Under ER 5.7, adopted in December 2003, a lawyer who operates a separate investment advisory business may refer non-clients to an investment advisory firm that pays a referral fee to the lawyer, so long as the lawyer takes reasonable steps to assure that the non-clients understand they are not receiving legal services and they do not have the protections of a lawyer-client relationship. A lawyer who provides such services to former clients must also comply with the confidentiality requirements and other obligations under ER 1.9, and should take particular care to assure that the former clients understand they do not have a lawyer-client relationship with respect to the investment transactions. A lawyer may not refer a current client to such a program, however, unless the lawyer meets the "heavy burden" of showing compliance with ER 1.7 and 1.8(a). Also, a lawyer who provides investment advisory services must satisfy ERs 7.1 through 7.3 and maintain separation between the law practice and the lawyer's investment advisory business so that they do not appear to be related.
To the extent previous Arizona ethics opinion 98-09 is inconsistent with ER 5.7 and the analysis in this opinion, the earlier opinion is no longer effective.
A dissenting opinion issued contemporaneously by the committee, recommends a per se ban against lawyers accepting money from third-party professionals in exchange for referring law clients to those third-party payors. However, like the majority, we agree that a lawyer can accept a fee from a third-party professional for referring non-clients to the third-party's firm, provided that the lawyer complies with Rule 5.7.
FACTS[1]
The inquiring attorney proposes to contract with an investment advisory firm to provide investment-related services -- as distinct from legal services -- to persons in Arizona. The lawyer would register, either individually or through a corporation, as an investment advisor in compliance with state and federal laws and would maintain his investment advisory functions as a separate business distinct from his law practice. The investment advisory firm would pay the lawyer a fee for referring customers to the firm; this fee would be an ongoing percentage of the customer's fees to the investment advisory firm for its services.
The lawyer's involvement with regard to the investment services would be limited to the following: (1) providing materials about the investment advisory firm to the customer; (2) introducing the customer to the registered personnel of the investment advisory firm; (3) attending meetings where the firm's personnel would explain the investment program and assist the customer in choosing investment services suited to the customer's needs; and (4) receiving copies of periodic investment advisory statements so that the lawyer may monitor the customer's involvement in the investment program.
Thus, it would be inaccurate to characterize the payment involved as merely a "referral" fee; instead, the lawyer would offer, through a separate business, limited investment-related services and would be paid a fee or commission based on an ongoing percentage of the fees paid by the customer to the investment advisory firm.
The lawyer would not provide investment-related services in the same matter in which the lawyer provides legal services. The lawyer also would disclose in writing to the customers that the investment services are not legal services and the protections of the client-lawyer relationship do not apply.
QUESTION PRESENTED
Do the Arizona Rules of Professional Conduct prohibit a lawyer from receiving a fee for referring persons to an investment advisory firm in the described circumstances?
RELEVANT ETHICAL RULES
ER 1.7 Conflict of Interest: General Rule
(a) Except as provided in paragraph (b), a lawyer shall not represent a client if the representation involves a concurrent conflict of interest. A concurrent conflict exists if:
. . .
(2) there is a significant risk that the representation of one or more clients will be materially limited by the lawyer's responsibilities to another client or to a third person or by a personal interest of the lawyer.
(b) Notwithstanding the existence of a concurrent conflict of interest under paragraph (a), a lawyer may represent a client if each affected client gives informed consent, confirmed in writing, and:
(1) the lawyer reasonably believes that the lawyer will be able to provide competent and diligent representation to each affected client;
(2) the representation is not prohibited by law; and
(3) the representation does not involve the assertion of a claim by one client against another client represented by the client in the same litigation or other proceeding before a tribunal.
ER 1.8 Conflict of Interest: Prohibited Transactions
(a) A lawyer shall not enter into a business transaction with a client or knowingly acquire an ownership, possessory, security or other pecuniary interest adverse to a client unless:
(1) the transaction and terms on which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed and transmitted in writing to the client in a manner that can be reasonably understood by the client;
(2) the client is advised in writing of the desirability of seeking and is given a reasonable opportunity to seek the advice of independent counsel in the transaction; and
(3) the client gives informed consent, in a writing signed by the client, to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction.
ER 5.7 Responsibilities Regarding Law-Related Services
(a) A lawyer may provide, to clients and others, law-related services, as defined in paragraph (b), either:
(1) by the lawyer in circumstances that are not distinct from the lawyer's provision of legal services to clients; or
(2) by a separate entity which is controlled by the lawyer individually or with others.
Where the law-related services are provided by the lawyer in circumstances that are not distinct from the lawyer's provision of legal services to clients, the lawyer shall be subject to the provisions of the Rules of Professional Conduct in the course of providing such services. In circumstances in which law-related services are provided by a separate entity controlled by the lawyer individually or with others, the lawyer shall not be subject to the Rules of Professional Conduct, in the course of providing such services, only if the lawyer takes reasonable measures to assure that a person obtaining the law-related services knows that the services of the separate entity are not legal services and that the protections of the client-lawyer relationship do not apply.
(b) The term law-related services denotes services that might reasonably be performed in conjunction with and in substance are related to the provision of legal services, and that are not prohibited as unauthorized practice of law when provided by a non-lawyer.
ER 7.1. Communications Concerning a Lawyer's Services
A lawyer shall not make a false or misleading communication about the lawyer or the lawyer's services. A communication is false or misleading if it contains a material misrepresentation of fact or law, or omits a fact necessary to make the statement considered as a whole not materially misleading.
ER 7.2. Advertising
(a) Subject to the requirements of ERs 7.1 and 7.3, a lawyer may advertise services through written, recorded or electronic communication, including public media.
(b) A lawyer shall not give anything of value to a person for recommending the lawyer's services except that a lawyer may:
(1) pay the reasonable costs of advertisements or communications permitted by this Rule;
(2) pay the usual charges of a legal service plan or a not-for-profit or qualified lawyer referral service. A qualified lawyer referral service is a lawyer referral service that has been approved by an appropriate regulatory authority; and
(3) pay for a law practice in accordance with ER 1.17.
(c) Any communication made pursuant to this Rule shall include the name and office address of at least one lawyer or law firm responsible for its content.
(d) Every advertisement (including advertisement by written solicitation) that contains information about the lawyer's fees shall be subject to the following requirements:
(1) advertisements and written solicitations indicating that the charging of a fee is contingent on outcome or that the fee will be a percentage of the recovery shall disclose (A) that the client will be liable for expenses regardless of outcome unless the repayment of such is contingent upon the outcome of the matter and (B) whether the percentage fee will be computed before expenses are deducted from the recovery;
(2) range of fees or hourly rates for services may be communicated provided that the client is informed in writing at the commencement of any client-lawyer relationship that the total fee within the range which will be charged or the total hours to be devoted will vary depending upon that particular matter to be handled for each client and the client is entitled without obligation to an estimate of the fee within the range likely to be charged;
(3) fixed fees for specific routine legal services, the description of which would not be misunderstood or be deceptive, may be communicated provided that the client is informed in writing at the commencement of any client-lawyer relationship that the quoted fee will be available only to clients whose matters fall within the services described and that the client is entitled without obligation to a specific estimate of the fee likely to be charged;
(4) a lawyer who advertises a specific fee, range of fees or hourly rate for a particular service shall honor the advertised fee, or range of fees, for at least ninety (90) days unless the advertisement specifies a shorter period; provided, for advertisements in the yellow pages of telephone directories or other media not published more frequently than annually, the advertised fee or range of fees shall be honored for no less than one year following publication.
(e) Advertisements on the electronic media may contain the same information as permitted in advertisements in the print media. If a law firm advertises on electronic media and a person appears purporting to be a lawyer, such person shall in fact be a lawyer employed full-time at the advertising law firm. If a law firm advertises a particular legal service on electronic media, and a lawyer appears as the person purporting to render the service, the lawyer appearing shall be the lawyer who will actually perform the service advertised unless the advertisement discloses that the service may be performed by other lawyers in the firm.
(f) Communications required by paragraphs (c) and (d) shall be clear and conspicuous. To be "clear and conspicuous" a communication must be of such size, color, contrast, location, duration, cadence, and audibility that an ordinary person can readily notice, read, hear, and understand it.
ER 7.3. Direct Contact with Prospective Clients
(a) A lawyer shall not by in-person, live telephone or real-time electronic contact solicit professional employment from a prospective client when a motive for the lawyer's doing so is the lawyer's pecuniary gain, unless the person contacted:
(1) is a lawyer; or
(2) has a family, close personal, or prior professional relationship with the lawyer.
(b) A lawyer shall not solicit professional employment or knowingly permit solicitation on the lawyer's behalf from a prospective client by written, recorded or electronic communication or by in-person, telephone or real-time electronic contact even when not otherwise prohibited by paragraph (a), if:
(1) the prospective client has made known to the lawyer a desire not to be solicited by the lawyer;
(2) the solicitation involves coercion, duress or harassment; or
(3) the solicitation relates to a personal injury or wrongful death and is made within thirty (30) days of such occurrence.
(c) Every written, recorded or electronic communication from a lawyer soliciting professional employment from a prospective client known or believed likely to be in need of legal services for a particular matter shall include the words "Advertising Material" in twice the font size of the body of the communication on the outside envelope, if any, and at the beginning and ending of any recorded or electronic communication, unless the recipient of the communication is a person specified in paragraphs (a)(1) or (a)(2).
(1) at the time of dissemination of such written communication, a written copy shall be forwarded to the Clerk of the Arizona Supreme Court and the State Bar of Arizona at its Phoenix office;
(2) written communications mailed to prospective clients shall be sent only by regular U.S. mail, not by registered mail or other forms of restricted delivery;
(3) if a contract for representation is mailed with the written communication, the contract shall be marked "sample" in red ink and shall contain the words "do not sign" on the client signature line;
(4) the lawyer initiating the communication shall bear the burden of proof regarding the truthfulness of all facts contained in the communication, and shall, upon request of the State Bar or the recipient of the communication, disclose:
(A) how the identity and specific legal need of the potential recipient were discovered; and
(B) how the identity and knowledge of the specific need of the potential recipient were verified by the soliciting lawyer.
(d) Notwithstanding the prohibitions in paragraph (a), a lawyer may participate with a prepaid or group legal service plan operated by an organization not owned or directed by the lawyer that uses in-person or telephone contact to solicit memberships or subscriptions for the plan from persons who are not known to need legal services in a particular matter covered by the plan.
RELEVANT ARIZONA ETHICS OPINIONS Ariz. Ethics Op. 99-09 (lawyer may provide securities and insurance services to clients for commissions if lawyer satisfies ER 1.7 and ER 1.8).
Ariz. Ethics Op. 98-09 (lawyer's acceptance of referral fee from investment adviser for referring clients to the advisor is a "per se" conflict of interest under ER 1.7).
OPINION Analysis of the question presented largely turns on ER 5.7, which expressly recognizes that lawyers may provide "law-related services" either in circumstances that are not distinct from providing legal services to clients or by a separate entity that is controlled by the lawyer individually or with others. Investment services, as the comments to ER 1.8 recognize, are an example of law-related services. ER 1.8, cmt. ¶ 1; see also ER 5.7, cmt. ¶ 9 (identifying examples of law-related services, including providing financial planning).
Before the adoption of ER 5.7, Arizona was among several states that concluded it is an impermissible conflict of interest for a lawyer to receive fees from an investment advisory firm for referring clients to the firm for investment services. [2] Other states, however, have concluded that such referral fees do not violate the ethical rules provided certain requirements are met, including adequate disclosure and consent by the client involved in the transaction. [3]
In Opinion 98-09, the Committee considered a referral program similar to the one described by the inquiring attorney. The Committee then concluded that a lawyer's operation of an investment advisory referral program would constitute a "per se" conflict of interest under ER 1.7(b). This opinion did not address the application of ER 1.8(a) concerning business transactions with clients. See Ariz. Ethics Op. 98-09 at 4 n.2. It is also somewhat in tension with a later opinion, Opinion 99-09, which concluded that a lawyer, who was registered as an investment advisor, may offer investment services to existing clients if the lawyer "stringently complies" with all of the requirements of ER 1.7 and ER 1.8. The later opinion recognized the lawyer would be paid a commission for selling investment products to client customers, and discussed a California ethics opinion concluding that, subject to certain requirements, a lawyer could receive commissions for referring clients to an insurance agent who sold them policies. See Ariz. Ethics Op. 99-09 at 4-5.
Since the Committee issued these opinions, the Arizona Supreme Court in 2003 significantly amended the Rules of Professional Conduct, and the amendments included the addition of ER 5.7. This rule concerns a lawyer's provision of "law-related services" and is based on, but not identical to, Model Rule 5.7 as approved by the American Bar Association ("ABA").
Provision of "law-related services" is also sometimes referred to as ancillary business activities. ER 5.7 reflects an evolution in the view of the propriety of such activities by lawyers. See ABA CTR. OF PROF'L RESPONSIBILITY, ANNOTATED MODEL RULES OF PROFESSIONAL CONDUCT (5th ed. 2003) at 501-603 (discussing background to model Rule 5.7). The ABA House of Delegates in 1991 approved a rule that flatly prohibited lawyers from providing ancillary services except to clients in connection with the provision of legal services. That rule, however, was repealed the next year. In 1994, the House of Delegates approved the predecessor to ER 5.7, which recognizes that lawyers may provide "law-related" or ancillary business services and identifies circumstances in which such activities are subject to the ethics rules governing lawyers.
As adopted in Arizona in 2003, ER 5.7 provides:
A lawyer may provide, to clients and to others, law-related services, . . . either:
Law-related services are in turn defined as "services that might reasonably be performed in conjunction with and in substance are related to the provision of legal services, and that are not prohibited as unauthorized practice of law when provided by a nonlawyer." ER 5.7(b). As noted above, investment services are identified in the comment to ER 1.8 as an example of law-related services.
The circumstances in which a lawyer provides "law-related services" determine whether the lawyer is subject to the Rules of Professional Conduct in the course of providing such services. In this respect, it is important to distinguish between non-clients and clients.
1. Provision of Investment Services to Non-Clients
Under ER 5.7, if a lawyer provides investment services to a non-client through a separate entity that is controlled by the lawyer individually or with others, the lawyer "shall not be subject to the Rules of Professional Conduct in the course of providing such services," provided that the "lawyer takes reasonable steps to assure that a person obtaining the law-related services knows that the services of the separate entity are not legal services and the protections of the client-lawyer relationship do not apply." ER 5.7(a).
In contrast, a lawyer who provides law-related services in circumstances that are not distinct from the lawyer's provision of legal services, rather than through a separate entity, is subject to the Rules of Professional Conduct in the course of providing such services, even when the lawyer does not provide legal services to the person for whom the law-related services are performed. See ER 5.7 and cmt. ¶ 2.
The inquiring attorney states that he will provide the investment services through a business separate from his provision of legal services. ER 5.7 requires that the services be provided by a "separate entity" if the Rules of Professional Conduct are not to apply to the lawyer's provision of investment services. Although the Rules do not specify any particular form of organization for such an entity, they clearly contemplate some form of business organization distinct from that in which the lawyer provides legal services. The rule further requires that the lawyer, individually or with others, control the entity through which the law-related services are provided.
Provided that the inquiring attorney is operating his investment services activities through an entity distinct from his legal practice, ER 5.7 further requires the attorney to take reasonable steps to assure that non-client customers know that they are not receiving legal services and that the protections of the lawyer-client relationship do not apply.
The steps necessary to assure an appropriate understanding by non-client customers will depend on the circumstances. "The burden is upon the lawyer to show that the lawyer has taken reasonable measures under the circumstances to communicate the desired understanding. For instance, a sophisticated user of law-related services, such as a publicly held corporation, may require a lesser explanation than someone unaccustomed to making distinctions between legal services and law-related services, such as an individual seeking tax advice from a lawyer-accountant or investment services in connection with a lawsuit." ER 5.7, cmt. ¶ 7.
In this context, the lawyer should explain, "in a manner sufficient to assure that the person understands the significance of the fact, that the relationship of the person to the business entity will not be a client-lawyer relationship." Id., cmt. ¶ 6. "This communication should be made before entering into an agreement for provision of law-related services, and preferably should be in writing." Id.
Thus, the inquiring attorney would be acting prudently in providing written disclosure to customers that the investment services are not legal services and the protections of a client-lawyer relationship do not apply. Written disclosure may not, however, be sufficient in all circumstances, as the attorney must explain these facts in a manner sufficient to assure that the particular customer involved understands their significance.
The question posed by the inquiring attorney contemplates that the lawyer will be providing certain investment-related services through a separate entity (the lawyer's investment advisory business), and that entity in turn would receive "referral fees" or commissions from a third-party investment advisory firm to which non-client customers are referred. The Rules of Professional Conduct do not prohibit this activity if the requirements of ER 5.7 are met. Moreover, the Rules do not themselves require the lawyer to disclose to the non-client customer the particular fee arrangement between the lawyer and the investment services firm to which the customer is referred. The Philadelphia Bar Association recently reached a similar conclusion in an opinion applying ER 5.7 to real estate services offered to non-client customers by business entities in which lawyers are involved. See Phila. Bar Ass'n Op. 2002-7.
This Opinion, we emphasize, does not address what disclosure obligations or other legal requirements may apply to the lawyer's activities independent of the Rules of Professional Conduct (e.g. any obligations that may exist under state or federal securities laws or consumer protection laws). Instead, the Opinion presumes that the lawyer complies with applicable legal requirements governing the investment activities. Moreover, even though a lawyer may not be subject to the Rules "in the course of providing" law-related services in circumstances identified in ER 5.7, the lawyer remains "subject to those Rules that apply generally to lawyer conduct, regardless of whether the conduct involves the provision of legal services." ER 5.7, cmt. ¶ 2 (citing ER 8.4.). For example, even if a lawyer were not otherwise subject to the Rules in providing investment services to non-clients, it could be professional misconduct under ER 8.4 for a lawyer to engage in fraud or deceit with regard to such services.
Special considerations apply with regard to non-clients who are former clients. In these circumstances, the lawyer should take particular care to assure that the former client understands that he is not entering an attorney-client relationship with the lawyer who is providing investment services through a separate business entity and that the protections of the attorney-client relationship do not apply to transactions with such an entity. Moreover, the lawyer must also comply with ER 1.9. In particular, the lawyer may not reveal information (for example, to the investment advisory company with which the lawyer works) relating to the representation or, except where information has become generally known, use any information relating to the representation to the disadvantage of the former client.
Finally, as noted above, the lawyer will be subject to the Rules of Professional Conduct in providing investment-related services unless: (1) the services are provided by an entity distinct from that through which the lawyer provides legal services, and (2) the lawyer takes reasonable steps to assure the customers of the separate entity know that its services are not legal services and the protections of the lawyer-client relationship do not apply. If these conditions are not met, the lawyer must adhere to the Rules of Professional Conduct in providing law-related services, and customers of such services must be treated as existing clients for purposes of the Rules. See ER 5.7(a), cmt. ¶ 3.
2. Provision of Investment Services to Clients
ER 5.7 also recognizes that a lawyer may provide law-related services to existing clients. But more exacting ethical restrictions then apply, whether or not the attorney offers such services through an entity separate from the lawyer's provision of legal services. Where a lawyer contemplates business dealings with an existing client, the Rules impose a "heavy burden" on the lawyer to show compliance with "stringent disclosure and consent requirements." These requirements may, as a practical matter, be difficult to meet. See Ariz. Ethics Op. 99-09 at 5.
"When a client-lawyer relationship exists with a person who is referred by a lawyer to a separate law-related services entity controlled by the lawyer, individually or with others, the lawyer must comply with ER 1.8(a)." ER 5.7, cmt. ¶ 6. Similarly, the comment to ER 1.8 notes that this rule applies to the lawyers engaged in the sale of law-related goods or services, such as investment services, to existing clients of the lawyer's legal practice. ER 1.8, cmt. ¶ 1.
Also relevant is ER 1.7, the general conflict of interest rule, which recognizes that "[l]oyalty and independent judgment are essential elements in the lawyer's relationship to a client." ER 1.7, cmt. ¶ 1. Under ER 1.7(a), a lawyer generally may not represent a client if there is a significant risk that the representation will be materially limited by the lawyer's personal interest. Such a "personal interest" conflict may not be waived by a client's informed consent unless, despite the conflict, the lawyer "reasonably believes" the lawyer will be able to provide competent and diligent representation. ER 1.7(b).
Where existing clients are involved, the facts posed by the inquiring attorney describe a proposed business transaction with a client. As such, the transaction must satisfy both ER 1.7 and ER 1.8 to comply with the ethical rules.
As a threshold determination, the lawyer must assess whether the lawyer can refer the client for investment services by the lawyer's separate business, which will receive fees from a third-party investment advisory firm, and also "reasonably believe" that the lawyer will be able to provide competent and diligent representation as required by ER 1.7. See Ariz. Ethics Op. 99-09; Conn. Bar Ass'n, Informal Op. 97-16 (1997). If the answer to this question is no, the lawyer may not provide investment advisory services to the client.
Application of ER 1.7 raises the question whether a lawyer's accepting a "referral fee" for providing investment-related services to a client poses a "per se" conflict of interest under ER 1.7. Opinion 98-09, as noted above, concluded that operation of an investment advisory service very similar to that described by the inquiring attorney presented a "per se" conflict or, in terms of the current Rules, a nonconsentable conflict. For several reasons, we do not believe that Opinion 98-09 is correct with respect to the investment program described by the inquiring attorney.
First, and perhaps most importantly, Opinion 98-09 predates the adoption of ER 5.7 and does not discuss the proposed transaction in terms of ER 1.8(a), which governs business transactions with clients. See Opinion 98-09 at 4 n.2 . ER 5.7 does not adopt a blanket prohibition on a lawyer referring a client for ancillary business services in which the lawyer has a financial interest, but instead contemplates that ER 1.8(a) will apply to such activity. With respect to existing clients, the program described by the inquiring attorney does, in fact, involve a transaction in which a lawyer would be engaging in a business transaction by virtue of providing investment-related services and receiving a referral fee or commission from a third party.
Second, in concluding that the proposed payment of a referral fee for investment services presented a "per se" conflict, Opinion 98-09 noted several concerns. Specifically, the opinion observed that if a lawyer receives a fee from a third party for referring a client for investment-related services, then: (1) disclosure of the attorney-client relationship to a third party for a fee may reduce the client's confidence in the lawyer's ability to provide independent advice; (2) the lawyer's professional judgment may be affected by the fact that the lawyer will receive a fee that is a percentage of the fee the client pays to the investment advisory firm; (3) the client may be reticent with the lawyer because of concerns that information will be given to the investment advisor; and (4) the lawyer, in the converse situation, could not pay a fee to the investment advisor firm for referring clients to the lawyer. See Opinion 98-09 at 5-6.
These concerns, however, do not support the conclusion that a "per se" or unconsentable conflict arises if a lawyer accepts a fee or commission - even if characterized as a referral fee - from an investment advisory firm to which a lawyer, providing investment-related services, refers clients. The concerns noted in points (1) and (3) are obviated by the fact that a lawyer in this situation must comply with the obligations of ER 1.6 regarding confidentiality. Absent a client's informed consent, a lawyer generally may not reveal information relating to the representation of the client to a third party. See ER 1.6(a). This confidentiality rule applies not only to matters communicated in confidence by the client, but to all information relating to the representation, whatever its source. Id. cmt. ¶ 3. See also Conn. Bar Ass'n, Informal Op. 97-16 (1997) at 2 (noting that lawyer who refers client to investment advisor and receives referral fee must comply with ER 1.6). Moreover, we note that the same concerns, and the same obligations of confidentiality under ER 1.6, would apply if the lawyer referred the client to an investment advisory company and directly charged the client a fee for the lawyer's investment-related services.
The concern noted in point (2) is no different than any other situation where a lawyer contemplates entering a business transaction with a client. The prospect that the lawyer will benefit financially in either situation poses the danger of affecting the lawyer's independent judgment. But the Rules do not contemplate that this danger in itself supports a blanket prohibition on lawyers engaging in business transactions with their clients. Instead, the Rules provide such transactions may be permitted if the stringent requirements of ER 1.7 and ER 1.8(a) are satisfied in the particular circumstances.
With respect to point (4), the fact that lawyers may not pay others fees for referring clients to the lawyer, we note that ER 5.7 expressly contemplates that lawyers may refer persons, both clients and non-clients, to separate entities for non-legal, but law related, services. Presumably, the lawyers involved will charge for such services. Thus, the issue presented is more correctly posed as whether a lawyer who provides law-related services to a client may be paid for such services by a third party in the form of a "referral fee" or commission. This situation is more like a third party paying for a lawyer's providing legal services to a client than a lawyer paying the third party for referring the client to the lawyer. Under ER 1.8(f), a lawyer is not prohibited "per se" from accepting payment from a third party for representing a client. Instead, such payment is permitted so long as the client gives informed consent, there is no interference with the lawyer's independent professional judgment or the client-lawyer relationship, and information relating to the representation is protected as required by ER 1.6.
Finally, as also noted above, Opinion 99-09 concluded that a lawyer may offer securities and investment-related services to legal clients if the lawyer complies with the requirements of ER 1.7 and ER 1.8(a). This opinion recognized that the lawyer would be paid a commission for selling securities or insurance products to a client and did not base its conclusion on whether the commission was paid by the client or the third-party provider of the securities or insurance products. Instead, Opinion 99-09 focused on whether, in any particular transaction, a lawyer could reasonably believe that the provision of the non-legal services would not adversely affect the legal representation and, if so, whether the client gives written consent to a transaction that satisfies the fairness requirements of ER 1.8(a) after sufficient disclosure. See Opinion 99-09 at 5-6.
For the foregoing reasons, we agree with the approach taken in Opinion 99-09 and believe it should apply to the inquiring attorney's acceptance of a referral fee, through the lawyer's separate investment services business, for referring clients to an investment advisory firm. Hence, ER 1.7 presents a threshold inquiry, but not a "per se" barrier. [4] A lawyer may not accept such a fee unless the lawyer reasonably believes that the lawyer will still be able to provide competent and diligent representation to the client. If this condition is met, the lawyer must then consider the requirements under ER 1.8(a).
Under ER 1.8, a lawyer may engage in a business transaction with an existing client only under narrowly defined conditions. Although ER 5.7 allows a lawyer to provide law-related services to a client through a separate entity, the lawyer still must satisfy the specific requirements under ER 1.8:
(1) the transaction must be fair and reasonable to the client;
(2) the transaction must be fully disclosed to the client and transmitted in writing in a manner that the client can reasonably understand;
(3) the client must be advised in writing of the desirability of seeking and must be given the opportunity to seek the advice of independent legal counsel in the transaction; and,
(4) the client must give informed consent, in a writing signed by the client, to the essential terms of the transaction, and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction.
ER 1.8(a).
A lawyer faces a "substantial burden" in showing that these requirements are met. See Ariz. Ethics Op. 99-09 at 6-8.
In the context of a lawyer providing investment-related services to an existing client, the lawyer must show that each such transaction is fair and reasonable. Id. Among other things, the lawyer will bear the burden of showing that the lawyer's compensation is reasonable under the circumstances and that the "client was not taken advantage of in any way." Id. (quoting Cal. State Bar Standing Comm. on Prof'l Responsibility Op. 1995-140 at 6.) Thus, the lawyer will be obliged to show that any fees or commissions received are reasonable in relation to the investment-related services provided to the client referred to the third-party investment advisory company. See Ariz. Ethics Op. 99-09 (noting lawyer's burden to show reasonableness of compensation received in form of commissions for brokering insurance or securities products to clients).
The transaction must also be fully disclosed to the client in a manner the client can reasonably understand. Such disclosure must include all of the facts relating the lawyer's relationship to any particular investment advisory firm whose products he might sell, including the amount and manner in which the lawyer will receive commissions or fees. The lawyer also must disclose whether comparable products or services are available from other sources and their relative costs and all the reasonably foreseeable adverse consequences of the transaction. See Ariz. Ethics Op. 99-09 at 7.
ER 1.8 also requires the lawyer to advise the client in writing of the desirability of seeking the advice of independent legal counsel in the transaction, and the client must have a reasonable opportunity to seek such advice. Thus, a lawyer who contemplates providing investment advisory services to existing clients must affirmatively encourage them to obtain the advice of independent counsel and not merely casually suggest that they consult with another lawyer. See Ariz. Ethics Op. 99-09 at 8. [5]
The final requirement under ER 1.8 is that the client provide, in writing, informed consent to the essential terms of the transaction and the lawyer's role in the transaction, including whether the lawyer is representing the client in the transaction. A client's consent is not "informed" unless the lawyer adequately explains both the material risks of the proposed transaction and reasonably available alternatives. See ER 1.0(e); ER 1.8, cmt. ¶ 2.
The inquiring attorney states that legal services will not be provided in the same matter in which clients are provided investment-related services. It is particularly important that clients understand that they are not receiving legal services and that certain protections, such as the attorney-client privilege, do not apply to the investment transactions. Moreover, the inquiring attorney is acting prudently in not providing legal and investment-related services in the same matter. Significant risks are posed where a lawyer attempts to play a dual role as both a legal advisor and participant in a transaction. A lawyer may not even seek a client's consent to such dual roles unless the lawyer reasonably believes that the lawyer still can provide competent and diligent representation, which may be impossible given the lawyer's interest in the transaction. See ER 1.7(b); ER 5.7, cmt. 8.
3. Advertising and Maintaining Separation of Law-Related Services
The inquiring attorney notes that while the investment advisory activities will be conducted through an entity separate from that providing legal services, the lawyer will work out of a single office. Separate phone numbers and letterhead will be used for the investment-related activities, and the letterhead and business cards for the investment business will not indicate that the lawyer has a license to practice law. Moreover, the inquiring attorney states that separate books and records will be kept for the investment-related business as distinct from the attorney's legal practice. The inquiring attorney also states that he will not use the investment-related business as a conduit for directing clients to the lawyer's legal practice.
Under ER 5.7, "a lawyer should take special care to keep separate the provision of law-related and legal services in order to minimize the risk that the recipient will assume that the law-related services are legal services." ER 5.7, cmt. 8. Moreover, a lawyer who operates an investment advisory referral program must also comply with ERs 7.1 through 7.3 regarding advertising and solicitation. See ER 5.7, cmt. 10.
A lawyer operating a separate law-related business is generally prohibited under ER 7.2(b) from giving any person anything of value for referring prospective clients to the lawyer for legal services. Moreover, under ER 5.4, a lawyer generally may not share legal fees with a non-lawyer, including non-lawyers who might be involved in a lawyer's separate law-related business activities.
In Opinion No. 97-08, this Committee clarified previous Arizona opinions regarding a lawyer's participation in dual professions. The opinion states that "the major theme gleaned from these [prior] opinions is that, although simultaneous engagement in a business career and the practice of law is permissible, the businesses/professions must be kept independent in operation and practice." Ariz. Ethics. Op. 97-08 at 4. Specifically, a lawyer may operate an ancillary business such as investment services from the same physical location as his or her law office, but must maintain "separate phone numbers, letterheads, books and records as well as assuring that all legal files will remain confidential." Id. Furthermore, the lawyer may include on legal letterhead and business cards that he or she is also a Registered Investment Advisor. Ariz. Ethics Op. 88-05 (1988). The lawyer may not, however, show both licenses on letterhead or business cards for his or her investment advisory service. Id. By following these precautions, a lawyer may reduce the risk of confusion when providing both legal and non-legal services.
CONCLUSION
In the circumstances described, under ER 5.7, the inquiring attorney, who operates a separate investment advisory business, is not ethically prohibited from referring non-clients to a third-party investment advisory firm and accepting a referral fee from the firm. The inquiring attorney may also refer current clients to an investment advisory firm and accept a referral fee if the lawyer complies with ER 1.6, ER 1.7 and ER 1.8(a). Finally, the inquiring attorney must comply with ERs 7.1 through 7.3 and take special care to keep separate the provision of legal and non-legal services to avoid public confusion.
DISSENT TO OPINION NO. 05-01
INTRODUCTORY COMMENT Unlike the majority, we believe the Committee should reaffirm its earlier view in Op. 98-09, which recommended imposing a per se ban against lawyers accepting money from third-party professionals in exchange for referring law clients to those third-party payors. However, like the majority, we agree that a lawyer can accept a fee from a third-party professional for referring non-clients to the third-party's firm, provided that the lawyer complies with Rule 5.7.
OTHER APPLICABLE ETHICAL RULES ER 1.8 Conflict of Interest; Current Clients; Specific Rules
* * * *
(f) A lawyer shall not accept compensation for representing a client from one other than the client unless:
(1) the client gives informed consent;
(2) there is no interference with the lawyer's independence of professional judgment or with the client-lawyer relationship; and
(3) information relating to representation of a client is protected as required by ER 1.6.
DISCUSSION Analysis Under Rule 5.7: Identify The Proposed Services And Determine Whether or Not Any Of Them Are Subject To The Rules of Professional Conduct:
We begin our analysis with Rule 5.7, entitled "Responsibilities Regarding Law Related Services." Also known as "ancillary services" law-related services are defined in Rule 5.7(b) as "services that might reasonably be performed in conjunction with and in substance are related to the provision of legal services, and that are not prohibited as unauthorized practice of law when provided by a nonlawyer."
To be sure, lawyers in Arizona and elsewhere were allowed to provide law related services before Rule 5.7 was adopted. [6] The innovation brought about by Rule 5.7 is that it established a standard gate-keeping mechanism to determine whether and when the Rules of Professional Conduct apply or do not apply in cases where such services are provided by a lawyer or by an entity owned or controlled by a lawyer. The Rule 5.7 analysis must be performed regardless of whether the persons referred by the lawyer are the lawyer's law clients or not.
Rule 5.7 states that the Rules of Professional Conduct apply with full force when the law-related services are provided in circumstances indistinguishable from the lawyer's law practice. By contrast, Rule 5.7 states that the Rules of Professional Conduct do not apply when the law-related services are performed by an entity owned or controlled by the lawyer, separate from the lawyer's law practice, provided that the lawyer takes reasonable measures to assure that a person obtaining the law-related services knows that the services of the separate entity are not legal services and that the protections of the client-lawyer relationship do not apply. There is a limited exception in the latter case: Even when the law-related services are being provided in such a manner that the Rules of Professional Conduct otherwise do not apply, the lawyer must still comply with Rule 1.8(a) when the law-related (ancillary) services are being provided by the lawyer to law practice clients.
The lawyer in the present inquiry proposes to offer two services, both of which fall under the definition of "law-related services" within the meaning of Rule 5.7(b) in the sense that either could be undertaken by a non-lawyer without "practicing law": (1) making referrals to a third-party investment firm and (2) performing a limited "watchdog" function over the activities of the third-party firm. The issue is whether the proposed services will be provided in circumstances distinguishable from the lawyer's law practice and whether the lawyer takes reasonable measures to assure that a person obtaining law-related services knows that services of the separate entity are not legal services and that the protections of the client-lawyer relationship do not apply. Rule 5.7(a).
While the gate-keeping function in Rule 5.7 does not directly depend on whether or not the persons referred by the lawyer are clients of the lawyer's law practice, the involvement of clients can be a factor in determining whether or not the services will be provided in circumstances "indistinguishable" from the lawyer's law practice.
In this case, one of the proposed services is the rendition of a referral. By its very nature, a referral is a form of advice - a recommendation. Regardless of whether or not advice given by a lawyer to a client in the course of the attorney-client relationship is considered to be "legal advice," the advisory function lies at the very heart of the attorney-client relationship. The fact that the lawyer set up a separate entity to make the referrals is eclipsed by the substance of what the lawyer and the investment advisor are trying to accomplish and by its potential effects on the lawyer's law clients. The whole point of paying a referral fee to a lawyer is to tap into the relationship of trust and confidence nurtured over time between the lawyer and the lawyer's clients for the benefit of the lawyer and the person paying the referral fee. But the relationship of trust and confidence that gives the lawyer the credibility to make the referral does not disappear just because the lawyer proposes to wear a different hat when rendering that advice. The substance of the transaction controls, not the form, and the substance is that the referral and the fee are designed to build a bridge leading directly from the lawyer's door to the third-party investment adviser's door. Thus, whenever the persons being referred are law firm clients, the referrals are indistinguishable from the lawyer's law practice and are subject to the Rules of Professional Conduct.
By contrast, whether or not the Rules of Professional Conduct apply when the referrals are made to persons who are not clients of the lawyer's law practice depends on whether or not the lawyer complies with Rule 5.7.
A word of caution is in order here. Our dissenting opinion should not be interpreted to mean that the Rules of Professional Conduct always apply when law related services are being provided to clients. That is not what Rule 5.7 says and that is not what we are saying in this dissent. The Rules of Professional Conduct do apply whenever the lawyer renders advice to law firm clients in circumstances which cannot be distinguished from the law practice (again, regardless of whether or not the advice, strictly speaking, is "legal advice"). But whether the Rules apply to other services (including the rendition of advice) provided to law clients outside of the law firm depends on the nature of those services and any other relevant factors which tend to establish or negate connections between the proposed service and the law practice. In other words, it is important to carefully identify and distinguish each proposed service and determine whether it can be differentiated from the law practice.
For example, see Comment 5 to Rule 5.7. That comment clearly envisions situations where the services provided by the lawyer's separate entity are sufficiently distinguishable from the law practice that they may be carried on outside of the Rules of Professional Conduct. However, because the referral is to the lawyer's own business, the lawyer must still comply with Rule 1.8(a) (business transactions with clients) if the persons being referred are clients of the lawyer's law practice. As we interpret Comment 5, the referral and the services rendered by the ancillary business are two separate things. The referral is the lawyer's introduction to the ancillary business, not a service rendered by the ancillary business itself. Thus, while the activities of the ancillary business may not be subject to the Rules of Professional Conduct (except Rule 1.8(a), when the services are provided to clients), the referral itself is subject to all applicable Rules of Professional Conduct because it makes the connection between the lawyer's law practice and the lawyer's ancillary business.
The Lawyer Cannot Accept A Third-Party Fee For Referring Clients To The Third Party Payor
In Ariz. Op. 98-09, the Committee recommended imposing a per se ban against lawyers accepting referral fees for referring law firm clients to third party professionals. In that case, as in this case, the third-party was an investment adviser. We expressed the view that the situation presented a non-consentable conflict under Rule 1.7(b). In other words, we were of the opinion that the inherent problems were such that no lawyer could reasonably conclude that the conflict could be cured by disclosure and consent. As more fully explained below, those of us who have joined this dissent continue to recommend the adoption of a per se ban against lawyers receiving third-party referral fees in exchange for referring law clients to the person paying the lawyer's fee.
Turning to the present inquiry, we note some ambiguity in the facts. In Op. 98-09, the lawyer was not proposing to do anything other than make referrals. In that case, it was clear that the fee was being paid solely for making the referral. By contrast in this case, the lawyer is proposing to make the referrals and to perform a limited monitoring or "watchdog" function. It is unclear whether the lawyer has any legal duty to perform the monitoring function. No matter. There are no facts to indicate that the third-party investment firm would withhold payment of the lawyer's fee if the lawyer failed to monitor the investment firm's activities - something that seems highly unlikely as long as the referrals keep coming. Indeed, without the referrals the lawyer wouldn't have any accounts to monitor. In other words, in this case at least, the monitoring services are inseparable from the referrals.
So long as the reality of the transaction is that a third-party professional is proposing to pay a lawyer to refer law clients to the third-party, the lawyer is barred from accepting those payments under Rule 1.7 and Op. 98-09. Indeed, as more fully set forth in the paragraphs that follow, we believe that the per se ban recommended in Op. 98-09 is supported not only by Rule 1.7, but by Rule 1.8(f) as well.
Initially, allowing lawyers to be paid for referring clients to unrelated professionals seems to fly in the face of the public protection spirit of the Rules of Professional Conduct. We note only two express references to referrals in the Rules of Professional Conduct: The first is ER 1.5(e), which prohibits lawyers from accepting referral fees from other lawyers unless, among other things, the referring lawyer assumes joint responsibility for the representation. The second is ER 7.2(b), barring lawyers from accepting referrals from paid "cappers." Against this background, it seems self-contradictory that rules of more general application, for example, ERs 1.7(b), 1.8(a) and 5.7, should be construed to allow lawyers to, in effect, become cappers for other professionals without assuming any responsibility for the third-party's treatment of the lawyer's clients. That incongruity was not lost on the Committee when it drafted Op. 98-09. [7]
We also believe that a per se ban is justified by a cost-benefit analysis that burdens the client with all the risks while all the benefits go to the lawyer and the third-party payor. Arrangements of this nature are fraught with inherent conflicts, otherwise known as risks. Those risks will be borne solely by the client who will be faced with the prospect of uncertain and expensive litigation or no remedy at all if the risks come to pass. That is inconsistent with the policy of protecting the public when the referral fee doesn't benefit the client in the least.
But more fundamentally, the conflicts and the impairment of the lawyer's judgment inherent in this situation are indelible, and the potential cure threatens to do more harm than good. Thus, we believe that the per se ban is supported by Rule 1.7(b) and Rule 1.8(f), alone or in combination with one another.
As we already pointed out, a referral is a form of advice (a recommendation). Under Rule 1.8(f)(2), a lawyer would never be permitted to accept payment from a third party if that payment were conditioned on the lawyer giving specific advice. But that's exactly what happens when a third party pays a referral fee: the lawyer won't get that fee unless he advises the client to consult the person paying the lawyer's fee. Although the degree of impairment may vary depending on the individual lawyer, impairment of the lawyer's professional judgment is unavoidable when the lawyer's self-interest depends on the nature of the lawyer's advice. In addition, the whole intent behind payment of the fee is to narrow alternatives that would "otherwise be available to the client," a practice proscribed under Rule 1.7. See Comment 8 to Rule 1.7.
Moreover, before the lawyer could accept a third-party referral fee, Rule 1.7(b) would require the lawyer to disclose the fee and explain how the lawyer's advice may be tainted by the payment of that fee. At a minimum, the lawyer would have to disclose the following risks: (1) the alternatives presented to the client are being narrowed; (2) the lawyer is referring the client to the third-party professional based not solely on the lawyer's best professional judgment; (3) that the lawyer's judgment may be clouded by the payment of a fee from the very person who proposes to take over the client's affairs. In other words, the lawyer would have to disclose to the client, in effect, "There's a risk that I'm putting my self-interest above your well-being." Worse, the client will be told that these risks pertain to making a referral, a form of advice, which strikes at the heart of the attorney-client relationship.
Aside from the fact that the necessary Rule 1.7(b) disclosures would eviscerate the very purpose of the referral - to tap into the relationship of trust and confidence between the lawyer and the client - there is a strong likelihood that, in many cases, the disclosure itself will undermine the client's trust and confidence in the lawyer if the disclosure is properly made. If the disclosure is not properly made, there is a strong likelihood that it will be because the lawyer had a financial incentive not to make a bona-fide disclosure. In other words, the proposed arrangement presents a lose-lose situation both for the well-being of the attorney-client relationship and for the larger system of justice in which it functions.
The dissenters believe that, under ER 1.7(b) and ER 1.8(f), a lawyer is barred from accepting a fee from a third-party professional in exchange for referring law clients to the third-party. Whether the lawyer can accept such a fee for referring non-clients depends on whether the lawyer complies with Rule 5.7.
Footnotes
[1] Formal Opinions of the Committee on the Rules of Professional Conduct are advisory in nature only and are not binding in any disciplinary or other legal proceedings. c State Bar of Arizona 2003
[2] Such opinions generally concluded that a lawyer's acceptance of a referral fee created an impermissible conflict of interest, irrespective of disclosure and consent by the client. See Iowa Sup. Ct., Board of Prof'l Ethics and Conduct, Op. 99-04 (1999); Ky. Bar Ass'n, Op. E-390 (1996); Me. Bar Ass'n, Op. 184 (2004); Md. State Bar Ass'n, Op. 96-17 (1995); N.Y. State Bar Ass'n, Op. 682 (1996); N.C. State Bar Ass'n, Op. 99-1 (1999); Ohio Sup. Ct., Bd. of Comm'rs on Grievances and Discipline, Op. 2000-1 (2000); Tex. State Bar Ass'n, Op. 536 (2001); Vt. Bar Ass'n, Op. 98-8.
[3] See Cal. State Bar Ass'n, Op. 1999-154 (1999); Conn. Bar Ass'n, Informal Op. 97-16 (1997); Fla. Bar Ass'n, Op. 02-8 (2004); Ill. State Bar Ass'n, Op. 97-04 (1998); Mich. State Bar Ass'n, Op. RI-317 (2000); Mo. Bar Ass'n, Informal Adv. Op. 960124; Pa. Bar Ass'n, Op. 2000-100 (2000); R.I. Sup. Ct., Ethics Advisory Panel, Op. 99-08 (1999); Utah Bar Ass'n, Adv. Op. 99-07 (1999).
[4] To the extent Opinion 98-09 conflicts with this conclusion, that Opinion has been superseded by ER 5.7. We note, furthermore, that the analysis in the present opinion is limited to situations where a lawyer is conducting investment advisory services - and accepting referral fees - through a separate business as contemplated by ER 5.7. This opinion does not suggest that it would be appropriate for a lawyer, through the lawyer's legal practice, to accept referral fees for referring clients to non-lawyer professionals.
[5] If a client has independent counsel in a transaction, the requirement of full disclosure under ER 1.8(a)(1) may be satisfied by written disclosure by the lawyer involved in the transaction or the client's independent counsel.See ER 1.8 cmt. ¶ 4.That a client has independent counsel is also relevant in determining if a transaction is fair and reasonable as required by ER 1.8(a).Id.
[6]See the Committee's previous opinions to that effect (ancillary businesses not prohibited) summarized in Ariz. Op. 97-08 at pp. 2-4.
[7] See Ariz. Op. 98-09, p. 6, "Finally, the Committee notes that in the converse situation an attorney would not be permitted to pay a referral fee to the investment adviser firm or another third party for referring clients to the attorney under ER 7.1(j).