US law firms have spent big to attract elite Hong Kong talent, but with so many firms apparently obsessed with gaining eminence in the volatile IPO segment, recouping their investments will inevitably prove arduous.

In 1983, the tragic and mysterious death of John Wimbush signalled the end of one of Hong Kong’s infamous property booms. It also marked the peak of an era when Hong Kong’s local lawyers were among the wealthiest in the world. Some were earning in excess of HK$20 million (just under US$2 million) a year, this being almost 30 years ago.

Wimbush, the senior partner of Deacons, Hong Kong’s leading law firm, was found dead at the bottom of his swimming pool with a manhole tied to his neck. Wimbush had been caught up in one of Hong Kong’s deepest corporate scandals. The Carrian affair could rival the demise of BCCI or Enron for colour and intrigue.

Wimbush’s supposed suicide note was discovered, but after a detailed inquest into his death, the jury returned an open verdict. Almost 30 years on and still there is a whiff of murder. Wimbush was the principal legal adviser to Carrian, a company that in 1981 bought what is now the Bank of America building in Hong Kong’s Central district. It immediately announced the sale of the tower to two Hong Kong businessmen for a 100 per cent profit, a deal that was eventually discovered to be a complete fraud. When Hong Kong’s stock market collapsed in 1983, the full-extent of the scandal was laid bare.

While Wimbush’s death came at a time when Hong Kong’s resident lawyers were earning millions, those huge remuneration packages appear to have returned thanks in part to a hiring spree by America’s elite law firms. Chicago’s Kirkland & Ellis is understood to have guaranteed a package of US$6 million for three years to at least two of its eight newly recruited Hong Kong partners.

In 2011, with Hong Kong’s capital market more effervescent than anywhere else in the world, ostentatious compensation packages have returned to the legal market.

Wall Street firms such as Simpson Thacher & Bartlett, Sullivan & Cromwell and Davis Polk & Wardell have all launched Hong Kong law practices in the last two years, by recruiting the cream of the capital markets community. Not to be outdone, Chicago’s Kirkland & Ellis announced it was recruiting eight new Hong Kong-based partners in August this year.

David Patrick Eich, founder of Kirkland & Ellis’s Hong Kong branch, refused to comment on the compensation offered to the new partners, but admits that the firm worked extremely hard to get its targets. ‘Kirkland has a persuasive platform for standout practice leaders. It is an entrepreneurial place, there is very little bureaucracy and the firm is deeply committed to Asia,’ he says.

The issue of lavishly remunerated lawyers is certainly not new in Hong Kong. Yet while Hong Kong’s local lawyers got rich in the early 1980s thanks in part to the property boom and the comparative shortage of expert advisers, many current residents complain that the market has now become saturated.

Indeed, such is the clamour to gain a share of Hong Kong’s apparent pipeline of initial public offerings (IPOs) – which was recently halted by the Eurozone debt crisis – that decent margins are hard to come by. For some, it makes these immense wages hard to reconcile.

The first wave

Deacons is no longer the dominant force that it was up until the mid-1980s, but it now carves a niche as the premier remaining independent firm in Hong Kong. At the time of the Carrian affair, Deacons and its closest Hong Kong rival Johnson Stokes & Master (now Mayer Brown JSM) were coming to terms with the influx of large London law firms – Slaughter and May was one of the first to arrive in 1974.

As a British colony and with a legal system that closely resembled that of the UK, London firms were able to practise Hong Kong law overnight. As a senior partner at a leading international firm in Hong Kong recalls: ‘You were brought out on Friday, sworn in on Saturday and you were working on Monday.’ This automatic qualification is no longer in existence.

UK law firms were able to generate a substantial presence in Hong Kong at an astonishing rate, such that they were quickly able to achieve parity with local giants Deacons and JSM.

American firms in comparison have bided their time, largely sticking to US legal advice on an exclusive basis. But this changed noticeably in 2005, when Skadden created a Hong Kong law team with the hire of Nick Norris from Simmons & Simmons and Dominic Tsun, who had recently resigned from Linklaters. These two quickly developed a Hong Kong practice that eventually became a credible threat to Magic Circle firms that had come to dominate the market.

More recently, as the number of Hong Kong listings have surged, further US firms have recognised the need to have credible Hong Kong law practices. Christopher Wong, a new Hong Kong partner at Simpson Thacher & Bartlett, who was recruited from Freshfields Bruckhaus Deringer this year, says: ‘If you look back in history to the 1980s and 1990s, US companies coming to do business with Chinese companies in those days wanted to use New York law as the governing law of transactions and Chinese companies were content to play by those rules as they were just starting to do cross-border deals. But as China has grown in stature, there was no longer a law that was the default governing law. Parties gravitated towards using Hong Kong law more and more because Hong Kong law is a very robust system of law and Chinese companies have a sense of familiarity with Hong Kong law, especially after the return of Hong Kong sovereignty to China in 1997.’

Kirkland’s Eich has similar sentiments: ‘The backlog of Chinese corporates looking to obtain public capital is very significant compared to other parts of the world. Our buildout in capital markets is commensurate with that opportunity.’

Eich reveals that since the firm established the Hong Kong office in 2007, he increasingly recognised that financial sponsors, such as the firms’ marquee private equity clients, were looking to exit through the Hong Kong Stock Exchange. With many Chinese businesses already listed on the capital market, more and more M&A transactions were being governed by Hong Kong law.

When Kirkland worked on Bain Capital’s investment in Chinese retailer Gome Electrical Appliances in 2009, Eich discovered that impressive Hong Kong lawyers were in existence and it encouraged him to think about localising the firm’s presence in the former British colony. ‘We were in the trench with Nick Norris in an unusual and complex transaction,’ he recalls. ‘He totally out performed, was fanatically methodical, worked very hard and was fun to work with. That is when the idea first crossed my mind that there were M&A lawyers operating at that level in the Hong Kong market.’

One Hong Kong partner at a UK firm is adamant that Kirkland was forced to build out its Hong Kong law practice and capital markets capabilities, because it was unable to keep a toehold on Bain Capital, its cornerstone client in Asia. As ever, with private equity sponsors always assessing the best exit strategy from an investment, a Hong Kong listing was becoming an increasingly attractive route until the Eurozone debt crisis appeared to halt the rush in mid-2011.

Indeed, one senior partner at a leading Hong Kong firm believes that these ostentatious remuneration packages would never have been offered had Kirkland realised the effects of Europe’s fiscal problems on the local market – the team of eight new partners were announced in August before the true extent of the Greek sovereign debt crisis came to light.

Balancing the books

Kirkland is also entering an extraordinarily competitive market. Firms have historically found it incredibly hard to achieve respectable margins on Hong Kong IPOs and have essentially been forced to make associates work night and day to ensure that even modest profits can be realised. Some firms are even reported to be working on these deals as a lossmaking exercise designed to secure longer-term client relationships.

Stock charge-out rates for an IPO were previously in the range of US$1.6m with an additional US$600m for drafting the prospectus. But market participants say that lower-bids became endemic in the middle of 2010. ‘You are lucky if you make a 15 per cent margin,’ comments a business development professional at a leading firm in Hong Kong.

Work on an average Hong Kong IPO can last between seven to nine months, with a senior associate and two junior associates working on the deal full-time for seven-and-a-half-hours a day, along with paralegals working on verification. The business development specialist says that a lead partner will often supervise two or three other deals at the same time.

Associate attrition has become a serious problem in recent years, with so many firms in Hong Kong developing corporate practices that are widely referred to as ‘IPO sweatshops’.

This was an issue that Linklaters began to address in 2003 and 2004 following the SARS epidemic that resulted in a complete halt to the IPO pipeline.

According to Hong Kong corporate partner Chris Kelly, Linklaters recognised that its corporate department was too reliant on IPO work and that it was strangling the enthusiasm of its associates.

A review led by former head of Asia and now firm-wide managing partner Simon Davies resulted in the practice becoming much more selective about which deals to bid for. Kelly says that aim for the corporate department was to have 60 per cent to 70 per cent of the work being driven by M&A and no more than 40 per cent from IPOs over a five-year period. ‘We are primarily an M&A franchise,’ he explains. ‘An IPO is an alternative exit position for many of our clients and that is just one thing that is expected of us.’

Associate attrition is now limited to in the region of five per cent, a remarkably low figure compared to many of Linklaters’ competitors. ‘The attrition rate is extremely modest,’ Kelly says. ‘One of the things that we hear is that people want to get out of the IPO sweatshop environment. Some of our competitors might have 20 IPOs on the go at one time and one associate doing all the verification across five or six IPOs. It is very efficient and it is probably getting the most out of the engine, but it is not the way to get associates to stick around.’

Other firms with an intense focus on IPOs say that it enables them to develop tight relationships with Chinese corporates in particular and investment banks, but Kelly says that IPO work is only one way of developing connections. ‘Investing in client relationships can be done in a number of ways,’ he explains. ‘Issuers don’t necessarily acknowledge the investment that you put into a deal. We can say that we will look at compliance issues across a variety of jurisdictions and they may see more value in that. For a start, not every corporate issuer turns into a good corporate client.’

This approach is rather unique with many of Linklaters’ increasing number of competitors still seemingly obsessed with the IPO world.

Deacons is still very much in that camp and maintains a healthy share of midmarket deals. Corporate finance partner Ronny Chow says the firm uses a different methodology to ensure that margins are achieved and associates are retained. ‘All our partners are working partners,’ he explains. ‘We don’t have a policy of rainmaking partners and we are very hands-on on the transaction. The complaints from associates in other firms is that they don’t know what to do and there is a lot of wasted time. We provide close guidance to associates and give them the right directions at the beginning.’ Chow claims to achieve more than ten chargeable hours per day.

Taking on the challenge

Taking on this environment will be tough for the new cohort of ambitious US firms. Having offered such grand remuneration packages to these new partners, the firms will have to work incredibly hard to see a return on their investment.

One senior figure at an independent Hong Kong firm says that the big difference between the huge wealth that lawyers accumulated in the 1980s was that ‘they got rich on the work that they had done’. He explains that today’s partners are being remunerated on the assumption that they will achieve certain targets and with the market currently depressed due to the Eurozone saga, this could lead to internal crises when partners receive more than they deliver.

Needless to say, Kirkland’s Eich is adamant that the firm’s sizeable investment is not such a risk. He claims that since the new team was put in place in October, the firm is already witnessing results. ‘We have been retained by nearly all the bulge-bracket banks in the last three weeks,’ he states. ‘Before we did this, I spent two weeks, eight hours a day, talking to dozens and dozens of bankers, and polling them on the many facets of every capital markets practice in Hong Kong.’ Eich says that when it comes to Hong Kong listings, he is especially confident: ‘If you have the dominant players like Dominic Tsun and Li-Chien Wong, where else are people going to go?’

Eich’s confidence is not without foundation. Tsun is certainly regarded as a market leader in Hong Kong IPOs and furthermore, it has assembled a more than credible US securities practice through the hire of David Zhang, John Otoshi and Benjamin Su from Latham & Watkins. The three have led more than 35 US IPOs by Chinese companies since 2003.

This is where the fast growing US firms have a distinct advantage. As one senior partner at an international firm in Hong Kong comments: ‘I think the English firms are going to lose market share. What these US firms have is America. The English firms just can’t be classed as global if they don’t have a credible US capability. The difference is that the US firms can offer two things. They are not English and the English colonial thing doesn’t work in this town, and they can offer US capital markets. Chinese corporates get credibility from listing in the US and listing in Hong Kong, but can you name a Chinese state-owned enterprise that has listed in the UK?’

That said, there have been a growing number of ‘going private’ transactions over the last couple of years thanks to the growing weight of regulation and disclosure requirements imposed in America, a burden that many Chinese companies that are listed in the US have found hard to live with.

This may also have a marked effect on the willingness of Chinese corporates to list in the US. Last year, Simpson Thacher & Bartlett advised on 18 US IPOs by Chinese issuers, but just three in 2011.

With the slow trickle of Hong Kong IPOs – after the torrent of the first six months of 2011 – competition among the growing number of capital markets focused firms is going to be even more heated. Increased competition inevitably leads to lower charge-out rates and lower charge-out rates don’t tend to mollify the anxieties of profit-conscious firms that have attracted big names with lots of money.

One long-serving Hong Kong partner at an international firm says that the writing could be on the wall: ‘US firms are obsessed with China listings in the region and in the US. It is a one trick story and they are in the middle of the trick. Most of these deals are done essentially for free and what they are looking for is the follow-up work, but then the client just puts that out to tender like everything else.’ It could be an expensive trick.

Chris Crowe is a freelance journalist and writer.