Whatever Happened to Law Firms Going Public?
As a follow-up to Peggy’s very interesting post below on the performance of global versus non-global law firms, let me raise an issue that has, for obvious reasons, disappeared in the last year, but which was a topic of discussion in 2007 and might well re-surface at point in the future: law firms going public via an IPO and listing themselves on a stock exchange.
The first firm worldwide to do so was in Australia, Slater & Gordon, a class action personal injury plaintiffs firm, in May 2007. Its IPO price was AUD 1.00, rose to 1.40 in the first days after the offering, and is currently at AUD 1.35. (SGH.AX) [Kevin - I'm curious to know how Slater & Gordon is seen in Australia and NZ? Any observations?]
As the Wall Street Journal law blog notes, there are difficulties doing the same thing in the United States, at least at the moment:
It’s against the rules, for one. Ethical rules i.e., the American Bar Association Model Rule 5.4 prohibit firms from selling equity shares in law firms to non-lawyers. Specifically, it says that a lawyer shall not share legal fees with a non-lawyer. The problem legal ethics types wrestle with is that as a public company, a law firm would have a potential conflict between its duty of loyalty to its clients and its duty of loyalty to its shareholders. Another reason: Lawyers also vigilantly protect the attorney-client privilege, and many fear that by being a public company, a law firm could risk divulging client confidences.
The comments to that blog post are interesting, too:
Dumb idea. Let’s not forget that all of the “profits” from a partnership go to the partners. Why would some partners remain in a firm if their “profits” go down? Plus, to the extent they received dividends on any shares, those dividends would be taxed twice (once at corporate level, then to the shareholders).
From an ethical standpoint, how hard would it be in a shareholder derivative suit for the plaintiff class (Milberg Weiss et al) to subpoena not only a corporation’s records, but also the records of its publicly traded law firm? Also, would a firm have to file 10k and other SEC documents? Could a shareholder demand to know what “holdings” a law firm had – i.e. which clients it was doing work for and how much money was due to the corporation/firm?
This is a bad idea propagated by people with dollar signs. Remember, the fat pig is the one slaughtered (and never forget Finley Kumble, Brobeck, etc.)
Slater & Gordon say in their offering prospectus that investors are actually third in line – following the courts and following clients. But one might seriously wonder whether saying such a thing makes it so, and whether ethically it could possibly make sense for regulators to allow to be set up such a profound conflict of interest and then say, don’t worry, we can police it.
More fundamental economically is the motivation driving the whole idea. The partnerships most frequently cited as the inspirations are Blackstone and Goldman Sachs. Neither one is doing so well in the current environment, obviously. But there is a more fundamental issue – they are investment vehicles, and require large amounts of capital to operate and, as it happens, leverage as well. To that extent, going public gives them access to the large pools of capital that are basic to their proprietary trading businesses.
A professional firm is different; it is selling its expertise, not leveraging the management of capital. In Business Associations, I used to discuss why public corporations came about, in the search for larger pools of capital for … capital investment. Whereas professional partnerships have relatively low capital requirements, and lawyers quite possibly (at least compared to doctors) lowest of all, being based as much on a regulatory monopoly as expertise and not requiring a lot of fancy physical plant and equipment. (What’s the law firm equivalent of even a basic xray machine in a doctor’s office – a computer? Lexis or Westlaw? Not even close.)
This suggests, then, that the motivation for going public, in the case of law firms, is a lot closer to the motivation that many have ascribed to Blackstone and other formerly private ‘private’ equity groups – the desire of the partners to cash out their presumed expertise now against the (risky, as it unsurprisingly turns out) future returns they will generate for public shareholders. Law partners – same basic idea: cash out now.
And to judge by the private equity firms (with the possible exception of private-to-public Goldman) the lesson is that both capital management firms and professional firms have an incentive to go public and take the public’s cash for their future performance precisely when they judge that their future performance will decline. As a private equity friend remarked to me, never, ever invest when the private money goes off the table and public’s goes on; when the public is invited in, the party is already over but no one told the public shareholders. The private equity principals tell the public that their cash will enable them to ramp up the bets with the same performance and return, but really they are selling the promise of future services whose value they themselves have discounted today – because if they had that much confidence in their future services, it is doubtful they would share the returns with anyone else.
This general rule is likely especially true of lawyers, given that their capital requirements are remarkably low and easily covered with plain old debt. The lawyers who judge themselves least likely to produce fat future returns are on average the ones with the most incentive to cash out now. And that is likely to become more true if more firms were to go public.
For that matter, too, one of the most striking law firm phenomena in the US recently has been the collapse of famous name firms as partners simply defect – triggering, in at least one case, a line of credit covenant in which the bank rather cleverly said that it reserved the right to take over credit decisions if more than a certain number of partners departed in a given quarter. I’m not quite sure how you structure a public company that will still be as good a deal for public shareholders as it is for partners in a private enterprise where you can’t prevent partners from walking away with their clients. Sure, you can structure in all sorts of monetary penalties in lieu of specific lawyer performance to take effect when a lawyer walks with his or her clients; I don’t know whether that would be ethical or not. But that increases the rational transaction costs that those same lawyers will take such into account when they structure compensation, insurance, etc.
It is hard for me to see that these costs, which are ratcheted up in the case of the public firm because of its public shareholders, don’t
- (a) drive up fees to clients or, more likely, because of competitive pressures with other, still private law firms,
- (b) drive down returns to shareholders on a risk adjusted basis, either because the share price reflects that risk or the (high, because of uncertainties and not just risks) cost of insuring against it, or else because the risk-event happens in the form of that “unthinkable” event, viz., the law firm collapses and the shares are wiped out with it.
(Plus there is the welfare problem of whether it is socially efficient to create a pool of capital to invest in … more lawsuits. Possible, I suppose. But … unlikely.)
(Larry Ribstein’s as always astute analysis of the economics of this is over at The American.)