United States: Hedging An Expansion Bet

Schulte Roth & Zabel has finally taken the plunge overseas. Well, maybe just a toe in the water.

Schulte Roth & Zabel’s New London Office is surrounded, literally, by a cautionary tale. Schulte opened the office in September in the nearly vacated digs of Denver’s Holme Roberts & Owen. Holme had gone to London in 1991 to represent Rocky Mountain telecommunications clients in European deals. But with the telecom industry tanking, Holme has had to scale back its London operation to a skeleton staff of four lawyers.

The smell of failure may still linger at 20 Savile Row, where Holme and Schulte now share space. But the new tenants don’t seem concerned. Schulte partners believe that their firm will succeed where others have failed because of its focused strategy. It aims to become a major player in only one European market: hedge funds. Befitting this singular aim, Schulte is starting modestly in London, with only eight lawyers, all focused on hedge funds.

"We have a laser approach to this. We don’t expect to ever be a full-service firm in London," says Marc Weingarten, a Schulte partner who did much of the due diligence on the London move.

Schulte’s slow-and-steady approach to its first overseas office (and its only office outside of New York City) is emblematic of its culture. The first-generation firm has grown from an initial eight lawyers in 1969 to over 300 today. In 2001 Schulte was ninety-second in revenue on The Am Law 200, and its profitability ranked twenty-first, at just under $1 million per partner. But for a brash upstart, Schulte is a highly cautious outfit. "We are fans of the ‘Cravath [Swaine & Moore] model’—that we can do virtually everything from New York, as long as people don’t mind traveling," says partner Daniel Shapiro. New offices drain profits, and Schulte, says firm cofounder Paul Roth, is "fiscally conservative."

Roth first considered a London office in 1999, while in England to speak at an American Bar Association event. After his speech, Roth visited the U.K. offices of some of the firm’s American banking clients. Many, he says, expressed a desire to expand their hedge fund offerings in Europe. The U.K. hedge fund market is about five to ten years behind the U.S. market, says Roth, and other Continental fund markets are even more fledgling. Roth saw a lot of opportunity for growth, and he figured that U.K. fund managers would look to import hedge fund structures that Schulte, as one of the leading hedge fund law firms in the United States, had helped devise. "I’m sitting there thinking, ‘We developed these [hedge fund] products. I don’t want [a U.K. firm] coming along and profiting off that,’ " says Roth.

When Roth returned to New York, he circulated his notion that it might be time for the firm to expand overseas. Some of his partners were leery, Roth recalls: "There was some concern that it would be a drain on profitability." In typical fashion, Schulte proceeded cautiously. Roth and partner Weingarten were dispatched to London in 2000 on fact-finding missions. They visited European fund managers, as well as accountants and brokers servicing the funds. The lawyers say they learned not only that the European hedge fund market was growing, but that it was not overrun with lawyers. "Brokers and accountants complained that they couldn’t get their [legal] work turned around quickly enough," says Weingarten. "They said they’d welcome another serious [legal] provider." Despite that encouragement, the Schulte partnership didn’t sign off on a London office until May 2002. Asked about the delay, Shapiro says, "We are cautiously aggressive. We don’t move without thinking carefully."

In September, Shapiro left Manhattan and his Upper East Side apartment to head Schulte’s London operation. Shapiro is one of the eight founding members of Schulte. The posting is unusual for such a senior partner, but the 63-year-old lawyer says that he is excited to be back in London, where he was a Fulbright scholar in the early 1960s. "I want to [practice law] for five to eight more years," says Shapiro, a tax lawyer who specializes in hedge fund work. "I figured that I might as well be part of something new."

Schulte’s narrow focus should help ease Shapiro’s transition. According to London accountants, lawyers, and recruiters, Schulte is already well known in

the London hedge fund community. "Schulte will be a useful addition to the market," says Ratan Engineer, a partner in the U.K. offices of Ernst & Young, which advises many European funds. "It should pick up a good bit of business."

It had better. The firm faces enormous start-up costs. Prime real estate isn’t cheap in London, and Shapiro concedes it will take six to 18 months for the new office to turn a profit. Schulte, moreover, faces tough times. Most European hedge funds haven’t escaped the bear market and are posting paltry returns. And the growth in new funds has slowed. George Van, CEO of Nashville’s Van Hedge Fund Advisors International, Inc., which tracks international fund activity, estimates that about 200 new European funds have been formed, mainly in London, in each of the past two years. "That number will be down a little this year," says Van. But Shapiro says the firm is finding work. "We already have been hired by four new hedge fund managers to do four very big funds in our first two weeks," says Shapiro. "We will be very busy. Will it last? I don’t know."

Schulte’s stiffest competition will come from Simmons & Simmons and the London offices of Philadelphia’s Dechert. "Simmons and Dechert are well known and do act for a lot of [European] hedge funds," says Simon Rees, an accountant with London’s Rees Pollock. "To break into that is difficult. I don’t know how easily [Schulte’s] U.S. credibility can be converted into U.K. credibility."

Even Schulte’s competitors say that the firm has name recognition. But Peter Astleford, head of Dechert’s hedge fund practice in London, believes he enjoys one advantage over Schulte: size. Dechert has 150 lawyers in London and a 20-lawyer financial services team, which, says Astleford, can handle the gamut of hedge fund matters. "Schulte has a great hedge fund practice in the U.S.," he says, "It is less clear whether this will give them an entrée at the top level [in Europe] without . . . full-service European backup." Simmons, meanwhile, has 24 fund lawyers and more than 500 lawyers in London.

Hedge fund work is, indeed, a full-service endeavor. In setting up hedge funds, which are usually structured as a limited liability partnership, law firms offer primarily regulatory and tax advice. But firms also advise on the sort of matters pertinent to any start-up business, suchas hiring staff, forming contracts to govern the relationship between partners, and negotiating leases on office space. Hedge funds are staffed fairly leanly, from a few managers to as many as 50 people, and it usually takes two to three months to set up a fund. After lawyers finish their fund-formation duties, they often continue to represent fund managers in their ongoing business, from buying securities to defending lawsuits.

Shapiro says that Schulte’s London team can handle funds’ regulatory and tax needs, but he concedes that the firm doesn’t yet have local labor, real estate, or litigation capacity. "We will grow," Shapiro says. "We have, right now on my desk, 15 resumes from people who would like to come work for us." He says Schulte’s London office has space for up to 20 lawyers, but, not wanting to get ahead of himself, he declines to specify when the office will reach critical mass. Shapiro notes that most of his hires to date have been U.K.–qualified. Schulte can use U.S. counsel on various aspects of European deals, but, says Shapiro, the firm prefers to staff its London office with U.K. lawyers.

London recruiters confirm that Schulte has generated a good deal of buzz among would-be lateral candidates. The firm is offering so-called mid-Atlantic salaries: lower than U.S. salaries, but higher than U.K.–based firms. "We have spoken to people who are very interested in Schulte," says Hillary Spicer, asenior recruiter with London’s Kellyfield Consulting.

"There is an element of risk in a [U.S. firm’s] move [to London]," says Spicer, citing Pittsburgh’s Buchanan Ingersoll as an example of a U.S. firm that has faltered in London. Buchanan launched in January 2000 and built up a 12-partner, virtually full-service operation. But the firm couldn't sustain a full-service practice and has scaled back its office to two partners. "We have made a decision to restructure our London office," says firm spokeswoman Lori Lecker. "The market changed, and a firm such as ours has to shift with the market." Spicer believes Schulte will fare better because of its cautious approach. "They seem to have thought carefully about this," she says. "They haven’t dived into it."

Some firms might consider that faint praise. Not Schulte.