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September 2000
Published in CBA Record
© Chicago Bar Association. Used with permission.
Trust Us: How Rules on Referral Fees Influence the MDP Debate
By Michael L. Shakman and Diane F. Klotnia
Many law firms want the right to sell other services and products, such as accounting, insurance, investment advice and perhaps even health care and retirement advice. The wish to offer a multi-disciplinary practice (MDP) is based on anticipated and actual competition from accounting firms -- who already provide an extensive range of legal services previously provided by lawyers -- and competition from other possible “one-stop” professional providers.
However, MDP runs up against well-established concepts concerning the lawyer’s role and responsibilities to clients that are reflected in several ethics rules. In fact, many of the issues raised by MDP are not new at all. They have been extensively discussed in considering efforts by lawyers to sell non-legal professional services, such as investment advice. A look at the treatment of the issues in that context helps to focus the ethical and practical debate on MDP.
Lawyer Referrals to Investment Advisers
Have Generated Many of the Same Issues as MDP
Several state bars’ ethics committees have considered whether a lawyer may accept an ongoing fee from an investment adviser for referring a client to the adviser. Typically, the fee is based on a percentage of the investment management fee paid by the client to the adviser.
Ethics committees that have considered the issue agree that accepting an ongoing referral fee runs head on into several basic ethical rules governing the attorney-client relationship. Those are the rules that prohibit a lawyer from representing a client where the lawyer has a personal interest that is in direct conflict with the interest of the client or from entering into a business transaction with a client, unless there is sufficient disclosure and informed consent by the client. In Illinois, these are Rules of Professional Conduct 1.7(b) and 1.8.
The issue is whether an attorney who receives an ongoing referral fee based on the amount of assets his or her client has invested can ever satisfy the disclosure and consent requirements of the Rules.
Can Disclosure and Consent Satisfy the Ethical Rules?
Several ethics opinions have concluded that the answer is an unqualified no. The state bars of New York, Iowa, Arizona, Kentucky, Vermont and Ohio have concluded that Rule 1.7(b) absolutely bars a lawyer from accepting an ongoing referral fee. No amount of disclosure or consent, according to those ethics decisions, can avoid the restrictions of 1.7(b). The fact that the lawyer will receive a fee every time the client pays the investment adviser -- and the fact that the fee increases as the investments increase -- creates a direct and substantial conflict.
They concluded the conflict will, consciously or not, necessarily impair or affect the attorney-client relationship and interfere with attorney’s ability to exercise independent professional judgment. NY State Bar Ass’n, Committee on Prof. Ethics, Op. 682 (June 7,1996); AZ Committee on Rules of Professional Conduct, Advisory Op. No.98-09 at 5 (Nov.1998) (“With this monetary incentive, it is possible that the attorney may refer a client to the investment adviser firm, despite the fact that the client’s financial interests would be better served through other means.”). See also Kentucky Bar Ass’n, Ethics Committee, Op. No. E-390 (July 1996) (attorney’s interest in fee may cloud exercise of independent judgment on behalf of the client).
The Kentucky bar also noted that, whether they are called kickbacks or referral fees, the fees are generated because a lawyer allowed someone else to make a profit from the client. Regardless of disclosure, this creates an appearance of impropriety. KY Op. E-390. Others have concluded that disclosure may not remedy the problem because “[c]lients view recommendations of other professionals as part of their representation by their lawyers, and expect that lawyers will act as trusted fiduciaries in such matters.” NY Op. 682; see also Ohio Supreme Court Bd. of Commissioners on Grievances and Discipline, Op. 2000-1 (Feb. 11, 2000); Iowa Supreme Court Bd. of Professional Ethics and Conduct, Op.99-04 (Dec. 9,1999).
Disclosure of the lawyer’s ongoing financial incentive may serve only to reduce the confidence and trust a client places in his or her lawyer, and the client may be reticent to be candid with his or her lawyer because of a fear that the lawyer will share confidential information with the investment adviser. Id. According to these ethics opinions, acceptance of such a referral fee creates a non-waivable conflict, barred under Rule 1.7(b).
Illinois and other states, including Connecticut, Utah, Missouri, Rhode Island, Michigan, and Pennsylvania, have taken a more permissive view. They concluded that referral fees are not automatically unethical if the lawyer complies with disclosure and consent requirements of Rules 1.7 and Rule 1.8 (which imposes restrictions on a lawyer entering into business transactions with a client),and otherwise complies with regulatory and common law.
What Impact on MDP?
Do these opinions bear on the future of MDP? Sharing fees with non-lawyer professionals in a multi-disciplinary practice has attributes similar to accepting a referral fee. If the lawyer refers a client to an in-house accountant or investment adviser and the client uses that professional’s services, additional fees will be generated for the firm and the lawyer will benefit by sharing in those fees through his or her percentage interest in the firm.
If the arrangement between lawyer and in-house adviser is simply a fee-sharing arrangement with no joint responsibility to the client, then states that absolutely prohibit accepting a referral fee would likely also prohibit in-house advisers from sharing their fees with referring in-house lawyers. The same financial self-interest that was of concern to those ethics committees should be of an equal concern where the adviser is in-house. The lawyer would have the same financial incentive to encourage his or her clients to use the in-house adviser and to invest the maximum amount of assets with that adviser.
Moreover, the “absolute prohibition” view adopted by some state ethics committees may have implications that reach beyond their borders. The Iowa State bar, for example, has advised that Iowa lawyers may not accept referral fees even if they are also licensed in states that permitted acceptance of referral fees. Iowa Op. 99-04.
In light of the Iowa opinion, could referral fees be shared even indirectly with Iowa lawyers? Probably not. It seems unlikely that the Iowa state bar would conclude that its lawyers could achieve indirectly what they could not do directly. If referral fees could not be shared indirectly, nationwide firms who have offices outside states like Iowa may not be able to share fees with its Iowa-licensed partners. If other states, such as New York, adopted the Iowa view, the future of MDP would seem to be very dim.
What Would Disclosure Require?
Setting aside the particular additional complication presented by the Iowa opinion, would multi-disciplinary firms be permitted in states that do not read Rule 1.7(b)or 1.8(a)as absolutely barring acceptance of ongoing referral fees?
In theory, yes. A lawyer could make the disclosures necessary and obtain the consent necessary to overcome the prohibitions of Rules 1.7(b)and 1.8(a). But as a practical matter, disclosure may not be realistic. Illinois, for example, permits acceptance of referral fees, but requires full disclosure to and consent by the client.
At a minimum, that would require disclosure of all aspects of the lawyer’s financial interest in referring the client to an in-house adviser. It would also include the timing, nature and amount of the fees to be received as result of the referral, as well as the fact that other service providers are available. It would include all foreseeable risks of the transaction, including the fact that the lawyer would not be involved in any way to protect the client’s interest but would nonetheless continue to receive a portion of the advisor’s fee. Pennsylvania Bar Ass’n Comm. on Legal Ethics and Professional Responsibility and Philadelphia Bar Ass’n Professional Guidance Comm., Joint Formal Op. 2000-100 (March 2000); Illinois State Bar Ass’n Advisory Opinion on Professional Conduct 97-04 (Jan. 23, 1998); Conn. Bar Ass’n, Informal Ops. 94-25 (Aug. 10, 1994) and 97-16 (June 4, 1997).
Meeting the disclosure and consent requirements in the context of a referral to an outside adviser is difficult enough. One ethics committee has cautioned that “[t ]he risk that Attorney will be viewed to have engaged in a conflict of interest is quite high in this type of situation.” Missouri Office of Chief Disciplinary Counsel, Informal Advisory Op. No. 960124. Another warned that “it will be very difficult for a lawyer to maintain independence while taking a percentage of an investment broker's services due to a client referral.” Utah State Bar Ethics Advisory Opinion Committee, Op. No.99-07 (Dec. 3, 1999).
If satisfying the disclosure requirements is difficult when the lawyer simply receives a fee for referring matters to an outside adviser, arguably it is even more difficult when the non-legal adviser is in-house. If the lawyers and in-house advisers own percentage interests in revenues of the multi-disciplinary firm, the lawyer would have a financial incentive to encourage the client to utilize services of the in-house financial advisers, as well as accountants and other non-law professionals.
Is Client Consent Realistic?
To satisfy the disclosure requirements, the lawyer might also have to disclose to the client all aspects of his or her financial arrangement with the in-house advisers, including the percentage ownership interests of each, how distributions are made and when. It is hard to imagine that many lawyers or law firms would be willing to disclose to a client such intimate details concerning the sharing arrangement within the firm.
The lawyer would also have to advise the client that the lawyer would not be representing the client’s interests with respect to the investment or other work performed by the in-house adviser, and that the lawyer might be acting to maximize the lawyer’s interest in the fees generated by the client’s use of the in-house adviser. Without making known such basic facts, could a lawyer who shares in the ongoing fees generated by the client ever be found to have fully disclosed to the client the risks of the transaction? And could a client ever be said to have consented to an arrangement where the lawyer’s interest in protecting the lawyer’s own fee was paramount to protecting the client’s interest. If a lawyer does fully disclose all relevant facts, would a reasonable client ever consent?
These questions suggest that regardless of whether a state adopts an absolute prohibition or a permissive view of Rules 1.7(b) and 1.8(a) with respect to accepting referral fees from non-lawyers, the disclosure requirements of those rules would effectively prevent MDP as an ethical matter.
Why are Referral Fees Among Lawyers Permitted?
Lawyers may, under some circumstances, receive a fee for referring a legal matter to an outside lawyer if there is disclosure of the fee-sharing arrangement and of the fee. Illinois Rules 1.5(f) and (g) address this situation. Lawyers within a firm have a financial incentive to refer their clients to other lawyers within that firm for legal services, yet they are not required to disclose to the client details about the firm’s fee-sharing arrangement. Why should those fees be treated differently, as an ethical matter, than fees based on referrals to non-legal advisers?
The answer may lie in the lawyer’s continuing liability to the client. When a lawyer makes a non-negligent referral to an outside adviser, the lawyer would have no liability to the client if the adviser acted negligently and caused the client to lose his or her investment. The only interest of the lawyer -- other than preserving good relationship with the client -- is a financial interest in the ongoing referral fee. In contrast, in order to share in the fees generated by referring a client to another lawyer, the Rules require the referring lawyer to disclose the arrangement (and obtain consent of the client). In addition, the lawyer must also accept responsibility for the services performed as would a partner of the receiving lawyer. See Rule 1.5(f) and (g). The same is true for in-house referrals -- a partner is jointly and severally liable for the negligence of the other attorneys in the firm.
Does Continuing Liability Solve the MDP Ethical Problem?
The referring lawyer’s continuing potential liability is a countervailing interest that insures, to the extent possible, that a lawyer will not act purely out of his or her own pecuniary self-interest in referring a client to another lawyer within the firm for additional legal services or in referring a client to an outside lawyer where the referring lawyer shares in the fee.
This potential liability of the referring lawyer insures that the lawyer will exercise care in selecting the lawyers to whom to refer a client. If members of a multi-disciplinary practice are similarly liable for the conduct of each other vis-a-vis the client, then that same countervailing interest would exist. That would be a significant distinction from referrals to outside, non-legal advisers. Just as lawyers who refer clients to other lawyers within the firm do not have to disclose their fee sharing arrangement within the firm, there should be no reason why lawyers would have to disclose the fee sharing arrangement with non-lawyers within a multi-disciplinary practice. All that depends, however, on the assumption that lawyers would be jointly and severally liable to their clients for malpractice or negligence of the in-house advisers.
The D.C. Rules Provide Some Guidance For MDPs
The District of Columbia stands alone in permitting lawyers, under limited circumstances, to enter into partnerships with non-lawyers and, in that context, to share legal fees. See D.C. Rules of Professional Conduct, Rule 5.4(b). However, the requirements are so stringent that most, if not all, MDPs would not be permitted. Under the D.C. Rules, the nonlawyer participants must “perform[] professional services which assist the organization in providing legal services o the client,” and the “sole purpose” of the lawyer-nonlawyer partnership must be the provision of legal services. See D.C. Rule 5.4(b).
The D.C. Rules are aimed at allowing, for example, economists to work in a firm with antitrust or public utility lawyers, social workers and psychologists or psychiatric social workers to work with family law practitioners, and CPAs to work with tax lawyers or others who use accountants’ services “in performing legal services.” See Comment 7 to D.C. Rule 5.4. D.C.’s requirement that the legal services be the “sole purpose” of such partnerships runs directly counter to the intended purpose of MDPs -- that is, to provide services from a multitude of professional disciplines.
Although the D.C. Rules fall short of sanctioning MDPs, they confirm that, if MDPs are ever to be permitted, nonlawyer participants would have to assume the ethical obligations that constrain lawyers. The D.C. Rules expressly require that all persons, including nonlawyers, who have managerial authority or a financial interest in the firm must undertake to abide by the rules of professional conduct. Further, lawyers who have such a financial or managerial interest must also undertake to be responsible for the nonlawyer participants to the same extent as if they were lawyers under Rule 5.1 (imposing obligations on partners and supervising attorneys). See D.C. Rule 5.4(b)(2) and (3).
Notably, the lawyer-nonlawyer partnership must set forth in writing all the conditions imposed by the D.C. Rules to “ensure that these important conditions are not overlooked in establishing the organizational structure or entities in which nonlawyers enjoy an ownership or managerial role equivalent to that of partner in a traditional law firm.” Comment 4 to D.C. Rule 5.4.
Shared Liability Doesn’t Address All the Issues
Will bar ethics committees faced with the issues presented by MDP find shared liability an acceptable rationale for permitting a relationship that is either forbidden or extremely hard to approve under existing rules when the referral is to an outsider?
There is no way to tell in advance, but it seems clear that the shared-liability justification does not fully address the issues raised by MDP. In the case of a referral to another lawyer in the firm, the referring lawyer can fairly be assumed to know something about the quality of that individual’s work -- whether the referred lawyer is competent and does a good job. As the referred matter proceeds, the referring lawyer is likely to keep some track of how well it is being handled. These are the realities of law practices that should generate professionally competent representation for the client.
But in the case of a referral to an investment adviser, accountant, actuary, insurance provider or other non-lawyer professionals -- even if the non-lawyer adviser is a partner in the firm and there is shared liability for mistakes -- the referring lawyer may not possess the technical skill to determine whether the services are being performed well. That was one of the concerns that led the Kentucky bar to conclude that such fees were barred as a per se matter. See KY Op.E-390.
If this concern is overcome, the referral to an insider adviser is still a business transaction between law firm and client. It is difficult to see why the disclosure and consent requirements that are so hard to satisfy in the case of an outside referral would not apply -- and be equally hard to meet -- if the business transaction is with an insider adviser.
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