firms are facing an uncertain new landscape following the demise of two of Wall Street's biggest and most established investment banks.

The bankruptcy of Lehman Brothers and the announced acquisition of Merrill Lynch by Bank of America will no doubt produce a flurry of legal activity. In particular, Lehman's massive filing, involving some $600bn (£337bn) in debt, will keep scores of lawyers occupied for years to come.

But for most large corporate law firms, which depend on financial institutions as the cornerstones of their client lists, Monday's developments, combined with the earlier demise of Bear Stearns and the possible imminent collapse of insurance giant AIG, portend dark days ahead.

"There's not a firm in the city that's not terrified about what's going on right now," said the managing partner of one top New York firm, who asked to remain unnamed because he was dealing with a heavy volume of client inquiries about the current situation.

Both Lehman and Merrill had been battered over the past several months by exposure to securities backed by defaulting mortgages. Lehman opted for bankruptcy after failing over the weekend to secure a buyer or government assistance. AIG is frantically trying to raise $40bn (£22.7bn) to avoid a potentially fatal credit downgrade stemming from insurance payouts also related to the mortgage crisis.

"There's a tremendous amount of instability," he said. "It's a question of whether you are fortuitous enough to be representing a financial institution that survives or whether you represent one that's not going to be around much longer."

The managing partner said the issue stretched beyond those firms that regularly represented Merrill or Lehman. Questions now being raised about other banks and the prospect of new financial regulation stemming from the turmoil, he said, will likely further hammer an already moribund private equity market and also severely restrict hedge funds.

Much is at stake. Investment banks and financial institutions are the main reason New York firms dominate the legal profession in terms of profitability. Unlike cost-obsessed corporate clients, financial clients have generally been willing to pay 'full-rate' or premium fees to their favoured firms. Firms from elsewhere in the country and across the ocean have invested heavily in New York offices to try to get a piece of Wall Street's action.

A major fear now is that further waves of forced consolidation and new government regulation may entrench a cost-cutting mentality on Wall Street.

But it is not just corporate firms that looked to financial institutions' deep pockets. Plaintiffs firms filing suits on behalf of shareholders of failed companies generally seek the largest recoveries from banks who they claim facilitated securities fraud at companies like Enron or WorldCom. These suits in turn keep large firms' litigation practices humming.

"I was just thinking about that this morning," said class action lawyer Salvatore Graziano, of securities cases that might be affected because of the collapse of Lehman. Graziano, a partner at New York-based Bernstein Litowitz Berger & Grossman, said there were cases across the nation that had gone on for years, costing the plaintiffs lawyers millions, which might be dead with the Lehman bankruptcy or a possible AIG filing.

The chairman of another New York firm, who also cited frantic client calls in requesting anonymity, said the turmoil on Wall Street means the 'spotty' year for law firms so far is going to get spottier.

"The slowdown that's existed is not going to lift for a good long while," he said. But he also predicted "there will be some winners and some losers" in the current situation.

He said Weil Gotshal & Manges, Lehman's bankruptcy counsel, is the one certain winner in all of this, as the complicated case will likely spin off eight-figure bills for years. Another source said Weil Gotshal also conferred with AIG on Monday.

Major bankruptcies also usually throw off M&A deals, though such representations are subject to court supervision and scrutiny of fees. Clients are also clamouring for advice from law firms on how to deal with exposure to Lehman assets.

But whatever work is produced by the Lehman bankruptcy likely pales next to the stream of underwriting work and litigation the bank once provided.

Simpson Thacher & Bartlett has been Lehman's primary firm for underwriting and M&A advisory work, though damage to the firm may be mitigated if Lehman deal teams migrate to other banks with which Simpson enjoys good relations.

The picture is somewhat different for Cadwalader Wickersham & Taft, which regularly represented Lehman in its offerings of mortgage-backed securities, overreliance on which proved the investment bank's fatal weakness. Cadwalader, which has laid off 130 lawyers so far this year, has already felt the downturn more sharply than other law firms. Lehman's demise further dampens hope for a recovery in Cadwalader's core securitisation practice.

Those firms that have regularly represented Merrill Lynch face the challenge of dealing with the investment bank's new owner.

Merrill Lynch has had strong historical ties with Shearman & Sterling in particular, and the bank's present vice chairman and general counsel, Rosemary Berkery, began her career at the firm. Shearman is currently representing Merrill in the $50bn (£28bn) deal with Bank of America, which was represented by Wachtell Lipton Rosen & Katz.

But it remains to be seen if Shearman and other Merrill stalwarts like Skadden Arps Slate Meagher & Flom will continue to have dependable roles under Bank of America's management.

The onetime NationsBank of Charlotte, which acquired Bank of America in 1998, has regularly turned to Wachtell for corporate-level M&A advice, but its investment bank has only rarely been lead underwriter or adviser in major transactions, so it has a sparser record of hiring deal counsel. Its acquisition of Merrill, one of the leading underwriters in the world, will make Bank of America one of the top players on Wall Street.

A number of New York law firms have successfully weathered the takeover of a major financial services client in the past several years. Milbank Tweed Hadley & McCloy chairman Mel Immergut has said his firm got even more work from longtime client Chase Manhattan Bank, following its 1996 acquisition by Chemical Bank and its 2000 merger with JPMorgan. Likewise, Shearman itself previously dealt with the 1998 acquisition of mainstay client Citibank by Sanford Weill's Travelers Group.

The totality of circumstances is different from the late 1990s though. As one of a shrinking number of Wall Street giants, Bank of America may have a stronger hand dealing with the many law firms clamouring to represent it.

The clamour will not just be from corporate firms though. Graziano noted that Bank of America will be expected to take on any Merrill liabilities. On top of its January 2008 acquisition of Countrywide Financial, the nation's largest mortgage lender, Bank of America can expect a heavy litigation burden, the plaintiffs lawyer said.

Post on 16 September by Anthony Lin on the website of New York Law Journal, Legal Week’s US sister title.