Southern District Judge Lewis A. Kaplan (See Profile) said on Feb. 7 that he would either dismiss for lack of standing a challenge by Jacoby & Meyers to a state ban on law firms accepting equity investors, or he would abstain from hearing the matter.

At a hearing on New York state’s motion to dismiss the firm’s challenge to New York Rule of Professional Conduct 5.4, Judge Kaplan said Jacoby & Meyers had failed to meet one of the requirements for standing because it had yet to show it had a redressable injury (See papers filed by Jacoby & Meyers in opposition of motion).

The rule, he said, “was only the beginning of Jacoby & Meyers’ problems” because other provisions of state law would also prevent the firm from accepting outside investment in return for equity—an argument advanced by Assistant Attorney General Daniel Schulze.

Judge Kaplan made it clear from the outset that the firm would get no relief in his court.

“The plaintiff has come back with papers that state the attorney general is just completely wrong,” the judge said. “In my opinion, someone is totally wrong, but it’s not the attorney general.”

The firm’s lawyer, Jeffrey I. Carton of Meiselman, Denlea, Packman, Carton & Eberz, made a brief argument but after getting nowhere with the judge, ended his presentation quickly.

Should Judge Kaplan elect to abstain, Mr. Carton’s option would be to head to state court to litigate issues of state law, including the claim that the First, Second, Third and Fourth departments of the Appellate Division violated State Judiciary Law §90 because Rule 5.4 gives the judiciary the power to regulate the conduct of lawyers but not the power to regulate commerce. Any appeal from the Appellate Division would be heard by the New York Court of Appeals.

A dismissal for lack of standing would prompt Mr. Carton to appeal to the U.S. Court of Appeals for the Second Circuit, which he says is his preferred avenue. But even there, it is possible that the issue could end up in state court if the Second Circuit were to certify a question on Rule 5.4 to the New York Court of Appeals.

The state court path is one Mr. Carton said he would like to avoid.

“Abstention would send us back to the very body that enacted the rule,” Mr. Carton told Judge Kaplan.

Abstention by Judge Kaplan would come under the discretionary “Pullman Doctrine,” where a federal court may decline to decide a legal action over which it has jurisdiction but where a state judiciary is capable of rendering a definitive ruling on the matter. Railroad Commission of Texas v. Pullman Co., 312 U.S. 496 (1941).

At a November hearing, Judge Kaplan had told Mr. Carton that the attorney was pushing “a huge rock up a hill” to convince the court first on standing, then on ripeness, and finally on Pullman abstention (NYLJ, Nov. 4, 2011).

On Feb. 7, Judge Kaplan said other restrictions in state law meant that, “even if Jacoby & Meyers were right about Rule 5.4 it would get it exactly nowhere.”

One of those restrictions is in the state’s partnership law, where §1500(a)(I) prevents limited liability partnerships from having non-lawyers as partners.

Judge Kaplan disagreed with Mr. Carton’s characterization of the rule as a “blanket suppression of non-lawyer investment,” telling Mr. Carton the firm was free to head to a bank for financing.

But Mr. Carton said it was the “inability to access capital markets that is causing the harm” and the firm’s “cost of capital would necessarily fall” if the restriction were deemed unconstitutional.

Judge Kaplan said he was “forbidden,” or at least “highly discouraged” from issuing an opinion that would be academic and “the odds are extremely high that it would be an advisory opinion.”

In Jacoby & Meyers LLP v. The Presiding Justices of the First, Second, Third and Fourth Departments, Appellate Division of the Supreme Court of the State of New York, 11 Civ. 3387, Jacoby & Meyers claims violations of the First Amendment, the due process clause, the equal protection clause, the takings clause and the dormant commerce clause.

Similar challenges have been filed by the firm against rules barring equity investment in Connecticut and New Jersey, where motions to dismiss are now pending.

Just about every other jurisdiction has a similar rule in place, save Washington D.C., where limited investments are allowed up to a cap of 25 percent. Outside investment in law firms is permitted in the United Kingdom and Australia.

Jacoby & Meyers’s complaint in New York, filed in May, claims that Rule 5.4 puts small firms at a competitive disadvantage because they do not have the same access to capital as large firms.

Judge Kaplan said he would let the parties know soon whether he would abstain or dismiss for lack of standing.

After the hearing, Mr. Carton discussed his hopes for a dismissal and an appeal to the circuit.

“I would hope we’re headed to the Second Circuit because these claims are predicated on the U.S. Constitution,” he said. “It’s difficult to go into a state judiciary system that is the very architect of the rules we’re are challenging.”