By SHERRI CRUZ
There haven’t been any troubles,yet,with the practice made popular in Silicon Valley of lawyers accepting stock in their high-tech startup clients as payment for legal fees. But some attorneys are wary and say this is an ethical issue on the verge of bubbling over.
“It’s very good for the company and very good for the lawyer, if everyone is honest,” said Jeremy Miller, editor-in-chief of Orange County Lawyer.
The way it works: a law firm swaps its legal advice for stock equity in a high-tech client because the law firm wants to invest in the company, the high-tech company wants the attorney’s investment or, more frequently, the startup lacks cash. Some firms do an outright advice-for-stock swap, while others keep it “separate” by setting up an investment fund. For example, Silicon Valley law giant Wilson Sonsini Goodrich & Rosati, which advises firms such as Infoseek and Liquid Audio, keeps a running tab with its technology startup clients while separately investing in them.
“Sometimes they pay. Sometimes they don’t,” said Barry Taylor, attorney for the firm. The net effect is the winners pay for the losers. It’s been a good economic model, one with which the firm hasn’t lost any money, Taylor said.
“The problem is when things don’t go well it might not be a rosy situation,” said State Bar President Andrew Guilford, of the OC office of Sheppard, Mullin, Richter & Hampton. Lawyers are in the business of giving advice and if a law firm has a financial interest in its client, then it might be tempted to watch out for its financial interest. It’s a matter of mixing a fiduciary relationship with business. “The relationship is not consistent.”
The other side is it offers “access to justice” for small businesses that can’t afford a lawyer, Guilford said. In some respects equity payment is sort of like a contingency fee.
Nonetheless, Guilford said the existing rules are sufficient to provide protection in the event the transaction turns sour and his firm is open to the legal advice-stock swap, but does it infrequently.
Growing Trend
Although OC law firms don’t engage in the practice as much as their Northern California counterparts, it is increasing in popularity due to the growing base of high-tech companies in OC.
“Most of them start with no money,” said Nick Yocca Sr., referring to his firm’s roster of high-tech clients. Yocca is a partner in the Newport Beach-based Stradling, Yocca, Carlson & Rauth. That’s why the firm sometimes takes stock in its high-tech clients instead of insisting on cash payment.
In addition, “many of the companies want the lawyer to have an equity stake,” he said. Clients say that it makes the attorneys more attentive, even though Yocca says the firm treats all of its clients equally, with the same respect.
While Yocca says the firm has lost money on some of those arrangements, overall “we never lost enough to stop doing it.”
The firm usually risks about $5,000,but not more than $10,000,in pre-venture capital companies that have a solid management team. The main reason for taking equity is not to capitalize on an opportunity but to develop a long-term relationship with the startup, which later will require other legal services, he said.
O’Melveny & Myers recently opened its new office in the Irvine Spectrum and formally began the practice of bartering advice for stock in its technology clients. Jerry Carlton, managing partner, co-heads an in-house committee that signs off on this type of deal.
The firm has done about 13 partial equity fee transactions in OC. Carlton said it invests primarily to get a company as a client, not to make jillions of dollars on the shares.
“No one is counting on the stock in this pot making anybody real rich,” he said.
Ethical concerns are minimal, Carlton said, as long as there is disclosure and the firm assumes a passive shareholder stance.
While O’Melveny and Stradling are warm to the fee arrangement, other firms are testing the waters. Morrison & Foerster has not been involved in an equity-for-legal-services transaction, but Bob Mattson, head of the firm’s corporate practice, said it is formulating a policy to offer the alternative fee arrangement on a case-by-case basis. Mattson said it might take a small piece of a company and partial cash payment for legal advice.
“The sense would be you’d never end up with a huge amount of stock in the company,” thereby eliminating possible conflicts of interest, he said.
“For years, our answer was ‘We just don’t do that,'” said Don Martens, managing partner of Knobbe, Martens, Olson & Bear. Recently, however, that firm also decided to accept equity on a case-by-case basis, but still the firm doesn’t do it very often.
Gibson, Dunn & Crutcher has never swapped advice for equity either, said Ron Beard, chairman of GDC. However, GDC is considering setting up a separate fund where the firm can invest in technology companies. Although some of the firms it invests in will also be clients, Beard said most of the partners wouldn’t know about the fund, therefore, it wouldn’t compromise the firm’s legal advice.
Ethical Concerns
Bob Kehr, chair of the Committee on Professional Responsibility and Conduct of the State Bar of California, said the Bar has not issued an opinion on this type of transaction but it will be addressed this year.
“It is inevitable that there will be litigation on this,” he said.
How the courts will deal with it is unclear, but it also will be one of the focal points during the June 17 Western State School of Law in Fullerton symposium.
Right now, the transaction is basically governed by two rules. One says an attorney can’t charge an “unconscionable fee,” the other that an attorney can’t enter into a business transaction with a client.
But Kehr said those two rules leave some unanswered questions, such as: If a lawyer does X amount of work and gets 1,000 times X in stock, is that unconscionable? How do you value lawyer services? Do attorneys get an insider price on stock? Did the attorney negotiate that price? How does the lawyer sell his stock? If an attorney sells his stock, is it an act of disloyalty to the client?
Within the next two years, an ethics committee or a court likely will determine whether or not taking stock is a business transaction, he said. For now, “there’s a risk involved for any lawyer that does it.” And although attorneys are accepting that risk now, eventually “somebody is going to have hard feelings.” n
