Commentary: Close The Lawyer Loophole

Their ability to reduce legal liability for executives is fueling white-collar crime

Believe it or not, attorneys have to pass a "moral character" test before they are allowed to practice law. Because state bar associations purport to be concerned about protecting the innocent public from dishonest lawyers, they force applicants to provide character references and to undergo background investigations. Then candidates must raise their hands and make a solemn vow to abide by a detailed set of ethical rules that, among other things, forbid attorneys from assisting "a client in conduct that the lawyer knows is criminal or fraudulent."

In exchange for taking this little pledge of allegiance -- and passing the minimal character-screening test -- lawyers get quite a bit of power. Say an attorney advises a client that a too-good-to-be-true tax shelter is legal. If the Internal Revenue Service later challenges the deal, the fact that a duly licensed and approved lawyer blessed the shelter means that the client can generally avoid criminal prosecution, cut down potential civil liability, and face a smaller fine. In a wide variety of settings that go well beyond the tax world, attorneys are essentially empowered to give business customers something very valuable: a get-out-of-jail-free card.

There's increasing evidence that corporate lawyers are abusing this privilege. One good example is, in fact, tax shelters -- an area in which the IRS has recently unearthed several dubious schemes that got green lights from respected tax attorneys. But that's hardly the only instance. Critical elements of many of Enron Corp.'s most deceptive balance-sheet maneuvers were approved by big law firms, as were some of the trading strategies used to rip off mutual-fund investors.

This plague of dubious legal advice is giving prosecutors a big headache. To send a CEO to jail, they have to prove that the executive intended to break the law. But this becomes nearly impossible to do when attorneys write a gilded, watermarked, cotton-fiber letter saying that a particular gimmick is legal. The expensive piece of paper directly undercuts prosecutors' arguments that a manager has the necessary mens rea, or state of mind, to commit a crime. That's a big reason why the first excuse that has come out of the mouths of many of the most prominent white-collar wrongdoers, from Enron's Kenneth L. Lay and Jeffrey K. Skilling on down, is that their attorneys rubber-stamped their deeds.

That some of the Lays and Skillings of the world have had their legal exposure reduced might be tolerable if their attorneys had a corresponding increase in liability. But this isn't the case. Corporate lawyers are almost never sent to jail for helping out white-collar criminals. The civil liability of business attorneys was dramatically reduced by the Supreme Court's 1994 Central Bank of Denver ruling, which shielded lawyers and others who "aid" or "abet" securities fraud. And most state bar associations, notwithstanding their ostensible concern for the public, almost never impose discipline on lawyers in blue-chip firms. They would much rather hound paralegals selling cheap wills in strip malls.

As a result, there's a gaping loophole in our legal system. All an executive has to do to get away with fraud, it sometimes seems, is to have an attorney bless the wrongdoing. Attorneys are in "a unique position of trust, conferred upon them by their license to practice law, and they take advantage of that trust," says Los Angeles County District Attorney Steve Cooley, who created a special prosecutorial unit in 1999 to go after attorneys. "Historically, lawyers have been underprosecuted because of their special status."

It is time to start closing the lawyer loophole. Cooley's team is a great idea, but it's a small effort and has not been copied in any other major city. In late December, the IRS announced that it was beefing up its Office of Professional Responsibility and issuing stricter guidelines for tax opinion letters. That's a long overdue move, but again, it's not enough. Now Congress needs to restore the accountability for lawyers and other gatekeepers that was eliminated by the Central Bank of Denver decision. Prosecutors also need to redouble their efforts to throw crooked lawyers in jail, notwithstanding the fact that there are high hurdles to doing so. And judges need to stop giving as much deference to the so-called advice-of-counsel defense -- the legal argument that clients use when they try to claim that "the lawyer said it was O.K."

These are serious steps. But they are the only way to change a legal culture that is almost comically at odds with the profession's pompous self-image. In their own carefully crafted mythology, attorneys are custodians of the court who help clients comply with the law. But like auditors, business lawyers have found it harder to say no to big clients in recent years. "All of the financial incentives are for clients to seek out lawyers who give them the advice they want to hear," says University of Virginia law school ethics professor George M. Cohen. "And all of the financial incentives are for lawyers to give it."

Thus, many of the most highly paid corporate attorneys in America all but ignore the spirit of tax, corporate, and securities laws. Instead, they are often linguistic Houdinis who specialize in hypertechnical arguments as to why their client's rat poison meets the five-part test for being apple pie. Many corporate law firms have a "business ethos that does not appeal to a larger sense of right and wrong but instead defines itself solely in terms of technical compliance," wrote University of Miami law professor William H. Widen, a former partner at Cravath, Swaine & Moore in Manhattan, in an article in The Business Lawyer last year.

Sarbanes-Oxley Syndrome

The result, inevitably, is that broad notions of right and wrong have gradually disappeared from the big-time corporate law practice. In the eyes of many corporate attorneys, the fact that a particular tax shelter or corporate maneuver can be technically defended makes it morally and ethically right -- even if that makes a mockery of the law's substance.

This legal climate is making it a lot harder than it should be to throw executives in jail. And that, in turn, is forcing lawmakers to try to prevent future wrongdoing by devising increasingly detailed regulations governing how businesspeople, auditors, lawyers, and analysts should behave. Witness the Sarbanes-Oxley Act, a bureaucratic nightmare that is spawning a whole new industry in compliance software. Rather than force hundreds of managers to cut through red tape, it would make a lot more sense to put the few genuinely bad apples behind bars. But to do that, the lawyers are going to have to be held more accountable for the advice they give.

By Mike France

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