Wednesday, January 14, 2015

New Ethics Rules Limit Lawyer Conduct in PA

Broad new restrictions are being imposed on involvement by Pennsylvania lawyers with client investments. Included in the new attorney conduct rules issued by the PA Supreme Court on December 30th is a prohibition on a lawyer investing funds for a client if the lawyer or a family member of the lawyer receives compensation from anyone other than the client.
The new rules follow a number of recent high-profile incidents where millions of dollars in losses were incurred by attorney’s “investing” client funds.
New Rule 5.8 [see below] prohibits a lawyer from selling or placing an investment for a client unless (1) the lawyer is independently licensed to do so, and (2) the lawyer does not have a disqualifying financial interest in the transaction. Disqualifying financial interests include the receipt of compensation from a third party or an ownership interest in the entity that issues or manages the investment. The prohibitions in Rule 5.8 appear to be absolute such that they cannot be waived by the client even after full disclosure. 
Other changes are intended to make financial records be more accessible to the attorney disciplinary bodies that examine alleged attorney misconduct, and to ensure the prompt and complete disengagement from the practice of law by suspended or disbarred attorneys. PA lawyers should closely review the amendments to Rule 1.15 which tighten record keeping requirements for client trust accounts.  
Lawyers who have voluntarily gone on inactive status without fault must nevertheless comply with strict notification requirements if they serve in a fiduciary capacity (e.g. as trustee, agent under power of attorney, guardian). See the amendments to Rule Rule 217 of the Rules of Disciplinary Enforcement (R.D.E). To avoid the requirements of Rule 217, it appears that the lawyer may be able retire and formally apply for and be granted retired status. See Pa. R.D.E. Rule 219(i).    
The new rules have an extremely broad reach and implications that will surprise many lawyers. Rule 5.8 pretty clearly prohibits lawyers with appropriate licenses from selling life insurance or an annuity to a client if the lawyer will receive a commission from a third party on the sale. But less obviously, the rule may prohibit a lawyer who receives compensation as a bank director from recommending the bank’s trust department to clients. And it may prohibit a lawyer whose son is an investment advisor from recommending the services of his son.
Here is a link to the new and amended Rules. changes are in Annex A and Annex B.
I’ve reproduced new Rule 5.8 below in the hope that Pennsylvania lawyers who read this blog (especially those who are licensed to sell investment products) will go over it carefully. 

Rule 5.8       Dealing in Investment Products:  Prohibitions and Restrictions
(a)      A lawyer shall not broker, offer to sell, sell, or place any investment product unless separately licensed to do so.

(b)     A lawyer shall not recommend or offer an investment product to a client or any person with whom the lawyer has a fiduciary relationship, or invest funds belonging to such a person in an investment product, if the lawyer or a person related to the lawyer:
(1)     has an interest in compensation paid or provided by a person other than the client or person with whom the lawyer has a fiduciary relationship; or
(2)      has an ownership interest in the entity that sponsors, insures, underwrites, manages, or issues the investment product.

(c)      For purposes of this Rule:
(1)     the term “investment product” includes:   an annuity contract; a life insurance contract; a commodity; a swap; an investment fund, including but not limited to a collective trust fund, a common trust fund, a real estate investment fund, and registered investment company; a security, whether or not the security is registered with any federal or state securities regulator; or an investment adviser’s, bank’s, trust company’s, insurance company’s, or other financial institution’s service as an investment manager or investment adviser;
(2) “person related to the lawyer” includes a spouse, child, grandchild, parent, grandparent or other relative or individual with whom the lawyer maintains a close familial relationship; and
(3) the term “ownership interest” does not include shares of an issuer that has registered the shares under federal securities laws, the issuer’s shares are traded on a securities exchange that is registered under federal securities laws, and the lawyer’s aggregate interest in shares of all classes is less than one percent of the issuer’s outstanding common shares.

[1] Paragraph (a) prohibits a lawyer from brokering,  offering  to  sell, selling, or placing any investment product, as defined in paragraph (c)(1), unless separately licensed to do so. Licensing and registration requirements vary by state. Before offering or selling any investment product in relation to the provision of legal services, a lawyer must consult all applicable federal and state laws to determine eligibility, licensing and regulatory requirements. Paragraph (a) neither addresses the giving of investment advice nor is intended to supplant or otherwise affect federal and state laws that either require licensing and registration in order to give investment advice or exempt lawyers from their regulatory scheme.
[2] Paragraph (b) prohibits investment situations that are fraught with a potential for a conflict of interest or that provide an opportunity for the lawyer to control or unduly influence the use or management of the funds throughout the course of the investment. Clients who place their trust in their  lawyer  and assume or expect that the lawyer will protect them from harm are likely to feel deceived if substantial sums of money are lost on investments pursued at the lawyer’s recommendation or prompting and the lawyer or a person related to the lawyer either receives compensation or a pecuniary benefit from a person other than the client or has an ownership interest in the entity that sponsors, insures, underwrites, manages, or issues the investment product, even when the reason for the loss is limited to unexpected market conditions. The prohibition of paragraph (b) is not imputed to other lawyers in the lawyer’s firm or those lawyers’ relatives.
[3] This Rule applies to a lawyer under any circumstance—whether the lawyer is providing legal services, nonlegal services that are not distinct from legal services, or nonlegal services that are distinct from legal services. See Rule 5.7(e) for the meaning of the term “nonlegal services.” The prohibition of paragraph (b) is in addition to the restrictions imposed by Rules 1.7(a)(2), 1.8(a) and 5.7.


Unknown said...

I wonder about your last example about recommending the services of the son as investment advisor. To my reading of the rule, if the investment advisor fee is being paid by the client..then it falls outside of the rule (same for if the lawyer owns the RIA running as fee-only).

Said another way, 5.8(b)1 seems to read that if compensation is paid or provided by the CLIENT, then it's not violative.

Do you agree?


Jeff Marshall said...


I agree that if ALL the compensation is paid by the client, there appears to be no violation.

I think the violation for the lawyer would arise if the broker receives a fee or other compensation from anyone other than the client.


Dave Thompson said...

Like you point out it is important to have checks and balances when it comes to clients fund trusts. You don't want one lawyer to have soul control of the money. Having multiple people look after the money will ensure it is used for the right things at the right time.