It’s About Time: Corporate Responsibility Law Finally Makes Lawyers More AccountablePublished: August 14, 2002 in Knowledge@Wharton
Although the reputations of CEOs, accountants, bankers, analysts, and even consultants have suffered during the recent spate of corporate scandals, lawyers so far have escaped blame, let alone indictment. But that may change, as it should, says Wharton legal studies professor Richard Shell. President Bush’s new corporate responsibility legislation requires that lawyers report to their clients (the corporate board of directors) any evidence they acquire of a “material violation of securities law or breach of fiduciary duty.” In the following article, Shell, who is writing a book on how firms use legal strategies to gain competitive advantage, talks about the new legislation and makes a distinction between Trusted Counselors and Legal Enablers.
Why does it always seem like lawyers slip the noose? The current corporate scandals have taken their toll on CEOs, accountants, bankers, analysts, and even consultants. But the lawyers, lurking in the shadows of every story, have escaped so far. The jury in the Anderson case convicted, some of the jurors said, because one of Anderson’s in-house lawyers advised the firm to delete damaging information from a press release. But no one is talking about indicting the lawyer. And Enron’s legal advisors at Vinson & Elkins must have known something about the energy business when they landed the energy company as a client back in the 1980s. But when they issued “true sale” opinion letters approving Enron’s “special purpose entities,” they became business dummies, disclaiming all business expertise regarding the wisdom of these entities. So far, Enron’s creditors have not been able to get to them.
Now comes President Bush’s new corporate responsibility legislation. It places substantial new duties on CEOs, accountants, and, lo and behold, lawyers. Under the new law, lawyers must report to their clients (the corporate board of directors) any evidence they acquire of a “material violation of securities law or breach of fiduciary duty.” This new duty, minimal as it may seem to the rest of us, has the American Bar Association on the warpath. With some lawyers claiming the profession was the victim of a “sneak attack,” the ABA has announced a lobbying campaign to reverse the law or persuade SEC Chairman (and lawyer) Harvey Pitt to dilute it. Why is the legal profession so worried? Because the new law pricks at the heart of a system under which lawyers have always escaped accountability in business cases.
There are, essentially, two models of the lawyer’s role in business, the Trusted Counselor model and the Legal Enabler model. The former is what law school deans talk about at graduation and retired lawyers write about in their memoirs. Trusted Counselors act as officers of the court whose job is to prevent clients from falling into crime. When their advice goes unheeded, they withdraw in protest. On rare occasions, they even blow the whistle.
The Legal Enabler model, by contrast, is what the average corporate lawyer follows to make a living at the law. Legal Enablers pass no judgments on corporate acts and take no positions on the wisdom of business decisions. Instead, they provide morally neutral risk analysis. Their stock in trade is not legal judgment; it is legal rationalization. They provide legal spin to justify both questionable as well as sound transactions. Ned Kelly, a former corporate lawyer who now heads up Mercantile Bankshares, said recently, "I don’t know, frankly, that lawyers ever really say ’no.’" Instead, said Kelly, lawyers provide "the basis for factors that should go into the decision and [give] someone a recommendation."
The new statute, in its effort to protect the securities markets from more fraud, dumps the Legal Enabler model and requires lawyers to be Trusted Counselors. And that has many in the profession worried.
But there is a silver lining here for clients. If the law sticks, it will require lawyers to learn a skill many have steadfastly resisted: how to add real value to business decisions. Lawyers who want to help clients figure out ways to make money while avoiding “material violations of securities laws and breaches of fiduciary duty” will need to become experts not only in legal technicalities but also in the nuts and bolts of a client’s business strategy. Clients have wanted this from their lawyers for years.
Jeffrey Humber, a senior vice president at Merrill Lynch, said at a recent law school conference in Virginia, "I am looking for a business partner in my lawyer … I need lawyers who understand what I do." And an informal survey of 149 CEOs in 2000 by the American Corporate Council Association confirmed this aspiration for the lawyer-client relationship. The two most common reasons these chief executives gave for choosing to hire in-house counsel were 1) a desire to have lawyers who "understand the company better" (93%) and 2) a need for legal experts who could "participate in strategic planning" (89%). But they appeared to have limited success finding such attorneys. When asked what their lawyers actually did for them, only 37% reported that their legal advisors were “critically important” in strategic planning work.
Under the new law, lawyers will have a duty to speak out when a given business strategy carries high legal risk. As Elihu Root, a seasoned corporate lawyer from the Gilded Age, once said: “About half the practice of a decent lawyer is telling would-be clients they are damn fools and should stop.” The new law, in effect, creates a duty to say “stop” or face stiff legal sanctions.
This new role will take some getting used to. First, corporate leaders bent on crime will no longer have the benefit of advice from first-rate lawyers. This, of course, is a good thing. But the ABA is worried that even honest corporate executives may decide to keep the lawyers “out of the loop” on important decisions to reduce the risk that an over-zealous attorney will go running to the board before a final strategy is fixed. This is a legitimate concern, but it should recede as lawyers become more knowledgeable about business and better at being partners who, in Humber’s phrase, “understand what I do.”
Second, there will be tensions between what this law requires and some time-honored protections that helped Legal Enablers thrive. For example, both the attorney-client privilege (which bars from evidence conversations between lawyers and clients about “legal options”) and the so-called “work-product” doctrine (which permits lawyers to withhold documents created in anticipation of litigation) help Legal Enablers develop legal rationalizations for dubious corporate acts without fear that their work will be reviewed later in court. What happens under the new law when a lawyer learns of possible securities law or fiduciary breaches in the course of having a privileged conversation or reviewing a work-product document? There should be no conflict. The board of directors, to whom the lawyer must report any violations, is the “client.” The new law helps lawyers remember who they are working for – the corporation, not management.
So this new law is a small step in the right direction for the legal profession. Congress and the SEC should resist the ABA’s attempts to overturn it. We will have far fewer Enrons and Worldcoms if the legal profession has more Trusted Counselors. Business leaders desire this type of legal service. Now all we need are more lawyers with the business acumen and professional responsibility to offer it.