California moves to curb private equity influence over law firms

California lawmakers have approved new restrictions on private equity involvement in law firms, as states begin to push back against the structures investors are using to enter the US legal market.

The California Senate and Assembly last week passed Assembly Bill 2305, which would prohibit private equity firms and other corporate investors from influencing the practice of law.

Assembly member Ash Kalra, who introduced the legislation, has said it is designed to close “emerging loopholes” and protect the independence of lawyers.

The bill now heads to state Governor Gavin Newsom, who has until the end of September to act on it, The Wall Street Journal reported.

The MSO question

At the centre of the debate are management services organisations, or MSOs.

Under the model, a law firm can separate parts of its business such as non-legal back office operations into a separate company which outside investors can own, while the legal practice remains owned by lawyers.

The structure has become one of the main routes for private equity into the US legal sector, where most states prohibit non-lawyer ownership of law firms.

California's bill seeks to limit how much influence those outside businesses can have over lawyers and the practice of law. Kalra has argued that structures including MSOs and alternative business structures have been used to find ways around existing restrictions.

California is the third state this year to take action over private equity's involvement in law firms, following Colorado and Illinois.

Commenting on similar legislation passed in Illinois in June, legal consultant Crispin Passmore said that it largely restated existing ethical obligations and that a properly structured MSO should already comply with them.

Private equity circles Big Law

The legislation comes as private equity interest in the US legal market grows.

The Financial Times reported in August that major firms including Paul Weiss, Quinn Emanuel and Proskauer have held discussions with private equity firms or bankers about taking outside capital.

Later that month, the FT reported that Charlesbank Capital was nearing a deal to invest in US insurance disputes firm WSHB using an MSO structure.

Arizona and Utah are the only states that allow non-lawyers to invest in legal services through alternative business structures.

That contrasts with England and Wales, where outside ownership of law firms through ABSs has been possible for nearly 15 years.