Consequential Responsibility for Client Wrongs: Lehman Brothers and the Regulation of the Legal Profession

Publication Date01 Jan 2013
AuthorRichard Moorhead,David Kershaw
Consequential Responsibility for Client Wrongs: Lehman
Brothers and the Regulation of the Legal Profession
David Kershaw*and Richard Moorhead**
Should transactional lawyers bear responsibility when their competent actions facilitate unlawful
activity by their client? Or is a lawyer’sonly concer n to act in the client’s interest byproviding her
with the advice and support she seeks? The high profile failure of Lehman Brothers provides a
unique opportunity to explore these questions in the context of the provision of a legal opinion
by a magic circle law firm.A legal opinion which, although as a matter of law was accurate, was
a necessary precursor to an accounting treatment by Lehman Brothers which was described by the
Lehman’s Bankruptcy Examiner as ‘balance sheet manipulation’.The article argues that the law’s
existing understanding of when consequential responsibility should be imposed on those who
assist another’s wrongdoing provides a theory and a tool-kit whose application can be justifiably
extended to the professional regulation of transactional lawyers.
Lawyers are rarely far from controversy. Entrusted by the State as custodians of
the rule of law, their public and adversarial role often brings them into conflict
with popular perceptions of justice and fairness. In zealously defending and
advising the unpopular and the ‘guilty’, the ethics of lawyers are readily prob-
lematised. In the context of adversarial trials, the legal profession and the courts
have developed a series of rules to manage the problem of overly zealous
lawyering.These are principally organised around the idea of the public interest
in ensuring that the court is not mislead. In the transactional context, there are
fewer rules and significantly less scrutiny of the tension arising from a lawyer’s
zealous pursuit of their clients’ interests and the public interests concerns which
such lawyering generates.This is true even though the justifications for zealous
transactional lawyering are weaker.
In the United States a variety of financial scandals have led to scrutiny of the
ethics of corporate transaction lawyers,1whereas in the UK corporate lawyers
have largely avoided public and regulatory attention.2UK corporate lawyers have
*London School of Economics.
**Centre for Ethics and Law, University College London.We are very grateful for helpful discussion
and comments on earlier versions of this article from Rob Baldwin, Marlies Braun,Vanessa Finch,Bob
Lee, Doreen McBarnet, Roger McCormick, Christopher Napier, Peter Ramsey, Edmund Schuster,
StevenVaughan and the anonymous referees of the article.
1 See,for example, R.W. Gordon,‘A New Role for Lawyers?The Corporate Counselor after Enron’
(2003) 35 Conn L Rev 1185.
2 Although Marks & Spencer plc vFreshfields Bruckhaus Deringer [2004] 1 WLR 2331 prompted a rare
exception. See: J. Flood,‘Transnational Lawyering: Clients, Ethics and Regulation’ in L. Mather
and L. Levin (eds), Lawyers in Practice: Ethical Decision Making in Context (Chicago:University of
Chicago Press,2012); M. Herman,‘Conflict of interest costs Freshfields lawyer £59,000’The Times
2 August 2007 and J. Loughrey, ‘Corporate Lawyers and Corporate Governance’ (Cambridge:
Cambridge UP, 2012).
© 2013The Authors.The Modern Law Review © 2013 The Modern Law Review Limited. (2013) 76(1) MLR 26–61
Published by BlackwellPublishing, 9600 Garsington Road, Oxford OX42DQ, UK and 350 Main Street, Malden,MA 02148, USA
successfully relied on the duty to their client, sophistication in the delivery of
legal services, and legal professional privilege to shield themselves from criticism.3
The idea that the lawyer’s primary function is to zealously advance their clients’
interests has acted as an ideological justification for the alignment of the profes-
sion’s commercial interests with their clients’ interests and as a barrier to closer
investigation of the role and responsibilities of transactional lawyers.
This article examines this rationalisation of the transaction lawyer’s role in the
context of the collapse of Lehman Brothers. A pivotal moment in the credit
crisis, Lehman’s collapse is of profound public interest. Clearly lawyers did not
cause the collapse of Lehman, but Linklaters, a London headquartered corporate
law firm, provided advice and a legal opinion which was an important compo-
nent in enabling Lehman to implement suspect accounting practices. These
accounting practices misled regulators and the capital markets in the run up to
Lehman’s collapse and prefigured alleged securities law violations by Lehman’s
Linklaters’s role in relation to Lehman’s problematic accounting practices was
to provide a legal opinion as to whether short term bank financing known as
‘repo’financing, carried out through Lehman’s UK subsidiary,amounted to a sale
and repurchase arrangement or a secured loan under English law.Without the
opinion the accounting practices and the alleged securities law violations could
not have taken place.Yet,as we show in the article, the opinion was accurate and
unlikely to raise ethical questions or attract any sanction under current profes-
sional regulations.
The Lehman’s Repo scenario raises an interesting question: should lawyers
bear any ‘consequential responsibility’ for unlawful client activity facilitated by
their legal advice and counsel, even when such advice is accurate and competently
provided? If so,is it practically possible to impose such consequential responsibility
on lawyers through professional regulation and what would be the appropriate
conditions of its application? The Lehman Repo scenario provides a particularly
useful case-study to assist us in answering these questions because of the complex
financial context and regulatory frameworks which it involves. We explore
whether such complexity renders the imposition of consequential responsibility
on transaction lawyers unworkable.We argue that it does not.A strong theoretical
and practical case can be made for imposing limits on the zealous pursuit of client
interests by holding transaction lawyers to account where their actions generate
areal, substantial and foreseeable risk of client action that is unlawful or ‘probably
unlawful’. In making this argument through an examination of the Lehman repo
affair, we emphasise that we do so by way of case study only.Due to the limited
public record and the level of uncertainty about what actually happened, we are
not in a position, nor do we attempt, to determine whether Linklaters should be
criticised under our suggested framework of responsibility.4
3 See, for example, United States of America vPhilip Morris and British AmericanTobacco [2004] EWCA
Civ 330.
4 The Solicitors Regulatory Authority (SRA) has previously announced an investigation buthas not
responded to our requests to confirm the instigation or outcome of the investigation.An earlier
version of this paper was forwarded to the relevant partner at Linklaters for comment.We received
no comments.
David Kershaw and Richard Moorhead
© 2013 TheAuthors. The Modern Law Review © 2013The Modern Law Review Limited. 27
(2013) 76(1) MLR 26–61
To consider whether consequential responsibility should be imposed on trans-
action lawyers we set forth,in the following parts of the article, a detailed account
of Lehman’s problematic repo transactions and the accounting rules applicable to
them.The article then considers Linklaters’ legal opinion: its validity and its role
in enabling Lehman to implement the suspect accounting treatment which in
turn facilitated the alleged US securities law violations.
With this understanding in place, the article then explores the theoretical case
for consequential responsibility. It considers approaches to consequential respon-
sibility set forth in UK criminal and civil law rules on accessory liability.It argues
that underpinning these accessory liability rules is a theor y of consequential
responsibility that justifies the imposition of accessory liability only where the
secondary party facilitates a ser ious and foreseeable risk of wrongdoing by the
primary party and where the regulated activity in question raises public interest
concerns beyond the interests of the acting parties.We argue that this theory of
consequential responsibility, coupled with the core tenets of what it means for
law to be a profession,provides a basis for extending consequential responsibility
to transaction lawyers through professional regulation.
The final part of the article looks at whether consequential responsibility is
already recognised by UK professional regulation. It argues that the notion
contained within the current regulation that lawyers should consider, indeed
prioritise, the public interest could in theory form a basis for imposing conse-
quential responsibility on transaction lawyers. However, we argue that the
concept of the public interest has not been fashioned with any regard to
transaction lawyering and the economic incentive structures of transaction
lawyers.As a result, current regulation does not constrain overzealous transaction
lawyering. We conclude with some thoughts about possible approaches and
parameters for regulation.
Banks finance their activities through individual deposits from retail customers
and loans from other banks and financial institutions.5Much of this bank to
bank finance is provided for only a few days before being refinanced from the
same or a different source.This market in short term funding is known as the
repo market. From an economic perspective, repo-finance involves a secured
loan: a bank requires short term finance and uses existing assets as collateral to
secure that finance.Whilst repo transactions may make look like, and are typi-
cally described as,6secured loans, they are structured as sales and subsequent
repurchases of the assets. Through a legal lens, the borrowing bank sells the
assets to the lending bank and then repurchases them shortly thereafter on the
agreed terms.
5 On banks’ current dependence on such short term finance see ‘US funds show true state of
Eurozone Banks’ Financial Times 25 August 2011.
6 See,for example,‘Bank runs left repo sector exposed’ FinancialTimes 10 September 2009, observing
that ‘in a repo an investor can borrow cash from another party, using securities as collateral for
the loan’.
Consequential Responsibility for Client Wrongs
© 2013 TheAuthors. The Modern Law Review © 2013The Modern Law Review Limited.
28 (2013) 76(1) MLR 26–61

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