May 16, 2021

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Law Firms Avoiding Business Ventures Risk Falling Behind

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Last year the largest accounting firms in the world earned 10 times more revenue than the largest law firms. Why would law firms leave that kind of money on the table while accounting firms are cashing in?

For decades, the U.S. legal profession has enforced a narrow view of the types of ancillary services a law firm may offer clients. Services supporting core legal functions have been deemed acceptable, while broader services not related to providing legal advice generally have not.

Contrast that with the accounting profession. Big Four firms are now referred to as consulting or advisory firms rather than simply accounting firms as in years past. This is not merely a semantic evolution. Revenue from their consulting services has equaled or even exceeded that of traditional audit services.

A Tale of Two Professions

How did we arrive here? Was it just a matter of poor business decisions by law firms? The answer is not that simple. It is hard to imagine big firm lawyers not looking to maximize revenue.

There is a critical difference: The position each profession takes on its ethical duties and obligations to clients and the effect on their respective business models.

There are various underlying reasons for these differences, but how the duties of loyalty, confidentiality, and potential conflicts are treated is critical. The duties of loyalty and confidentiality are foundational to the practice of law. With a few very specific exceptions, a lawyer cannot be compelled to disclose a client’s confidential communications or information obtained during representation, nor can lawyers put their own or anyone else’s interest ahead of the client. These are critical elements of the attorney’s fiduciary obligations to the client.

What Happens in Audit Doesn’t Stay in Audit

While accountants have general duties of confidentiality, such duties are not as strict as those of their attorney counterparts. Indeed, in certain contexts, accountants have a duty of independence from the client.

Accountants require neutrality in executing their obligations to the public, as for example, when auditing the financial statements of a public company. A logical outgrowth of this impartiality has been a less monolithic view of acceptable services by accounting firms and a narrower definition of conflicts than the legal profession.

The legal profession’s approach to service restrictions functions as a horizontal limitation across the law firm’s entire client base. There are services that a law firm can provide and those it cannot, period. It is not a client-by-client analysis. One can argue this has helped perpetuate a professional monopoly by keeping other businesses (e.g., accounting firms) from breaking into the law business—at least in the U.S.—but it has also created a vacuum filled by multi-billion-dollar consulting, technology, and service firms.

Viva la Revolution

Large accounting firms never ceded such ground. Beginning in the early 1970s, the largest accounting firms embraced the idea that they could offer consulting services beyond the accounting and audit functions and, despite initial internal tension, this expansion has continued up to today. The large accounting firms decided to analyze potential conflicts of interest on a client-by-client basis to determine what services they could or could not offer.

Providing ancillary (i.e., non-audit) services to audit clients was restricted only for that client—a vertical limitation. But for non-audit clients the limitations did not apply. Thus, the accounting firms could expand services horizontally as much as they wanted.

And expand they have. In 2020, the largest of the Big Four reported revenue of $47.6 billion, more than 10 times that of the largest law firm at $4.15 billion (figure from fiscal year 2019). The dramatic increase in revenue has been driven primarily by growth in consulting and advisory work (43% between 2012 and 2018) rather than audit services (3% in the same period).

But generating massive new consulting revenue streams has not been the only result of accounting firms’ narrower view of conflicts and broader view of acceptable services. It has significantly benefited the broader business world. There has been trailblazing work creating value through innovation, process improvement, data-driven decision making and technology.

In sharp contrast, the legal profession has not blazed such innovation trails. In fact, the legal function is the one area that has not kept pace with the larger business community. Inherent risk aversion, fear of change and other cultural factors have no doubt contributed to this inertia. But it is hard to deny the role played by these self-imposed ancillary service limitations.

Some law firms are taking steps to counter this trend by forming innovation teams and limited practice-related consulting services but this only nibbles at the edges. The profession generally continues to focus solely on practicing law. The underlying rules and ethical standards will likely remain unchanged. In the absence of change, there is still hope. Some forward-looking firms are attempting to take a bigger bite. They are forming collaborative alliances with service providers and consulting firms that could recoup some of the money left on the table.

All the while, over a half century, the impact on the broader business world of the accounting profession’s position on conflicts and permissible services has been profound. This powerful agent of change has helped drive what has come to be called “Digital Transformation.” This, in turn, has been a strong force in the larger cultural and economic movement known as “The Fourth Industrial Revolution.”

The question is, will law firms finally and fully embrace the change and step up to the plate?

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

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Tom Barnett is senior vice president and divisional general counsel at UnitedLex, a technology and legal services company.