The history of inhouse legal

Once upon a time, there was hardly such a thing as an in-house legal department in a bank at all. There was one, but it was a sleepy area in the basement, rather like a library, populated by a handful of damp introverts who would quietly prepare board minutes and maintain the firm’s register of charges. Their idea of a business trip was an excursion to companies house to be rebuffed when trying to file a Slavenburg.

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Now, at the time, banks did big, clunking deals. These transactions — mergers, acquisitions, equity offerings, bond issues, syndicated loans — were big, risky affairs, involving parties who weren’t well acquainted sending each other pots and pots of money: not just millions, but tens or hundreds of millions or, every so often, billions.

So two rather obvious observations:

• Firstly, if you are regularly funnelling hundreds of millions of dollars around the financial system, things easily can go wrong and, when they do, they go badly wrong.
• Secondly, a very small portion of a couple of hundred million dollars, when you look at it next to, say, a nice house in Surbiton, is still a very large sum of money.

Therefore bankers, who themselves might collect as much as seven percent of the value of those big, clunking, multi-million dollar deals, would quite happily spend say one percent of that value on a decent firm of lawyers to make sure nothing went wrong. Meanwhile, the ashen men and women of the in-house legal team were hardly involved, at least until it came time to have a charge registration rejected.

Lawyers at these firms found they could name a preposterous hourly rate and the banks would not blink.

After all, work needed to be done, and it was the lawyers who would usually do the hard yards, churning out thousands of pages of verbiage, running down every quixotic idea, accommodating every spurious risk factor, war-gaming every nightmare market that the issuer’s finance director could confect. The lawyers regularly worked through the night to meet an artificial deadline imposed by a junior analyst who, when it was met, would ignore the proffered draft for a couple of days before advising, without remorse, that he’d forgotten to mention the deal changed Thursday last, and the draft, knocked up in lieu of a long-planned anniversary dinner, hadn’t been needed in the first place.

The rise of the magic circle

Forged of these fires was the magic circle, a concept which has been with us since at least the time of the First Men and, yea, even unto the primordial pagan era before them when Children of the Forest roamed the Woods of Bretton.

The business model of the magic circle was a simple form of intellectual rope-a-dope: we will turn heaven and earth to document whatever you require us to document, whenever you want it, with two considerations: firstly, our legal opinion will disavow responsibility for all the stupid things you made us put in the documents, and secondly you will pay us handsomely, by the hour, without question, for doing so. Our end of the bargain is our blood, sweat, toil and tears, expended in the pursuit of whatever hare-brained intellectual contrivance should catch your fancy. Yours is to pay, through the nose, for the privilege.

Since, in the context of a two-hundred million dollar deal, whatever we ask you to pay us will be a drop in the ocean, everyone wins.

For many years, this state of affairs was all fine and capital: everyone clipped their ticket, lived prettily and maintained nice homes in the stock-broker belt to and from which they commuted each day in late-model German cars. Inhouse legal barely got a look in, but to trot along to companies house every now and then to have a Slavenburg rejected. It was the corporate end-clients who paid for it, after all, and since their executives were commuting from the same stock-broker belt in the same sorts of cars as the bankers, they weren’t any more bothered about it than anyone else.

As the roaring nineties wore on, the deal pipeline grew ever fatter. Fortune-seeking young contrarians started pitching up in London from all sorts of far flung places clutching foreign degree certificates and the switchboard number for Robert Walters. Law firms hired them — us — on the spot, rightly supposing they would work like Spartans, expect little by way of pay, and bugger off after a couple of years to spend the rest of their lives pleasure-boating on Auckland harbour and kicking the crap out of the rest of the world at Rugby Union. A handful stayed, mainly for the cricket.

The rise of the weaponised legal department

Still, as the deals came through ever faster, and the legal bills got ever bigger, the bankers began to wonder whether they could rationalise that legal spend a bit. “Perhaps we could be a bit more economical here,” they reasoned. “And the less we spend on the legals, the nicer our German cars will be.”

An obvious friction-point was the hand-off between the bank and the law-firm. It was clunky: bankers and lawyers don’t really speak the same language: Bankers communicate in spreadsheets, lawyers in turgid memoranda.

“Why don’t we hire some lawyers of our own to manage the legal relationship?” thought the bankers. “If they filter out all our stupid questions, and maybe head off some of the wild goose chases, we won’t burn so much legal expense. And our name will be spelled right on the football team, too: that’s pretty important.”

And so the bankers started to hire lawyers from the law firms. Again, everyone won: the bankers got their bigger cars; the firms could parachute under-performing associates into the banks where they could steer deal-flow back to their almae matres, the associates got investment banking bonuses and got to go home at 6pm.

Heroic associates who liked being beasted till 5am and working weekends stayed at their law firms, became equity partners and cultivated aneurysms etc. But aneurysms are not for everyone. In-house life had its moments, but it was a lot less of a slog, and you got to kick law-firm associates around. Of those who went in-house, few returned to law firms.

So began the modern in-house legal team. This worked well for everyone: deals got done more efficiently, the embarrassing sensation of seeing your firm’s name misspelled in the final prospectus disappeared from the commonplace and banks started to structure ever more elaborate deals, as the cost and capability of legal structuring inside their organisations mushroomed. The in-house legal eagles, it transpired, weren’t so useless after all. They started to understand their organisations and the business rationales, and found they could do more than just steer instructions back to law firms, translate banking gibberish and check the football team. They started to add value.

But legal departments started to get really big. This was a direct consequence of the wish to reduce external legal spend. The better staffed you were, the less you spent. Within ten years, in-house teams that had numbered a handful were running into the hundreds.

Here come the management consultants

All good things must die, and as the encroaching modernist orthodoxy of managing to margins gripped the city, bean-counters turned their attention to the scale of these legal activities. Which, by 2005, was colossal. The sunk cost of legal — pay and perks for four hundred internal lawyers, and the external legals on your massive pipeline of mergers, IPOs and CDOs going out the door, was in the high hundreds of millions of dollars. By the early 2010s, rocked by litigation and regulatory action in the wake of the financial crisis, most global banks’ legal overheads were running into the billions.

Remember our obvious observation above: a very small portion of a colossal number is still a very big number. If you can knock even five percent out of a billion dollar run-rate, you are going to look like fifty million bucks of hero.

Some business analysts arrived, intent on becoming heroes.

“We seem,” they noted, “to be spending a shit-ton of money on lawyers, and it doesn’t seem to have done us much good. We took a bath on Russia, Enron, WorldCom, and now half the known financial universe has imploded. We seem to have an internal team of three hundred legal eagles, and we are spending half a billion on external legal firms. And everything still seems to be blowing up. Can we not do something about this?

Thus began Zarathustra’s down-going.

When you’ve been spending money like it comes out of a tap, it isn’t hard to look like a hero: you just turn off the tap. It helps when deal flow is flat-lining and the litigation portfolio is winding down by itself, but still: credit where it is due: the consultants cut the legal spend by twenty-five percent, annually, over four or five years. That’s a lot of hero.

The role and influence of these analysts grew: at first, it was an MBA with the title “chief of staff”. Then she became “legal chief operating officer”. Now the team has its own budget and the same kind of hiring mandate the legal department itself had fifteen years earlier, and calls itself “legal operations”.

It is a deft re-brand: “chief of staff” sounds like, and was, a kind of retired military adjutant who ran the CPD program and no-one took seriously. “Chief operating officer” sounds a more organised attack on the freedom and profligacy of the professional class. But “legal operations” sounds like a factory: a long-term industrial undertaking that is intended to displace the artisanal weavers and will be here for good.

In this way the great retrenchment of in-house legal began, and for ten years kept pace. Much low-hanging fruit was picked. But eventually, legal spend was collared, and opportunities to eek out cost dried up.

Digression: the dogma of cost control uber alles

Note the narrative sweep here: industrialisation. Scale. Control. Margins. The approach to the problem of legal comes from a particular viewpoint. The accountant’s.

It is quantification, not evaluation, and along a single dimension: reducing cost. The question is never what to do, or why to do it, but how cheaply to do it. The full beam of analytical, reductive rigour is trained on that single question: how can we do all this for less and less money? Hence, management’s laser-focus on the delivery of legal services over the nature of the services themselves. How they should be delivered, with what tools, out of which segments, at which cost.

Now management orthodoxy has understood for decades that it isn’t cost by itself, but wasteful cost, that is the problem in a distributed manufacturing process: raw materials do cost money. You do have to pay machine operators something. You can’t avoid the basic minimum costs of doing something properly. Rather, you rigorously test your processes to check you are doing it properly — and not overdoing it by wasting materials, over-engineering, having your staff standing idle or engaging them in unnecessary activity. This was Toyota’s profound insight: through sheer analytical rigour in eliminating waste from its manufacturing process in the 1950s and 1960s, it beat the American auto-manufacturers to a pulp.

Cost and waste

Now the thing about costs and waste is that they are not some kind of astral yin and yang, orbiting each other in a sort of stable zero-sum relationship. Some costs are worth it; some are not. Some costs are obvious; some are hard to see.

The easiest costs to see are salaries. Salaries are big, lumpy and easily stopped: you simply dispense with those to whom you are paying them. This has passed for sport amongst finance executives for many years.

But “stupid questions” and “bad ideas”, prolix procedures and incomprehensible documents are also costs. Smaller costs, to be sure, but more numerous, much harder for the executive suite to see, and really hard for them to stop. They don’t stop being costs just because the executive team can’t see them.

And here is the converse to the observation above: very smalls sum of money, if you add enough of them up, amount to a very large sum of money.

The funny thing is that the management team can see that very large sum of money, even though they can’t see any of the small ones.

Silly questions distracts not just those who ask them, but those to whom they are addressed: all who are hindered from doing more productive things. Hare-brained notions skitter around the skirting-boards of all organisations, out of sight, unchecked, by their nature creating more stupid questions, more bad ideas, triggering little chain reactions of stupidity and waste. If not answered quickly and clearly, these chains sometimes harden into policies, procedures, work-streams, teams and even whole departments.

Eventually, this institutionalised, low-level vacuity creates its own invisible tide of cretinaiety, sloshing around the organisation, delaying things, pulling useful people into its undertow, spawning its own little waves of dreck and powering armies of little administrators chasing these fripperies down and, as they go, building out yet more complicated operational infrastructure. For all the outsourcing, offshoring and down-sizing of the last 20 years, UK financial services employment has remained largely stable.

But when the costs are so big, it is really hard not to obsess about them, in the round, as a thing in themselves. Especially if you are an accountant, and you don’t understand the product or the manufacturing process anyway. “I know,” the benighted business analyst will complain, “that cost isn’t important. But the CFO wants to see a five percent reduction. Every year.”

Wicked and tame

One last digression: Toyota’s lean production management technique works best in “tame” environments where all dependencies are mapped and all possible outcomes known. Where your environment is “wicked” — imperfect data, non-linear interactions, convex risks — you need three things that are generally designed out of tame production lines: expertise, autonomy, and redundancy.

In the real world, all environments — even factories — are a mix of wicked and tame components. It’s a continuum. In banking, the trade-off is between product development and tail-risk management on one hand — wicked problems — and scaling and monetising products on the other — tame problems.

In a perfect world, legal eagles are at their best in purely wicked environments. You consult them when things go wrong, your normal assumptions don’t work and you don’t know what to do. There are inevitably routine things every lawyer must do, but you can assess the lawyer’s real value by judging where along that tame-wicked continuum she generally sits. Evaluating her proficiency at tame problems is straightforward: how good is she at getting out of the way: standardising and simplifying formerly “legal” functions into the operational business-as-usual: rendering them in need of as little explanation to muggles as possible. To what extent can she map out predictable legal processes into decision trees and playbooks and hand them off to an operations team (or, at the limit, automate them) altogether. If legal is stuck in the middle of routine process, approving, ticking boxes, reviewing forms that should be standard, legal is being wasteful.

The other, wicked part of the lawyer’s day job — one humbly submits, the important part — is a lot harder to evaluate, and is impossible to evaluate if your only prism is cost.

Which brings us neatly back to the question of what the legal department does for all that money it costs. Is there really no waste there? What is really wrong with the legal department.

What’s really wrong with in-house legal

Now acres of ink have been spilled, books written, monographs published, thought-pieces floated, on the problem of how to fix in-house legal. LinkedIn is awash with them; all in awe of technology’s current gallop; their mundane propositions all clothed in expressions of the richest finery.

There is a common theme: legal is profoundly broken, always has been, habitually lags in any kind of innovation, but this time, now we have paradigm-shifting new technology, things are different. We can rebuild it. We have the technology. We have the capability to make the world’s first bionic legal department. Better than it was before. Better, stronger, faster.

But, friends, the problem is not technological, it isn’t new, and it doesn’t require vision. It is rather dreary and age-old. It is easy to state, if not fix:

Legal is too expensive and too slow.

This in turn hinges on two things, neither of them soluble by chatbots:

• Over-reliance on external counsel: in-house lawyers are still far too ready to send straightforward work out. This was the original plan, to be sure, and it made sense when the bank only had three lawyers, but times have moved on. In-house teams are the size of middling international law firms. They skew more senior and have far more institutional experience than their private practice equivalents. They should not need to refer English law questions to outside counsel, yet still they routinely do it.
• We over-engineer legal documents: Partly because any professional adviser is short an ugly option should anything go wrong, and partly because all rent-seekers tend towards iatrogenesis, legal documents are absurdly over-engineered. They are far too incomprehensible, inscrutable and, even for those who do understand them, they are shot through with overblown protections the parties do not need and will never use, but which are nonetheless argued about and nickel-and-dimed over for weeks of months. Even contracts that aren’t particularly high risk increasingly suffer from “banking envy”.

Now it is far easier said than done, but were we to address these cultural phenomena — neither are easily solved problems to be sure, but aligning systems and incentives to influence behaviour a lot more than management theory does — then much of the millenarianism we are seeing would melt away. You don’t need artificial intelligence to review your confidentiality agreements if the market agrees a short, plain, standard form. You don’t need document assembly if you standardise and simplify your ISDA schedules.

But these problems require an understanding of human psychology and a deep grasp of the legal and market conventions — qualities with which your average MBA is not liberally endowed. Template:Inhouse legal history