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My Impression Now: Data on Rule 5.4

by Jim Doppke

In my last post, I wrote about In re Karavidas, the ways in which it changed attorney regulation in Illinois, and how it can be seen as the foundation for future reform efforts. The profession – in Illinois and elsewhere – is beginning the discussion of “re-regulation,” and asking how we can change regulation in the future to best meet the needs of an innovating landscape while also protecting the public from ethical violations. I’ll have some viewpoints on that in coming posts; but for now I’d like to focus on the present. What are we regulating in Illinois now?

Many recent reform efforts involve Rule 5.4, which prohibits nonlawyer involvement in law firms or corporations that are authorized to practice law. What can a current look at the enforcement of that rule tell us about whether the rule should be amended?

Of the 961 formal complaints filed in Illinois in the last 10 years, only 17 have charged the respondent-attorneys with violations of Rule 5.4. The last one was filed in 2015. To put an even finer point on it, since 2000, only 4 complaints have charged violations of Rule 5.4(d), which prohibits lawyers from participating in corporations “practicing with or in the form of a professional corporation or association authorized to practice law for a profit” if nonlawyers own interests or have officer positions in the corporation, or if they have the right to direct or control the lawyer’s judgment. Nor were the analogous sections of the pre-1990 Code of Professional Responsibility frequently charged: a search for Rule 3-103 (prohibiting partnerships with nonlawyers) produces 2 cases in the searchable record, and a search for Rule 5-107(d) (prohibiting forming corporations if nonlawyers own stock or direct lawyers’ judgment) produces none.

In researching the issue for this post, I have found just one Illinois disciplinary case in which the 5.4(a) and (d) violations charged involved a lawyer receiving (apparently) passive funding, in the manner envisioned by current reform efforts. The lawyer received $19,000 in capital funding from an unlicensed person for a corporation that was allegedly formed in order to practice law. The lawyer was also found to have shared legal fees with the unlicensed person. The lawyer had abruptly abandoned his practice and moved out of state; he defaulted in the disciplinary proceeding as well. Therefore, the Hearing Board report does not contain specific detail concerning how the investment came about, the basis for the allegation that the purpose of the corporation was to practice law, or information about just how passive the investment was. It does not specify whether anyone was harmed by the arrangement, or how that harm occurred. The lawyer was suspended indefinitely; the case appears to be an outlier.

In the early part of this decade, some 5.4 cases involved lawyers forming corporations that provided (or claimed to provide) loan modification services. When nonlawyers operated those companies, various state and federal laws prohibited them from receiving up-front fees; but those laws contained exemptions for lawyers. Thus, nonlawyers sometimes arranged to collaborate with lawyers willing to act as a front for the business. The harm in those situations was that lawyers sought to assist non-lawyers in receiving fees they weren’t entitled to receive, placing the clients of the company in jeopardy of losing the money they paid without getting loan modification services. That fact pattern does not appear to have arisen in an Illinois formal complaint in the last five years.

I do not argue that any discipline imposed in the filed cases was not warranted, or that those prosecutions were otherwise unjust. I do think, though, that declining enforcement of a rule can indicate that a regulatory environment has already changed, and that it is therefore good to examine changing the rule to better suit the profession’s needs.

At the recent The Future Is Now 2.019 and #MakeLawBetter conferences, many prominent speakers with wide experience in law, capital funding, and business made clear the growing sense that the profession now needs the ability to seek outside capital funding from sources that do not have law licenses. “Law corporations” have become able to offer law-adjacent services that compete with law firms, but they do so with the competitive advantage of readily available capital funding. Proposals to reform Rule 5.4  to better accommodate such funding for law firms are grounded in that reality.

The conduct that was found to violate Rule 5.4 in prior cases is not necessarily the same as a lawyer obtaining outside capital funding in exchange for an ownership interest in a firm that provides legal services. In light of that, and in light of the rare-and-getting-rarer enforcement of Rule 5.4, it does not appear necessary to continue to consider every lawyer-nonlawyer association, or every nonlawyer dollar to be verboten.

As the California proposal to amend Rule 5.4 notes, there could be sweeping change, or there could be incremental change. The incremental steps could involve permitting joint ownership of law practice entities, but requiring majority ownership by lawyers, recognizing that lawyer control and judgment remains important. A broader proposal could allow virtually any kind of lawyer-nonlawyer collaboration and participation in funding, with client consent. A third alternative could be to combine the two approaches: allow lawyer-and-nonlawyer collaboration and funding, and in any case require explicit agreements with clients that specify that that no person or entity who is not licensed to practice law will make decisions involving legal skill or legal judgment. Rule 1.4 could even be amended to require, or at least suggest via a comment, such agreements as an element of appropriate attorney-client communication.

The California and Arizona proposals regarding Rule 5.4 sound radical, but they don’t have to be seen that way, especially when we consider the ways in which recent enforcement of the existing rule indicates a diminishing sense of the rule’s importance or impact. If the reality of the rule and its enforcement has changed, perhaps the rule should too.

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