CA Legislature Puts the Brakes on Ownership of Law Firms by Non-Lawyers

On February 25, 2022, an open session of the California State Bar’s Closing The Justice Gap Working Group (“CTJG” or “Working Group”) took place that could pause the short-term prospects of allowing non-lawyers to own and invest in law firms. Specifically, the Working Group made three potentially game-changing decisions.  

First, and most importantly, the Working Group will modify its membership and limit members to those who have experience working in California. While other states including Utah, Arizona, and Florida have all discussed the matter of nonlawyer ownership, the California State Bar agreed that relevant experience in California would be necessary to be part of the Working Group.  

Second, the minutes of the February 25 meeting show that the State Bar agreed to streamline the Working Group to reduce the administrative burden these meetings place on the State Bar’s staff. More than one participant has expressed frustration with the Working Group’s organizational structure. The Working Group itself is comprised of multiple subcommittees, which will be eliminated moving forward.   

Third, the Working Group’s Charter will be changed so that the roles of the California legislature and Supreme Court are more clearly defined. In addition, the Charter will more explicitly identify who will be allowed to participate in the regulatory sandbox. This will include stricter screening of the financial interests of those entities who would be allowed to be part of the Working Group.  

If these changes seem out of step with what the Working Group had been doing previously, it’s because they are. These changes are not an accident. They are a direct response to criticisms of the Working Group articulated by members of the California legislature.  

On December 7, 2021, a letter from the Senate was sent to the California State Bar arguing that allowing corporations to take part in ownership of law firms would cripple the integrity of justice and legal systems for consumers. The letter was co-signed by Assembly Member Mark Stone (D–Monterey Bay) and Senator Tom Umberg (D-Santa Ana). Stone and Umberg are both attorneys. Mark Stone received his J.D. from Santa Clara University of Law in 1988 and was an attorney from 1993 – 2003 before becoming county supervisor of Santa Cruz County in 2003. Tom Umberg graduated from UC Hastings in 1980 and was Assistant U.S. Attorney in Orange County before being elected to the California State Assembly in 1990.

Stone and Umberg took direct aim at the underlying rationale of the Working Group and its ability to provide more representation to the middle class and other underserved communities. “The regulatory sandbox could become an open invitation for profit-driven corporations, hedge funds, or others to offer legal services or directly practice law without appropriate legal training, regulatory oversight, protections inherent in the attorney-client relationship, or adequate discipline to the detriment of Californians in need of legal assistance.” 

Stone and Umberg also voiced concern that the “the State Bar has used a substantial amount of its resources for the CTJG, as well as the Paraprofessional Program Working Group, apparently utilizing hundreds of hours of staff time and an unknown amount of other State Bar resources.” They argue that the Working Group is preventing the State Bar from carrying on its “core mission of protecting the public by correcting the delays and defects in the attorney discipline system.” To support this contention, the letter points out that “the State Bar’s backlog of discipline cases grew by 87 percent since December 2015 and that recent changes to the system have significantly reduced its efficiency.” With the State Bar already dealing with a heavy backlog stretching over seven years, there is not enough bandwidth space to consider changes that could “fundamentally infringe on the basic and paramount obligations of attorneys to their clients.” 

The letter from Stone and Umberg had an immediate and powerful impact on the Working Group. The initial response was to put meetings of the Working Group on hold for two months. Given that the Working Group is agreeing to change its composition and its charter, it will take months if not years to put these changes into effect. Moreover, considering the rocky relationship between the State Bar and the legislature, with the legislature having almost all the leverage, it wouldn’t be surprising if the changes made to the Working Group signal that efforts to allow non-lawyers to own law firms will be put on hold in California for the foreseeable future. With Florida recently deciding not to follow the lead of Arizona and Utah, delays in implementing changes in California are likely to have repercussions throughout the country.   

The Regulatory Sandbox isn’t dead, but it is looking a lot less inevitable than it did a few months ago.  

Florida Bucks the Trend Toward Nonlawyer Ownership

With all the changes impacting law firms right now, it would be easy to overlook an important regulatory development that recently took place. In November, the Florida Bar Association’s Board of Governors unanimously voted down proposals to test nonlawyer ownership and fee sharing in legal practices. The decision represents a sharp deviation from the trend of “regulatory sandboxes” that have taken root in states including California, Utah, and Arizona.

Debating arguments from the Florida Supreme Court’s Special Committee to Improve the Delivery of Legal Services, which suggested these measures as opportunities to improve access, board member Josh Chilson expressed concerns, saying, “I’m troubled that this is being offered with no real evidence that the proposal will improve access to justice… This is a bell that once rung, will never be able to be unrung.” Member Sia Baker-Barnes asserted that allowing companies driven by profit to enter the legal services industry would impede the “independent judgment of a lawyer… critical to the fair administration of justice in [the] state.”

Those who support opening up law firm ownership to nonlawyers rely on a variety of arguments, ranging from a belief in the power of markets to assertions that such changes will improve access to legal representation among the middle class. The Florida Bar should be commended for asking for more evidence and reaching a unanimous decision.

Whether you think these changes are long overdue or expect they will bring on the demise of the legal profession, it’s clear that, if implemented, these changes will be very hard to reverse.  So let’s dig deep and examine whether allowing nonlawyers to invest in law firms is the best and only way to improve access to justice. Let’s also explore more incremental changes that will enhance the economic standing of law firms that represent individuals. As consultants to law firms, we see firsthand that the more financially secure a law firm is, the better positioned it is to serve a wider range of clients.

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

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.