'THE BIGGEST MALPRACTICE RISK'Author(s): Paul MarcotteSource: ABA Journal, Vol. 73, No. 10 (AUGUST 1, 1987), p. 32Published by: American Bar AssociationStable URL: http://www.jstor.org/stable/20759431 .

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U

An attorney called on to help a new business venture issue stock faces an exciting challenge. But the

challenge is also the lawyer's greatest malpractice risk.

Robert O'Malley, loss prevention counsel for Attorneys Liability As surance Society Ltd. (ALAS), says that representing a new client and start-up enterprise in an initial secu rities offering is "the single most dan gerous activity" for lawyers.

O'Malley, a panelist at the Ray Garrett Jr. Corporate and Securities Law Institute at Northwestern Uni

versity School of Law in April, said law firms are becoming wary as a re sult.

'There are a few firms who, hav

ing been burned, have recently de clined as a matter of policy to take on cases like that," he said.

If trouble develops in financing, disappointed investors and lenders may target the law firms in their suits, said O'Malley. Frequently, the law

yer has left his role as adviser and become a participant in the transac tion.

"Juries tend to throw the book at a prestigious law firm that appears to have let its good name be used by an inexperienced or incompetent promoter to add class to an otherwise

shaky deal," he said. ALAS provides professional lia

bility insurance for about 330 large law firms, which include 32,000 law yers. Roughly $35 million of $48 mil lion in claims paid by ALAS has involved corporate securities work.

THE FATAL THREE Many of the largest claims had

the "fatal three" combination, ac

cording to O'Malley. That, he says, is a new client, a start-up enterprise and an initial securities offering.

"If the lawyer's footprints are all over the deal as investor, creditor, corporate manager, unofficial man

ager ... those additional activities, and the conflict of interest inherent therein, will usually be fatal," said O'Malley.

O'Malley suggests: Know your client, especially if

your role is to help it raise money.

Make sure you're independent. Above all, don't accept stock in lieu of a cash fee.

Don't invest in the offering. Avoid conflicts of interest by making sure that any stock lawyers own in the company is "locked up" so that it can't be sold for at least a year.

Don't permit any lawyer of the firm to become a director or officer of the issuer. Before committing to a new client, insist on permission to talk with the client's former lawyer and certified public accountant.

Find out why the prospective issuer has been unwilling or unable to obtain financing from the usual private sources. Does it mean the of fering will be unusually risky?

Potential liability problems arise when lawyers involve themselves in the management of client corpora tions or sit on the board of directors. Also, failing to adequately monitor the work of law partners or to screen new clients will increase the risk for firms.

O'Malley predicts courts even

tually will impose vicarious liability on law firms for actions taken by lawyers who sit as directors on client companies. Vicarious liability is a real

risk if the director position can be shown to be valuable to the firm from the standpoint of business develop

ment or prestige. He sees partner peer review as

an effective way to reduce the risk. A few firms have developed procedures for partners to review each other's work systematically. Such reviews should be done annually, according to O'Malley.

"We're seeing some horrible sit uations where the partner had too much autonomy, too much inde pendence and too little supervision by the firm," said O'Malley.

"We've had terrible health prob lems as well as reckless and shoddy legal work that have resulted in claims that easily could have been detected and avoided if there had been a partner peer review system."

Another way to reduce risks is to have committees screen new clients. Most large firms still allow a single partner to commit the firm to a new client.

"I think it is just insane in this rough-and-tumble world to depend upon the individual judgment of your partners with respect to new clients," said O'Malley. ?Paul Marcotte

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^ ^ ^ ^ ^HhIhhBIBB

^ Robert O'Malley: "Firms are declining to take on cases."

32 ABA JOURNAL / AUGUST 1, 1987

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