Duties to the Public at Large

A. Context

Widespread anxiety over lawyers’ ethics is sometimes said to have started with the Watergate scandal in the 1970s. The Republican President, Richard Nixon, was alleg­edly implicated in a plot to enter the offices of the Democratic Party, photograph documents and place bugs in the run up to an election.

Watergate led to calls for the end to self-regulation of lawyers in the US. In response the American Bar Association (ABA) produced a new model code of professional responsibility emphasising the need for good conduct. It also required that profes­sional responsibility be taught on ABA-approved law degrees. Indirectly, Watergate raised the issue of whether lawyers should be under explicit duties to avoid harm to the public at large, or sections of the public. This remains a hotly contested issue.

The kinds of situation where lawyers might be subject to a broader duty is where they hold client information which, if revealed, may help to prevent financial, envi­ronmental or public health disasters. Limited examples of such reporting regimes already exist. In relation to the environment, for example the Aarhus Convention imposes obligations on public authorities to disclose environmentally sensitive infor- mation.^[2248] The creation of such responsibilities potentially risk in-house and external lawyers advising corporations being subject to conflicts between their public duties and their duties to clients.^[2249]

In situations in which clients try to hide environmental activity that is obviously a public risk, lawyers cannot be involved.

B. Regulation

Lawyers’ codes of conduct are generally silent regarding collective third party respon­sibilities. The Solicitors’ Code of Conduct 2007, for example, required only that solici­tors act with integrity towards the courts and ‘others’ as well as their clients and also ‘not behave in a way which damages or is likely to damage the reputation or integrity of the profession’.^[2251] The latter obligation is expressed negatively. There are no posi­tive duties in the Rules to promote justice, or access to it, and no duty to consider the impact of any action on wider society.

The general outcome that opens Chapter 11, ‘Relations With Third Parties’, speci­fies that, ‘you do not take unfair advantage of third parties in either your professional or personal capacity’.^[2252] It is arguable that this outcome envisages that the solicitor is dealing with an identifiable third party. In most circumstances it would be impossible to know whether an unfair advantage is being taken unless the other party is known. Therefore, in exploring a basis of responsibility, one is forced back to the principles underpinning the SRA Code of Conduct and the very broad duties to uphold the rule of law and the administration of justice. As discussed below, these are not a promising foundation for the kinds of obligation needed to prevent social harm.

C. Financial Risks

One of the areas in which damage to collective third party interests is most obvious is in financial and stock markets.

i. Liability for Financial Loss at Common Law

The common law provides some context for considering the responsibility of lawyers and other professionals for financial losses caused to groups rather than individu­als. The key cases often concern auditors or surveyors, who are required to prepare documents upon which a party beyond their immediate client can rely. Such ‘remote’ parties can sometimes suffer financial loss as a result of their reliance. Liability for economic loss due to negligent misstatement was confined to cases where the statement or advice had been given to a known recipient for a specific purpose. Additionally, the maker had to be aware of this purpose and that the recipient would rely on this advice and act on it to his detriment.^[2253]

In 1990, the proposition that a duty might be owed to a wide class of people was tested in Caparo Industries Plc v Dickman.^[2254] A firm of accountants, TR, had pre­pared an auditor’s report on a public company, F, as required by statute. The purpose of the document was to report on the stewardship of the company by the directors, enabling shareholders to exercise their class rights in general meeting. C had pur­chased shares in F as part of a takeover bid and, relying on TR’s report, had then bought further shares.

The report gave a false picture of F’s projected profits and C suffered a loss. C brought an action against two directors of F, alleging negligent misstatement. The Court of Appeal distinguished existing shareholders, to whom TR owed a duty, and potential investors, to whom no duty was owed. If existing shareholders held on to, or sold shares based on the accounts, and suffered loss, they should be able to sue. The House of Lords upheld an appeal by the accountants, deciding that no duty of care was owed to either group.

The House of Lords decided that, applying the three standard tests for a duty of care, proximity, foreseeability and reliance, no duty to existing shareholders, or to potential investors, arose. Auditors of public companies preparing routine company accounts, as opposed to reports for a specific purpose for an identified party, owed no duty to the public at large making investment decisions. To impose such a liability would open the floodgates to an indeterminately wide class of people. The House of Lords thereby limited liability for economic loss due to negligent misstatement. This applies only to cases where the statement or advice is given to a known recipient, for a specific purpose of which the maker was aware, and upon which the recipient had relied and acted to his detriment.

ii. Professional Responsibility for Financial Loss

a. Striking the Balance

Cases such as Caparo v Dickman are merely indicative of the courts’ current attitude to third party liability for negligence. Lawyers are not in the same position as auditors certifying company accounts when it comes to producing information on which reli­ance may be placed. Nevertheless, the increasing prevalence of financial catastrophes raises questions about the preventative responsibilities of professionals. Some would wish to see more of a balance struck between duties to clients and wider duties to sec­tions of the public, shareholders, employees and pensioners.

It has been argued that, in the USA in relation to the collapse of the Enron Corporation, traditional principles of neutrality and partisanship operated to ‘sprin­kle... transactions with holy water’, that were, in reality, designed to confuse the pub­lic or conceal their true nature.^[2255] Regulation might attempt to address this problem. For example, it might be desirable to impose a duty on lawyers to report risk of significant financial loss or other harm to a public authority. Failure to do so might be used as a basis for legal liability.

b. Public Duty Based on Government Indemnity

Those suffering financial harm with no legal or insurance claim may be lucky. Their losses may sometimes be shouldered by government and paid for by the taxpayer. It is therefore, arguable that professionals who participate in activity that causes financial losses owe a duty to the wider public to avoid such losses occurring. These issues have been thrown into particularly sharp relief by the global financial crisis. This was pre­cipitated in 2008 by risky behaviour on the part of global financial institutions. Some of this behaviour may have been illegal or, at least, breached financial regulations. Many of the institutions involved had professionals, including lawyers, at the core of operations or took the advice of leading firms.

c. Exploring the Limits of Professional Responsibility

The next section examines three case studies of major financial calamities in which lawyers participated. All three involve US financial disasters and only the last involves an English law firm in a leading role. It is, nevertheless, useful to see how such situa­tions unfold, what role lawyers played and what actions were taken to deal with the situation. The advantage of these case studies is that regulators tend to publish reports. The crises relate to the Savings and Loan scandal (the Kaye Scholar affair), the collapse of the Enron Corporation and the failure of Lehmann Brothers. Each case study concludes with a section considering the implications of what happened for regulation in England and Wales.

iii. The Kaye Scholer Affair

a. Context

The collapse of US Bank, Lincoln Savings and Loan, and the role of its lawyers, Kaye, Scholer, Fierman, Hays and Handler (Kaye Scholer) in the affair stimulated considerable academic debate in the US.^[2256] The bank was controlled by a financier, Charles Keating, who took advantage of looser banking regulation in the 1980s to use bank funds to finance real estate developments.

Kaye Scholer were appointed lawyers to the bank in 1986. The banking regulators were concerned that many banks were over-extended. Lincoln Savings and Loan had just been through a regulatory investigation stimulated by concerns that it was engaged in ‘unsafe and unsound’ banking practices. One of Kaye Scholer’s main tasks was to convince the regulator that the bank was viable. It assumed control of com­munications with the bank and resisted the regulator’s attempts to uncover the true situation for several months. Eventually, the regulator closed the bank in 1989.

Management of the liquidated bank passed to a new federal government agency, the Office of Thrift Supervision (OTS). This agency had broad powers of investiga­tion and could pursue directors of financial institutions and their accountants and lawyers. OTS charged Kaye Scholer with providing the bank with reckless advice, misstating facts to the regulator and failing to disclose information showing that the bank’s practices were ‘unsafe and unsound’. They sequestrated (seized) the law firm’s assets.

Three days after its assets were sequestrated Kaye Scholer settled, paying $41 mil­lion and agreeing to restrictions on the practising certificates of some of its lawyers. Unsurprisingly, the circumstances of Kaye Scholer’s capitulation caused anxiety among US lawyers. The power to freeze a law firm’s assets for assisting a client was unheard of in 1986. There was therefore concern about what standards the OTS were applying. Because of the settlement, the formal charges against Kaye Scholer were never adjudicated.

b. The Lawyers’ Role

One of the concerns generated by the Kaye Scholer case was the question of what responsibility lawyers owed to unidentified third parties when protecting client inter­ests. The OTS, sifting through the confidential records of the defunct bank, found documents suggesting that it systematically misled the regulatory authorities for three years prior to its collapse. Simon’s analysis of the pleadings in the case showed active participation by Kaye Scholer.^[2257] He concluded that, had the firm not provided mis­leading information to the regulator, numerous dubious transactions would not have happened and substantial losses would probably have been prevented.

c. Legal Liability

The fact that the firm’s actions may have been a cause of financial loss to depositors and investors, losses underwritten by the government, raises the question of whether Kaye Scholer should have been liable to pay compensation. This would be controver­sial because it attaches substantial blame to the lawyers. While they may share some fault, the behaviour of the bank was the primary cause of the losses. It should also be noted that the government regulator might also share blame. It could have acted more decisively if it was dissatisfied with the way the bank or its lawyers responded.

Hazard suggests a tenable basis for a claim by shareholders or other individuals affected by the collapse of the bank. He argues that Kaye Scholer failed in its duty to the client (the bank) by following the instructions of a third party (Keating, the corporate management of the bank). Therefore, the case can be read as the OTS step­ping into the shoes of the corporation to enforce the rights of shareholders against the directors and the bank’s lawyers.

Simon suggests that the OTS proposed two possible standards for liability under the statute allowing it to seek recovery. The first was a minimal obligation not to mislead explicitly. The second, higher, standard was to fulfil the client’s obligation of full disclosure under the banking regulations. The regulator’s argument for the higher duty was based on two arguments. The first was that the firm had actively ‘interposed’ itself between the regulator and the client by insisting that the regulator should deal directly it.

The second argument for a positive duty to disclose was based on the alleged exis­tence of a general duty to reveal regulatory evasion by clients. Simon agrees that the first argument could be the basis for responsibility to make full disclosure, but regards the second as less plausible. Even in the context of a strict regulatory regime operating in the public interest, he could see a basis for a wide obligation of disclosure.

d. Professional Responsibility

Simon saw the key ethical issue raised by the case as the lawyer’s obligation to withdraw when he cannot act for a client without furthering a fraud.^[2258] The relevant conduct rule is unambiguous. It provides that ‘a lawyer shall not counsel a client to engage, or assist a client, in conduct that the lawyer knows is criminal or fraudulent’.^[2259] This raises questions. Did the bank’s activity meet the definition of criminal or fraudulent? If so, were the lawyers aware of this? If so, should they be liable to compensate for resulting financial losses?

On the issue of whether what happened was criminal or fraudulent, the bank’s director, Keating, was convicted in the early-1990s of offences including fraud and conspiracy. He served four and a half years in prison before the convictions were over­turned and lesser counts substituted. While these lesser counts still included elements of fraud, the quashing of the original convictions creates doubt about what conduct was known to Kaye Scholer’s lawyers.

It is also unclear whether, if Kaye Scholer’s lawyers knew about specific activity, they also knew that it was criminal or fraudulent as legally defined at the time.^[2260] These were issues the Bar could have pursued through disciplinary proceedings against individual Kaye Scholer lawyers, but did not do so. The New York Supreme Court, the disciplinary authority, found no grounds for professional discipline. Nevertheless, civil judgments worth billions of dollars remain outstanding against Keating and his associates.

e. Political Implications

Simon suggests that the legal establishment defended Kaye Scholer by arguing that lawyers’ duty of confidentiality bound them not to disclose details of their client’s actions. The duty, it was said, was more relevant and binding because the firm was instructed in anticipation of litigation by the regulator. The statements to the regula­tor were in the nature of arguments rather than statements of fact. Simon’s critique of this defence is that a key argument for confidentiality is that it encourages disclosure of planned wrongful conduct, allowing lawyers an opportunity to dissuade clients from the wrongful course of action.^[2261] This was patently not what the Kaye Scholer lawyers did.

The Kaye Scholer affair divided opinion among US academics on the issue of protecting collective third party interests. Simon argued that the failure of the Kaye Scholer lawyers to attempt to dissuade the bank reveals the flaw in lawyers’ ethics. The legal establishment’s defence of Kaye Scholer casts doubt on the US profes­sion’s capacity to regulate itself. Other academics supported the profession’s position. Pepper argued that confidentiality allows clients to legitimately explore the limits of legality.^[2262] Macey pointed out that any expectation that Bar institutions would not defend Kaye Scholer and client confidentiality was naive.^[2263]

Miller argued that Simon’s conclusions are based on a misinterpretation of the circumstances of the Kaye Scholer affair.^[2264] First, the ‘onerous standard’ Simon proposed was the standard that, in fact, applied. The difficulty with the case was the unproven nature of the allegations. Miller also argues that the payment by Kaye Scholer to settle the case does not prove the firm’s guilt. The regulatory body had obtained an order freezing the firm’s assets and effectively stopped them from trad­ing. Settlement, he argues could therefore be seen as the only prudent course for the firm. Moreover, it was arguably an oppressive and unethical tactic by government lawyers, possibly used only because they were doubtful about their ability to prove the charges.^[2265]

f. Ethical Implications for England and Wales

In England and Wales, it is clear that a lawyer whose client proposes criminal or fraudulent activity, and cannot be persuaded otherwise, must withdraw from rep­resentation. Were lawyers found liable in a case on similar facts to Kaye Scholer, it would generate pressure for recognition of firmer obligations to third parties. As we have seen, ethics rules generally aspire to a higher standard than the law. A formal finding of liability would involve formulating an obligation encapsulating lawyers’ responsibility to unidentified third parties when engaged in commercial work for clients.

Simon suggests that the facts of Kaye Scholer justify imposing an intermediate standard of disclosure on lawyers. Lawyers, he argues, should be prohibited from directly or indirectly misleading conduct and ‘from providing any services substan­tially related to active unlawful client conduct’.^[2266] ‘Unlawful’ is a vague term that could be interpreted to cover civil liability. If it did not, it is not clear how Simon’s proposed rule would be preferable to the model rule forbidding assistance to a client in conduct that the lawyer knows is criminal or fraudulent.

iv. The Enron Scandal

a. Context

The role of lawyers in the collapse of the energy giant, Enron, in the US in 2001 caused as much ethical soul searching as the Watergate scandal. One of the major issues that arose was whether the lawyers acting for Enron owed a duty to safeguard the interests of the shareholders, the employees and possibly the pensioners of Enron, or, even more widely, the community at large. All these groups were harmed or placed at risk in numerous ways by the collapse into bankruptcy of a mega corporation.

Enron, once one of the seven largest corporations in the world, went bankrupt in 2001 leading to the eventual dissolution of its accountant and auditors, Arthur Anderson, then one of the five leading accountancy firms in the world.^[2267] Enron traded in financial contracts connected with their energy assets. Enron executives managed to hide losses of billions of dollars using accounting loopholes and false financial reporting and by pressurising Arthur Andersen to ignore the issues. Many of these financial arrangements involved creating a multitude of partnership organ­isations, the main aim of which was to allow a sanitised version of the corporation’s accounts to be presented to the public. This gave a totally false impression of the corporation’s security and solvency.

The arrangements also made a lot of money for the individual executives involved in their creation, including at least one in-house lawyer employed by Enron. Much of this was clearly not only unlawful but criminally fraudulent. Many of the senior managers involved were sentenced to prison terms. An Enron insider, not a lawyer, finally revealed the fraud and the corporation collapsed, resulting in the loss of the loss of 4000 jobs and $70 billion of savings and shares. Shareholders filed a $40 bil­lion lawsuit, but enjoyed limited success through legal actions. Arthur Anderson were charged with obstruction of justice after destroying documents, emails and files relat­ing to Enron auditing.

b. The Lawyer’s Role

Lawyers play a significant role in offering shares and securities on financial markets. They are primarily responsible for the verification of the legal requirements for the prospectus for an initial public offering. Markets depend on the integrity of informa­tion and on credible disclosure of material facts facilitating informed investment deci­sions. Lawyers are generally regarded as ‘gatekeepers’, independent professionals who serve investors by preparing, verifying or assessing disclosures. They are effectively, field marshals of the disclosure process.^[2268]

Lawyers were involved in many facets of the Enron scandal. First, ‘attorneys all played an important role in the process of drafting and certifying disclosure state­ments, and advising whether the legal and accounting requirements governing [the partnership organizations] had been met’.^[2269] Secondly, senior lawyers in the corpora­tion, presented with evidence of malpractice, failed to investigate or take any action. Thirdly, an outside firm of lawyers, Vinson & Elkins, were implicated in some of the illegality, yet also agreed to undertake, at the request of Enron itself, an investigation into the process once questions were asked about the probity of the way the company was being run.

The outside law firm was investigating its own work. It was in a position where its interest conflicted with those of other third parties. Unsurprisingly the report that resulted from the firm’s investigation was short, exculpatory and dismissive. Finally, once it was clear that government investigation and litigation was likely to ensue, one of Enron’s senior employed lawyers began to shred the evidence. A misleading press release was drafted on Enron’s position.

c. Legal Liability

Legal action by groups like shareholders and pensioners, whose interests should have been a primary concern to lawyers acting on behalf of Enron, was a clear possibility. As in most corporations, the chief executive officer (CEO) was purporting to act on behalf of the corporation and had authority to give the lawyers instructions. The cor­poration was the ‘real’ client and its interests were different from those of the CEO.^[2270] It was clear, however, that the Enron lawyers, both in-house and external firms, identi­fied with the senior executives of the organisation and were not acting independently of their interests. As Gordon noted, ‘[a]t best, the lawyers were closing their eyes to the risk of disaster; at worst they were helping to bring it on’.^[2271]

In the aftermath, 16 people pleaded guilty to charges alleging crimes committed at the company, and five others, including four former employees of Merrill Lynch, the brokerage and securities firm, were found guilty at trial. It is clear that many of the lawyers involved had broken a variety of accepted ethical norms and had also been involved in the promotion of fraud. A senior lawyer who shredded evidence had attempted to frustrate a federal investigation. Five years after Enron collapsed, two in-house lawyers were charged with civil fraud in connection with one deal each in the pre-Enron collapse.^[2272] In 2009 the actions were settled by payment of total fines of just over $50,000 and agreement to a suspension from appearing before the Commission for two years.^[2273] The settlement terms included no admission of wrongdoing.

Although civil legal action by members of third party collectives is a theoreti­cal possibility, it can be expensive for individuals relative to the sums in issue. Civil actions are also risky because of courts may fear ‘opening the floodgates of liability’. Therefore, discussion often revolves around the scope for attaching criminal liability to lawyers’ acts^[2274] rather than civil liability for losses.

d. Professional Responsibility

If lawyers are to be effective gatekeepers of certain financial transactions, their inde­pendence and integrity must be safeguarded and it must be clear where their duty lies. The ABA’s Model Rules provides a broad permission to disclose information that may have prevented some of the Enron dealings and may have given the regulator reason to take a closer look at the company. The rules provided that:

[A] lawyer may reveal [confidential] information... to the extent the lawyer reasonably believes necessary ‘to prevent the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer’s services.^[2275]

This is obviously permissive, allowing, but not requiring reporting.

Gordon notes that many state Bar rules go further than that, for example, by pro­viding that ‘a lawyer shall reveal such information to the extent the lawyer reasonably believes necessary’.^[2276] One view of how this changes the obligations of lawyers is that any fraud, especially one accomplished through lawyers’ efforts,

must try to get clients to correct the wrong, and that if the client does not comply, the lawyer may or must withdraw and disaffirm any documents he has helped to prepare; and if serious harm is likely to result, may or must disclose to relevant parties or authorities.^[2277]

As Gordon notes, an interpretation that would turn lawyers into self-regulators of financial services would be highly controversial. It is expected that lawyers should withhold consent to risky financial dealings, and entirely reasonable that they should counsel clients against them. It is something else to require that they report suspicions to the authorities because it undermines the trust relationship with clients. It would also ensure that independent law firms would be kept at the margins of financial activ­ity as far as possible, thus depriving them of the possibility of dissuasion.

The effectiveness of Vinson & Elkins, the external law firm, as a brake on illegal dealing may have been reduced by the fact that Enron was its largest client. Many of the firm’s employees had taken jobs with Enron as in-house counsel. It is difficult for an external firm to act as a gatekeeper of legality when it is in a dependent role in relation to clients. It is easier, and in the external firm’s own interests, to look the other way.

e. Political Implications

In 2001 and 2002 there were numerous Senate committee hearings about Enron and the issues of accounting and investor protection. In 2002 Congress passed the Company Accounting Reform and Investor Protection Act, also known as the Sarbanes-Oxley Act. The provisions of the Act appear to be a direct response to Enron’s governance failings. They include establishment of a Public Company Accounting Oversight Board to develop standards for auditing, provisions on inde­pendent audit and expanded financial disclosure requirements.

The Sarbanes-Oxley Act imposes specific responsibilities on lawyers.^[2278] It empowers the Securities Exchange Commission (SEC) to set minimum standards of professional conduct for attorneys appearing and practising before it. Attorneys are required to report material violation of securities law, or fiduciary duty or similar violation by companies or their agents to either the chief legal counsel or the CEO of the com­pany. If the recipient of the report does not act on the evidence reported, lawyers are required to then report to the audit committee of the board of directors.^[2279] Failure to report could lead to the attorney facing criminal charges and civil action.

The requirements for internal audit were considerably bolstered after Enron. Audit committees had to include independent members. Attorneys could also report to another committee of the board of directors comprised solely of directors not employed directly or indirectly by the company. There was, however, no statutory obligation to alert the SEC if reports did not lead to action. In a company like Enron, where involvement was widespread, it may be that only an outside reporting require­ment would be a deterrent or provide a remedy.

f. Implications for England and Wales

While the lawyers in Kaye Scholer came on the scene after the event, and concealed matters that exacerbated loss, Enron lawyers were complicit in wrongdoing. Some of these lawyers were employed in-house. This raises the issue of whether they were right to protect confidentiality and whether, had they been in England, their advice would have been privileged. The issues, including the question of ‘who is the client’ in a corporate context, arose in Three Rivers v Bank of England.^[2280] If it were clear that illegal activities were going on, privilege could not be claimed. The duty of confiden­tiality would, however, still apply. This would leave the whistle-blowing lawyer in an awkward position.

It does not appear that the lawyers advising Enron were personally motivated by greed, although keeping a well-paid job may be a good enough incentive not to rock the boat. Because the court case against them did not happen, their motivations were not revealed. It may be that their perception could have been that such a powerful corporation could not be doing anything so wrong. If they had suspicions, or more, they may simply have been looking the other way.

If the Enron lawyers knew full well the scale of the problems at the corporation their inaction raises the issue of whether their perceived duty to the client ranked too highly. If so, it may be that they were not attuned to the need to protect the corpora­tion from its own leaders. Some commentators think that their behaviour is perfectly consistent with that of large firm lawyers generally.

Nancy Rapoport blames the conduct of the Enron lawyers and similar cases to the ‘eat what you kill’ philosophy of large firms, the work ethic that constitutes a ‘race to exhaustion, a race to sloppiness, and a race to malpractice’ with no countervailing ethic within the work environment.^[2281] This raises the question of what can be done, through education or otherwise to change this mind-set. It is often asserted that big City solicitors’ firms in England and Wales also identify more with their corporate clients than with the legal profession as a whole or the Law Society as its regulatory body.

As in the Kaye Scholer affair, the Enron Corporation did not get the benefit of their lawyers’ advice against wrongdoing. The attitude of both the CEOs of Enron and its lawyers seemed to be that legal obligations were to be got round or evaded if at all possible; the law ‘seen as merely an imposition and a nuisance’^[2282] and not as a guide to conduct. This suggests a need for a positive obligation to alert those higher up in corporate hierarchy that illegality, or suspected illegality, is being perpetrated.

One lesson to emerge from the Enron debacle was to avoid compromising the inde­pendence of the lawyers by restricting their proximity to corporate clients and other professionals. It would be sensible to require independent firms, unconnected with the transactions in question, to perform any gatekeeping functions.

An associated concern is whether the capacity of law and accountancy firms to act as effective gatekeepers would be reduced by multi-disciplinary practice. Steven Crane, President of the New York Bar Association, noted of the Enron debacle that

[i]f such conflicts exist within the framework of an accounting firm that does not provide legal services to the public, there can no longer be any serious questions that allowing lawyers to practise under the same roof, with their duties of client confidentiality and loyalty, would be a colossal mistake.^[2283]

Enron may have encouraged caution in the European Court of Justice. It upheld the right of Netherlands, and therefore other European Member States, to prevent lawyers entering into MDPs with accountants, even if this restricts competition. Jonathan Goldsmith, Secretary-General of the Council of the Bars and Law Societies of the European Union, told The Lawyer magazine in an interview on this matter:

We’re not trying to get glory out of Enron and the poor people affected, but that is exactly what we were warning. The integrity of a service, whether auditing or legal, is undermined if you’ve got pressure from other professions selling services across yours.^[2284]

V. Lehman Brothers Holdings Inc

a. Context

At the time that Lehman Brothers Holdings Inc (Lehman Bros) filed bankruptcy proceedings in 2008 it was the fourth largest investment bank in the US. The world financial crisis beginning in 2008 was not caused by the collapse of Lehmann Bros, but it was a precipitating event in that process.^[2285] The bankruptcy caused losses to large numbers of small investors. The global economic crisis continues to cause unemployment and financial hardship around the world. Unsurprisingly, reviews of regulatory systems for financial services precipitated by the crisis have paid particular attention to what went wrong at Lehman Bros. One factor examined was the role and responsibility of professional firms servicing the financial industry.

Lehman Bros was one of a number of companies that held onto a specific kind of property investment, known as sub-prime mortgages. During 2007 and 2008 the value of these investments were shown to be worth considerably less than their book values. Lehman Bros’ collapse, precipitated by this fall in its value, began a period of volatility in financial markets. Congress was forced to agree a $700 billion package to stabilise the markets.

In 2010 a court-appointed examiner, Anton R Valukas, published a report showing that Lehman Bros converted assets into cash for periodic financial statements, mis­leading regulators and investors as to its true position.^[2286] This accounting treatment was known as Repo 105. Under Repo 105, short-term loans were shown as sales, reducing financial liabilities on Lehman’s balance sheet. The accountancy firm Ernst & Young faced financial malpractice charges and its chief executive faced criminal charges for allowing the use of Repo 105.

b. The Role of Lawyers

In order to justify using Repo 105 Lehman Bros had to prove that the transactions shown on its balance sheet were ‘sales at law’. In order to do so they needed a ‘true sale’ opinion letter from a law firm. No American firms would issue such a letter because, under American law, repos were not legally sales. Lehman Bros therefore obtained a true sale opinion form Linklaters, a magic circle firm in the City of London. The letter was addressed to the company’s European branch, Lehman Brothers International Europe (LBIE). LBIE was based in New York and used the letter to satisfy the legal requirement.

Linklaters’ opinion was significant in the accounting treatment. It was required by financial regulators as part of the regulatory process. It had to be available to audi­tors as evidence for an accounting treatment or security rating. The opinion therefore facilitated Lehman Bros adopting the approach that misled regulators and the capital markets and led to the collapse of Lehman Bros. It is not known whether Linklaters knew the exact purpose for which the opinion was provided or the implications of providing it. Nevertheless, $50 billion of debt was hidden.

c. Legal Liability

The administrators of Lehman Bros predicted payments of 33 cents on the dollar to creditors. In 2010, Mr. Valukas concluded there were credible civil claims against Lehman Bros’ chief executive, its former finance chiefs and Ernst & Young. By 2011, however, the SEC doubted that it could prove that the accounting treatment was illegal.^[2287] Even if blame could be attached to using the controversial treatment, SEC officials were doubtful that Lehman investors could show that they had suffered loss. The SEC’s position cast doubt on the possible success of criminal proceedings.

d. Professional Responsibility

Kershaw and Moorhead argue that Lehman Bros’ collapse exemplifies situations in which transaction lawyers could be made subject to tighter regulation.^[2288] Firms in Linklaters’ position could not be liable in civil law in the absence of inducement, procuration or ‘knowing assistance’ in a breach of trust or fiduciary duty. They could however, be constrained by the threat of misconduct charges. A request for a true sale opinion letter, they suggest, should put a corporate law firm on notice of a particular kind of risk. Kershaw and Moorhead argue that, where there is a real, substantial and foreseeable risk of client action that is unlawful, or probably unlawful, a finding of misconduct would be justified.

e. Implications for England and Wales

Empirical studies of the lawyer and client relationship suggest that corporate and commercial clients are usually in a position to dictate to lawyers. In a highly competi­tive market these clients can readily find other lawyers and will do so if they are dissat­isfied. This puts lawyers under considerable pressure to satisfy clients. A requirement that lawyers suspicious of their clients’ motives should refuse to act would mean that clients simply moved to other lawyers. There would be significant problems for regula­tors in proceeding against corporate law firms for breach of any such requirements.

It is perhaps because of the difficulty of regulating commercial transactions that the ethical codes of the legal professions in England and Wales do not address the responsibility of transaction lawyers, except in the context of conveyancing. Corporate clients did not appear at all in the index of the vast 1999 edition of the Guide. They were only obliquely mentioned in the Solicitors’ Code of Conduct 2007 in relation to conflicts of interest. The SRA Handbook 2011 does not contain any relevant outcomes. While Enron occurred under previous regulatory regimes, this hypothetical discussion proceeds as if the SRA Handbook 2011 was in force during similar circumstances.

The prospect of an expanded third party liability is not really offered by the SRA Principles. The leading contenders, upholding the rule of law and the proper admin­istration of justice, have very specific meanings, reflected in previous codes and the current Handbook. The sparse notes to the principles suggest that upholding the rule of law and the proper administration of justice encompasses ‘obligations not only to clients but also to the courts and third parties with whom you have dealings on your clients behalf’.

There is a positive reference to the broader interest in the notes to the principles. This suggests that ‘where two or more come into conflict the one which takes prece­dence is the one which best serves the public interest in the particular circumstances, especially the public interest in the proper administration of justice.’^[2289] Of course, before the public interest becomes a factor, two principles must conflict. The lack of specific principles relating to collective third party financial interests means that the note will be largely irrelevant in the contexts under discussion. This means that any obligation to specific and identifiable third parties, or collective ones, is circumscribed.

In the notes accompanying the SRA Principles, acting with integrity is also inter­preted narrowly. It is said to refer to ‘professional dealings with clients, the court, other lawyers and the public’. This mentions third parties and the public, but not in such a way that suggests specific or wide duties. Regarding ‘maintaining the trust the public places in you’ the note also suggests a narrow conception, that ‘[m]embers of the public should be able to place their trust in you’. Nothing in the SRA Handbook, or the previous history of regulation, suggests that solicitors need have collective third parties in contemplation when they act.

Kershaw and Moorhead search for a basis for professional responsibility, in situa­tions like Lehman Bros, lies in what they refer to as ‘the core tenets of what it means for law to be a profession’, specifically the professional principles of upholding the rule of law and not doing anything that undermines public trust. These, they argue, provide a basis for imposing consequential responsibility on lawyers when their actions facilitate unlawful activity. It is more likely, however, that a new principle would be needed on which to base outcomes related to third party collectives.

Kershaw and Moorhead suggest that Outcomes Focused Regulation provides too much scope to corporate transaction lawyers to ignore risk. Therefore, they argue, the SRA Handbook should include a provision requiring lawyers not to assist a cli­ent where that assistance creates a foreseeable likelihood of wrongdoing, defined as breach of criminal or civil law or regulation. This would be something like Simon’s suggested rule (‘you do not provide any services substantially related to active unlaw­ful client conduct’).

In order to achieve the impact that Kershaw and Moorhead intend, it would probably need to be accompanied by an outcome, such as the state Bar rule cited by Gordon. This states that ‘a lawyer shall reveal such information to the extent the lawyer reasonably believes necessary [to avoid unlawful client conduct]’. Even if this could be used as a basis for sanctions against transaction lawyers, it would probably be used infrequently. Kershaw and Moorhead speculate that, because of the considerable difficulty in taking action, regulators would only proceed in cases of substantial detriment to clients, third parties or the public interest.

A final implication of the Lehman Bros case study derives from the multi- jurisdictional nature of Linklaters’ involvement. As discussed, Linklaters provided a ‘true sale’ opinion letter to Enron’s European arm. If, however, they knew that it was for use in the US, they could have been caught by SRA Chapter 13A, ‘Practice Overseas’. The main outcome is that ‘you must be aware of the local laws and regula­tions governing your practice in an overseas jurisdiction’.^[2290] In that case they would be required to disregard an ‘outcome to the extent necessary to comply with that local law or regulation’.^[2291] In that event law firms would be subject to the more explicit US regulation.

vi. Conclusions on Lawyers’ Responsibility for Financial Risks

Based on Three Case Studies

These case studies demonstrate the fact that financial regulatory authorities are strug­gling to control financial markets. The problem is controlling risk without unduly restricting financial institutions’ freedom of action. Lawyers are not quite as exposed in these situations as accountants, but they are often involved. The more extreme examples are often crimes and punished as such. Lawyer regulation is struggling to deal with the implications of the scale of risk and the likelihood that lawyers will be implicated in financial catastrophe and regulatory recriminations. The specific prob­lem arises where lawyers are not directly guilty of criminal conduct but might have prevented client crimes had they been required to break confidentiality.

There are a number of difficulties with a duty to report. One is the circumstances in which a duty is triggered. If it is a duty to report a suspicion, as with money laundering, it would arguably depend on fine distinctions. Such an obligation would weaken chances that lawyers would be trusted with information in the first place. An alternative is that regulation requires independent lawyers to perform a specific gatekeeping function, such as, in the Lehman Bros example, certifying a true sale. If, however, tighter regulation of specific lawyer gatekeeping functions is required, it should be specified for a particular requirement. It is more difficult to conceive of a generally appropriate regulatory formula.

D. The Environment

Although financial scandals have very serious short- and medium-term consequences, damage to the environment may be irrecoverable. Such risks pose a threat to future generations. The main argument against imposing obligations on lawyers to protect the environment is impracticality. If an overseas government permits logging, for example, even though this may cause environmental damage, the basis for whistle­blowing in unclear. If the regime does not permit it, the English-based law firm is already required not to participate in the illegal activity. The gap in the situation is that the firm is not required to report its client’s proposed activity.

Many regard it as shocking that lawyers are not obliged to report clients causing illegal pollution or planning activity that will precipitate ecological problems, such as illegal deforestation overseas. These risks could be mitigated by introducing a positive duty of whistle-blowing for certain public risks. This would, however, raise a familiar collateral issue; it would diminish the potential of the lawyer to offer wise counsel. This argument would be more persuasive if it was known that such counselling is being undertaken effectively. Since such evidence is unlikely to be produced, the duty to offer counsel to avoid harm could be made more explicit.

If a duty to prevent collective third party harms were imposed, it would be impor­tant to ensure it did not impinge on litigation privilege. Corporations charged with offences in relation to collective harms are still entitled to effective representation. To avoid conflict of interest, they should not be represented by lawyers implicated in causing the very harm that is the subject of litigation. It would be sensible, therefore, for any future rules to clarify that lawyers involved in precipitating relevant harms should not act in related litigation.

VI.