Heightened Securities Liability for Lawyers Who Invest in Their Clients: Worth the Risk?^
In the 1990s, the American economy exploded with new technology and a proliferation of software and Internet companies. These companies dominated the markets and made necessary the coining of the phrase "dotcom millionaires" to describe the rags-to-riches lifestyles of their founders. While the average initial public offering ("IPO") in 1999 increased the price of its stock by 170%, the average technology IPO increased its price by 234%.1 Additionally, the top ten IPOs of the year were all either Internet or technology-related companies.2 This technology boom forced law firms to reevaluate their practices because their new clients demanded that tradition be put aside in order for lawyers to better meet the changing needs of start-up companies. At the same time, lawyers whose practices concentrated on high-- tech firms sought a way to share the benefits of their clients' staggering successes. The combination of client demands and attorney ambitions led lawyers to make the transition to investing in their clients' businesses in unprecedented ways. According to an ABA Journal analysis of Securities and Exchange Commission records, one in three lawyers representing the more than 500 companies in IPOs in 1999 held stock in that company at the time of the IPO.3 The report also showed that sixty-three law firms handled the 500 IPOs, either on the side of the company or the underwriter, and that those lawyers held stock in 174 of those companies.4 These investments proved to be very profitable, as the report showed that the lawyers' holdings in more than forty percent of the companies were worth over one million dollars each, and firms investing in nine of the companies saw the value of their holdings climb to over ten million dollars each.5 With numbers such as these, it is no wonder that so many firms have decided to invest in their clients.
After such a successful 1999, neither the dot-com companies nor their lawyers expected the sharp downsward turn of the stock market in April of 2000. While critics were certain that this crash would be the end of lawyers'
interest in investing in their clients, the lawyers whose practices focused on the technology industry seemed willing to continue their investments. As one journalist reported, "the recent market downturn has not dampened the trend."7 In explanation of Cooley Godward's8 continuing investments in clients after the economic slump, Mark Tanoury, the chairman of the business department at Cooley, said, "[w]e take a longer view .... We're all big believers in this economy."9 While some firms indicated that they are now more selective in their investments, none have announced abandonment of the practice.1 Since the stock market plunged, the type of work these law firms are doing in representing their clients is changing from public offerings to mergers and acquisitions, but their lawyers seem to be as busy as ever.11 Only time will tell if the market will recover, or if lawyers will eventually abandon the practice of investing in their clients and return to the billable hour. For now it appears the trend is here to stay.
Investing in clients may have several effects on the practice of law.12 Investing in clients may bring lawyers extended liability under the securities
laws if their clients' investors become suspicious of fraudulent activity. Section 10(b) of the Securities Exchange Act of 1934 declares it illegal "[t]o use or employ. .. any manipulative or deceptive device or contrivance in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors."13 As will be discussed later, investing in clients aids plaintiffs in fulfilling the specific pleading standards required to bring suits against lawyers under this section, and investments make it easier for plaintiffs to show that a lawyer was acting with scienter, one of the elements of a Section 10(b) claim. …