In case you missed it, two weeks ago there was argument at the Second Circuit on the dismissal in New York of the Jacoby & Meyers suit. Jacoby & Meyers is a New York firm (with offices in Connecticut and New Jersey) that sued a variety of state officials in all three states where they operate over the prohibition in their lawyers’ ethics rules on non-lawyer stock ownership. From what I read, its lawsuit may see new life.

J&M wants to incorporate itself as a stock corporation and offer shares to private or public non-lawyer investors. In the business world it is called “going to the market” or financing business with equity. It is prohibited in every jurisdiction except one, though it is all the rage in other common-law countries such as England and Australia. .

The bar has a long tradition of condemning outside ownership. The theory is that non-lawyer managers, boards of directors or shareholders would be focused more on profits and less on client service. Feelings on this continue to run deep. At the recent American Bar Association meeting in Chicago there was a proposal to prohibit the Ethics 20/20 Committee from even talking about changing this rule. But the outrage at shutting off debate was so large that nearly 100 delegates signed up to speak against not even studying the issue. Faced with days of hearings, the ABA House wisely decided to let the committee further explore the issue.

J&M’s litigation has not gone well to date. State officials in each state have raised all sorts of issues, including that J&M cannot sell shares in the form of corporate organization they presently have, has not suffered any losses to date and never even asked if they could sell shares. J&M (probably rightly) simply assumed that when the rules say no, they mean no, and claimed that the prohibition of financing a law practice with equity was wrong, illegal and unconstitutional..

Since the J&M lawsuit began, several large law firms have imploded, including Dewey & LeBoeuf. I was fascinated to read that Dewey’s partners had financed their operation not with equity (which is prohibited) but with debt, and had sold and personally guaranteed hundreds of millions of dollars of bonds. That got me thinking — how is financing a firm with debt any different than with equity? Are lawyers who have signed personal guarantees for large bonds, or signed notes or mortgages to finance lines of credit, any less inclined to make decisions in their economic self-interest over those who have sold shares in their firms? Or might they be more likely to do so?

Employees and officers of stock corporations certainly have to worry about profitability. And the idea of non-lawyers deciding what cases to take, how much to bill, and whether a client should be retained or retired gives me pause. But at the end of the day, when you finance with equity, the shareholders bear the risk of loss. Compare that to lawyers who have financed their firms with debt. Does anyone think that these lawyers would not be worrying about the same concerns? Debt financing is OK, and equity financing is prohibited? How does that make sense?

Handicapping appellate litigation is a notoriously uncertain game. (Remember the Obamacare arguments at SCOTUS?) But the legal prognosticators think that the Second Circuit may allow J&M to replead their case at the district court level and allow it to proceed. That puts the defendant judges and court officials back on the hot seat to answer the question of whether the prohibition on equity financing serves important governmental ends and purposes.

As I pointed out the last time I wrote on this topic, I think that the greatest strength to the J&M case is the constitutional challenge. If it is determined that the rule (either as written or as enforced) impedes commerce, it may be given heightened or strict scrutiny. If that happens, some clever folks are going to have to explain how debt and equity financing are so different that one is prohibited and the other is allowed.

Meanwhile, Fairfield attorney Fred Ury and his colleagues on the Ethics 20/20 committee can put their thinking caps on and see if some compromise rule might be proposed to unscramble the mess. Change comes slowly, and nowhere more so than in bar rules. But change comes… •