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ABA Ethics Opinion Allows Passive Investment in Out-of-State ABS

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On September 8, the American Bar Association (ABA) addressed lawyers’ ethical obligations as investors in firms with nonlawyer owners. Formal Opinion 499, issued by the Standing Committee on Ethics and Professional Responsibility, permits attorneys throughout the country to act as passive investors in Alternative Business Structures (ABS) that may not be allowed within a given lawyer’s state of licensure.

The issue, which we have covered in earlier stages of development, has worked its way to the fore, as states have created and extended regulatory changes to admit nonlawyers as owners in legal practices. The new ethics opinion clarifies how lawyers admitted to practice law in states without such permissions can still get involved in these business models.

The District of Columbia has allowed for nonlawyer partners since 1991 with limitations, but in recent years, others have joined the push. In 2021 alone, Utah extended its “regulatory sandbox” to a total of seven years, and Arizona eliminated Rule 5.4, which was modeled by the ABA to prohibit lawyers from splitting their legal fees with nonlawyers. The State Bar of California launched its own pilot program in May 2020 based on recommendations from its Task Force on Access Through Innovation of Legal Services (ATILS).

What last month’s opinion expressly condones is passive investing from lawyers admitted to practice law in other states. Providing guidance around potential conflict-of-interest issues, the committee broadly explains that attorneys would not be in violation of their ethical duties in making financial investments in ABS where such entities are allowed, so long as that lawyer has no active management role with the organization. As described in their conclusion below, the committee defines a passive investment as one in which the lawyer making the investment would not have a hand in the day-to-day operations of the ABS or be privy to confidential client information.

A lawyer admitted to practice law in a Model Rule jurisdiction may make a passive investment in a law firm that includes nonlawyer owners operating in a jurisdiction that permits such investments provided that the investing lawyer does not practice law through the ABS, is not held out as a lawyer associated with the ABS, and has no access to information protected by Model Rule 1.6 without the ABS clients’ informed consent or compliance with an applicable exception to Rule 1.6 adopted by the ABS jurisdiction… If, however, at the time of the investment the Model Rules Lawyer’s investment would create a personal interest conflict under Model Rule 1.7(a)(2), the Model Rule Lawyer must refrain from the investment or appropriately address the conflict pursuant to Model Rule 1.7(b).

This opinion will likely catapult the topic of nonlawyer ownership to prominence in additional states as lawyers are now being tempted to contribute to the growth of entities outside of their home locales. State bar associations and other advocates for the legal community will be forced to confront the fact that the current set of rules could favor firms in places like Utah and Arizona, shifting investment dollars out of other states. The most significant aspect of this opinion is that it may contribute to California adopting similar rules to those in Utah and Colorado. And given California’s size, that would be a game-changer for many U.S. lawyers.

The Time Is Now for CA Lawyers to Voice Their Opinions on Nonlawyer Ownership in Law Firms

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Members of the State Bar of California’s Closing the Justice Gap working group are split over how broad to make the state’s trial of regulatory changes. The board of trustees approved the working group, which is tasked with considering changes in nonlawyer ownership and fee sharing, in May 2020. Its SCOPE subcommittee is currently debating whether or not the organizations allowed to participate should be limited to those serving low-income individuals.

The program stems from the state bar’s Access Through Innovation of Legal Services (ATILS) task force, with the initial aim of making legal services more affordable and accessible to residents in the low-to-middle income brackets. Some members of the group, including law professor Bridget Gramme, argue that findings from similar regulatory changes in countries like the UK have suggested that “to promote innovation, it makes the most sense to keep the structures as open as possible, ‘especially at the beginning.’” Others counter that allowing nonlawyer ownership in legal entities that serve businesses would not “have as much chance at downward assistance,” as put by OneJustice Volunteer Of Counsel Toby Rothschild.

Depending on how the state bar and ultimately the California Supreme Court decide, ownership and investment in law firms could be shared by organizations including the Big Four accounting firms and venture capital firms, as well as tech companies like Rocket Lawyer, which was among the first entities allowed into a similar regulatory scheme in Utah.

Utah’s situation is instructive. The program was initially created on a two-year basis but recently extended for a total of seven years. Of 22 authorized entities reported so far by the Utah Supreme Court’s Office of Legal Services Innovation, several fall into the categories of “lawyers employed/managed by nonlawyers” or “non-lawyer provider w/ lawyer involvement.” The long-term repercussions of more generous regulatory changes are not yet apparent, with Arizona making one of the more drastic moves just last summer when it completely eliminated the ethics rule barring nonlawyer ownership.

It’s difficult to overestimate the significance of these current and proposed changes, but attorneys in California still have time to make their voices heard. If you are part of the legal services industry in California, now is the time to get involved, attend the meetings, and voice to representatives of the state bar your support for or opposition to these shifts. With the working group due to make recommendations to the State Bar of California’s board of trustees next September, the coming year will have an enormous impact on the future of the legal profession in the state. According to Bloomberg Law, the SCOPE subcommittee will meet again June 4, with the full working group meeting June 18.

Utah and Arizona Moving Forward With Nonlawyer Ownership of Law Firms

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As California considers major regulatory changes that would allow non-lawyers to own stakes in law firms, we are closely following updates in Utah, where similar shifts are a step ahead.

Citing “crisis levels” of demand for affordable legal services stemming from the effects of COVID-19, the Utah Supreme Court on August 14 announced its decision to permit nonlawyer ownership and investment in law firms as a move toward greater access to justice. Accompanied by changes to the Rules of Professional Conduct, the regulatory sandbox created a two-year trial period, at the end of which the Utah Supreme Court can make these changes more permanent.

With the exception of one solo practitioner offering a 10% stake to his paralegal, the initial batch of organizations allowed into Utah’s pilot project is largely comprised of legal technology firms.

LawHQ is sharing revenues with software developers in relation to an application which would allow users to report spam communications and join lawsuits against those behind the messages or calls. 1Law is offering legal advice via chatbots, and LawPal would automatically generate legal documents for matters of divorce, custody, eviction, and property-seizure. The last of those announced so far is Rocket Lawyer, which the ABA Journal emphasized in its coverage earlier this month. The platform, which has already been serving as a middleman between consumers and attorneys, along with assisting in the creation of legal documents, is taking this opportunity to hire lawyers directly.

Arizona followed Utah just weeks later, eliminating rules that previously blocked nonlawyers from having financial stakes in firms, and the state went a bit further. The Arizona Supreme Court at the same time created a category of nonlawyer licensees permitted to represent clients in court. These “legal paraprofessionals” are expected to adhere to the same ethical requirements applicable to lawyers, and one must “meet education and experience requirements, pass a professional abilities examination, and pass a character and fitness process” to qualify.

The changes in Arizona have gone into effect without a temporary trial period, but alternative business structures will have to go through a “rigorous application process.” Arizona’s Task Force on the Delivery of Legal Services cited technology and free market competition as benefits of this change that could lead to greater access to justice. Rocket Lawyer is also expected to play a role in Arizona.

It remains unclear how nonlawyer ownership in law firms will evolve. For example, will the Utah Supreme Court or other proponents of this shift prevent venture capital and private equity firms from backing legal technology firms that are, in turn, permitted to own or invest in law firms? The answer to this question may have a huge impact on the financial fortunes and independence of lawyers, especially as California considers moving in the same direction as Utah and Arizona.

CA State Bar Innovation Task Force Takes a Pause

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As we have previously reported (see posts here and here), a task force assembled by the State Bar of California has encountered significant pushback from the legal community. The Task Force on Access Through Innovation of Legal Services (ATILS) was created to address issues of access to justice in the state. Charged with “identifying possible regulatory changes to enhance the delivery” of legal services, the group offered sixteen recommendations last summer, which, most notably, included proposals for non-lawyers to share in ownership and fees.

The outcry suggested that such changes would put consumers at risk, with some referencing the state’s recent issues with “notarios.” These unlicensed immigration consultants were banned by the state assembly after allegedly “tak[ing] advantage of vulnerable populations,” and many argue the existing regulations around who is eligible to provide legal services protect clients from unethical practices. Other state bar associations have also expressed their opposition to allowing non-lawyers to invest in firms and share law firm profits.

On Thursday, March 12, the bar tabled recommendations from the task force, describing the move as “an attempt to make sure we have the best information in front of the board at the right time.” The regulatory body credited “political headwinds” for its decision to delay approving any recommendations. Among the next steps held off by trustees was the launching of a group to study a regulatory sandbox much like the one established in Utah. Such a pilot program would test recommendations on a small scale to predict the impact of each proposed shift.

Members of the task force expressed disappointment as the foundational issue remains unaddressed. Nearly 4,000 Californians were surveyed in the California Justice Gap Study which ATILS used as the basis for its recommendations. The data expressed that people in the state “regardless of income” were often “navigating critical civil legal issues without legal representation or meaningful legal assistance.” With Californians receiving “inadequate legal help” if any for eighty-five percent of legal issues, the survey concluded, “Failure to access legal services is a result of both a service gap (supply) and a knowledge gap (demand).”

These findings led the task force to its viewpoint that “something more than modest tweaks to the existing regulatory environment is needed,” and the group set out to evaluate such regulations as those concerning fee splitting from the get-go. ATILS endorsed “the twin goals of public protection and enhanced access to legal services,” but many of the 3,000 public comments received in reply questioned the ability of the task force’s recommendations to meet those aims. The opposition proved enough to postpone the bar’s efforts, at least for the next few months.