Opinion #184. Lawyer's Referral of Clients to an Investment Advisor in Exchange for Referral Fees

Issued by the Professional Ethics Commission

Date Issued: March 30, 2004

Question

The Commission has been asked whether it would be a violation of the Maine Bar Rules for a lawyer to receive compensation from an independent investment advisory firm (“investment advisor”), in which the lawyer has no other interest or involvement, in exchange for the lawyer’s referring clients to the advisor for investment management services.

The inquiring lawyer has provided the Commission with a copy of the proposed contract by which the investment advisor proposes to enter into this arrangement with the lawyer. The contract provides that the lawyer would be an independent contractor of the advisor, with the only service provided by the lawyer to be the referral of the lawyer’s clients’ business to the advisor.

The proposed contract contemplates that the investment advisor would continue to make cash payments to the lawyer for as long as the client’s assets remain under the management of the advisor. Initially, the fee paid to the lawyer, in exchange for referring a client for the advisor’s services, would be calculated based upon the value of the referred client’s assets managed by the advisor. Future compensation would be adjusted for any contributions or withdrawals by the client of funds placed with the advisor as well as any appreciation or depreciation in the value of the client’s assets under the advisor’s management. The client would not be paying larger management fees to the investment advisor than if the lawyer had not been involved in making the referral. In other words, the lawyer making the referral would receive a portion of the investment advisor’s usual management fees, based upon the value of the principal of the client’s account as calculated over time. At the time of making the referral, using the investment advisor’s forms for this purpose, the lawyer would make written disclosure to the client concerning this arrangement.

Opinion

The Commission believes that this arrangement would violate the Code of Professional Responsibility in at least two respects. First, the arrangement would violate Maine Bar Rule 3.4(f)(2), which prohibits a lawyer from acquiring a pecuniary interest adverse to a client unless, among other requirements, the terms are fair and reasonable to the client. Second, the arrangement would violate Maine Bar Rule 3.3(a), which prohibits a lawyer from entering into an agreement for, charging or collecting an excessive fee.

Not Fair or Reasonable to the Client

Of most direct bearing on this question is Maine Bar Rule 3.4(f)(2)(i), which provides, in pertinent part, as follows:

A lawyer shall not knowingly acquire a property or pecuniary interest adverse to the client …, unless:
(A) The transaction and terms in which the lawyer acquires the interest are fair and reasonable to the client and are fully disclosed to the client in manner and terms which should have reasonably been understood by the client.

The Commission finds that the referral fee at issue here is inherently unfair and unreasonable to the client.[1] The singular purpose and design of this arrangement is to influence the lawyer to make recommendations to the lawyer’s client for the benefit of an investment advisor who is paying the lawyer to do so, in stark contrast to the lawyer’s being motivated by the best interests of the client. This arrangement is so adverse to the fiduciary relationship that is the foundation of the lawyer’s responsibility to the client, that the Commission finds it to be fundamentally and objectively unfair and unreasonable to the client, and therefore in violation of the Bar Rule.[2]

Excessive fee

Maine Bar Rule 3.3(a) provides that a lawyer shall not enter into an agreement for, charge or collect an illegal or excessive fee. The Rule defines a fee as excessive “when, after a review of the facts, a lawyer of ordinary prudence would be left with the definite and firm conviction that the fee is in excess of a reasonable fee.” Factors to be considered as guides in determining the reasonableness of a fee include, among others, the time and labor involved, the skill requisite to perform the service, the fee customarily charged in the locality for similar services, and the responsibility assumed by the attorney.

In weighing these factors, the Commission believes the referral fee[3] contemplated by the proposed arrangement is plainly excessive. First, the arrangement provides for potentially significant compensation to be paid for essentially no time or effort on the part of the lawyer. Second, there is little or no skill or judgment exercised by the lawyer. Third, in our experience, fees for referrals of this sort are not customarily received by Maine lawyers, many of whom would consider this practice unprofessional. Finally, the lawyer in this situation assumes no responsibility for the consequences of the referral and undertakes no responsibility for the quality of the investment advisory services rendered. In sum, it is fair to say that the fee, which may aggregate a large sum over time, is unearned by any service the lawyer has performed or will perform in the future, at least insofar as the client’s interests are concerned.

In coming to this determination, the Commission is mindful of the conflict among bar ethics commissions and similar bodies in other states that have struggled with this and related questions.[4] However, having evaluated the views of these other states, the Commission believes and that its conclusion is most consistent with both the letter and the intent of the Maine Bar Rules in upholding the integrity of the fiduciary relationship between lawyer and client.[5]

For these reasons, the Commission views the transaction described in the question presented to be in violation of the Bar Rules.


Footnotes

[1] The Commission does not reach the issue of whether the client can make informed consent to the lawyer’s relationship with the investment advisor under the factors set forth in Bar Rule 3.4(b)(2). The Commission believes that no amount of explanation by the lawyer and no amount of sophistication of the client can overcome the inherent unfairness and unreasonableness of this arrangement to the client’s interests and the consequent undermining of the fiduciary relationship between lawyer and client.

[2] Also potentially implicated here is the general principle of Bar Rule 3.6(a) that “A lawyer must employ reasonable care and skill and apply the lawyer’s best judgment in the performance of professional services.” The contemplated arrangement raises serious questions about whether a lawyer being paid by an investment manager to solicit the client’s business for the advisor is in circumvention of this rule as well.

[3] We view the referral fee in this case as received in connection with the delivery of legal services, and therefore subject to the Bar Rule covering excessive fees, even though it is paid by the investment advisor instead of the client. The referral would occur in connection with, and arise from, the attorney-client relationship and could not be reasonably distinguished, in the client’s mind, from the provision of legal advice. See Maine Bar Rule 3.2(h). Maine Bar Rule 3.12(b) recognizes that legal fees may be paid by third parties, but, the lawyer must not allow the third party to direct or regulate the lawyer’s professional judgment.

[4] Compare: Opinion 682 (1996) of the New York Committee on Professional Ethics of the New York State Bar Association, to the effect that a lawyer may not accept a fee from an investment advisor for referring clients to the advisor, because, among other reasons, clients reasonably expect their lawyers to act as fiduciaries in rendering such advice, and the amount of compensation involved is not objectively determined by the transaction; Opinion 99-08 (1999) of the Ethics Advisory Panel of the Rhode Island Supreme Court, to the effect that a lawyer may not provide both legal services and investment services to a client when the lawyer has a financial interest in the client’s investment decisions, but a lawyer may conduct an investment advisory business with a law client provided the lawyer informs the client of the potential conflicts of interest, advises the client to obtain independent counsel and otherwise complies with the lawyer’s obligation to assure fairness, client consent and confidentiality; Opinion 2000-1 (2000) of the Ohio Supreme Court Board of Commissioners on Grievances and Discipline, to the effect that a lawyer may not receive referral fees from a financial advisor to steer clients to the advisor for investment advice, citing an irreconcilable conflict of interest that cannot be cured by full disclosure because the lawyer’s participation in such a scheme would impair the lawyer’s professional independence and fiduciary duty to the client and also would amount to a prohibited business transaction between lawyer and client; Informal Opinion RI-317 (2000) of the Michigan State Bar Commission on Professional and Judicial Ethics, apparently reversing an earlier opinion (RI- 146 (1992)), determining that it is not inherently unethical for lawyers to profit from referring clients to an investment advisor, so long as the client gives informed written consent, but recognizing that this arrangement precludes the lawyer from giving legal advice to the client in the event that there arises a dispute with the investment advisor; Opinion 97-04 of the Illinois State Bar Association Committee on Professional Ethics (1998), to the effect that a lawyer cannot collect referral fees for sending clients to investment advisors unless the lawyer can overcome a presumption of undue influence over the client, showing that the transaction was fair and that the client had the opportunity to seek independent counsel after full disclosure; Opinion 1998-99/10 of the New Hampshire Bar Association Ethics Commission (2000), in which that Commission deadlocked concerning the issue, with the advice being that a lawyer who wishes to engage in this practice should give serious thought to whether the lawyer’s independent judgment to the client would be compromised; Opinion 98-09 (1998) of the Committee on Rules of Professional Conduct of the State Bar of Arizona, to the effect that a lawyer may not engage in this practice since it may interfere with the client’s ability to be candid with the lawyer, may affect the lawyer’s independent professional judgment, and, if the client becomes an adversary of the investment advisor, may place the lawyer in an impossible conflict; Opinion 97-16 (1997) of the Committee on Professional Ethics of the Connecticut Bar Association, to the effect that a lawyer may accept such an investment referral fee if the client gives informed, written consent; Joint Formal Opinion 2000-100 (2000) of the Pennsylvania Bar Association Commission on Legal Ethics Professional Responsibility and the Philadelphia Bar Association Professional Guidance Committee, to the effect that a lawyer may accept such an investment referral fee so long as the lawyer takes great care to obtain valid client consent and the fee will not influence the lawyer’s judgment or otherwise impair the attorney-client relationship, recognizing that the “preferred practice” would be for the lawyer to pass on the referral fee to the client; Opinion 99-07 (1999) of the Utah State Bar Ethics Advisory Commission, to the effect it is not per se unethical for a lawyer to accept such an investment referral fee but that the lawyer has a heavy and “very difficult” burden to assure that the lawyer can maintain independence while taking a cut of the advisor’s compensation.

[5] Many of the opinions of the states that find this practice to be potentially ethical set forth conditions that this Commission finds to be so unrealistic as to fortify the conclusion that the correct course is to consider the practice per se unethical, as other states deciding the question have found. For example, the Utah ethics panel, while technically allowing the practice, has said that it would be “very difficult” for a lawyer to engage in it and still maintain the required independence, with the lawyer obligated to consider whether the client may later have concerns that the lawyer has not provided unbiased advice or that the lawyer’s loyalty to the client has not been compromised. Likewise, the Pennsylvania ethics panel, while technically allowing the practice, states a number of challenging factors that the lawyer must weigh in determining that the relationship with the client remains that of trust, including the sufficiency of the disclosure, the sophistication of the client, the independence of the advice and the reasonableness of the referral fee. The New Hampshire ethics panel, while deadlocking on this question, was able to articulate that the lawyer must at least consider whether the client has received a benefit from the lawyer’s referral recommendation, and whether there may arise an inherent compromise of loyalty that would influence the lawyer’s judgment. In sum, all of the panels that technically allow the practice have at the same time admonished that the lawyer must remain independently loyal to the best interests of the client, a prospect that this Commission considers to be essentially impossible under the circumstances presented.


Enduring Ethics Opinion