Law Firm Ownership in the United States

Non Lawyer Ownership of Law Firms and the Professional Independence of a Lawyer

In its latest manifestation of attitude, Jacoby & Meyers has filed suit in three states seeking to overturn prohibitions against nonlawyer investment in law firms.

Even at its creation in 1972, Jacoby & Meyers had attitude. When Leonard D. Jacoby and Stephen Z. Meyers opened their first legal clinic in Van Nuys, they distributed a prospectus and sent out press invitations to an open house–both apparent violations of existing restrictions on lawyer advertising.

After the State Bar began disciplinary proceedings, the two attorneys held a news conference and handed out media kits about their clinic, which offered, among other services, basic uncontested marital dissolutions for $100 to $250. According to Justice Frank K. Richardson’s bitter dissent to the subsequent landmark decision permitting legal advertising, Jacoby & Meyers had publicly charged “that the Bar felt economically threatened by such a successful attempt at delivering high quality, low-cost legal services.” (Jacoby v. State Bar of California, 19 Cal. 3d 359, 383 (1977).) A month later the U.S. Supreme Court ruled that another state bar’s advertising ban violated the First Amendment, finding it had “originated as a rule of etiquette and not as a rule of ethics.” (Bates v. State Bar of Arizona, 433 U.S. 350, 371 (1977).)

Since the 1970s Jacoby & Meyers has had its ups and down–but it still has attitude. Most recently, however, it has chosen to litigate rather than provoke.

On May 18 of this year the nationwide firm filed three nearly identical class actions–in New York, New Jersey, and Connecticut federal courts–challenging the constitutionality of state judicial bans on nonlawyer ownership of law practices, based on ABA Model Rule 5.4. The nearly identical lawsuits make claims based on alleged violations of the Commerce Clause, the 14th Amendment, and, most interesting, the First Amendment rights of free speech and association. (Jacoby & Meyers Law Offices LLP v. Presiding Justices, No. 11-CV-3387 (S.D.N.Y.); No. 33-AV-001 (D. N.J.); No. 11-CV-817 (D. Conn.).)

“Our client’s ability to raise the capital it requires to grow is encumbered by the ban on nonlawyer ownership. That gives it standing to sue,” says Jeffrey I. Carton, a partner in the New York firm of Meiselman, Denlea, Packman, Carton & Eberz who represents Jacoby & Meyers.

“It would have been a bold and very courageous action to purposefully violate the rule, sticking a finger in the eye of the state bar grievance committees,” Carton says. “But defending a grievance is not the best way to tee up a constitutional challenge.”

Andrew G. Finkelstein, managing partner of Jacoby & Meyers’s Northeast offices, says the decision to file the suits had a twofold basis. First, he explains, “We had a lack of confidence in the various administrative bodies responsible for enforcing the ethical rules. There have been no meaningful modifications in the rule, or any sense of urgency.”

To be fair, the ABA recommended amending MR 5.4 twelve years ago–but its House of Delegates overwhelmingly rejected the proposal. In 2001 the State Bar of California’s Task Force on Multidisciplinary Practice voted down a measure that would ease the ban on sharing fees with nonlawyers, and its rules revision commission recently endorsed a version of MR 5.4. This spring, the ABA Commission on Ethics 20/20 recommended no changes to the rule, although it will hear further comment from members at the Annual Meeting this month.

Jacoby & Meyers’s second basis for heading to court was economic. While the ABA continues to debate the issue, Finkelstein complains, Australia and the United Kingdom have permitted nonlawyer equity ownership of law firms. Australia’s Slater & Gordon held a public stock offering in 2007, and the UK’s Legal Services Act–which gives law firms access to equity capital–takes effect in October. Lyceum Capital, a UK-based private equity firm, anticipated the development last year by investing 㿅 million in a legal services business that provides back-office support to law firms.

“The ABA may be OK being behind the curve, but Jacoby & Meyers is not,” Finkelstein says. “I’m already competing against legal entities that have an unfair advantage.”

Should the Jacoby & Meyers class actions reach the U.S. Supreme Court–and Carton anticipates appeals–the significance of the global market in legal services may influence Justice Anthony Kennedy, who has expressed interest in arguments based on international law. And given the current makeup of the Court, the real kicker may well be the plaintiffs’ First Amendment claim.

Renee N. Knake, an associate professor at Michigan State University College of Law, anticipated Jacoby & Meyers’s free speech and association claim in an article due to be published next year by the OHIO STATE LAW JOURNAL. Knake cites Justice Kennedy’s recent observation in Citizens United v. FEC (130 S. Ct. 876, 913 (2010)) “that the Government may not suppress political speech on the basis of the speaker’s corporate identity. No sufficient governmental interest justifies limits on the political speech of nonprofit or for-profit corporations.”

“Citizens United is very much part of our interest in bringing these actions,” Carton says. “And after the First Amendment cases decided by the Supreme Court this term, it feels like we’re on the side of the angels.”

The gist of the First Amendment argument is the right of lawyers to associate with nonlawyers in their businesses, and the right of the recipients of speech–potential clients and the public at large–to receive unencumbered information and ideas from these firms. Knake contends it’s grounded in a Civil Rights-era case holding that the state cannot ban the delivery of legal services through an arrangement involving the NAACP, its affiliates, and lawyers (NAACP v. Button, 371 U.S. 415, 42829 (1963)).

Knake believes the First Amendment “situates the argument in economic reality” by simultaneously addressing Big Law’s desire for cheaper working capital, the public’s unmet need for legal services, and the profession’s inability to absorb young lawyers at anything near the rate that law schools are producing them.

“It’s difficult to predict what a market for corporate-owned legal services would look like, but I like to use a Wal-Mart example,” she says. “Corporate ownership could increase competition, drive down prices, depress some lawyer compensation, and serve people who don’t even know how useful legal services can be.”

Fellow legal academics–including Professor Larry E. Ribstein at the University of Illinois College of Law and Professor Milton C. Regan at Georgetown University Law Center–have proposed satisfying the concerns of state bar ethics panels with mechanisms for limiting the influence of private capital: derivative instruments, ownership qualifications, equity limits, and trading restrictions. Knake argues that there is little real difference, in the potential for nonlawyer influence on professional conduct, between lines of credit from banks and restricted equity capital.

What’s driving the current campaign to open law firms to private capital, however, is competition with international firms. “The academic argument is no longer a [mere] diversion,” Knake says. “Now we have traction.”
Indeed, in early March a Republican state legislator and lawyer in North Carolina introduced a bill that would permit nonlawyers to own up to 49 percent of a law firm; outside investors could also buy into accounting firms.
As for the three Jacoby & Meyers suits, Carton says he has received notices of appearances from the respective state attorneys general who will represent the defendants. He anticipates a facial challenge on the pleadings for each, followed by briefing and oral arguments later in the year.

California’s ban on nonlawyer equity capital, Carton says, is “on the drawing board” for another constitutional challenge. Jacoby recently sold a majority interest in the firm’s Southern California region to Kabateck Brown Kellner of Los Angeles, telling reporters he “felt it was time to get the next generation involved and spend more time on expanding.”

Non Lawyers Owning Law Firms: External (Non Lawyer) Investment in Law Firms

To make sure that private investors don’t influence legal decisions to the detriment of clients, the American Bar Association’s Commission on Ethics 20/20, in May 2012, won’t recommend policies allowing nonlawyer ownership of law firms.

Composed of judges, law ethics professors, and liaison members from the ABA governing board, the ethics body earlier already rejected some forms of nonlawyer ownership allowed in other countries, including passive, outside nonlawyer investors.

Ownership of law firms

Many jurisdictions prohibit nonlawyers to have an ownership interest in law firms. This means that law firms cannot raise external capital through an IPO or private equity capital. As it currently stands, capital can only be raised through additional capital contributions from existing or new equity partners, or through taking on debt, usually in the form of a credit line secured by their A/R or by issuing a bond.

Alternative law practice structures are currently prohibited in every U.S. jurisdiction except the US District of Columbia (which permits lawyers to share a management and/or financial interest with nonlawyers in entities that are limitedto providing legal services). They are becoming more common, in foreign jurisdictions, such as the UK, Canada, and Australia.

American law firms doing business overseas are in a quandary over how to balance the more permissive rules on business structures in other countries and the more restrictive regulations in U.S. jurisdictions.

But see the ABA Rule 5.4 (Professional Independence Of A Lawyer):

(a) A lawyer or law firm shall not share legal fees with a nonlawyer, except that:

(1) an agreement by a lawyer with the lawyer’s firm, partner, or associate may provide for the payment of money, over a reasonable period of time after the lawyer’s death, to the lawyer’s estate or to one or more specified persons;

(2) a lawyer who purchases the practice of a deceased, disabled, or disappeared lawyer may, pursuant to the provisions of Rule 1.17, pay to the estate or other representative of that lawyer the agreed-upon purchase price;

(3) a lawyer or law firm may include nonlawyer employees in a compensation or retirement plan, even though the plan is based in whole or in part on a profit-sharing arrangement; and

(4) a lawyer may share court-awarded legal fees with a nonprofit organization that employed, retained or recommended employment of the lawyer in the matter.

(b) A lawyer shall not form a partnership with a nonlawyer if any of the activities of the partnership consist of the practice of law.

(c) A lawyer shall not permit a person who recommends, employs, or pays the lawyer to render legal services for another to direct or regulate the lawyer’s professional judgment in rendering such legal services.

(d) A lawyer shall not practice with or in the form of a professional corporation or association authorized to practice law for a profit, if:

(1) a nonlawyer owns any interest therein, except that a fiduciary representative of the estate of a lawyer may hold the stock or interest of the lawyer for a reasonable time during administration;

(2) a nonlawyer is a corporate director or officer thereof or occupies the position of similar responsibility in any form of association other than a corporation ; or

(3) a nonlawyer has the right to direct or control the professional judgment of a lawyer.

ABA comment on this rule:

[1] The provisions of this Rule express traditional limitations on sharing fees. These limitations are to protect the lawyer’s professional independence of judgment. Where someone other than the client pays the lawyer’s fee or salary, or recommends employment of the lawyer, that arrangement does not modify the lawyer’s obligation to the client. As stated in paragraph (c), such arrangements should not interfere with the lawyer’s professional judgment.

[2] This Rule also expresses traditional limitations on permitting a third party to direct or regulate the lawyer’s professional judgment in rendering legal services to another. See also Rule 1.8(f) (lawyer may accept compensation from a third party as long as there is no interference with the lawyer’s independent professional judgment and the client gives informed consent).

This ABA rule was created to prevent conflicts of interest. The assumption is that a lawyer working in a firm owned by a private equity firm would be conflicted between a lawyer’s duties to the client and the courts and the expected short-term returns of the private equity firm. Similar conflicts are feared if the lawyer works for a publicly traded firm as s/he could be tempted to evaluate decisions in terms of their effect on the stock price and the shareholders.

As different jurisdictions around the world are changing their rules in favor of allowing nonlawyers to own law firms, it is still forbidden in the U.S.

Resources in the issue

The Legal Marketing Association provided this resource:

• June 29, 1905 Legal Services Act of 2007 http://www.legislation.gov.uk/ukpga/2007/29/pdfs/ukpga_20070029_en.pdf

• April 13, 2007 Slater & Gordon Prospectus http://www.slatergordon.com.au/files/editor_upload/File/prospectus/Prospectus.pdf

• April 30, 2007 Law Firms, Ethics, and Equity Capital: A Conversation Mitt Regan http://scholarship.law.georgetown.edu/cgi/viewcontent.cgi?article=1000&context=cslp_papers

• August 3, 2009 Private Equity Considers Investing in U.K. Law Firms (Update1) Lindsay Fortado http://www.bloomberg.com/apps/news?pid=newsarchive&sid=asso5puZd5fA

• September 1, 2010 Law, the Investment Barbara Rose http://www.abajournal.com/magazine/article/law_the_investment/

• September 30, 2010 LETTER FROM LONDON: U.K. Law Firm Investment Countdown Enters Final Year Chris Johnson http://amlawdaily.typepad.com/amlawdaily/2010/09/lawfirminvestment.html

• October 28, 2011 Selling Pieces of Law Firms to Investors John Eligon http://www.nytimes.com/2011/10/29/business/selling-pieces-of-law-firms-to-investors.html?pagewanted=all

• December 2, 2011 Discussion Paper http://www.americanbar.org/content/dam/aba/administrative/ethics_2020/20111202-ethics2020-discussion_draft-alps.authcheckdam.pdf

• December 2, 2011 Initial Draft Proposal for Comment http://www.americanbar.org/content/dam/aba/administrative/ethics_2020/20111202-alps_choice_of_law_r_and_r_final.authcheckdam.pdf

• December 2, 2011 Ethics 20/20 Edges Toward Decision on Endorsement of Versions of Alternative Law Practice Structures James Podgers http://www.abajournal.com/news/article/ethics_20_20_edges_toward_decision_on_endorsement_of_versions_alternative/

• December 6, 2011 ABA Inches Closer to Vote on Nonlawyers Owning Stake in Firms Joe Palazzolo http://blogs.wsj.com/law/2011/12/06/aba-inches-closer-to-vote-on-nonlawyers-owning-stake-in-firms/

• January 20, 2012 More major law firms assess plans to join ‘Tesco law’ revolution Sofia Lind http://www.legalweek.com/legal-week/news/2139883/major-firms-assess-plans-join-tesco-law-revolution

• February 3, 2012 Poster child for Tesco law in Australia heads to UK- Race for the consumer legal market begins with news that Australia’s Slater & Gordon is to buy Russell Jones & Walker Neil Rose http://www.guardian.co.uk/law/2012/feb/03/slater-gordon-russell-jones-walker-abs

• February 6, 2012 Firms flock to take up ‘Tesco Law’ status Caroline Binham http://www.ft.com/intl/cms/s/0/c046c44a-50e8-11e1-8cdb-00144feabdc0.html#axzz1nR3XLSXs

• February 10, 2012 Continental Breakfast: Three U.K. Firms Ink External Investment Deals As Legal Services Shakeup Starts Chris Johnson http://amlawdaily.typepad.com/amlawdaily/2012/02/ukexternalinvestmentdeals.html

• March 9, 2012 Judge Rebuffs Challenge to N.Y. Ban on Non-Lawyer Firm Ownership Mark Hamblett http://www.newyorklawjournal.com/PubArticleNY.jsp?id=1202544898642&slreturn=1

• March 23, 2012 Does Nonlawyer Ownership of Firms Threaten the Independent Judgment of Lawyers? Emily Fisher http://hildebrandtblog.com/2012/03/23/does-nonlawyer-ownership-of-firms-threaten-the-independent-judgment-of-lawyers/

• April 1, 2012 Trailblazer: A Harvard MBA goes where no nonlawyer has gone before http://www.law.com/jsp/tal/PubArticleTAL.jsp?id=1202546740816

• April 2012 April 13, 2012 blog post Stephen Mayson http://stephenmayson.com/

• April 17, 2012 Joe Palazzolo http://blogs.wsj.com/law/2012/04/17/aba-case-has-not-been-made-for-nonlawyer-ownership/

• April 17, 2012 ABA Panel Abandons Nonlawyer Ownership Proposal Sara Randazzo http://amlawdaily.typepad.com/amlawdaily/2012/04/aba-firm-ownership-nonlawyer.html

According to Silvia Hodges, “some say the market already has moved beyond the bar’s restrictions….
As practice changes, financing changes, governance in other countries changes, the U.S. has to consider the
impact on those practicing law in the U.S. It is not something the U.S. can ignore: If external money (from capital
markets) funds law firms from other countries that U.S. law firm compete with or oppose them, it would very likely
have an impact on what firms can do for their clients. If the law firms themselves can’t have outside investors, the market will continue to chip away at every part of a law firm that is not the pure provision of legal advice. Anything that can be provided legally by a third party will be.”

Law professor Larry Ribstein, associate
dean for research at the University of Illinois College of Law, says: “The question used to be: ‘Will the ABA change
Rule 5.4?’ The question now is, ‘Who cares?’ If the ABA wants to continue to regulate a tiny fraction of the legal
market, they can keep their rule.”

ABA Commission of Ethics do not develop a proposal on ownership of law firms

In http://www.abajournal.com/magazine/article/summer_job_ethics_20_20_commission_shelves_nonlawyer_ownership, James Podgers writes that the ABA Commission on Ethics 20/20 has decided not to develop a proposal on whether nonlawyers should be allowed to have some form of limited ownership interest in U.S. law firms.

“After the close of the commission’s two-day meeting in early April 2012, co-chairs Jamie S. Gorelick and Michael Traynor issued a statement (PDF) confirming that the commission agreed to shelve plans to submit a proposal on nonlawyer ownership for consideration by the association’s policymaking House of Delegates in February during the 2013 ABA Midyear Meeting in Dallas.

Gorelick and Traynor indicated that feedback from other bar associations and individual members of the profession did not suggest a groundswell of support for revising the ABA Model Rules of Professional Conduct to permit a limited form of nonlawyer ownership. The Model Rules, which are the direct basis for professional conduct rules in all states except California, do not permit nonlawyer ownership.”