Since 1994 I am a vice-president of the German Bar Association (DeutscherAnwaltVerein, DAV), the professional association of German lawyers. Within that organization I am Head of the International Law Committee and member of the Committee on Professional Associations, further I am Council Member of the International Bar Association and Member of the Parliamentary Assembly with the German Federal Bar which is the body that has adopted the Professional Rules of Conduct for Lawyers of 1997 (Berufsordnung für Rechtsanwälte, BORA).
I was among the first international bar leaders participating in the ABA Annual Meeting Programs for Distinguished International Guests to draw the attention to MDP problems as they were evolving in Europe and in particular in Germany. I am therefore not only honored by but also grateful for today’s opportunity to present my views to this Commission.
My presentation will cover more practice and facts than theory.
I shall be using the term MDP to describe a professional practice combination of lawyers on the one hand and accountants and/or tax advisors on the other hand.
The MDP situation in Germany is characterized by a number of aspects which are significantly different from the situation in the USA.
- In Germany a lawyer who is a member of the Bar (Rechtsanwalt) is a so-called "independent organ of the administration of justice", just like a judge (§ 3 German Lawyers Act, Bundesrechtsanwaltsordnung). Due to this position, the Legal Advice Act (Rechtsberatungsgesetz) gives such lawyers basically a monopoly to handle legal matters of third parties. The purpose of this monopoly is not to protect the lawyers but to ensure in the interest of the public at large a high quality of legal advice and representation.
While tax advisors have always been permitted to give advice on tax law both accountants and tax advisors initially where not permitted to give legal advice. Reality, however, was different, and for decades accountants and in particular tax advisors have done certain types of legal work for their clients, in particular the drafting of company articles of association and partnership agreements. Some twenty years ago this practice within certain limits was sanctioned by the courts.
Today the Legal Advice Act by express provision gives accountants and tax advisors the right "to do the legal work in matters in which they are professionally engaged insofar as the legal work has a direct connection with the duties of an accountant or tax advisor". This means that the accountant and tax advisor may do legal work only within the frame of an existing mandate. In real life the term "existing mandate" is interpreted by accountants and tax advisors to mean not a specific individual mandate but the general client relationship. Many try to acquire legal work even without such underlying client relationship.
Looking vice-versa, a lawyer may work in taxes since tax law is part of the law in general. However, neither lawyers nor tax advisors are permitted to do accounting work. Thus, there is a clear one-way-street situation.
- German law permits MDPs between lawyers, accountants and tax advisors. The right to set up a MDP follows from the freedom of profession as protected in Article 12 German Constitution. It is now specifically recognized in the German Lawyers Act (Bundesrechtsanwaltsverordnung, § 59a).
In fact there are many small MDP firms in Germany which have as partners lawyers, accountants and/or tax advisors. By experience these small MDPs do not seem to have shown any of the problems which today are being discussed in our context, such as protection of independence, confidentiality and avoidance of conflicts. These problems have come out in reality and in the eyes of the beholder only with the ever growing trend of accountants, in particular the Big Five, to expand into other activities, including in particular legal advice. The reasons for this difference in my view are various. Many of the small MDP firms are run by consensus among the partners who in quite a few cases belong to the same family. Thus, the issue of who dominates whom which I will discuss later in detail does not come up. Most notably, the aspect of influence from the outside which is typical in the case of the large MDP firms which in fact are members of the Big Five international networks, is missing in the case of the small MDP firms.
To demonstrate the size of the problem factually: The number of lawyers employed by or associated with the accounting firm and doing legal work for clients make the Big Five rank among the biggest law firms in Germany.
Lawyers employed by an accounting firm are subject to the laws and rules applicable to lawyers provided they are members of the bar (Rechtsanwalt). If they have completed their legal education, however are not members of the bar (in which case they have to call themselves not "Rechtsanwalt" but "Assessor" which however is a distinction that large parts of the public are not familiar with), they are not subject to the laws and rules applicable to lawyers, and since they are not accountants, they are not subject to the laws and rules applicable to accountants either. When they do legal work for clients on the accounting firm’s letterhead, they are covered by the right of the accounting firm to do legal work which I have described above, together with its conditions and limits which in practice are neglected. The question whether the lawyer employed by an accounting firm is admitted to the bar or not is of particular importance in connection with the conflict of interest issue. A non-bar member lawyer employed by an accounting firm is subject not to the conflict of interest rules for lawyers but to the rules applicable to the accounting firm which are less stringent as I will explain later.
Today, basically all of the Big Five have legally independent law firms associated with them. The legal form of such firms is mostly a company with limited liability, occasionally a partnership. Most of these firms are the result of a spin-off of lawyers from the accounting firm. In other European countries major independent law firms have joined the network of the Big Five, in particular in Spain, in France and in England. So far this has not yet happened in Germany, however in my view it is only a question of time when the offer on the table is so attractive that it cannot be resisted. I know positively that concrete offers have already been made and have led to serious negotiations.
Often these law firms include in their name the name of the accounting firm, use the logo of the accounting firm and describe themselves as member of the international network of the accounting firm.
The reasons are numerous why accounting firms have chosen to do legal work out of separate law firms. Experience has shown that there are cultural and structural difficulties to combine lawyers and accountants in large numbers in one organization. A separate law firm is more attractive to recruit top quality associates. And not to forget: The fee level for legal work is usually higher than for accounting work, in terms of both statutory fee scale and hourly rates, and such higher fees by virtue of the law or by the force of reality can be charged only by a law firm and not by an accounting firm.
- I am now turning to the internal relationship between the accounting firm and the associated law firm.
In some cases both firms share offices, telephone lines and staff. I know of one case where the law firm had no staff of its own at all. The accounting firm, whenever necessary, would use the stationary of the law firm.
Quite often, enquiry letters from clients addressed to the accounting firm are replied to by the law firm when, given the nature of the question, the involvement of the law firm seems appropriate. The client is usually not asked for his consent before his letter of enquiry is passed on to the law firm.
In beauty contests for new assignments the accounting firm often includes legal services in the package, offering either a package price or a discount on one of the two parts of the package.
I know of cases where the accounting firm has suggested that the client should retain the legal department or the associated law firm for a legal opinion on a specific question, in order to ease the unqualified opinion on the financials. Vice-versa, I know of client companies who for that particular purpose, namely to prejudice the audit work, have given the accounting firm a legal assignment on a particular question with balance sheet relevance.
Basically nothing is known about the legal relationship between accounting firm and associated law firm. However one should be rather safe to assume that the structure of this relationship is very similar to the structure between the various national companies within the international network of the Big Five. This would mean that there is at least a certain profit sharing in the form of referral fees, service fees and other intra-group charges the level of which is fixed from time to time so as to obtain the desired result. According to the Professional Rules of Conduct for Lawyers (§ 27 BORA) third parties must not share in the economic results of the work of a lawyer unless they exercise their profession jointly with the lawyer. Reality, I am afraid, is different.
Similarly, the top lawyers in the associated law firm (or in the legal department of the accounting firm) are also partners in whatever international organization is used by the respective Big Five firm in order to jump national boundaries and to bring all partners under one roof.
- All of this leads to the critical issue of independence. The German Accountants Act (Wirtschaftsprüferordnung, § 28) for the protection of the independence of the accountants requires that the majority of managing partners, of capital and of voting rights must be with accountants. This requirement goes back to the 8 th EC Directive on Company Law. The Tax Advisors Act establishes similar majority requirements for tax advisors in the case of a firm of tax advisors. No such majority requirements exist with regard to a law firm. As a consequence, lawyers can never dominate a firm of accountants or a firm of tax advisors whereas accountants and/or tax advisors can dominate a MDP law firm.
A few years ago I have brought this imbalance to the attention of EC Commissioner Monti, suggesting that majority requirements as stipulated in the 8 th Company Law Directive in favor of accountants should also be established for the protection of independence of law firms. The reply of Mr. Monti was negative, he saw no need for European law to protect the independence of the legal profession. The independence of the accountants was protected, he said, in order to ensure the impartiality of the auditor’s opinion on financials of companies on which cross-border trade within the EC must rely. The independence of lawyers, he said, is lacking this European dimension.
The aspect of professional independence was again brought to the attention of the EC in a submission by the German Bar Association in connection with the Price Waterhouse/Coopers & Lybrand merger. The Commission told us that in this merger control proceeding, as we had known of course ourselves, only market effects could be taken into account. To look after the protection of the independence of lawyers, the Commission said, was a task for the member states.
Of course, MDPs are of relevance for the professional independence not only of the lawyers but also of the other professions, in particular of the accountants. We have specifically made the point to the Commission that the independence of accountants can be at risk not only by the various aspects covered in the 8 th Company Law Directive but also by any non-auditing work such as general consulting work and legal work. We received no reply with regard to this point.
The Commission had addressed this problem several years ago in a Green Book on the Auditors, presenting some ideas to ensure the independence of auditors. It seems that the Commission is no longer pursuing this project which had met with opposition from the accountancy profession. The official explanation seems to be that under the so-called subsidiarity principle introduced in the EC Treaty in the meantime this issue should be left to the member states.
Some of you may wonder why I am giving you these European law aspects. Of course, the structural situation in the USA is quite different in that legislative and/regulatory power vests with the competent bodies of the individual States. However, whatever you do, I expect you to run into problems similar to those that we are encountering in Europe and in the individual EC Member States.
As regards the aforesaid majority requirements for the protection of independence (managing partners, capital, voting rights), such requirements were included in the Amendment of 1998 of the German Lawyers Act which has introduced detailed provisions on law firms which are carried out in the form of a company with limited liability. This means that a MDP company with limited liability can call itself a law firm only if the three aforesaid majorities are with lawyers; it can call itself an accounting firm if the majorities are with accountants, and it can call itself a tax advisory firm if the majority is with tax advisors. The insertion of this provision in the German Lawyers Act was met with opposition from the accountancy side who argued that the majority requirements for lawyers would lead to contradictions and inconsistencies. Indeed, these inconsistencies exist, and they should be removed by the legislator by adequate harmonization, and not by the lawyers giving up the protection of their independence. As the law stands at the moment, a MDP company with limited liability can be a law firm and an accounting firm at the same time only if there is a sufficient number of professionals which qualify both as accountant and lawyer.
Here again, it appears doubtful whether the aforesaid majority requirements are sufficient to protect the independence of lawyers. We all know how to limit independence by appropriate contractual arrangements.
It is important to note that the aforesaid introduction of majority requirements in favor of lawyers does not pertain to MDP firms in the form of partnerships. Therefore, all that I have said above with regard to MDP partnerships remains valid.
- Lawyers, accountants and tax advisors in Germany are subject to basically the same obligation of confidentiality and enjoy the same right to refuse testimony. Unlike the situation in other countries, auditors in Germany are not under the obligation to disclose to the authorities certain matters that they find during an audit. Therefore we do not have a conflict between confidentiality obligation of one profession and disclosure obligation of the other profession.
- There exists, however, a remarkable difference as regards conflicts of interest. A lawyer is forbidden to represent conflicting interests. This prohibition is laid down in the Lawyers Act (§ 43a para. 4 BRAO), in the Professional Rules of Conduct (§ 3 para. 1) and in Criminal Law (§ 156 Criminal Code). This prohibition applies to the entire firm, i.e. no lawyer within the same firm may work against the other. The term conflict of interest according to the majority view means an actual conflict and not a potential conflict.
The clients cannot waive compliance with these conflict of interest rules, due to the fact that these rules exist not only in the interest of the clients but also in the interest of the public at large which a lawyer through his work for a client is serving on the basis of his function as an "organ of the administration of justice" (§ 3 German Lawyers Act). The interest of the public at large so protected pertain to the independence of the individual lawyer and to the integrity of the bar as indispensable part of a fair system of justice. It is only possible for the clients either to give a joint mandate or to exclude the area of conflict from the mandate. As lawyers we all know that taking this avenue in order to avoid a conflict of interest in reality often leads to even greater practical problems.
The conflict rules of accountants and tax advisors are quite different. These professions are not subject to any statutory prohibition, only to a prohibition set out in the Rules of Conduct.
The Accountancy Act contains a provision (§ 49) according to which an accountant is prohibited to act if there exists concern that he may be prejudiced. This provision is looking primarily to audit work where a conflict of interest in the legal sense can hardly arise, and not to other activities such as accounting, business consulting, legal advice and alike.
The Professional Rules of Conduct for Accountants (§ 3 para. 1 BOWP), as a provision below the level of statutory law, prohibit the representation of conflicting interests however make an express exemption in case all clients agree. Thus the conflict rules in the case of accountants are at the disposal of the clients. With tax advisors the situation is comparable. Neither accountants nor tax advisors when giving legal advice in a conflict situation without the consent of the clients commit a punishable offence, the violation of conflict rules constitutes a criminal violation only for lawyers.
It happens occasionally in Germany that in a M&A transaction one and the same accounting firm is acting for both the seller and the purchaser. A partner in the German member firm of one of the Big Five when we recently had lunch together prided himself that his firm in a large M&A bidding process had done the legal and financial due diligence for a total of three bidders, using, of course, for the different clients different teams from different offices. While all of this seems almost unthinkable for a lawyer the explanation is quite simple for an accountant: The clients have waived the conflict rules based on the promise of Chinese Walls.
There is nothing that ruins good morals as fast as bad examples. I am presently advising the German government in a privatization transaction. There were two bidders in the bidding process that were represented for all legal work (documentation and due diligence) by the same law firm. This conflicting representation was based on Chinese Walls and the consent of the clients. It would be a nightmare to figure out what would happen if in such a situation one of these clients were to challenge in court or before the anti-trust authorities the victory of the other in the bidding process!
- The Parliamentary Assembly with the German Federal Bar when adopting the Professional Rules for Lawyers has tried to solve the problems stemming from the fact that these rules are stricter than the Professional Rules of Conduct for Accountants and Tax Advisors. The Assembly could not subject the accountants and tax advisors working in a MDP with lawyers to the obligations incumbent on the lawyers, due to the fact that the Assembly has no jurisdiction over accountants and tax advisors. The Assembly therefore had to use a different approach.
§ 30 of the Professional Rules of Conduct for Lawyers permits a lawyer to work in a MDP with members other professions only if such other members, in addition to their own conduct rules, also comply with the Professional Rules of Conduct for Lawyers. Similarly, according to § 33 of the Professional Rules of Conduct for Lawyers a lawyer who works in whatever organization for joint professional activity, such as a partnership or a company with limited liability, must ensure that these Rules are also complied with by such organization. This means that the stricter conflict of interest rule applicable to lawyers would supersede the more lenient rules of accountants and tax advisors. In most cases, this is paper only and reality is different. How can the lawyers in an existing MDP force the non-lawyers to comply with the rules of conduct for lawyers if the lawyers represent the minority among the partners or if the lawyers are only employees of the firm?
All of this underlines the need for having the provisions of applicable Professional Statutes and Rules of Conduct for the various professions in a MDP harmonized to the greatest extent possible, at least in the areas of confidentiality (where applicable) and conflict of interests. It is just not realistic to assume that without such harmonization the rules for lawyers whenever they are stricter than the rules for the other professions, in reality will be complied with by the entire MDP; to the contrary, it is more likely that the lawyers will adjust to the more lenient standards of accountants and tax advisors.
In my view this would be an undesirable result. It would take away from the obligations and rights of lawyers which follow from their particular status within the administration of justice. Lawyers are not mere suppliers of commercial services but collaborators of justice as a French court once has stated. This is exactly what the German expression "organ of the administration of justice" means. As regards the accountants, their auditing function, and only this function, serves a public interest, too, and in this respect the accountants are an important element in a free economic system. However, this interest goes just into the opposite direction, namely disclosure. Even when looking to this auditing function, the accountancy profession is lacking the particular status within the administration of justice which is given to the lawyers as a duty and as a privilege at the same time, not for their personal benefit but for the benefit of their clients and of the system as such.
Unfortunately there is very little discussion so far in Germany of these basic issues. Some experts, of course, are aware of the problem, and the German Bar Association is in touch with the Federal Ministry of Justice in order to obtain the urgently needed harmonization of the relevant statutory and rules of conduct provisions. It is not only the justified request for an equal level playing field for two competing professions; more important is the aspect that for the sake of proper administration of justice the risk of lowering the standards for lawyer must be excluded
- Let me now shift the focus of attention to the accountants, in particular insofar as they act as auditors. According to a decision of the Germany Supreme Court in Civil Matters of April 21, 1997 in the so-called Allweiler case (BGHZ 135, 260) an accountant who has given business, legal, tax or accounting advice to a company is not disqualified to audit the financials of such company and to opine thereon. All such non-auditing activities are not harmful for the auditing function as long as they are limited to the giving of advice and as long as it is up to the company whether or not to follow such advice. In my view this decision is extremely questionable. To look to the freedom of management to accept or not to accept the advice received is formalistic and neglects reality. Apart from that, the auditor reviews not only financial figures but also matters such as the management report to shareholders and the adequacy of risk control systems installed by the company. How can an auditor do so without prejudice if he himself or one of his colleagues in the same firm has advised the management on which business strategy it should follow or which risk control systems it should install? Needless to say that the Allweiler decision has been warmly welcomed by the accountancy profession.
Incidentally, the effects of the Allweiler case are not limited to Germany, they may reach out into the US, given the fact that more and more German companies are listed on the New York Stock Exchange. These companies must submit their audited financials to the SEC. Should the SEC when looking at the auditor’s opinion on these financials, accept the lenient German standards on professional independence or should the SEC insist on the stricter US standards? To my knowledge the SEC not too long ago has become aware of this problem.
Some three years ago, Bremer Vulkan, a group of shipyard companies owned by the city of Bremen went bankrupt. The city government through decades had pumped funds into this group. When all these funds were lost in the bankruptcy the city parliament set up an investigation commission to look into the detailed reasons for the failure. The report of the commission cites the fact that the accounting firm (one of the Big Five) that throughout the years had audited the financials had also advised the group on various questions as a consultant. This was reported once or twice in the German papers last fall, that was all.
- Before I conclude I would like to briefly address some specific questions that have been put to me and that have not yet been covered by my foregoing remarks:
- Legal malpractice suits are not as common place in Germany as in the US, however there is a clear trend for growth both in numbers of suits and in amounts. When comparing malpractice suits against lawyers and against accountants in Germany, the accountants, it seems to me, are carrying a greater load.
- The demand for "one-stop shopping" by clients and the distinction by which type of clients are rather difficult issues. There does not seem to be many empirical data available. To my knowledge CSS, an English research institution, in this regard has recently carried out a field study in Germany. Based on my own experience and the experience of my partners I think that the one-stop shopping approach by the accounting firms has been successful with certain but not with all clients. This approach of course offers advantages in particular for the less sophisticated client. However there are also quite a few clients who have tried out the one-stop shopping with an accounting firm once and have returned for the next transaction or legal problem to their old law firm, or for that purpose to a new law firm, after they had learned the hard way that one-stop shopping does not per se lead to high quality of work. A director of a large company once told me "I learned my lesson about one-stop shopping. On balance it serves the interests of the accounting firm more than the interests of the client firm.". Of course, a less sophisticated and a less demanding client would view this issue quite differently.
As regards the accounting firms there are in my view basically two benefits. One is the benefit of the inside track that they enjoy in the acquisition of mandates for legal work. The second benefit which is the only one stressed by the accounting firms, is that the combination of accounting and legal work may increase the quality of work. While this is indeed so, it does not per se justify that both types of work are performed vis-à-vis the same client.
- As regards imputation of knowledge within a MDP firm there are no rules in Germany specifically applicable to the professions in question. Rather the general rules apply. These rules pertain to any form of organization both under private law and under public law. Under the old doctrine the imputation of knowledge depends on the function of the respective persons. In very simple words, there is an imputation within the first and second level of management. The modern doctrine is looking not to the level in the hierarchy but rather to the relevance of the piece of information. Whatever piece of information, giving its nature and importance, should be recorded in the files in the ordinary course of business, is imputed to the organization all members of which are under an obligation to make enquiries in the files (duty to record, to preserve and to enquire).
It is clear that the internal imputation of knowledge cannot overrule the confidentiality obligation vis-à-vis the clients. However there is the question whether a partner who from a colleague actually learns of a certain piece of information or to whom such information is imputed, has the right to use this information when advising his own client, of course without making any disclosure. The question goes even further, namely whether such partner, as a result of the mandate given to his firm, is under an obligation to do so. In this context another issue arises, namely what is the effect of Chinese Walls that may have been set up within the firm, and how far would the legal consequences reach if the client in question has agreed to the setting-up of Chines Walls. All of these are questions to which no answer has yet been given.
- Lastly I have been asked what recommendations I would make to this commission. I offer a sequence of answers.
When making your decision whether and to what extent to lift the present ban on MDPs you should look to the function of the lawyer within the legal system of administration of justice and within society, and more specifically to the need to protect the independence of the legal profession. Protection from competition as such is irrelevant. In my experience the quality of legal work by law firms in many cases is not only comparable but superior to the quality of legal work carried out by accounting firms or their associated law firms, except that a number of clients just does not know. Competition should not be a problem to the quality and client minded law firm.
Should you decide to lift the ban, you should address the problems that would potentially follow therefrom.
These problems concern first of all again the aspect of independence of lawyers. You may wish to introduce requirements of majority for lawyers and, equally important, protection against domination by contracts or any other means.
To lift the ban could also affect the auditing function insofar as the non-auditing activities potentially have negative effects on the impartiality of the auditor. In this respect you may wish to consider to permit MDPs only with the proviso that no audit work is carried out. This would to a large extent eliminate the inside track advantage for the accounting firm, however this would only be a side effect of the aforesaid requirement. The purpose of the requirement would be to eliminate the risk of potential negative effects in the area of independence of the auditor.
An alternative would be to permit MDPs, including the auditing function, however to request that legal work and audit work must not be performed in parallel for the same client and his group companies but only for different clients.
When permitting MDP you may wish to impose the requirement that the firm is prohibited to work with Chinese Walls, no matter whether the person acting is a lawyer, an accountant, a tax advisor or whatever else. Such a requirement would be justified because Chinese Walls not only are inconsistent with the legal profession but have recently also been rejected for the accounting profession by a landmark decision of the House of Laws in the Brunei case involving KPMG.
In case you decide to lift the ban on MDP it is in my view extremely important that the statutory provisions and the Professional Rules of Conduct which regulate the exercise of the various professions are harmonized to the greatest extent possible. Since this harmonization lies in the hands of the competent bodies of the individual US States, you should consider to make completion of such harmonization a precondition for lifting the ban on MDP for any given state.
To make matters even more complex: All aforesaid elements are interfaced with one another. In particular, your basic decision to lift the ban or not may very much decide on whether and how you think you can deal with the consequences.
Assume you decide to lift the ban of MDP not at all or only to a certain extent or under certain conditions. You should then consider the fact that the front runners of the MDP movement, namely the Big Five, are operating as international networks. Would this commission hold it acceptable or not that there are foreign member firms in these networks that are subject to less strict requirements? The question is similar to the question mentioned above whether the SEC accepts opinions on financials from accountants in countries with more lenient independence standards. This shows that the MDP issue with its elements of liberalization and regulation has not only a national but also an international connotation.
Thank you for your attention.