Hildebrandt International and The Citigroup Private Bank Law Firm Group are pleased to present this 2006 Client Advisory highlighting the trends that we perceived in the legal market in 2005 as well as the trends that we believe will impact the market in 2006.

Overview

The year 2005 proved to be a good year financially for the legal industry but fell short of the revenue and profitability growth rates of the last five years. According to Citigroup data from 146 US law firms, the compound annual growth rates of revenue and profits per equity partner for the 2000-2004 period were 10.8 percent and 9.6 percent, respectively. From the data now available, it appears that 2005 growth levels were lower.

That said, the overall levels of revenue and profits in 2005 still increased substantially over 2004. Those increases were driven largely by a rebound in corporate and M&A practices - particularly during the fourth quarter of the year - and by more overall stability in transactional work than was the case in 2004. Litigation practices also continued strong throughout the year, though without significant growth over 2004 levels.

Merger and consolidation activity among US firms continued at a healthy pace in 2005, while the internal growth of firms, though higher than the prior year, continued to be somewhat slow. While the total number of lawyers in large firms grew by 4.4 percent last year, that increase was well below the high growth rate of 8.2 percent seen in 2001. Moreover, much of the growth in total numbers was attributable to the continuing pace of mergers and lateral acquisitions.

The pace of merger and consolidation activity during the past year was symptomatic of the continuing segmentation of the legal market as the economic gap between the most profitable firms and those in the next tier continued to grow - both nationally and regionally. Indeed, Citigroup analysis shows that the profits per equity partner of the 30 most profitable firms in the country are now more than double that of other firms, and the gap is widening.

In the sections that follow, we have highlighted the trends that characterized the legal market in 2005.  We have also described our projections for the current year, both financial and otherwise, and offered some recommendations for firms to consider in positioning themselves for competitive advantage in the year ahead.

Economic Performance

The economic performance of US law firms was solid in 2005, although growth in revenues and profits slowed somewhat, margins narrowed slightly, and productivity was flat to 2004. As noted above, we expect that - when all of the figures are in - the rates of growth in both revenue and profits per equity partner will be below the compound annual growth rates of 10.8 percent and 9.6 percent, respectively, achieved by US law firms during the preceding five-year period (2000-2004). Despite these results, there was a noticeable uptick in activity in the second half of the year (and particularly in the fourth quarter), a trend that augurs well for the start of 2006 and perhaps for the full year.

For most US firms, the growth during the past year was driven by a resurgence in corporate and transactional work, augmented by continuing strong litigation activity. In many firms - particularly in New York - there was also a strong upswing in M&A work.[3] Although overall activity for many firms was slower earlier in the year than expected, an upsurge in the fourth quarter assured a strong finish for most. Moreover, the growth in corporate and transactional work in the US was mirrored internationally. In the UK, Continental Europe, and Asia, traditional corporate and finance practices during 2005 recovered from the doldrums of the previous two or three years and came back much stronger than expected.

Overall, during 2005, large law firms in the US grew internally (in terms of the total number of lawyers) by 4.4 percent.[4] This represented an increase over the growth rate of 1.5 percent in 2004, which was the lowest since 1994. However, it was well short of the 8.2 percent growth rate recorded in 2001. Because the growth in total billable hours during the year lagged the growth in headcount, the overall rise in headcount actually caused productivity to slow and dampened growth in both revenues and profits per partner for the year.

Paralleling the relatively modest growth in overall lawyer headcount, the slowdown that we have seen over the past couple of years in the growth of the ranks of equity partners also continued in 2005. While the total number of partners in large law firms increased by 4.6 percent in 2005 (up somewhat from the 4.2 percent increase the preceding year), most of this growth was in the non-equity partner ranks. Indeed, the number of new equity partners increased by only 3.9 percent, compared to a 9.2 percent increase among non-equity.

Today, among the largest firms, the non-equity ranks constitute about one-quarter of all partners (a total of 10,314 non-equity and 30,278 equity partners). Since, in most firms, profitability is highly correlated to equity partner productivity, it is not likely that this trend will be reversed in the foreseeable future.

Notwithstanding the solid economic performance of most firms, there were signs in 2005 of growing pressures on the bottom line, pressures that could make it increasingly difficult for firms to achieve double digit growth in profits per equity partner during 2006. One such warning sign, according to Citigroup, is declining realization rates among the 30 most profitable firms in the country and relatively flat realization rates among other firms, a trend that may signal increasing discounts in response to client pressures or, in some instances, clients insisting upon multiple-year rate schedules. From our conversations with firms across the country, we believe that client pressures for discounts are increasing.

At the same time, the rate of growth in law firm expenses in 2005 continued at about the same level as in 2004.  As many firms face significant technology upgrades, increasing occupancy expenses, and perhaps higher interest rates on borrowings, there is little reason to think that upward pressure on firm expense budgets will not continue. The one potential bright spot on the expense side had been associate salaries - where most firms have for the past couple of years resisted significant structural changes. There is now, however, ample evidence that law firms may once again be ratcheting up associate salary scales, in part in response to competitive hiring pressures from investment bankers and consulting firms. Recent associate salary increases in both Los Angeles and New York tend to confirm this trend. Although some firms are now moving toward compensation systems that de-emphasize base salaries in favor of larger incentivebased bonus payments (a salutary move in our judgment), the pressures to increase overall associate compensation levels in 2006 are likely to contribute to a higher growth rate in expenses during the year.

Looking ahead to 2006, we believe that law firm revenues and profits per equity partner will grow at about the same pace as in 2005. Although firms will continue to resist significant growth in lawyer headcount and will continue to manage their expense budgets carefully, we believe that growing pressures for discounts, coupled with increases in "big ticket" expense items, are likely to limit both revenue growth and improvements in profitability. Although the resurgence of M&A activity may boost premium fees for some firms, we forecast that revenues overall will grow at slightly under 10 percent in 2006 and that overall profitability will grow by around 10 percent.

Growth and Consolidation [5]

Law firm merger activity remained strong in 2005 with 49 completed mergers and acquisitions involving US law firms, up slightly from 47 in 2004. The key trend relative to 2004 was that the average size of mergers increased, with the average size of the smaller or acquired firm growing from 30 lawyers in 2004 to 67 in 2005.

The largest merger of 2005 was the combination of DLA, Piper Rudnick, and Gray Cary Ware & Freidenrich, a transaction that created a transatlantic firm of some 3,000 lawyers. The second largest merger was the combination of Pillsbury Winthrop and Shaw Pittman, a deal resulting in a firm of about 900 lawyers. Rounding out the top mergers were the combinations of Edwards & Angell with Palmer & Dodge; Squire Sanders & Dempsey with Steel Hector & Davis; Ropes & Gray with Fish & Neave; and Kirkpatrick & Lockhart with Nicholson Graham & Jones.

Domestically, New York and California remained the strongest inbound markets for mergers during 2005.  In New York City, there were a total of 8 mergers, the largest involving Ropes & Gray and the IP firm of Fish & Neave. California had 6 mergers, all involving out-of-state firms entering or expanding in the market, and all but one of these transactions were focused in Northern California.

There were 4 law firm dissolutions in 2005, about the same as the 5 that occurred in 2004 but significantly fewer than the 13 in 2003. The most prominent firms that dissolved this past year were New York-based Coudert Brothers (a firm founded in 1853) and Boston-based Testa, Hurwitz & Thibeault (a firm founded in 1973).

The past year also saw the significant expansion of US law firms through the opening of new branch offices.  There were a total of 66 branch office openings in 2005, up substantially from the 24 reported in 2004. Firms announced the opening of new branches in 22 states, with the highest concentration being in New York (10 new offices), followed by Texas (7), and Illinois (6). California, Pennsylvania, and the District of Columbia had 5 new offices each.

Reflected in part by these branch office statistics, lateral acquisitions of individual partners, groups of partners, and (in some cases) whole practice groups by one firm from another continued unabated as in prior years. If any pattern was evident in this constant churning of the lateral market, it appeared to be that the larger national firms are increasingly "cherry picking" talent from everyone else, including particularly from regional and mid-sized firms that may find it increasingly difficult to compete - not only in terms of compensation but also in terms of their client bases and support systems.

These patterns also suggest another reality that continued to emerge in 2005: the segmentation of the US legal market has continued and is accelerating. This fact is particularly evident in the widening gap between the most profitable firms in the country and the next tier of firms below them. As previously noted, Citigroup analysis shows that the profits per equity partner of the 30 most profitable firms in the US are more than double those of other firms. Hildebrandt research has shown a similar pattern, though with somewhat narrower gaps, in many of the country's major regional markets. These significant and widening gaps are driven by the top firms exhibiting strong discipline in managing equity partner growth, working harder than others (particularly at the equity partner level), and building their leverage and rate advantages by focusing on high value added work.

What all this means in reality is that firms that have not already made it "to the top" - economically speaking - are highly unlikely to do so. The economic gap is simply too wide and is increasing too rapidly for most firms to be able to close it. In our view, many firms continue to set unrealistic long-term economic goals for themselves that simply cannot be achieved and that result in discontent among their partners when they are missed. Firms would be well advised to do a better and more candid job of examining their market positions - given their core practices and geographic locations - and setting reasonable targets to get them to the top of the market niche that makes sense for them. There is an economic ladder in the legal market that has many rungs; finding the right one for a particular firm requires strategic focus and a healthy doses of realism.

We expect that merger activity will continue in 2006 at about the same level as in 2005, and we expect that last year's trend toward larger mergers will also continue. Indeed, by year-end 2005, twelve mergers had already been announced to become effective during the first quarter of 2006, including the combination of Bingham McCutchen with Swidler Berlin and the merger of Orrick Herrington & Sutcliffe with the Paris firm Rambaud Martel.

Global Expansion[6]

The year 2005 saw an acceleration in the opening of overseas offices by US and UK law firms. There were a total of 57 new international offices opened in 21 countries during the year, a significant increase over the 39 reported in 2004. In addition, there were fewer international office closings reported in 2005 - 8 as compared to 12 during 2004. For the second year in a row, more firms opened offices in China than in any other foreign country. Firms opened 14 new offices there in 2005 (3 in Hong Kong and 11 on the Mainland) as compared to a total of 11 in 2004. Of the new Mainland offices, most were in Shanghai.

Apart from China, the most popular new foreign office location was Germany (with 7 new offices), followed by the United Arab Emirates (with 6), and Russia (with 5). Other destinations with at least 3 new offices each included Italy, Switzerland, Taiwan, and the UK. Of the 8 foreign office closings, 2 were in the Czech Republic, 2 were in Hong Kong, and there was one each in Azerbaijan, Hungary, Italy, and the UK.

Notwithstanding the popularity of China as a location for new offices in 2005, the commitment of law firms to the Chinese market - or even to Asia - remained substantially less than their commitment in Europe. During the past year, London continued to have the largest number of lawyers employed by US firms - some 3,618 among the NLJ 250 firms - followed by Paris with 1,117. Of the top 10 foreign cities for the NLJ 250 firms in 2005, the only non-European locations were Hong Kong (with 706 lawyers) and Tokyo (with 471).

To keep this activity in perspective, it is important to note that the total number of firms with foreign offices has not changed significantly over the past several years. In 1995, among the 250 largest law firms in the US, 102 had international offices - a significant increase from 54 in 1985. However, by 2005, that number had only increased to 105 (and in fact had declined from 109 the previous year). Those numbers, however, mask what has been a significant increase in transnational activity over the same period. In 2005, NLJ 250 firms had 533 international offices, a 9 percent increase from the 487 reported in 2004 and a 54 percent increase over the 346 reported in 1995. Similarly, in terms of the number of lawyers working in the international offices of NLJ 250 firms, there was a 19 percent increase last year (from 10,498 in 2004 to 12,460 in 2005), and the 2005 figure represented a 300 percent increase from 1995 (when there were 3,109 such foreign-based lawyers).

In addition to the new office openings described above, there were a significant number of US firms involved in cross-border mergers in 2005. As noted above, the largest were the combinations of Piper Rudnick Gray Cary with London-based DLA, and Kirkpatrick & Lockhart with London-based Nicholson Graham & Jones. Later in the year, DLA Piper Rudnick Gray Cary acquired the Russian and CIS practice of Ernst & Young, Linklaters combined with the Japanese firm Mitsui Yasuda Wani & Maeda, Cozen O'Connor merged with Toronto's Poss & Halfnight, Howrey Simon Arnold & White merged with the Paris IP boutique Cabinet Couste & Couste, Paul Hastings Janofsky & Walker acquired the Taiyo Law Office in Japan, and Squire Sanders & Dempsey combined with Warsaw's Wiater Law Office. And several firms acquired partners and practices throughout the world from the breakup of Coudert Brothers, most notably Orrick, Herrington & Sutcliffe and DLA Piper Rudnick Gray Cary in Asia.

It seems quite likely that the global expansion of US and UK law firms will continue apace in 2006, and it is also likely that China will continue to be a market of significant interest. That said, the primary international focus for both US and UK firms will continue to be Europe for the foreseeable future.

Of course, the most important question is whether firms are making money through their international expansion strategies. The answer to that question is difficult to get your arms around because firms account for their foreign operations in many different ways. That said, we are somewhat suspicious of the profitability of some of the recent growth we have seen in global markets (especially in Asia) and believe that there may well be some fallout for firms that entered international markets with ill-conceived strategies.

Performance of Mid-Sized Firms

As in past years, the trends that were evident in the legal market in 2005 posed special challenges for so-called mid-sized firms.[7] Although many such firms achieved strong economic results during the year, competitive pressures continued to ratchet up on many fronts. While there is no absolute correlation between size and  rofitability, it appears to be increasingly true that firms normally have to hit a certain "critical mass" in order to be competitive for most types of work from large corporate clients. A good example relates to global capabilities. Five years ago, most corporate general counsels were not particularly focused on the ability of a given firm to serve their needs on a global basis. Today, that attitude has changed dramatically, a change that undoubtedly reflects the increasing globalization of the business of clients themselves.

Mid-sized firms also face increasing challenges in recruiting and retaining top talent. While some such firms have been the beneficiaries of decisions by larger firms to spin off certain practices, many find themselves hard pressed to compete in the talent wars - in terms of compensation, breadth of client bases, support systems, etc. For mid-sized firms located in cities or regions with relatively stagnant economies, growth comes only by "stealing market share" from competitor firms, a strategy that in turn creates additional downward pressures on pricing and overall firm economics.

This is not to suggest that mid-sized firms cannot be profitable or successful. Indeed, there are many such firms around the country that are both - some of them in the ranks of the best and most profitable firms in the US.[8]  In our experience, the mid-sized firms that have been most successful are those that have focused strategically on specific practices or categories of clients where they could be most economically competitive, even against large national law firms. For some, that has meant focusing on mid-sized companies or start-up ventures; for others, it has involved developing niche specialties or practices requiring special "local" knowledge. For still others, strategic focus has meant "going regional" - i.e., expanding (usually through merger or acquisition) to serve an entire geographic market. Of the 49 completed law firm mergers last year, 23 (or some 47 percent) were between firms with primary offices located in the same or adjoining states. Likewise, of the 66 branch offices opened by US firms in 2005, there were 28 (or some 42 percent) opened in the same state as the firm's primary office or in an adjoining state.[9] The point is that, while size matters to some extent, it need not be a deciding factor in a firm's success. Far more important is the issue of strategic focus.

Client Demands and Expectations[10]

Legal expenditures by US corporations - particularly larger companies - continued to grow during 2005, increasing by about 6 percent over 2004. (This was the same percentage of increase as during the preceding year.) Total legal spending by companies as a percent of their US revenues grew during 2005 to 0.48 percent, the highest level in the past five years. Of the average total legal spend per company, about 39 percent was spent on inside lawyers and 61 percent on outside legal resources, a split that has remained fairly constant since the late 1990s.

One clear trend in 2005 involved continuing "convergence" practices among corporate general counsels - i.e., efforts to reduce the number of outside firms with whom they do business. There was an overall decrease in the average number of law firms used by corporate clients, as well as a concomitant increase in the percent of total outside counsel costs accounted for by the top billing law firms. Among the 140 companies surveyed in the Hildebrandt 2005 Law Department Survey, the median number of outside law firms paid was 125, the median number of law firms accounting for 75 percent of total outside counsel costs was 12, and the median percent of total outside counsel costs accounted for by the top billing law firm was 22 percent. At the same time, the median average hourly rate paid to a company's top billing firms increased by approximately 7 percent - up to $325 per hour.

Looking forward to 2006, we believe that convergence practices will continue. Indeed, 60 percent of corporate counsel surveyed by Hildebrandt indicated that they are currently going through a convergence process. The rising cost of legal services as a percentage of company revenues will also keep pressure on corporate general counsels to find new ways of controlling costs and to demonstrate their value to their companies.

As noted previously, we are already seeing evidence of increased fee discounts being offered by firms to large clients - even in the New York market. We believe that such discounting will continue, and perhaps even deepen, in 2006. This is even more likely in the growing number of companies that have placed the purchase of legal services under the overall control of their corporate procurement departments. Couple all of this with the "disintermediation" caused by improving technology - a phenomenon that has contributed to the ongoing "commoditization" of many areas of legal practice - and with the growing competence and sophistication of in-house counsel, and you have pressures on law firm profitability that could well escalate in 2006. While we expect overall demand for outside legal services to remain high during the coming year, these factors could well combine to dampen growth rates in many firms.

Looking at the management of corporate law departments in the coming year, we believe (as suggested above) that general counsels will continue to focus on cost reduction strategies. This will be particularly true as legal functions continue to be "de-mystified," and law departments begin to experience the same type of corporate controls and budget constraints imposed on other "business units." Beyond that, globalization will continue to be a challenge as companies face the complex task of managing legal issues on a worldwide basis including, incidentally, worldwide litigation. Just as in law firms, people issues will also continue to be a challenge for many corporate law departments, with professional development and career track questions being at the top of the list.

Firm Structure and Operations

There were a number of interesting developments during the past year relating to the structure and internal operations of law firms that we believe will continue to be important during 2006. These include (i) a significant shift in staffing patterns related to the use of "contract" or other temporary lawyers; (ii) a visible decline in morale and lack of confidence in leadership in many firms; (iii) a growing gap between the interests and expectations of middle-aged and older partners and younger lawyers; (iv) a growing interest in outsourcing as a means of controlling costs; and (v) the continuing saga of the so-called "Tesco Law" in the UK.

(i) Use of Contract Lawyers. Over the past few years, there has been a quiet revolution in the staffing patterns of many large law firms. In a growing effort to control costs and to avoid setting hiring goals for associates to meet peak work needs, an increasing number of firms have turned to so-called "contract" lawyers - i.e., lawyers hired for a specific case or project or to meet the "peak demand" needs in a particular practice but who have no expectation of permanent employment with the firm. In recent years, the numbers of such contract lawyers  mployed by large firms has increased dramatically, though the rate of growth slowed somewhat in 2005. During the past year, the number of contract lawyers in large firms grew 11 percent (to a total of 2,432).[11] This growth rate was substantially less than the 55 percent growth rate seen in 2004, but was still a healthy increase. It is no doubt a harbinger of things to come. Indeed, of the 147 firms responding to The American Lawyer's Am Law 200 Survey in 2005,[12] some 77 percent said they are currently using contract lawyers or plan to do so. This finding was confirmed more recently in a survey (in January 2006) by Hildebrandt of 20 of the country's largest law firms in which 16 (or 80 percent) indicated that they are currently using contract lawyers.

Such widespread use of contract lawyers - perhaps driven in part by steadily growing litigation practices in many firms - may be signaling a future fundamental shift in the structure of large law firms. Increasing use of temporary professionals may mean an overall downsizing of the permanent lawyer ranks in many firms - a trend that we may already be seeing in the modest growth in permanent lawyer headcounts over the past couple of years. Indeed, during 2005, the number of counsel, senior counsel, staff attorneys, and "other" non-partner, non-associate lawyers in large law firms actually declined by 1 percent (down to a total of 10,749).[13] Undoubtedly the trend makes good economic sense for most firms, allowing a much more efficient use of resources and avoiding the perennial problem of over staffing to meet the needs of a particular case or client.

The use of contract lawyers is not free of problems however. Supervision of large numbers of "temporary" employees requires fairly sophisticated management structures, and firms are well advised to manage the risks associated with such professionals very carefully. Such risk management should include particular attention to screening for imputed conflicts, providing adequate training and direct supervision, taking steps to ensure confidentiality, advising clients of the use of such lawyers, and structuring fair and ethical fee arrangements to cover their services.

(ii) Morale and Confidence Issues. During the past year, Hildebrandt consultants came across a number of firms that were doing quite well financially, but on many other measures (partner morale, internal trust, teamwork) they were failing and appeared very fragile. In a number of cases, Hildebrandt became involved because firm management perceived their firms' fragile condition, though they often didn't understand it given their economic success. Perhaps this is just a case of "a rising tide lifting all boats, even the leaky ones on a temporary basis," but there have been disturbing signs that a number of well-performing firms may be more fragile than they appear on the surface.

A couple of years ago, Hildebrandt undertook a study of law firm dissolutions over a ten-year period. One of the conclusions of that study, somewhat surprisingly, was that most firms that dissolve do so in a year when their revenues are at an all-time high. The experience of Citigroup supports this conclusion - a firm's financial performance is a "lagging" (not a "leading") indicator of a firm's overall health. The truth is that most law firm dissolutions are generally not financially motivated but rather are caused by a collapse of partner confidence. And that fact supports the oft-repeated adage that "most law firms are only two or three partners away from a dissolution" - at least if the right two or three partners leave and express doubts about the ongoing viability of the firm as they depart.

What all this suggests - and we believe that it is a more important point than ever given the current highly competitive legal environment - is that law firm leaders cannot afford to assume that good financial performance is all that matters. Social scientists have known for some time that motivating people isn't primarily about money. Rather, it's about vision and purpose, giving people the opportunity to do interesting work in an environment that supports and encourages them and allows them to feel a sense of real accomplishment. It is, in other words, about the "people stuff." Law firm leaders - even leaders of economically successful firms - ignore these realities at their peril.

(iii) The Generation Gap. The National Law Journal recently reported that one of the most frequent concerns voiced by law firm leaders responding to the 2005 Am Law 200 Survey was "their failure to connect with a new generation of lawyers."[14] This is consistent with our own experience. It seems that there is hardly a gathering of managing partners these days where someone is not complaining about the expectations or motivations of "Gen Y" associates.

In fact, there are significant differences in the interests and expectations of "Gen Y" associates from "Gen Xers," and from "Baby Boomers." For one thing, most young associates have no real expectation of remaining in their firms for their entire careers. They are simply not motivated by the prospects of "catching the brass ring" of partnership in the same way as their older colleagues were. Instead, they expect to have several jobs - and perhaps more than one career - during their lifetimes. The implicit bargain they have with their law firms is thus quite different from the traditional one of "work hard and have a shot at partner." Rather, they see the bargain as "I'll work hard, but what I want in return is good training and experience so that I will be prepared for my next job, whatever it is."

As firms have come to terms with this new reality, they have begun to take very seriously the need to plan and implement comprehensive training and professional development programs - programs focusing on leadership and personal development as well as on substantive (CLE type) legal issues. Within the past couple of years, a number of firms have announced ambitious programs along these lines, including some planned and implemented in partnership with business schools or other organizations. We believe that to compete effectively in the intensifying war for talent, every firm will have to become increasingly focused on its professional development offerings.

(iv) Outsourcing. The past year saw a continuing interest by law firms in "outsourcing" as a means of controlling costs. In some firms, this has taken the form of "in-house outsourcing" through the relocation of various back office and support services to lower cost locations. (Good examples are the operational support center created by Orrick, Herrington & Sutcliffe in Wheeling, West Virginia, and the global operations center established by Baker & McKenzie in the Philippines.) In other cases, firms have outsourced functions to external vendors, sometimes domestically but often off-shore. Although some firms have expressed reservations about outsourcing to off-shore locations, we believe that, overall, outsourcing will continue to grow as an attractive method for law firm cost containment. The cost savings are simply too compelling to be ignored. Moreover, we have now begun to see some examples of firms externally outsourcing limited types of legal research and analysis - a development that goes well beyond outsourcing of back office or support services. Clearly, outsourcing is a trend to watch for the future.

(v) The "Tesco Law." Late in 2005, the UK moved closer to a radical reform of the legal profession as the government published full details of its plans for the so-called "Tesco Law." That proposal, which would set up a new agency (the Office of Legal Complaints) to investigate consumer complaints against both barristers and solicitors, would allow - for the first time - ownership of law firms by non-lawyers. Indeed, the Lord Chancellor, Lord Falconer of Thoroton QC, has expressed the view that the new law could lead to law firms actually "going public" and listing themselves on the stock market.

The new law, which is based on recommendations made by Sir David Clementi, the former Deputy Governor of the Bank of England who was commissioned in October 2003 to undertake a review of the regulation of legal services, is not without its critics. But, given the strong support of the Blair government, it appears likely to be enacted.

Exactly what the impact of the new legislation will be or how law firms in the UK will respond to it either immediately or over time is hard to predict. Some large firms have said that they anticipate no change in their structure or operations as a result, but access to the capital markets could prove a powerful temptation over the long term. We will continue to monitor the situation with interest. Stay tuned.

Conclusion

Although growth rates were somewhat under 2004 levels, the legal profession had another solid year in 2005 in terms of financial performance. That marks five years of continuous financial success for the profession as a whole, although the performance of individual firms and regions has obviously varied during that period.

Looking ahead to 2006, we believe that healthy growth will continue but not at the same rates that characterized the market during the past five years. This conclusion is driven by the convergence of a number of factors that cannot be ignored:

• Hourly rates for most firms continue to increase, but the rate of increase has slowed
• Realization rates are flat or, for many large firms, down somewhat
• Given productivity improvements in many firms over the past several years, it will be increasingly difficult for them to achieve the same gains in productivity that characterized performance over the past half decade 
• While demand for litigation continues to grow, there are signs that rates of growth are leveling off
• The real estate market appears to be cooling down
• Many clients are working aggressively to reduce their legal costs, and convergence projects will take a toll on many firms
• Operational costs are rising, including perhaps a new round of associate "salary wars"
• Continuing growth and consolidation in the legal market will make it increasingly difficult for firms to differentiate themselves from their competitors

In short, there is ample evidence that the legal profession is subject to the same basic economic and market factors that affect other businesses. As in other market sectors, success in the business of law will increasingly depend on strategic vision and leadership, creative and effective management, and clear focus on client service. As always, we stand ready to assist our clients in meeting these challenges. Best wishes to you for a successful and profitable 2006.

---------------------------------------------------------------------------------

For additional information:

For Hildebrandt International - please visit www.hildebrandt.com

or call 800-223-0937 (US) or +44 (0) 207 307 0600 (UK).

For The Citigroup Private Bank - please call Dan DiPietro, Managing Director & Client Head of

The Citigroup Private Bank Law Firm Group at 212-559-8645 or e-mail dan.dipietro@citigroup.com

---------------------------------------------------------------------------------

[1] Our figures relating to the growth of headcount in law firms are taken from the NLJ 250 Survey as reported in The National Law Journal, Nov. 14,2005, at S3, col. 1.

[2] Detailed statistics concerning the 2005 performance of firms included in the Citigroup survey will be provided to participating firms through a separate Supplement to this Client Advisory. No aggregate or individual firm data from that survey is included in this Client Advisory.

[3] Thomson Financial has reported that, in 2005, M&A deals in the US increased by some 32 percent over 2004, with the total value of announced deals involving US targets topping $1.1 trillion. The last time US M&A activity exceeded $1 trillion was in 2000, when it hit $1.6 trillion.

[4] As previously noted, figures relating to the growth of headcount in law firms used in this paragraph and the following one are taken from the NLJ 250 Survey as reported in The National Law Journal, Nov. 14, 2005, at S3, col. 1.

[5] All of the merger, consolidation, and branch office data set out in this section are derived from Hildebrandt's Mergerwatch service and from Hildebrandt's own internal research staff.

[6] Data on global expansion is derived from Hildebrandt's internal research staff as reported throughout 2005 in Hildebrandt Headlines.

[7] Defining precisely what constitutes a "mid-sized firm" is difficult because the definition will vary depending upon the areas of a firm's practice, itsgeographic location, the number of offices it has, and other factors. Generally, however, we would define a firm as "mid-sized" if it had a minimum of about 50 lawyers and a maximum of 250 to 350.

[8] Of the 30 most profitable firms in the country, as identified by Citigroup, six are AmLaw 200 (as opposed to AmLaw 100) firms. In the main, these firms are single-office niche practice firms that are highly focused and preeminent in their fields of expertise.

[9] These data on the location of merger partners and of new branch offices are derived from Hildebrandt's Mergerwatch service and from Hildebrandt's own internal research staff.

[10] These data relating to legal expenditures by US corporations are drawn from the Hildebrandt 2005 Law Department Survey which includes 140 companies, 97 (or 69 percent) of which have $5 billion or more in revenues. The profile of the median participant in the 2005 Survey is a company with approximately $9 billion in revenues, over 20,000 worldwide employees, and a US law department with over 30 lawyers and 60 total staff, incurring over $27 million in total legal spending. The Survey covers a wide cross section of law departments by both size and industry and is available for purchase by law firms wanting to better understand the purchasing habits of their clients.

[11] Data on the growth rates of contract lawyers are taken from the NLJ 250 Survey as reported in The National Law Journal, Nov. 14, 2005, at S3, col. 1.

[12] The National Law Journal, Dec. 5, 2005, at 10, col. 1.

[13] For source, see note 11 above.

[14] Id.