February 11, 2005
When Attorneys Invest in Their Clients
Posted by Christine Hurt

Today I am guest lecturing in a colleague's Professional Responsibility class while he is away at a conference.  I am basically giving the students my job talk from two years ago, which came from an article that was in press at the time, Counselor, Gatekeeper, Shareholder, Thief:  Why Attorneys Who Invest in Their Clients in a Post-Enron World Are Selling Out, Not Buying In.  In preparing for the talk, the first thing that struck me in re-reading this article is that I know so much more about so many things than I did then.  Of course, at the time I thought I knew everything about my topic, but after teaching in the area for two years, I wish I could go back and rewrite certain parts.

I still believe in the hypothesis, however:  corporate attorneys, particularly attorneys representing clients in an IPO situation, should not invest in their clients.

The paper uses as the extreme examples of this practice the law firms of Wilson Sonsini, Brobeck, Venture Law Group, and Cooley Godward, who made literally millions from IPO clients in 1999 and 2000.  The most amazing example is Wilson, Sonsini's representation of Webvan, which resulted in the law firm's holding $51 million worth of Webvan stock after the first day of trading.  The firm held $24.5 million of VA Linux stock after the first day of trading.  By the end of 1999, the firm held $230 million from IPOs that year.  We all know how much hourly legal fees run in an IPO, and it's nowhere near even $24.5 million.

The ABA and other state bars have said that this practice does not run afoul of disciplinary rules because it's not unreasonable ex ante.  At the time the firm is given pre-IPO stock (or allowed to buy pre-IPO stock), the stock theoretically may be worthless.  Hence, it is unfair to judge the value of that fee ex-post.  However, during the 1999-2000 time period, no one thought that pre-IPO stock in a company that was securing legal representation to file an S-1 was worthless stock.  That being said, the advisory opinions from these agencies point to rules based on Model Rule 1.8, which allow attorneys to do business with a client as long as certain disclosures are made and consents given.

My main argument is that the fee is similar to a contingency fee (a "bet the farm" contingency fee), and that contingency fees are not appropriate in a corporate representation.  As an attorney representing a client in an IPO, or a merger, or some other large venture, one of your jobs is to tell the client when to walk away.  If you can tell that a deal cannot be done to your client's long-term advantage, will you be willing to tell your client to walk away if you will then not get paid for months and months of work?  Or, will you push to close the deal?  More specifically, will you push your client to make certain disclosures required by law if those disclosures will either push back an IPO or reduce the price, and your eventual "fee."? 

Additionally, I argue that an attorney cannot act as a reputational intermediary if the other party knows that a huge windfall is waiting for the attorney on the other side.  The larger this windfall becomes, and the larger a percentage of this attorney's income, then the attorney becomes captured and has no more independence than an in-house attorney.  This lack of independence frustrates one purpose of outside attorneys in corporate representations:  to be able to act as reputational intermediaries in the giving of opinion letters.

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