ABS simpliciter

The Gazette is reporting that the SRA, “has rejected the suggestion that innovative business structures present a greater risk of financial failure.” And in particular have said, or rather Crispin Passmore their Executive Director has said, that, “alternative business structures listed on the stock exchange or attracting private equity investors were no more likely to be profit-hungry than any other kind of legal services provider.”

I think this is a simplification which, if the Gazette have reported it accurately and fully, the regulators would be wiser to be a bit wary of.

What I think the SRA are right to push back against is those in the profession who are too quick to claim that lawyers are unsullied by the profit motive. It is flat out daft. Lawyer firms are businesses either by necessity (they need to make a profit to survive) or design (they want to make a profit because status, reward, and the joys of moolah are important to them). An important point here is that there are potentially intrinsic and extrinsic motivations at work in law firms. Let’s call those two motivations a justice orientation and a self-enhancement orientation for simplicity. Lawyers, indeed human beings generally, each balance those two orientations differently: for some self-enhancement is more important than others, similarly for some justice is more important than self-enhancement (see here for a study on commercial lawyers on this point and here for one on law students).* The same is very likely true for law firms. For this reason, some are more profit-hungry than others.

The same is also true for other businesses: the owners, managers, and employees all have their own justice/self-enhancement dispositions. Lawyers do not have a monopoly over the justice disposition and businesses do not have a monopoly over the self-advancement disposition. In this very simplistic sense, one would not have a reason for saying that ABSs cannot be more or less justice-oriented than law firms.

It is not that simple though. Firstly, there is important evidence that business structures, particularly financial incentives, influence how lawyers balance justice and self-enhancement concerns. In particular, in-house lawyers have been shown to take riskier decisions where they are more strongly aligned – through bonuses for example – with the commercial imperatives of the business (see this post where I discuss some of the research at length). Stronger financial incentives can and probably do mean in-house lawyers allow or help their clients to breach laws more often. I’d bet my bottom dollar the same is true for private practitioners in ABSs or law firms.

Again, at one level, it can be argued that both law firms and ABSs have mechanisms for aligning the commercial imperatives of the business and the behaviour of their lawyers. ABSs and law firms might be so similar as to be the same. If that were true, the SRA would be right to argue that there is no in principle reason for thinking that ABSs are worse than solicitors firms. Indeed, there are lots of reasons for thinking that firms have quite bad approaches to the management of incentives. Also, as that post on in-housers shows, other factors compete for and modify the influences on legal decision-making. ABSs might be better or worse in terms of the panopoly of potential influences on decisions and conduct.

The trouble is, it is not simply an in-principle decision. There is an important empirical question which is what are the influences work in ABSs and solicitors firms really and how strong or weak are they really? One would expect a great deal of variation between the groups: some ABSs will do a good job of managing those influences, as will some firms, and vice versa. That is not the same, however, as there not being some general differences between the two groups, or for particular subsets within those groups. Variation within groups does not mean there is no variation between groups.

To give a particular example, it is to my mind rather surprising to suggest that – in general – ABSs funded by venture capital would not be riskier. In general terms, it seems to me plausible, that generlaly they would be more driven by short-term economic interests than ABSs and law firms generally. And, again in general, they would also be more likely to have less sympathy for, interest in, create less space for, or manage for, a justice orientation in terms of the staff they attract and the way they deliver their work. In that sense, I think firms funded by venture capital probably are – at least a bit – more likely to be profit hungry than ordinary firms. My prior is that it is as daft to say otherwise as it is for law firms to say they are unsullied by the profit motive. The same may also be true for those listed on the stock exchange. No doubt many readers will be muttering about Carillion, given recent news.

I don’t want oversimplify; it is important to bear in mind that there may be benefits to some of the models which are riskier in regulatory terms. In particular, transformational change in the legal services market, should such a thing be possible, might be more likely to come from organisations with new ‘unlawerly’ ideas and a higher risk appetite. It might be – is in plenty of circumstances – worth tolerating higher regulatory risk for such potential benefits – but we should not pretend the risks are lower simply to seek out the benefits.

Of course I might be wrong. Venture capitalists might be just as balanced as lawyers or, more likely, law firms might be as financially driven as VCs. My central point is that we do not know enough about the competing strengths and weaknesses of ABSs in general or law firms, in general, to really, to begin to quantify properly the relative levels of risk. The SRA may have information which it is not shared which enables this quantification, but I doubt it. More likely, is the common approach of legal service regulators which is to make a claim in sympathy with their general policy and, because there is an absence of evidence, say there is no evidence to contradict it, or to cling to rather slim evidence in the favour of their preferred position. The LSB’s work on innovation tends to fall into this camp, for example. It is a product of small budgets and the hopes that they have for changing the legal services market,

In some ways, I do not criticise the approach: all decision-makers have to proceed in the absence of perfect, often even adequate, evidence. What I would criticise, however, is an un-nuanced awareness of the very significant gaps in knowledge and how they might impact on the correctness of, or in the implementation of policy. To reduce it to its simplest: I do not think we know how profit hungry law firms are in general and how profit hungry ABSs are in general. All will want profits, but some will want profits more than others. I would, in particular, speculate that certain kinds of ABSs would be generally at the upper end of profit-hungry spectrum and, again to speculate, in general, that would mean that ABSs were indeed more profit-hungry than law firms. Even if I am wrong about that it would be bizarre in the extreme to claim that ABSs and law firms risk profiles were the same. After all if ABSs are just like law firms why have ABSs? It would be rather convenient if they were different only in positive attributes.

That is not to say there would not be exceptions, or that (say) ABSs funded by venture capital should be forbidden, or indeed that they should necessarily be heavily regulated, but it would suggest they are probably somewhat higher risk. And that the higher risk should be borne in mind by the regulators when licensing, supervising, and/or investigating such licensees rather than finessed because of an overly-simple argument and absence of evidence. I supported, and continue to support, the introduction of ABSs into legal services. But I do not support the simple stories that are told about them. Quindell and so on remind us of the potential for spectacular failure. Firms fail too. Example and counter-example may not be enough to defend ABS policy if there is another spectacular implosion. Put another way, scandals are not rational and nor is the current argument about ABSs. Those arguments need a more robust foundation than they currently have.

*if you are interested in the studies but cannot gain access, please feel free to email me.


7 thoughts on “ABS simpliciter

  1. Richard, you are definitely correct that law firm partners are materially driven by the profit motive. I do think though if an ABS is funded by private equity/venture capital they must be absolutely ruthless in the pursuit of profit – they normally have a relatively short (sometimes 2-3 year)investment horizon for their funds, after which they look to exit through a secondary buy out or – depending on market conditions – an IPO. That pressure must have a major bearing on the way they go about business I would have thought. A very interesting area, worthy of more research!

  2. See also the SRA comment today on the research showing that price is not a significant factor in decisions by clients about where to go for conveyancing- this research used as a reason to quote price. No question that price openness is important and useful- just amazing how the SRA constantly twists the results of their research or their consultations without any integrity.

  3. In 45 years in-house practice, I cannot recall ever,or ever seeing colleagues, recommend that an illegal activity be undertaken. You would be correct to say ,however, that an in-house lawyer close to the business might have a higher appetite for legal risk – but legal risk and illegality are very different things.

    1. Thank you for your comment.

      I did not say that in-house lawyers recommended illegal activity. The position is usually more subtle than that. I think it is dangerous, and simplistic, I’m afraid, to (unintentionally) reduce professional responsibility to whether or not somebody recommends illegal activity. There is a whole range of activity short of recommending illegality which is relevant to misconduct by clients or, indeed, by professionals. Lawyers have to ask themselves, not only whether they have recommended the legality but whether they have been vigilant enough about what the facts of the situation are, whether they have been proactive enough, how they advise, when they advise, and so on. The same kind of considerations that go to being commercial enough are also relevant to whether one has been professional enough.

      In any event, I think you are mistaken to say that legal risk is different from illegality. In a way it is, but there is an overlap too. One example from many: look at Rolls-Royce and contracts for bribes being classified as high risk.

      1. I agree that the expression “legal risk” covers a wide spectrum from criminality to mere unenforceability in civil proceedings. My impression is that these days , risk professionals (including lawyers) in investment banks are appraised for the quality of their technical contribution, not on the basis that there advice is what their commercial colleagues want to hear. Obviously it is difficult to always get this right ,and we in-house lawyers are as fallible and human as you academics. It is tremendous working in-house as part of a business and inevitably you become partisan. Citibank dealt with this very well by having a lawyer independent from the business in question , signing off on new product approvals and the like, Generally,I found the senior management I advised very risk aware which is not to say on an issue like netting in China they might not take what some might perceive as an “aggressive view”. But an aggressive course of action is not necessarily illegal.

      2. Thank you. V interesting. I make no claims about academics and ethics, and definitely not one’s of superiority, either generally or for myself. Honest!

      3. Thank you for your very generous response. At the risk of going off-piste : A part of the problem of a lawyer being a risk manager is that we may not necessarily have a sufficient grasp of the commercial activities and drivers I.e. The facts of the matter, to be able to apply and analyse the applicable law/regulation. I think there is a lot to be said for it to be compulsory for lawyers in finance to be dual qualified i.e. In both finance and law, There are some LLM courses that address this, also ,I note, merely for example that some of the most able derivatives lawyers at Linklater’s are also holders of masters degrees in finance from the London Business School.

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