Federal Judge Dismisses Suit Challenging Ban on Outside Ownership of Law Firms

Sunday, March 25th, 2012 at 11:06 am, by Linda Shen

On March 8, federal district court Judge Lewis Kaplan of New York dismissed a suit in which Jacoby & Meyers, a 60-lawyer personal injury plaintiffs’ firm that is well-known for its televised legal advertising, challenged a state rule that bans non-lawyer investment in law firms.

Jacoby, which has offices in New York, New Jersey, and Connecticut, had filed lawsuits in each of these states in May 2011, each of which challenged the states’ rules of professional conduct prohibiting non-lawyers from possessing an ownership stake in law firms.  Similar restrictions on non-lawyer ownership of businesses exist in every jurisdiction in the United States, with the exception of the District of Columbia.  These ethics rules are established largely by the state supreme courts.  They stem from the concern that accepting non-lawyer investments may compromise the professional independence of a law firm and its lawyers, thereby undermining the duty to the client.  According to Stephen Gillers, an ethics professor at the New York University School of Law, “[t]he investors would have power over the lawyers and the investors, unlike the lawyers, are not governed by ethics rules.”  The defendants in each of these cases are state judges who authorize the rules of professional conduct.

In the New York lawsuit, Jacoby argued that Rule of Professional Conduct 5.4 violated the First Amendment freedom of association rights, along with several other constitutional provisions.  According to Jacoby, permitting investment from non-lawyers could help smaller law firms to compete with their larger rivals, as the current rule hurts the firm’s ability to raise capital to cover its technology and expansion costs.  Specifically, Jacoby stated in its New York complaint that other sources of funding, including bank loans and capital contributions by partners, were either too expensive or unavailable.  Consequently, the rule impairs the firm’s ability to offer low-cost legal services to “communities in which working-class, blue-collar and immigrant families reside.”  Jacoby further argued that “the practice of law in the United States is at serious risk of falling behind the rest of the world,” pointing to the fact that the United Kingdom and Australia have both in recent years changed their rules to permit outside investment in law firms.  Jacoby notes that it already has a number of high net-worth individuals committed to investing capital in the firm in exchange for equity interest, including Michael Ostrow, Anthony Costa, and Philip Cuarnieri, all of whom are directors in an Empire State Bank holding company called ES Bancshare, and the latter of whom is president of a New York Mercedes-Benz dealership.

In the New York ruling, Judge Kaplan did not reach the constitutional questions.  Instead, Judge Kaplan found that even if he were to strike down Rule 5.4 as unconstitutional, other New York laws would still restrict Jacoby’s ability to raise money from non-lawyers.  For instance, §1500(a)(I) of New York State’s partnership law prevents limited liability partnerships from having non-lawyers as partners.  Because Rule 5.4 was the only one challenged by Jacoby, any opinion he issued would be therefore be advisory and forbidden by the Constitution.  (Judge Kaplan wrote, “plaintiffs could not accept non-lawyer equity investments even if they won on the merits of their constitutional claims . . . Hence, the ruling that they seek would be a purely advisory declaration of the sort that is forbidden to federal courts under Article III of the U.S. Constitution.”)  Judge Kaplan also found that Jacoby lacks standing to bring the case because it has not shown it was harmed by the rule, and that federal court lacks jurisdiction to hear the case, which involves state court issues.  Additionally, he noted that allowing outside investment in law firms may be analogous to a “deal with the devil.”

Just shortly prior to the New York ruling, federal district court judge Peter Sheridan of New Jersey had allowed a similar lawsuit to proceed, denying a motion to dismiss Jacoby’s suit which had been filed by the justices of the New Jersey Supreme Court.  Sheridan ruled that the court needs to first determine if outside investment may already be permitted under the state’s rules of professional conduct, and had asked the New Jersey Supreme Court to explore that issue.  Sheridan additionally noted that the federal court still has jurisdiction over the constitutional issues that the suit raises.

In the Connecticut case, the Connecticut Bar Association has filed an amicus brief, which sided with the state judges and which criticized Jacoby for attempting to circumvent the “careful and thorough process” that exists for changing Connecticut’s rules of professional conduct.

In addition to the recent changes in rules by the United Kingdom and Australia, Jacoby’s lawsuits come at a time when non-lawyer ownership of law firms is under consideration by the American Bar Association (“ABA”) and the New York State Bar Association (“NYSBA”).  In December of last year, an ABA commission had released a draft paper analyzing a recommendation to allow firms to give non-lawyers they employ a financial interest in the firm and a share in its profits.  The ABA commission urged that an existing ban be maintained in the United States on the kind of outside investment that is currently allowed in the United Kingdom and Australia.  In February of this year, NYSBA President Vincent Doyle had announced that the association was forming a task force to study whether non-lawyers should be allowed to own equity in firms.

In light of Judge Kaplan’s dismissal, Jeffrey Carton of Meiselman, Denlea, Packman, Carbon & Eberz, the lawyer for Jacoby in this suit, said his client plans to appeal Kaplan’s decision to the Second Circuit, noting that Jacoby “is looking forward to changing the status quo” and that “[t]hese issues are far too important not be addressed substantively.” Carton further noted, “[t]he parallels that can and should be drawn to the challenge was the ban against attorney advertising decades ago, so in some respects, history repeats itself, it took those efforts all the way up to the U.S. Supreme Court.”

New York State Assistant Attorneys General, Daniel Schulze and Michael Siudzinski, are representing the New York judges who were named as the defendants in the lawsuit.