Policy Considerations: Investment in Clients

What and How to Invest

Investments may take many forms. Investments include securities obtained as a direct investment or received as a fee in lieu of cash. Stock and partnership interests, being the more common securities involved in transactions between clients and lawyers, may be acquired in a public or private offering. The firm may represent a variety of parties to the transaction, such as the issuer, underwriter, selling shareholders, etc. The opportunity may be in a company or affiliate involved in a merger, acquisition, tender offer or repurchase offer. The investment may be in the form of a stock offering, a loan, a joint venture interest or a partnership unit.

There are risks inherent in accepting stock or other indicia of ownership in a client as payment for legal fees and expenses if the securities are in an offering, which is conditioned on the amount of the securities being sold. For example, in a so-called “all or nothing” offering, investors could claim that a law firm violated the securities laws by allowing its fees and expenses to be paid with the securities being offered to other investors. The rationale is that, but for that transaction, the investors would have received their money back. Obviously, this issue arises only when the client suffers adverse economic consequences and the stock is worth less than what the investors paid. The same problem arises in offerings that are escrowed, until and unless the client sells a certain amount of the securities in question. In any such situation, the law firm must be especially careful.

The manner of holding the investment can vary significantly. Investments may be by the law firm, a law firm-controlled ancillary entity or by some or all of the lawyers individually. A holding company, a venture fund or a discretionary blind trust could own and hold the investment. Even then, the law firm needs a policy to protect against the use of insider information.

For the law firm, the initial question is what to invest. The most common investments are part or all of the law firm’s legal fees, the law firm’s money, money of a law firm-controlled entity and personal money of the partners and employees.

An issue if the investment is made by the law firm concerns how the profits (and losses) will be distributed to the partners. If legal fees are being used, the law firm must decide how to credit the originating, responsible and working lawyers, who are thereby reducing or eliminating cash collections. Law firms should consider whether the measure of equity participation on the investment is different when the gain or loss is realized.

The Amount of Investment

The amount of the investment may be set by guidelines or by the review process. A limitation of less than three percent of the client’s securities may be appropriate in most circumstances. Rarely should the investment exceed five percent. The greater the investment, the greater the lawyer’s or the law firm’s financial risk, and exposure to allegations of conflicts of interest and loss of objectivity. The law firm should avoid a control person or substantial influence situation, which means that there will be limits on investments despite the potential economic benefit if those investments are in fact successful.

Another consideration is whether the amount of the investment will preclude insurance coverage.  Some policies have exclusions that preclude coverage if the amount of the financial interest exceeds a certain percentage.