Professionalism Consequences of Law Firm Investments in Clients: An Empirical Assessment
Royce de Rohan Barondes
University of Missouri-Columbia School of Law
American Business Law Journal, Vol. 39, Spring 2002
Increasing attention has recently been focused on conflicts of interest among public companies and the professionals assisting those companies in selling or maintaining a market in their securities. Various financial relationships, in addition to fees for securities-related matters, may create conflicts of interest. Although the conflicts of interest involving accounting firms and investment banks have received most prominent recent attention, law firms also may have significant conflicts of interest. For example, a law firm may have an equity interest in its client. The Article provides an empirical assessment of the consequences of those law firm investments.
A data set was assembled consisting of common stock IPOs of non-financial firms in 1998 and 1999 for which Securities Data Company reported the required information. The Article examines the changes in prices from proxies for prices estimated during "beauty pageants," where investment banks are selected to manage IPOs, to the actual offer prices. The Article argues those price changes reflect the level of aggression of the participating counsel in requiring negative disclosure, a less aggressive approach either (i) not requiring disclosure of information that would be required to be disclosed were the law firm not to have an investment in its client; or (ii) allowing the disclosure to be in more innocuous language, i.e., burying the disclosure; or (iii) decreasing diligence procedures, resulting in the law firm not becoming aware of adverse information that it otherwise would uncover.
The results of ordinary least squares regressions show a positive relationship, statistically significant at the 1% or 5% level, between those price changes per share, whether expressed on a dollar basis or a percentage basis, and the frequency with which the issuer's lawyer has such an interest. That is, a greater frequency with which the law firm has investments in clients it takes public is associated with a positive change from a proxy for the beauty pageant price to the actual IPO price. The results also show a positive relationship, statistically significant at the 1% or 10% level, between those price changes, on a dollar basis, and the amount of the law firm's investment in the specific client being taken public. The relationship between law firm investment in the particular firm being taken public and the price adjustment is of the same sign, but generally not statistically significant, in models where the dependent variable is expressed on a percentage basis.
The Article concludes greater disclosure of the nature of these investments should be mandated and raises concerns whether these investments should be proscribed.
Note: This is a description of the article and not the actual abstract.
JEL Classification: K22, G30
Date posted: October 19, 2002