California takes on private equity influence over law firms
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California's state legislature last week passed a bill to restrict private equity investment in litigation firms, but it appears to have the bite of a goldfish.
Why it matters: Legal practices are greenfield for private equity, which has spent the past decade buying and rolling up virtually every other type of professional services partnership (financial advisory, medical, etc.).
Zoom in: The California bill, which Gov. Gavin Newsom has a month to sign into law, would stop financial sponsors from "controlling or improperly influencing litigation decisions or outcomes."
- Among barred activities would be choosing which clients to represent, determining financial terms of client representation, deciding on settlements, or advising on legal strategy.
Yes, but: The bill does not seem to curb private equity investments in managed services organizations (MSOs).
- MSOs are legally separate entities that handle a law firm's back-office operations (e.g., marketing, HR, etc.). They're sometimes compensated via revenue-linked fees — which new laws in Colorado and Illinois have sought to curb.
- They're the main way that PE buys into the legal sector, given that most state ethics rules mirror an American Bar Association requirement that law practices be owned by lawyers.
- As such, it feels like a pretty big whiff for California. One could argue that the state is just seeking to keep private equity out of law firm decisions, rather than law firm economics, but existing ethics rules appear to do that already.
What to watch: Charlesbank Capital Partners reportedly is negotiating an investment in California-based law firm WSHB. And yes, it plans to utilize an MSO.
- There's also a possible PE deal coming for personal injury giant Morgan & Morgan, which has numerous California offices.
The bottom line: California is worried about private equity influence on law firms, but private equity's lawyers seem to be one step ahead.
