Lured by the promise of stock market riches and driven by economic necessity, local law and accounting firms are increasingly accepting stocks and options as a form of payment from their clients.
O’Melveny & Myers, Arthur Andersen and Troop, Steuber, Pasich, Reddick & Tobey are among the prominent L.A.-area firms that either have started the practice or are considering it.
Trading equity for service, however, does raise ethical questions for firms that traditionally have been relied upon for impartiality. It’s also the latest indication of how Wall Street is dictating the business climate.
“Historically, we have been very cautious about accepting equity because of the intrinsic risk of a conflict of interest,” said Kent Graham, a partner with more than 30 years of experience at O’Melveny & Myers, the city’s oldest law firm. “But now we will certainly consider it on occasions.”
Arthur Andersen already is accepting equity as a form of payment in select situations, according to Dick Poladian, managing partner of the firm’s Los Angeles office.
“We do it when we feel it is in the strategic interest of both ourselves and the client,” he said.
Poladian noted that while the firm might make such arrangements for consulting or bookkeeping, it would not accept equity from companies it is auditing.
Equity is typically used as a “kicker” designed to enhance a traditional cash payment scheme, Poladian said.
“In the right situation, equity can help align the goals of both ourselves and the client, which is to enhance shareholder value,” he said.
The willingness to accept equity by service firms is seen as an outgrowth of the phenomenal stock market gains shown by high-tech companies. Indeed, Silicon Valley law firms such as Brobeck, Phleger & Harrison LLP first pioneered the use of equity as a form of payment.
So far, Arthur Andersen is the only major L.A. accounting firm that acknowledges equity arrangements. But it’s a well-established practice among smaller firms, according to Mannon Kaplan, managing partner at Miller Kaplan Arase & Co. in North Hollywood.
“It’s seen much more among the very small firms, where you have a close relationship with the client,” said Kaplan, whose firm, at times, accepts stock.
The trend is based in part on the ongoing departure of large corporate clients as well as the growing influence of smaller companies, many of them in high-tech. Accepting stocks is seen as a good way to develop a long-term relationship with companies that may not have a lot of cash to pay for services rendered.
“We have to be flexible,” said Frank Reddick, co-managing partner at Troop, Steuber, Pasich, Reddick & Tobey, which has also started accepting stock from client companies.
While Reddick conceded that some members of the legal community are uncomfortable with the practice, especially on the East Coast, the acceptance of stock is becoming a vital part of doing business with smaller companies.
“It is essential that we develop a relationship with these companies at an early stage,” he said. “Because it is the law firm that is there early on that is able to follow along as the company grows.”
The potential conflicts are obvious. “You have to make sure that you make decisions for the client based on sound legal considerations rather than what is good for your equity stake,” said Graham. “Sometimes, that line can get cloudy.”
That’s why some law firms are resisting the urge. “We have not been willing to accept equity from clients and I don’t see that changing,” said Wesley Howell, managing partner at Gibson, Dunn & Crutcher, the third-largest law firm in Los Angeles. “It creates too many complications when you are an owner. Like they say, when a lawyer represents himself, he has a fool for a client.”
But while law firms may have a policy of not accepting equity from a client, individual partners may be buying stocks in client companies.
At Troop, Steuber, Reddick says, clients sometimes use equity to pay legal bills without the law firm technically being involved often through a private placement. The company would then use that money to pay its bill with the law firm.
Another strategy for limiting the potential for conflict involves a firm investing in a client’s company through a third party, such as a venture capital firm. This way, the law firm is technically doing business with the venture capital firm, rather than the client.
While there are few regulations involving law firms’ involvement with their clients, accounting firms generally face tougher scrutiny from the Securities and Exchange Commission. And recently, the SEC has started to crack down on what it deems a weakening of accounting standards in corporate America.
“The SEC is taking a very hard look at the impartiality of accountants,” said Greg Moore, who heads the auditing practice at PriceWaterhouseCoopers LLP in Los Angeles. “Accepting stocks could send the wrong impression. We are not doing it.”