Earlier this week, I was asked whether I had considered approaching venture capital firms to take a stake in my business [Confluence Law Partners (CLP)] large enough to cover our "burn rate" for a year or two. Apparently, what makes CLP an attractive investment is that we are, in VC-speak, "post-revenue," i.e., in addition to having a business model that conceptually makes a lot of sense, we have an actual business that is generating revenues, and we could significantly increase profit by using outside investment to increase the scale of our delivery system.
The key assumption made by the person asking the question (who is a non-lawyer investment fund manager) was that non-lawyers like themselves could invest in, own or manage a law firm. Of course, this is prohibited under US regulations known as professional ethics.
However, not only is non-lawyer investment allowed elsewhere in the world, as explained after the jump, this change is coming to the US.
Australia permits unrestricted incorporation for companies that provide legal services. In May, 2007, the Australian law firm of Slater & Gordon completed an initial public offering and became the first law firm to be listed on the Australian Stock Exchange.
Similarly, in the so-called "Tesco law" (the phrase comes from a supermarket chain of the same name and refers to the potential for commoditized legal services offered by entities such as banks and supermarkets) the UK has changed its rules to permit non-lawyer investment beginning in October, 2011.
The smart money says the US can’t be far behind. "The ability of ‘magic circle’ law firms in London and their second tier competitors to structure arrangements and ventures with non-lawyers will give those firms individually, and the English legal profession collectively, a hitherto unimaginable competitive advantage," according Hinshaw attorney Anthony Davis in his December 2008 presentation to the Leading Legal Innovation conference sponsored by USC. "American lawyers and American based law firms must change the regulations or "be increasingly marginalized in the international marketplace."
This said, non-lawyer investment in the UK may be delayed. Just last week it was reported in the TimesOnline that the Tesco law may be headed for the "long grass." I’m neither a golfer nor an expert on the British slang, but I’m pretty sure the reporter is saying that England’s new coalition government is looking for ways to block implementation of the law.
In addition, opposition forces make the very compelling case that non-lawyer investment conflicts with core ethical values of having lawyers exercise independent and unconflicted professional judgment and confidentiality. Drinker Biddle partner Larry Fox, an articulate and passionate leader of the oppostion, recently testified before the ABA Ethics 20/20 Commission:
LAWRENCE J. FOX: I’m here to tell you that I think it would be a sad day if the American Bar Association endorsed different forms of business organization that compromised the professional independence.
PROFESSOR CAROLE SILVER: But you’re assuming that compromises.
LAWRENCE J. FOX: No, I’m not assuming that it compromises, because I’m in fact saying that we have an obligation to report to lawyers, not to nonlawyers who are not steeped in our values, not educated in our law schools, not subject to our discipline.
See 2/5/2010 Tr. at 148.
Mr. Fox has some compelling anecdotal evidence, courtesy of Arthur Anderson and Enron:
I always thought that the best argument against any change to [ABA Model Rule 5.4 prohibiting non-lawyer investment] was Arthur Anderson and Enron. We didn’t have to go very far or wait very long to get the proof of what happens when you end up mixing up various functions within an enterprise and ending up eroding the core function. And in that situation the core function was auditing. In our situation the core function is the delivery of legal services. . . And in [non-lawyer owned or managed business structures] what we’re stuck with is lawyers reporting, in effect reporting to nonlawyers who have no obligation to our rules of professional conduct and no dedication to those propositions.
See 2/5/2010 Tr. at 140-141.
Furthermore, the ABA is not yet ready to make any changes. Michael Traynor, the co-chair of the Commission, said "[W]e’ve not taken any positions on anything" and that "[W]e’ve just started." Id. at 149.
These arguments notwithstanding, economic forces ultimately will carry the day. Legal markets have so-far failed to innovate in ways that significantly reduce the cost of providing legal services or that produce global, nimble, multi-faceted and risk-taking lawyers capable of meeting the needs of a global, increasingly web-based, economy. For example, according to Susan Hackett, GC, Association of Corporate Counsel, there needs to be far better collection and mining of data across cases, clients and markets, far better training of lawyers to make business judgments, value-based (non-hourly) billing and the unbundling of traditional legal services and the outsourcing of services more effectively handled by other lawyers or non-lawyers. See The Slow Motion Riot-The Change Agenda for Legal Departments and Law Firms.
This innovation takes longer than the traditional annual cycle of the status quo AmLaw firm. Likewise, this innovation requires capital and business expertise that these firms simply don’t have. You want innovation? You want me to create a sustainable and profitable firm based on change agenda principles? Then I will need the non-lawyer investors and managers necessary to make it happen. So will just about everyone else. The removal of the current regulatory shackles is inevitable under the circumstances.
For those who worry what a large unregulated legal market will look like, Legal OnRamp’s Paul Lippe has it right – it already exists in the form of the modern legal department. The legal department aligns rewards with the performance of the business, substitutes non-lawyer service providers where they can more effectively and efficiently provide the required services, invests the time necessary to understand its client’s business goals, and aggressively leverages technology in the delivery of legal services. Perhaps most significantly, the modern legal department perceives little or no benefit from the current system of regulation.
Under the circumstances, those in favor of changing regulations prohibiting non-lawyer investment have the better argument and voices of those supporting the argument will increasingly grow louder and garner greater support.