In the IPO context, the issuer’s lawyers do perform a substantial investigation of the issuer. This is for a number of reasons including gathering the information necessary to draft the registration statement, performing the necessary due diligence to issue a legal opinion at closing to the deal underwriters, protecting the firm’s reputation by verifying the legitimacy of the deal, and avoiding later claims of malpractice. In this context, I don’t think its necessary to require additional investigation. Note, however, that the investigation does not entail much in the way of verifying the financial statements. In my view, this is how it should be--most lawyers simply do not have the expertise to pass on accounting matters. Passing on the financial statements is the role of the auditors (this distinction is reflected in the different treatment under the section 11 due diligence defense for expertized (financial statements) and non-expertized portions of the registration statement (everything else)).

Outside the IPO context or some other big transaction, there’s not a lot of investigation going on by the company's lawyers. Back in the day I routinely passed on drafts of public company annual and quarterly reports with doing little more than reading them, making sure they conformed with SEC content requirements, etc., and asking the CFO a few questions. In this context, I wasn’t the drafter (the company usually did the drafting based on the most recent prior report), no legal opinion needed to be issued, and my firm’s name wasn’t listed on the reports. If a firm was obligated to investigate in these and other contexts it definitely would result in higher fees, both because of more billable hours and more liability exposure for the firm.

I think it's too stereotypical to characterize accountants on the on-site diligence team and the lawyers as the deal-specific journeymen. Many outside lawyers have deep and involved relationships with their clients, and of course inside counsel has extensive access to information.

In my mind, the real challenge is that lawyers simply lack the expertise to second-guess the accountants' judgments, and accordingly the lawyers are forced to treat accountant-supplied data as gospel. Therefore, it can be very difficult for a lawyer to understand what's going on under the hood to produce the accountant's numbers.

Meanwhile, the accountants don't always understand the law, so some of their accounting judgments are just wacky when viewed from a legal perspective. For example, some accountants don't appear to know that the perfect tender rule gap-fills every UCC contract, so accountants may not raise an accounting red flag if a UCC sales contract lacks an acceptance provision--and will book the revenue without regard for the buyer's ability to reject.

Eric.

Some lawyers do apply a smell test and bring to the client's attention something that might not pass it. The lawyer may be limited as to how she may respond publicly. But in an egregious situation there are alternatives which may have an economic impact on the attorney, such as resigning. Some lawyers are prepared to do so, as they might otherwise feel compromised by the failure of the client to address the matter. At a minimum, a CYA memo should issue.

One of the points raised in the talk was, indeed, that high-level corporate accounting is not something that lawyers are equipped to review adequately. As for my point about the functional differences between (at least outside) counsel and accountants, I still stand by it, but come to think of it, I should attribute the inspiration for the observation to a question asked at the lunchby one of my colleagues at WNL. Not sure of the contours of blog credit, but there you go.

I would assert that the financial illiteracy of business lawyers is appalling. A recent survey found that 80% of Forbes 1,000 executives believe that their attorneys lack an understanding of accounting and finance! The language of business is accounting, and its underlying theory is that of financial valuation. Yet few lawyers have been trained in either accounting or finance, and the training that does occur tends to be either too pedestrian or too esoteric to be useful in practice. While business lawyers do not need to be financial economists or accountants, they do need a thorough knowledge and mastery of the concepts.

I came to this realization late in life, and went back to business school to address this deficiency. Subsequently, I returned to my law school, the University of Texas at Austin, to teach financial accounting to bright and earnest second and third year law students. It was one of the most fulfilling experiences of my career.

I hope to address this topic—the deficiencies in teaching financial accounting and finance in the typical law school curriculum-- more thoroughly in a future posting. Professor Roberta Romano of Yale Law School has some interesting recent thoughts on this topic in After the Revolution in Corporate Law, available on SSRN.