Ongoing Debates Re-Shaping Legal Industry: ABA Model Rule 5.4 at the intersection of regulation and innovation, with a Global Perspective
15 Jan 2024 | Agustín Iraola
Our previous article delved into the significant transformations sweeping through the legal industry, primarily driven by rapid AI technological advancements and evolving market demands. However, these changes are not happening in a vacuum. Central to understanding them is recognizing how they interact with the regulatory frameworks governing legal practice.
ABA Model Rule 5.4, which essentially governs the prohibition of non-lawyer ownership and fee-sharing in law firms, stands as a pivotal example in this context.
Against this backdrop, this article aims to dissect how the ongoing and potential amendments to Rule 5.4 not only mirror these industry transformations but also significantly influence them. We will explore how these regulatory developments, both in the U.S. and around the world, could become a decisive factor in accelerating (or not) the pace of change within the legal industry.
Traditional Legal Landscape and Liberalization
Tracing its roots to ancient Greece, the legal profession has undergone significant evolution. Athenian orators, akin to early advocates, were initially barred from earning fees, a restriction later lifted in ancient Rome, leading to the formal recognition and regulation of legal practice. Over centuries, stringent qualifications and regulations evolved, requiring formal legal education and bar association membership for legal practice. In the modern era, this has culminated in strict norms aimed at ensuring professional competence and integrity, among other things.
In the U.S. the legal profession is primarily regulated by state-specific rules, supplemented by the American Bar Association’s (ABA) Model Rules of Professional Conduct, guiding state bar associations.
In this context, the “liberalization” trend emerges as a key driver of change. Defined by Richard Susskind as the “relaxation of the laws and regulations that govern who can offer legal services and from what types of business entities”, this phenomenon challenges the existing regulatory framework, advocating for more choices in legal services and breaking what some see as a monopoly of traditional practices. In the U.S., the discussion of liberalization is intertwined with the specifics of ABA Model Rule 5.4, initially adopted in some way by most state bar associations.
What is ABA Model Rule 5.4?
ABA Model Rule 5.4 primarily focuses on maintaining the professional independence of lawyers. It essentially prohibits lawyers from sharing legal fees with non-lawyers, forming partnerships with non-lawyers if any part of the partnership involves the practice of law, and prevents non-lawyers from having a direct or indirect management or ownership interest in a law firm. This rule has long been seen as a safeguard, ensuring that lawyers’ judgment remains unimpaired by outside business interests.
Modifications and Debates Around Rule 5.4
In recent years, some state bar associations in the U.S. have reevaluated Rule 5.4, leading to significant modifications in the legal industry.
Arizona eliminated it in 2020, embracing Alternative Business Structures (ABSs), which allow non-lawyers to own or invest in law firms, with certain requirements.
Utah’s bar initiated a seven-year regulatory sandbox for non-lawyer-owned entities to provide legal services.
California, while not allowing non-attorney ownership, amended Rule 5.4 to enable greater fee sharing with certain non-profits. Other states, like Massachusetts and Georgia, have opted for middle-ground modifications, allowing certain fee-sharing arrangements with the client’s prior consent or within institutions that operate in states where this kind of practice is allowed.
States like Illinois, Michigan, and North Carolina are contemplating similar changes, whereas New York and Florida remain unchanged, maintaining the traditional structure of legal practice.
In response to these state-level changes and discussions, the ABA passed a resolution in August 2022 affirming its support for current Model Rule 5.4, highlighting the importance of maintaining lawyers’ professional independence and prioritizing client interests.
Global Perspective
Globally, the liberalization of legal services has seen significant developments. In England and Wales, the Legal Services Act 2007 introduced Alternative Business Structures (ABSs), enabling non-lawyers to own and manage legal businesses, fostering external investment and diversification in the legal sector. Scotland has implemented similar reforms, albeit more conservatively. Australia, pioneering in legal industry liberalization, also adopted ABSs, leading to notable examples like Slater & Gordon’s public listing in the Australian Securities Exchange, despite the final fate of that enterprise which finalized with the acquisition of the law firm by a private equity fund in 2023. These changes are reported to have neither significantly escalated malpractice cases nor diminished the revenues of major law firms; rather, they have facilitated broader access to legal services.
Potential Implications for the Legal Profession
As liberalization gradually takes root in the U.S. legal industry, the potential implications of amending Rule 5.4 or its state equivalents could be significant. Drawing from global experiences, some of them are particularly noteworthy:
- Access to Capital and Technology Development: the influx of external capital from private equity firms, venture capitalists, hedge funds, and corporations stands out as a major implication of non-lawyer ownership. This new funding would likely catalyze substantial technological innovation and growth, including the development of AI systems specifically tailored by those law firms to enhance their delivery of legal services.
- Opportunities for Small/Middle Market Firms: that very access to new sources of funding could revolutionize small and middle-market law firms, traditionally dependent on equity partner investments and fee-generated revenue. This change could allow them to more effectively compete with larger firms, leveling the playing field and fostering a competitive environment.
- Growth of Alternative Legal Service Providers (ALSPs): amendments to ABA rule 5.4 and its state equivalents, could significantly benefit ALSPs, which are typically engaged in commoditized, lower-end legal work. These providers may extend their services to complex legal advice through lawyer partnerships. LegalZoom, with its ABS license in the U.K. and authorizations in Arizona and Utah, exemplifies this expansion, reflected in its nearly 2 billion USD market cap on Nasdaq.
- Acceleration of Legal Service Disaggregation: the rise of ALSPs offering low-cost solutions is expected to expedite the disaggregation of legal work into specialized components. This includes areas like e-discovery, document automation, and contract management. Such a trend promotes competitive pricing, client cost benefits, and encourages innovation and specialization within the legal sector.
- Enhancing Access to Justice: the push for this regulatory relaxation is closely linked to increasing access to legal services, aiming to make legal advice more affordable and broadly accessible for those currently priced out of the market. Driven by increased investment, technological developments and new market competition, this initiative is expected to result in an expansion in the availability of legal services. This expansion is likely to lower costs in many legal areas, extending service reach and promoting equal access to the legal system.
- Impact of Accounting & Consulting Firms: The Big Four –Deloitte, KPMG, PwC, and E&Y– along with other accounting and consulting firms, have a longstanding role in legal services, particularly in areas like document review and fact discovery. Although direct legal practice is restricted for them in many U.S. states, these firms might significantly expand their services to include higher-end legal solutions if regulatory changes allow. Already surpassing traditional law firms in size and revenue, their established operations in markets like the U.K. under ABS licenses indicate potential for similar growth in the U.S.
Conclusion: Balancing Tradition with Innovation
The evolving legal landscape, exemplified by potential changes to ABA Rule 5.4, strikes a crucial balance between tradition and innovation. While the traditions of the legal profession –its professional rigor, ethical standards, and commitment– have long been its cornerstone, the winds of change are ushering in an era of unprecedented transformation driven by technology which needs to be joined by a propitious regulatory framework. This shift should ultimately benefit the heart of the $950 billion worldwide legal industry: the clients.
By embracing innovation, we are not discarding tradition but rather enhancing it, ensuring that legal services evolve to meet contemporary needs without compromising on their foundational principles. As this industry potentially unlocks greater volumes and varieties of legal services, it is the clients who stand to benefit the most – receiving better quality services at more affordable rates.
References
Susskind, Richard. Tomorrow’s Lawyers: An Introduction to Your Future. 2nd ed., Oxford University Press, 2017. American Bar Association. Model Rules of Professional Conduct. Jacoby, Conrad J., Esq. “Non-lawyer ownership of law firms — Are winds of change coming for Rule 5.4?” Thomson Reuters Institute, March 2022. Carr, David C. “Legislature Chills Non-Lawyer Participation in Providing Legal Services”. BLAWG 401, June 2022. Barton, Roger E. “Changing the stakes: how evolving law firm ownership rules could (or could not) re-shape the legal industry”. Thomson Reuters Institute, August 2021. Curle, David. “Scaling and Amplifying Legal Work, Part 3: Disaggregation in Legal Services”. OKira – Next Gen Lawyers, 2020. Stephanie Wilkins. “Cornell Tech Professor and Former Reed Smith Partner (Ed Estrada) Talks Legal Tech and Law Firm Business Strategy”. LegalTech News Online, November 7, 2022. Reynolds, Matt. “When it comes to deregulation of the legal industry, divisions run deep”. ABA Journal, November 16, 2023. Engstrom, David Freeman, Ricca, Lucy, Ambrose, Graham, and Walsh, Maddie. Legal Innovation After Reform: Evidence From Regulatory Change. Stanford Law School, September 2022.