Last week’s post discussed how the legal vertical is primed for interruption. So why hasn’t something big happened yet? If we follow Clayton Christensen’s theory of disruptive innovation, we can identify change at the margins: the rise of legal service providers. They have wrested “high volume/low value” legal tasks away from law firms to such a significant degree that document review, privilege logs, data mining (eDiscovery), and other tasks are now commoditized– signs of a mature sub-market for such services. Likewise, “legal consulting firms”, the larger ones comprised of hundreds of lawyers (as well as other professionals including economists, technologists, CPA’s, cyber-security experts, etc.) are providing services–and, increasingly, products– that compete directly with the very tasks law firms engage in: risk management, contracts, regulatory compliance, best practices to cite but a few in a growing list. These “legal consulting firms” have a significant advantage over the law firms they often compete with because they are not regulated by State Bars and can share profits with non-lawyers as well as receive financial backing from venture capital firms as well as from other institutional funding sources. True, they must work with law firms on the “legal” piece, but they can—and do—take a more holistic view of problem solving than law firms.
In contrast, law firms are prohibited from receiving “outside” initial funding –unless it is by lawyers. This prohibition relates principally to start-up funding since almost every law firm in America is reliant on banks to provide them with working capital. If this distinction seems strained and artificial to you, it does to me, too.
So with an ailing– if not broken–model, disruption occurring at the margins of the legal supply chain and inexorably wending its way up from lower to mid-value tasks, and, most importantly, clients clamoring for lawyers to deliver “more for less”, why is the legal vertical not yet experiencing full-blown disruption? Certainly, the conservatism of lawyers as a group is a factor. Besides, until recently they have generally had a good, long run of it and more often look for reasons why things can go wrong (disrupting the status quo) than how to make things better (and to address the broken model of traditional law as well as the access to justice crisis to cite but two things in desperate need of disruption).
(Self) Regulation is Impeding Disruptive Innovation in the US Legal Market
But the key reason for arrested legal disruption—at least here in the U.S., the largest legal market in the world—is (self) regulation and, more specifically, the persistence of Rule 5.4 (and related Rules and regulations). In sum, Rule 5.4 preserves the status quo and stifles disruptive innovation by prohibiting lawyers from sharing profits with non-lawyers; accepting seed capital from non-lawyers, and from allowing non-lawyers (with some limited exceptions) from partnering with non-lawyers. True, DC has adopted a more liberal version of 5.4, but this is of little comfort to a law firm seeking to practice outside the District where the rules governing each jurisdiction must be strictly adhered to.
But is the status quo worthy of such protection, especially where clients (customers) are dissatisfied and clamoring for change and where so many lawyers themselves acknowledge the broken model they operate in? A look at the UK is instructive, if not inspirational.
The UK Regulatory Scheme: An Accelerant for Disruptive Change that Should be Adopted Here
The British passed a remarkable piece of legislation in 2007 (which took effect five years later) in response to widespread public dissatisfaction with the legal delivery system. The legislative history of the Legal Services Act of 2007 (“LSA”) derives from a two-year inquiry into the UK legal market headed by Sir David Clementi, a former Deputy Governor of the Bank of England. Note: Sir David is an economist, not an attorney, and that may account, in part, for his tabula rasa analysis and frank recommendations for legal reform. Clementi did not mince words when he concluded that the “retail” and corporate segments of UK legal delivery were broken, in need of immediate and significant transformation, and, ultimately, not serving the public well. He noted the monopolistic characteristics of the self-regulated legal marketplace, noting that its structure discouraged—if not precluded—meaningful competition. To rectify this and to encourage disruption, Parliament passed the Legal Services Act of 2007. The Act advanced significant change to the British legal marketplace, most notably by:
- allowing lawyers to engage in fee sharing with non-lawyers;
- permitting lawyers and law firms to accept funding from institutional sources (read: doing away with the requirement that lawyers alone can fund law practices);
- paving the way for Alternative Business Structures (“ABS”), enabling law firms to be owned and, at least to some degree operated by non-lawyers.
The UK was not the first nation to jettison these key limitations on the way law firms operate; Australia blazed the trail soon after the new millennium and, in fact, had the first law firm IPO.
More recently, other nations, notably Canada, have considered allowing ABS’s in some form, recognizing that: (1) the current legal delivery model is not working (read: the public is not being well-served); (2) advances in technology enable lawyers (like those working in the industries cited above) to work remotely, collaboratively, and on a potentially more cost-effective basis than before and that is a good thing to promote; (3) there is an access to justice problem at the “retail” end of the market; (4) there is widespread client dissatisfaction in the corporate segment stemming from the value/cost gap; (5) globalization; and (6) the UK and Australia have paved the way for reform (and things there have not fallen apart). The Canadians also recognized the ascent of largely unregulated “legal service companies” who hold a distinct advantage over lawyers because—among other reasons—they are not limited in their potential funding sources.
- Still, as recently as 2012, the ABA has failed to endorse initiatives to liberalize the regulatory/ethical guidelines for US lawyers and this, I believe, is in part due to what must be viewed as a “goal line stand” to subvert disruptive innovation in the US legal market.
- The stated bases for opposition are predictable, if not flawed: (1) non-lawyer investment would create economic conflicts of interest for law firms that would adversely impact clients; (2) lawyer fee splitting with non-lawyers would somehow compromise objectivity and compromise the best interest of clients; and (3) deregulation would open the floodgates to those seeking to make law into a business. Of course, these reasons are easily countered because:
- clients, not lawyers, should be the paramount concern vis-à-vis regulations proscribing how legal services are rendered;
- law firms have demonstrated time and again that their economic interest is already regularly at odds with the client;
- law is already a business and has been for some time—with margins that far eclipse those of most service and product companies;
- self-regulation is not serving the interests of those to whom the lawyer has a fiduciary obligation to act in the best interest;
- the distinction between legal service providers and law firms is increasingly artificial and, at times, blurred;
- the cornerstones of the profession—confidentiality, the avoidance of conflict of interest, and zealous representation will not be abridged by sanctioning alternative business structures.
- These structures will unleash competition, drive down prices, enhance efficiency, promote transparency, and, ultimately, help to repair the trust in lawyers that has eroded so dramatically during the past several decades.
Conclusion: Let Them Play the Game
The US legal market is poised for disruptive innovation. All the ingredients are there except liberalization of existing Bar restrictions that no longer serve the interest of the public or even lawyers themselves (except, perhaps, a handful who are benefitting from preservation of the status quo). The innovation and value brought by legal service providers should be permitted to spread to law firms. Such change will surely accelerate the demise of law firms as we know them, but is that such a bad thing? New models will spring up that respond to the needs of today’s marketplace, and they will benefit clients—and most lawyers, too. As a recent article in The Guardian reviewing the effects of ABS on the UK legal market sagely concluded:
“It may be a difficult time to be a lawyer, but – at least in theory – it should be a better time to be a client.” Amen.
This post is the second of two posts that explains why disruption has not yet taken hold in the legal industry.