An Upbeat View: Nonlawyer Ownership of Law Firms

Even though law firms are now major business enterprises, outside investment seems to represent a profound step. Why? Because outside equity ownership is the clear stamp of a business that pursues profits. For those who find this alarming, the fact that all U.S. jurisdictions prohibit nonlawyer ownership of law firms is a line in the sand. Cross it, and law stops being a profession and starts being a business.

On the other side are those who believe the practice of law is already a business, no different from accounting or consulting. Maximizing profit is the name of the game. Thoughts that the legal profession plays a unique role in the United States, or that lawyers have distinctive obligations to clients and to the integrity of the legal system, are merely distractions.

It's time to realize that this way of framing the discussion is a dead end. Contrary to the clich', law practice is a profession and a business, not a profession or a business, and it's been a business since the first lawyer charged for services.

What might we discover if we abandon the tired profession/business dichotomy and seriously examine the issue? Outside equity ownership might not be the end of the profession as we know it. It might lead to more long-term investment. It might broaden the focus of firm management to include the firm as a whole, not just a few individual lawyers who produce big revenues. And it might take the shine off high-producing laterals whose only connection to the firm is the amount of their year-end distribution.

Consider the two main objections to outside ownership. The first is that it would permit nonlawyers to interfere with lawyers' exercise of professional judgment. The second is that the firm's duty to its shareholders would lead it to focus blindly on maximizing profits.

First Objection and Responses

In response to the first objection, firms can take various steps to prevent interference with professional judgment. A firm could, for instance, simply offer a minority of shares to outside investors. After Slater & Gordon's offering, for example, lawyers in the firm still own almost 56% of the shares. They control an even higher percentage of the voting rights.

Beyond controlling the number of securities it issues to outsiders, a law firm can determine the characteristics of the securities that it offers. A firm might, for instance, follow the model chosen by The Blackstone Group: remaining a partnership while being publicly traded. Illinois law professor Larry Ribstein calls this 'going privlic.' As Ribstein notes, the net result of the Blackstone arrangement is that those who purchase an outside interest in the company have minimal governance rights and receive only weak fiduciary protection.

A provision recommended by Sir David Clementi, who was asked to study the feasibility of firms going public in Britain, would further insulate lawyers. Clementi would prohibit investors from involvement in any matter the firm is handling and from having access to any client information. Investors in the firm would be explicitly advised that their share interests would contain these limitations.

Furthermore, regardless of whether its lawyers own a majority of the firm, a firm can specify the nature of the duty that it owes to shareholders. Slater & Gordon declares in its prospectus: 'Lawyers have a primary duty to the courts and a secondary duty to clients. … There could be circumstances in which the lawyers of Slater & Gordon are required to act in accordance with these duties and contrary to other corporate responsibilities and against the interests of shareholders or the short-term profitability of the company.'

A firm also could indicate that it's committed to providing a certain amount of pro bono representation each year or that it has other commitments that will not necessarily maximize short-term shareholder welfare. An investor in Slater & Gordon, for instance, knows that the firm is committed to the 'core value of social justice,' as the firm's prospectus declares. As long as all this is fully disclosed to prospective purchasers, the price of the security will reflect these conditions. Such statements of priorities and values could provide more explicit standards for evaluating firm behavior than vague expressions of a commitment to social responsibility currently issued by many firms.

Second Objection and Responses

The second major objection to nonlawyer ownership is that the very existence of shareholders creates pressure. Maximizing profits would inevitably become the top priority.

This objection is misplaced because permitting outside equity ownership is not likely to change the pressures felt by law firms. The only difference likely to occur: Instead of focusing on profits per equity partner, firms would emphasize share price. Indeed, when Mayer, Brown, Rowe & Maw cut 45 lawyers from the ranks of equity partners, James Holzhauer, the firm's incoming chair, explained that the firm needs 'to make sure our stock price stays high.'

Maximizing profits per partner is at least as compelling to a firm as any imperative to maximize share price. Any lawyer who generates enough revenue to be a senior equity partner probably also generates enough to be an attractive candidate in the lateral market. For some of these partners, the portability of their practice can result in minimal commitment to a firm. Such partners are the equivalent of short-term shareholders who won't hesitate to seek a better return elsewhere. When they leave, the firm loses both capital and business assets. Running a law firm can be like managing a baseball team made up totally of free agents: Your entire starting lineup can move to another team.

This situation reflects the fact that law firms combine ownership and control in equity partners. What would incentives be if, as in the public corporation, there were some separation of ownership and control? What if ownership were more widely dispersed and extended to outside investors?

First, corporate law is clear that directors generally do not have a duty to maximize shareholder wealth. To be sure, corporate directors devote considerable attention to increasing profits. The business judgment rule, however, gives them wide discretion in deciding how best to do that. Directors may consider the interests of a wide range of constituencies who make contributions to the company and may forgo short-term profits for long-term benefits. They also must be increasingly sensitive to the impact of public criticism on the reputation of the company. Law firm directors would have the same discretion to determine what policies promoted the interests of the firm as a whole.

Second, focusing on share price rather than profits per partner could lead to greater investment in the firm than occurs now. Investors dislike volatility; a firm will be attractive to outside investors only if it offers some promise of stability. Rather than rely on the vagaries of the lateral partner market, a firm interested in attracting investors might promote efforts to maximize the value of the firm as a whole. Such a firm would spend more on training, mentoring, and technology, and reap the rewards of investing in its people through a higher share price. The result might be a firm that is better able to establish and sustain a common culture in which people, for example, embrace more pro bono work or accept a policy of not taking aggressive positions on tax shelters.

Incentives

Would a firm that took this path be signing its financial death warrant? There is reason to think that the result would be just the opposite. Some corporate general counsel have suggested that the current law firm business model encourages firms to maintain profitability through growth and higher rates rather than through efficiency.

To be sure, there are grievances on both sides. Law firms complain that some corporate clients don't appreciate the financial pressures that they face, and that they squeeze firms unfairly on matters such as rates and the scope of conflicts of interest. Furthermore, corporations may reinforce a star system by emphasizing that they retain individual lawyers, not firms.

That there is some disenchantment with the current situation on both sides, however, suggests that both firms and corporate clients might benefit from incentives flowing from equity ownership in firms.

These incentives could generate even more benefits for individual users of legal services. Relatively routine services could be made more efficient and affordable by investments in technology. Indeed, the principal animating vision of the UK reforms has been to remove restrictions seen as stifling innovation in providing services to individual clients.

Individuals could also benefit from the ability of firms to raise capital to cover the costs of class action and multiple plaintiff representation. Handling these cases often requires firms to incur substantial upfront expenses on a contingency basis. Slater & Gordon, for instance, handles major class action and personal injury litigation. Capital from its stock offering will allow it to represent more of the 30,000 people who contact the firm each year.

Concluding Thoughts

Outside investment would be attractive to some firms but not others. I've suggested some possible scenarios, but they barely scratch the surface. Law firms would have to consider what kind of approach best enables them to balance business demands and professional values.

No ownership model in the abstract, however, will ensure protection of those values. The Kutak Commission that drafted the proposed American Bar Association Model Rules in 1981 understood this. Its recommendation for Model Rule 5.4, rejected by the full ABA, was to permit nonlawyer financial interests in law firms conditioned on written assurance of no interference with lawyers' ethical obligations. The comment to the rule declared, 'Given the complex variety of modern legal services, it is impractical to define organizational forms that uniquely can guarantee compliance with the Rules of Professional Conduct.'

In other words, we shouldn't kid ourselves that prohibiting equity ownership or any other business structure will preserve a sacred space for professional ideals to flourish. The only way those ideals will survive is through the hard work of lawyers who grapple daily with the task of balancing business and professional demands. We owe those lawyers a serious analysis of the implications of outside investment, not the reflexive claim that it's incompatible with law practice as a profession.

A slightly longer version of this article originally appeared in The American Lawyer, an affiliate of this newsletter.

Milton Regan, Jr. is a professor at Georgetown University Law Center and co-director of the Center for the Study of the Legal Profession. He is the author of Eat What You Kill: The Fall of a Wall Street Lawyer.

'If this gets into the U.S., it'll be the end of law as a profession.'

That was the comment by 'Anonymous' on The Wall Street Journal's Law Blog the day after Australian law firm Slater & Gordon held a public stock offering. 'Anonymous' probably spoke for many who follow the legal profession. Those folks will be even more agitated when pending legislation in the United Kingdom goes into effect that will permit firms there to issue stock as well.

Getting Past Either-Or Thinking

Even though law firms are now major business enterprises, outside investment seems to represent a profound step. Why? Because outside equity ownership is the clear stamp of a business that pursues profits. For those who find this alarming, the fact that all U.S. jurisdictions prohibit nonlawyer ownership of law firms is a line in the sand. Cross it, and law stops being a profession and starts being a business.

On the other side are those who believe the practice of law is already a business, no different from accounting or consulting. Maximizing profit is the name of the game. Thoughts that the legal profession plays a unique role in the United States, or that lawyers have distinctive obligations to clients and to the integrity of the legal system, are merely distractions.

It's time to realize that this way of framing the discussion is a dead end. Contrary to the clich', law practice is a profession and a business, not a profession or a business, and it's been a business since the first lawyer charged for services.

What might we discover if we abandon the tired profession/business dichotomy and seriously examine the issue? Outside equity ownership might not be the end of the profession as we know it. It might lead to more long-term investment. It might broaden the focus of firm management to include the firm as a whole, not just a few individual lawyers who produce big revenues. And it might take the shine off high-producing laterals whose only connection to the firm is the amount of their year-end distribution.

Consider the two main objections to outside ownership. The first is that it would permit nonlawyers to interfere with lawyers' exercise of professional judgment. The second is that the firm's duty to its shareholders would lead it to focus blindly on maximizing profits.

First Objection and Responses

In response to the first objection, firms can take various steps to prevent interference with professional judgment. A firm could, for instance, simply offer a minority of shares to outside investors. After Slater & Gordon's offering, for example, lawyers in the firm still own almost 56% of the shares. They control an even higher percentage of the voting rights.

Beyond controlling the number of securities it issues to outsiders, a law firm can determine the characteristics of the securities that it offers. A firm might, for instance, follow the model chosen by The Blackstone Group: remaining a partnership while being publicly traded. Illinois law professor Larry Ribstein calls this 'going privlic.' As Ribstein notes, the net result of the Blackstone arrangement is that those who purchase an outside interest in the company have minimal governance rights and receive only weak fiduciary protection.

A provision recommended by Sir David Clementi, who was asked to study the feasibility of firms going public in Britain, would further insulate lawyers. Clementi would prohibit investors from involvement in any matter the firm is handling and from having access to any client information. Investors in the firm would be explicitly advised that their share interests would contain these limitations.

Furthermore, regardless of whether its lawyers own a majority of the firm, a firm can specify the nature of the duty that it owes to shareholders. Slater & Gordon declares in its prospectus: 'Lawyers have a primary duty to the courts and a secondary duty to clients. … There could be circumstances in which the lawyers of Slater & Gordon are required to act in accordance with these duties and contrary to other corporate responsibilities and against the interests of shareholders or the short-term profitability of the company.'

A firm also could indicate that it's committed to providing a certain amount of pro bono representation each year or that it has other commitments that will not necessarily maximize short-term shareholder welfare. An investor in Slater & Gordon, for instance, knows that the firm is committed to the 'core value of social justice,' as the firm's prospectus declares. As long as all this is fully disclosed to prospective purchasers, the price of the security will reflect these conditions. Such statements of priorities and values could provide more explicit standards for evaluating firm behavior than vague expressions of a commitment to social responsibility currently issued by many firms.

Second Objection and Responses

The second major objection to nonlawyer ownership is that the very existence of shareholders creates pressure. Maximizing profits would inevitably become the top priority.

This objection is misplaced because permitting outside equity ownership is not likely to change the pressures felt by law firms. The only difference likely to occur: Instead of focusing on profits per equity partner, firms would emphasize share price. Indeed, when Mayer, Brown, Rowe & Maw cut 45 lawyers from the ranks of equity partners, James Holzhauer, the firm's incoming chair, explained that the firm needs 'to make sure our stock price stays high.'

Maximizing profits per partner is at least as compelling to a firm as any imperative to maximize share price. Any lawyer who generates enough revenue to be a senior equity partner probably also generates enough to be an attractive candidate in the lateral market. For some of these partners, the portability of their practice can result in minimal commitment to a firm. Such partners are the equivalent of short-term shareholders who won't hesitate to seek a better return elsewhere. When they leave, the firm loses both capital and business assets. Running a law firm can be like managing a baseball team made up totally of free agents: Your entire starting lineup can move to another team.

This situation reflects the fact that law firms combine ownership and control in equity partners. What would incentives be if, as in the public corporation, there were some separation of ownership and control? What if ownership were more widely dispersed and extended to outside investors?

First, corporate law is clear that directors generally do not have a duty to maximize shareholder wealth. To be sure, corporate directors devote considerable attention to increasing profits. The business judgment rule, however, gives them wide discretion in deciding how best to do that. Directors may consider the interests of a wide range of constituencies who make contributions to the company and may forgo short-term profits for long-term benefits. They also must be increasingly sensitive to the impact of public criticism on the reputation of the company. Law firm directors would have the same discretion to determine what policies promoted the interests of the firm as a whole.

Second, focusing on share price rather than profits per partner could lead to greater investment in the firm than occurs now. Investors dislike volatility; a firm will be attractive to outside investors only if it offers some promise of stability. Rather than rely on the vagaries of the lateral partner market, a firm interested in attracting investors might promote efforts to maximize the value of the firm as a whole. Such a firm would spend more on training, mentoring, and technology, and reap the rewards of investing in its people through a higher share price. The result might be a firm that is better able to establish and sustain a common culture in which people, for example, embrace more pro bono work or accept a policy of not taking aggressive positions on tax shelters.

Incentives

Would a firm that took this path be signing its financial death warrant? There is reason to think that the result would be just the opposite. Some corporate general counsel have suggested that the current law firm business model encourages firms to maintain profitability through growth and higher rates rather than through efficiency.

To be sure, there are grievances on both sides. Law firms complain that some corporate clients don't appreciate the financial pressures that they face, and that they squeeze firms unfairly on matters such as rates and the scope of conflicts of interest. Furthermore, corporations may reinforce a star system by emphasizing that they retain individual lawyers, not firms.

That there is some disenchantment with the current situation on both sides, however, suggests that both firms and corporate clients might benefit from incentives flowing from equity ownership in firms.

These incentives could generate even more benefits for individual users of legal services. Relatively routine services could be made more efficient and affordable by investments in technology. Indeed, the principal animating vision of the UK reforms has been to remove restrictions seen as stifling innovation in providing services to individual clients.

Individuals could also benefit from the ability of firms to raise capital to cover the costs of class action and multiple plaintiff representation. Handling these cases often requires firms to incur substantial upfront expenses on a contingency basis. Slater & Gordon, for instance, handles major class action and personal injury litigation. Capital from its stock offering will allow it to represent more of the 30,000 people who contact the firm each year.

Concluding Thoughts

Outside investment would be attractive to some firms but not others. I've suggested some possible scenarios, but they barely scratch the surface. Law firms would have to consider what kind of approach best enables them to balance business demands and professional values.

No ownership model in the abstract, however, will ensure protection of those values. The Kutak Commission that drafted the proposed American Bar Association Model Rules in 1981 understood this. Its recommendation for Model Rule 5.4, rejected by the full ABA, was to permit nonlawyer financial interests in law firms conditioned on written assurance of no interference with lawyers' ethical obligations. The comment to the rule declared, 'Given the complex variety of modern legal services, it is impractical to define organizational forms that uniquely can guarantee compliance with the Rules of Professional Conduct.'

In other words, we shouldn't kid ourselves that prohibiting equity ownership or any other business structure will preserve a sacred space for professional ideals to flourish. The only way those ideals will survive is through the hard work of lawyers who grapple daily with the task of balancing business and professional demands. We owe those lawyers a serious analysis of the implications of outside investment, not the reflexive claim that it's incompatible with law practice as a profession.

A slightly longer version of this article originally appeared in The American Lawyer, an affiliate of this newsletter.

Milton Regan, Jr. is a professor at Georgetown University Law Center and co-director of the Center for the Study of the Legal Profession. He is the author of Eat What You Kill: The Fall of a Wall Street Lawyer.