Freehills merger talks prompt firm to consider modified lockstep

Herbert Smith is set to overhaul its rigid lockstep structure, as merger talks with Australia's Freehills bring forward a consultation on whether the firm should introduce a more flexible system.

The firm is expected to begin reviewing its lockstep in the coming weeks, with changes to be considered in light of its potential merger with Freehills, which operates a modified lockstep heavily linked to individual performance.

No proposals have been discussed as the firm has yet to formally launch the review; however, partners suggest a number of issues could be considered both to better align the remuneration structure between the two firms and deal with longstanding criticism that pay for top earners has fallen behind key City rivals.

Changes set to be considered include lengthening the lockstep, increasing the difference between the top and bottom of the equity and introducing gateways to ensure performance criteria are met. Other options looked at in the past which could be reconsidered include a US-style tail-off at the top for older partners.

Herbert Smith originally pencilled in a review of its lockstep as part of the Project Blue Sky strategy review launched last spring, but never set a date for any discussions. The firm now plans to accelerate the process due to its talks with Freehills, which partners have suggested will result in a full financial merger but with each partnership likely to retain its own remuneration structure.

Herbert Smith currently operates a pure eight-year lockstep for equity partners running from 43 to 100 points, with partners moving up seven points in all but the final year, when they move up eight points. Profits per point stood at around £10,000 for 2010-11, with partners at the top making £1.007m against average profits per equity partner (PEP) of £892,000. This compares with average PEP at the magic circle of £1.27m.

As part of its efforts to tighten its hold on the equity, it is understood that Herbert Smith's management has informally extended the time partners spend in the salaried or 'B' partner rank from three years to four.

In contrast, Freehills' all-equity partnership is remunerated according to a heavily modified lockstep running from 40 to 120 points. Average PEP in last year's Am Law Global 100 stood at $970,000 (£617,000).

One ex-Herbert Smith partner said: "Herbert Smith always wanted to introduce some modifications to its partnership, but people feel the minute you tinker with the lockstep you're a step away from abolishing it. There are some strong views within the firm about it, but some factions would definitely welcome a change."

News of the impending review comes as Freehills and Herbert Smith move closer to a union, with some partners within the UK firm suggesting a vote is likely to take place within the next two months.

The tie-up could go live as early as July, with partners at Herbert Smith suggesting that a pure lockstep for the combined entity would be highly unlikely.