The announcement in July 2015 that offshore law firm Appleby was undertaking a management buyout of its fiduciary business, AFB, for an undisclosed amount, ignited fierce arguments and exposed persistent practical and philosophical differences within the offshore world. As offshore law firms play an ever-increasing role in cross-border fund formation, the lack of consensus over how they can and should operate is striking.
Just days before Appleby’s announcement in July came the news that three of the firm’s most senior funds lawyers, practice head Ian Gobin, counsel Matthew Taber and senior associate Jonathan Bernstein, would be leaving the firm for competitor Harneys.
The timing of the lawyers’ move recalls developments in March 2012, when offshore firm Walkers announced the sale of its fiduciary business, Walkers Management Services, to Intertrust for an undisclosed amount. This momentous development was nearly simultaneous with an exodus of 12 Walkers lawyers, some of whom openly expressed their dismay at a sale that allegedly would enrich senior Walkers equity partners on the verge of retirement while sacrificing the interests of more junior attorneys at the firm.
In May 2015, Walkers surprised observers with the announcement that it was getting back into the fiduciary business with the launch of Walkers Professional Services the following month. To some, this reversal was an affirmation of what they had known all along, that an offshore law firm functions best with a one-stop shop service for its clients.
The view from the ground
In an exclusive interview with IFLR1000, one of the defecting Appleby partners, former funds practice head Ian Gobin, put forth a rationale for his move closely linked to his view of the offshore market and the viability of different business models within it.
“Part of my decision to move centres around Harneys’ fiduciary services offering,” Gobin said.
“Over the last couple of years, the majority of firms have sold their fiduciary businesses, and the fact that they are now re-entering the market indicates a realisation that holding onto the fiduciary business is the right approach, from a client service as well as financial perspective. A Cayman law firm, in my opinion, needs to have a fiduciary arm in order to provide a combined high quality service to clients. Harneys has that,” he continued.
In agreement with Gobin was Peter Tarn, chairman of Harneys’ executive committee. In Tarn’s view, banks’ retreat from many markets fosters vast opportunity for independent fiduciary service providers with a grasp of their market and significant bench strength and systems at their disposal.
“That doesn’t have to mean unchanged ownership structures but suggests that a change requires something more strategic than simply sale to the highest bidder,” Tarn said.
Gobin and Tarn are hardly the only offshore legal experts to take a dim view of going the “independent route” and operating without a fiduciary affiliate. Discussions with directors and partners at Cayman law firms leave little doubt that Gobin is speaking for a significant number, if not a majority, of legal specialists in the offshore world. Many of them are eloquent about what they see as the complementary nature of legal and fiduciary affiliate services, and the difficulty of a law firm surviving the amputation of a traditional source of income for its partners.
David Lamb, a partner at Conyers Dill & Pearman, spoke with IFLR1000 about what he views as the necessity of a fiduciary affiliate for any law firm that wishes to be competitive.
"Almost by definition, cross-border work involves big-ticket transactions that require first-class expertise, not just in the delivery of legal advice, but also in the provision of offshore entities and ancillary services. For us, these are so interwoven that it’s almost inconceivable that we would follow Ogier or Walkers in selling our fiduciary arm,” Lamb commented.
Lamb noted that some offshore law firms have developed a slightly different approach from his firm’s, for example by making fund administration services available. This enables them to compete directly with onshore fund administrators. Such a model may be more easily salable, he said.
“As for the merits of a law firm without any fiduciary services at all, that’s not a model we would want to pursue. Having the affiliate, in our case Codan, makes the delivery of services in these cross-border transactions a lot easier. Everything is in-house. Our standard documentation, access to books and records, the ability to make amend registers and to make filings with the authorities without relying on third parties makes it much easier to effect these transactions which are complex with high sensitivities,” Lamb added.
But the views of Gobin, Tarn, Lamb, and others are by no means universal through the offshore legal world. On the contrary, many directors and partners are trenchant critics of a business model where law firms and fiduciary service providers operate side by side. In this kind of scenario, sources claim, it is all too easy for lawyers to try to steer business to fund management affiliates operating under the same corporate umbrella. The result is a corruption of the culture of the law firm, a deadening of its resolve to put the client’s best interest first.
In a discussion with IFLR1000, Daniel Priestley, head of Priestleys Law Firm in the Cayman Islands, analyzed the difficulties and complications that arise for directors trying to operate a law firm and a wholly owned fiduciary services business together. Such a feat can be tricky given the conflicts of interest that may arise, he observed. Fiduciary services businesses are annuity businesses, Priestley noted, and hence they can be highly profitable.
“When you are in a certain position at a law firm, at a certain age and level of seniority, and you see that asset, there is definitely an interest to cash out. You can use whatever excuse you like—focusing on being a law firm, the two entities have divergent philosophies, the affiliate doesn’t fit our business plan—but there’s also a huge financial incentive,” he said.
For his part, Priestley said he sees value in remaining independent, and in being quite circumspect with regard to fiduciary services offerings. The fact that a law firm could provide such services doesn’t necessarily mean that it should. Another thing to consider is that consolidation of the market leads to conflicts. As an example, Priestley cited situations where a dispute exists among a board, the company itself, and the shareholders, all of whom have different interests. Such a scenario requires representation by multiple law firms.
“We’ve gotten some very good work as a result of such scenarios. There are other firms that are like-minded and wish to remain independent and keep their profile in terms of fiduciary services low so they don’t fall afoul of conflicts of interest.”
Priestley contrasted the present with the go-go days of the 2000s, when a great deal of money was flowing and people didn’t get too concerned about service providers’ fees. Today, there is much more pressure on costs, he said. The overhead that larger firms have to cover means that they often charge rates that many people find exorbitant. This pushes clients away from the top-tier firms.
Marco Martins, partner at Harneys, was largely in agreement about the sensitivity around fees. “In some places, there are cultural and economic differences. Clients don’t want a relationship where any question they have, is a purely monetary exchange. In the emerging markets where people aren’t accustomed to the prices you see in New York and London, you have to have the flexibility and commitment not to scare them off by saying, ‘I had a five-minute chat with you, and that translates to a $300 bill,’” Martins commented.
Echoing Priestley, Huw Moses, Director, HSM, said he believes that over the years, Cayman fiduciary entities have generally been more profitable than the law firms that owned or controlled them. In the event of a sale, the fiduciary companies garnered a significant capital value, he noted.
“Certainly, I think, there is a general belief in the market in Cayman that some of the sales of fiduciary service companies were driven by the need of the partners of the law firm to obtain cash in order to pay out retiring law firm partners who had stakes in both the law firm and the fiduciary services company. Basically, the sales were a means of funding the exit of senior or founding partners, rather than taking on debt,” he commented.
Moses said that even though many of the selloffs have purportedly taken place as part of a refocusing of a law firm’s business, part of the motive has been the need to fund existing partners and shareholders.
“If you are a shareholder/partner supporting the decision to sell the fiduciary services arm of your business, you are balancing receipt of a share of the sale proceeds against reduced future income because you would no longer be receiving dividends from fiduciary services entities. It’s a balancing act,” he said.
The law firms can, in fact, survive without the fiduciary offering, because they were profitable in their own right, though perhaps not as profitable as the fiduciary services businesses, Moses said.
“There are obvious conflicts of interest that a law firm and a fiduciary entity under common ownership or control face in relation to providing their respective services to their clients, particularly when permissions are needed by directors or trustees and those directors or trustees are also partners in the law firm. I do not believe that the risk of conflicts and law suits arising from them has been the major motivation for the sell off by law firms of their fiduciary service companies.”
Richard Addlestone, a partner at Solomon Harris in the Cayman Islands, clearly does not view a fiduciary affiliate as being in any way necessary to a viable economic model for a law firm. Addlestone made his point clearly in analyzing how his own firm operates.
“We’re independent as we do not have an affiliated fund administrator nor do we provide the other ancillary fiduciary services such as directorships. We are clear of the conflicts that can arise from that,” he said. “We have relationships with local service providers and can help guide the client to one that suits them best. What I’ve been doing since I got here is leveraging off the contacts that I have at onshore law firms and other industry intermediaries and receiving a lot of interest in our product.”
As all of these comments make clear, opinion is sharply divided throughout the offshore legal world. For partners who may agree with arguments about the need to stay independent, there is an uncomfortable fact to face: The deal model may simply not be practicable, especially at the point in a law firm’s life when partners find themselves contemplating a sale. Whether one agrees or disagrees with the desirability of having a fiduciary services affiliate, law firms that change course – selling off an affiliate after relying on it for many years – will find themselves in a thorny and, for them, unprecedented situation.
Anthony Travers, director of Travers Thorp Alberga in the Cayman Islands, pointed out that it is not unusual for leading offshore law firms to have as much as 65% of their revenue generated by a fiduciary services provider or administrator.
“A number of these firms have recently seen the sale of what are effectively the ‘cash cows,’ usually for the benefit of a small and self-interested group of the partners. Unquestionably, this creates challenges for the law firm unless immediate steps are taken to realign its cost base with the new income stream. A number of the major offshore law firms have been endeavoring to do so but it is not that easy a task,” he said.
In Travers’s view, one factor making the process still more challenging is that, post-financial crisis, the low-profit model, and therefore the revenue line of such law firms, are harder to sustain.
“Inevitably too, given the increased levels of competition, there will be a shake out of the average in the offshore marketplace which is overpopulated and which in some firms, is already evident. In other firms, there is evident tension on the point. It clearly does not favor the interests of the more junior partners to effect a sale of the service provider if it produces the greater part of the firms’ income and regardless of the inherent conflicts of interest that exist in that relationship,” he said.
Travers said it isn’t surprising that the status quo tends to favor the maintenance of long-term relationships with onshore law firms and in-house counsel. Moving work, and instructing new counsel, carries a perception of risk with it.
“Competition has unquestionably driven down fees, and only those firms with the right model on costs and expenses will thrive in that environment. Nevertheless, changes to existing client relationships are infrequent, usually preceded by overbilling or technical errors (which are nothing like as rare as some clients may suppose),” Travers said.
“Whilst it will take some considerable time for a new firm with better quality advice and a better value proposition to establish itself in pre-existing markets, and inevitably in time through appearing on the other side of transactions or because some clients still insist on multiple fee quotes, the emphasis for the newer firms will be in new markets, particularly Asia, Central and South America and Eastern Europe, and at some point, we will no doubt add Africa to that list,” he added.