Private Equity and Legal Ethics: Can They Coexist?

Professional ethics is based on the principles of serving the interests of legal services clients, acting in the interests of justice and acting with integrity and honesty. Owners of law firms of course want to make good profits, and private equity houses who invest in law firms will also want to sell their asset on for a profit after 5 years or so.

Why though would any private equity backed firm be less professionally ethical than a law firm owned by its lawyer-partners? Why is any increase in private equity backing of law practices, for example, substantially different to the arrival of ABSs or, in recent times, the substantial reduction in numbers in equity partner cohorts?

In this article we explore this question and remind all parties of how crucial it is to the success of the investment that the business preserves its ethical values. We emphasise how vital it is that PE investors demonstrate an understanding of the regulatory landscape to the firms that they are speaking to and how law firms must help PE investors understand how deep ethics and compliance goes and how it is that that in the legal world you can be compliant but unethical or ethical but non-compliant.  

Of course, there is a difference between compliance with rules (i.e. something that is required) and acting in accordance with professional ethics (i.e. something that is the right thing to do).

But don’t good lawyers take those two things largely hand in hand? While the compliance line is fixed, the ethics line can be more flexible—and it’s true that a firm’s ownership or strategic direction, whether driven by private equity or traditional partners, can influence where it chooses to position itself ethically on various client-related issues. But legal ethics don’t simply shift or disappear based on business decisions made at a given moment. Doing what’s right goes beyond what’s merely required.

So can private equity ownership lead to an erosion of professional ethics in a law firm? The answer to that question should be ‘no’. The management of any private equity owned firm has no interest in doing anything that has any substantial effect on the likely adherence of its lawyers to the professional codes that they eat and breath. Any serious shortcoming leaves those lawyers’ careers, and the firm, exposed.

The better question is perhaps this – can private equity investors in law firms hold their businesses together under their model and thus secure their returns on disposal of their asset? With the big prize of equity partnership removed and their star performers and rainmakers working under less risk, but with arguably less incentive to maximise profit, can a private equity owned business keep all its good people and maintain levels of growth and a wider upward trajectory for the firm? Doing so achieves the core aim: making the firm an attractive prospect for purchasers a few years down the line. It must surely be that doing that successfully requires the firm to genuinely prioritise their clients’ interests, foster a culture of transparency, invest in future talent, and uphold ethical professionalism. For a private equity-backed firm to thrive, it must surely preserve these values. Only private equity-backed firms that recognise the link between principled conduct and long-term success will achieve the returns they seek when exiting the business. They will only succeed with ongoing established high standards of professional ethics at their core. It will be vital that they invest in talent and build ethical firewalls and transparent governance structures that have at their core ethically sound and regulatory compliant behaviours within the firm. That will be the only way for PE-backed law firms to survive and thrive.

Perhaps we can go so far as to say that this is a truly key issue for those in the private equity space who wish to purchase law firms to become fully conversant with. It is becoming clear that law firm acquisition is becoming a highly competitive market for any finance house and that many interactions end without an agreed deal between the parties. Owners of law firms want to maximise their return of course but, even if they don’t realise it themselves, they thrive on the meeting of minds in different ways, not least deep soundness in professional ethics. The legal profession is gradually being buried by regulatory compliance requirements and ethical expectations – the buyers who demonstrate a real understanding of the importance of the latter in particular will see discussions advance more often. Private equity houses must plan for this by showing a keen awareness of the weight of its importance when negotiating and then on completion ensuring that sound professional ethics will be core to its blueprint for the business.

The buyers must therefore understand from the start what professional ethics means in a law firm and then latterly be shown how the selling firm’s management team has trained its people on the firm’s ethical expectations and then applied those expectations to tricky ethical questions as they have arisen. An action can be compliant but unethical or indeed ethical but non-compliant – a discussion that leads to real understanding to any non-lawyer purchaser about the former will not just evaporate tension in negotiations but also set the new business on the path to short term, medium term and exit success.

If you have any questions or would like to discuss further, please contact Partner and Regulatory specialist, Nick Leale.