Mr. Chairman and members of the Commission: I am pleased to appear before you. Yours is a complex, difficult task You have undertaken it knowing that your work may profoundly affect the American legal system and the society it serves, and I admire you for doing so.
I will first make a few comments about my background by way of credentials and experience and will then indicate what I believe will be your overarching approach as you consider solutions to the problems before you. Following that, I will offer an explanation for the odd, perhaps unique, perch on which lawyers and accountants sit when they practice in the area of tax law. Moving then to our legal system and our profession as a whole, I will highlight the values that I trust you are minded to preserve and advance, and, finally, I will suggest changes from the status quo that you might consider recommending without placing those values in jeopardy.
As to my background: I have been a lawyer for 50 years. I practiced full time for 15 years in one of the large Philadelphia law firms, Wolf, Block, Schorr & Solis-Cohen, and I served as the firm’s managing partner for the last two years I was there. I then joined the University of Pennsylvania Law School faculty where I served as the Gemmill Professor of Tax Law and Tax Policy and as the Dean of the Law School. Twenty-three years ago I joined the Harvard Law School faculty where I am the Fessenden Professor of Law. My specialty within the law has been federal taxation, with a heavy emphasis on the income taxation of corporations and shareholders. Throughout my years as a professor I have remained active as a practitioner, consulting primarily with law firms, sometimes with the large accounting firms, and on a few occasions with clients directly. I have consulted on matters of tax policy with the U.S. Treasury Department, but except as a soldier, I have never been a government employee.
I have also been active in the work of the ABA, primarily but not exclusively with the Tax Section, serving on its Council and as Council Director of the Section’s Committees on Standards of Practice, Corporate Taxation, and Tax Policy and Simplification. I have published articles and books. For our present purposes the most relevant books are Standards of Tax Practice and Ethical Problems in Federal Tax Practice. Jim Holden, who has already appeared before you, is one of my co-authors on both books. Since becoming a law professor 35 years ago I have also served from time to time as an expert witness on both substantive legal matters and on issues of legal and tax accounting malpractice and securities fraud. I have been an expert witness both for and against all but one of the accounting firms that comprised the Big Eight, either when they were independent firms or since they consolidated into the Big Six or the Big Five, on the side of the accounting firms in about half the cases and opposed in the others.
Finally by way of background I want to add that The Law has been one of the loves of my life, not the only one, but a very important one. I believe deeply in the legal profession and the legal system for which it exists. As a young lawyer I heard Justice Frankfurter say to the group he was addressing that the legal profession is the noblest of all. That impressed me. I believe that it has sometimes been so, and I believe it can be so. It has been one of my professional goals and probably one of yours that it should be so.
Now to substance. Somewhat presumptuously I said that I would indicate what I assume your approach to the problem will be. It is nothing new. As Justice Brandeis would, I expect you to be bold. To be bold, Brandeis said, one must "guide by the light of reason." That calls for objectivity. It requires that one’s conclusions be based on facts and, in this setting, on the public interest, not on sloganeering about "one stop shopping" or who is eating whose lunch, or on pressures brought to bear by insufficiently disinterested parties. It demands that self-interested lobbying be recognized for what it is, and be resisted. As Charles Wright, the President of the American Law Institute, periodically reminds its members, they must check their clients and their clients’ interests at the door before they enter the conference hall to persuade and to vote. Charley does this in the same vein as Erwin Griswold had done earlier when the Dean reminded us all that he and other lawyers sell their services, but they are obligated not to sell their souls. The ALI had to withstand tremendous outside pressures when it was debating its Corporate Governance project, pressures to which the Institute almost succumbed until Professor Herbert Wexler, Geoff Hazard’s predecessor as Director of the Institute, reminded the members of their role and their fiduciary obligations. In the end, I believe that most of the ALI’s members guided not by their clients’ or their own self interests but boldly by "the light of reason." To their credit, they did so more recently as well, under Geoff’s leadership, when they grappled with the new Restatement of the Law Governing Lawyers. They eschewed a narrow, parochial focus on their professional financial interests which would have conflicted with and harmed the public interest. So I believe will this Commission and the American Bar Association.
On to tax law and its practitioners. Tax law is a funny thing. I think it fair to say that most CPAs know something about the federal income tax; many if not most lawyers do not. Especially in smaller communities lawyers retain accountants for their own tax needs and they refer their clients to them. In the past they often did not themselves retain tax lawyers nor refer their clients to them because there were none nearby or, sometimes, because they feared their clients would never return to them from the law firms in which the tax lawyers practiced. Now, of course, their worries are compounded because they fear their clients may not return from the accountants cum lawyers. How did this happen? In the beginning, in 1909 when Congress enacted the corporate income tax and in 1913 when it enacted the individual income tax, accountants had hands-on professional experience with the financial accounting concepts of income, expenses, depreciation, capitalization, cash and accrual basis, and the like. Most lawyers did not. Moreover, Congress had much earlier provided in 5 U.S.C. §500 that both CPAs and lawyers are authorized to represent taxpayers in matters before the Internal Revenue Service. That remains the law, and it preempts any state law to the contrary. After the Tax Court was created, it authorized all lawyers to represent taxpayers before it, and all other persons as well, not limited to accountants, but the nonlawyers would have to pass an exam to qualify.
Soon after 1913, particularly after we entered World War I, the tax law grew in size and complexity. Unlike in England where the Inland Revenue’s interpretations and determinations were taken as gospel, the IRS’s were challenged with increasing frequency. Case law developed rapidly. Administrative law, rulings and regulations, multiplied. Congress, the IRS, and the courts were explicitly as well as implicitly deciding that concepts and definitions that sufficed for financial accounting purposes would not suffice for income tax purposes. Indeed, definitions and principles long familiar to accountants were turned on their head under the income tax, and often for good reason. And soon it became clear that a fair and sensible tax system could not always be based on a literal or wooden reading of the words of the statute. Judicially created doctrines, many originating in the Supreme Court’s opinions of the ‘20s and ‘30s, provided the fundamental interpretive style and jurisprudence which to this day overlay the thousands of pages and the many volumes that comprise the Internal Revenue Code and the Treasury Regulations. In addition, every federal court, in addition to the Tax Court, has jurisdiction in federal tax cases. When no other claim against the government entitled the claimant to a jury trial, a taxpayer seeking a tax refund was (and is) entitled to a jury in the District Court, but not in the Tax Court or the Claims Court where tax cases are all Bench trials. Appeals from the Tax Court and the District Courts lie with the Courts of Appeal, and the Supreme Court may hear them on certiorari. The decisions of the Courts of Appeals will not infrequently conflict with each other, and the Tax Court might well continue to differ with a Court of Appeals that reversed it when an appeal from a case currently before it may be appealed to another. With all this, is there any wonder that the tax law Bar came to be, not just to handle tax controversies administratively or in litigation, but to advise clients at the transactional level when the mere words of the statute or the financial accounting concepts failed to convey the meaning or reach of the law? After World War II tax law began to attract many of the best and the brightest lawyers because the challenge of tax law practice was intellectually stimulating and promising, and because many of their legal colleagues were disinterested or, perhaps, inadequate to the task. The accountants lacked the fundamental legal education and training that were essential for a practitioner if he were to come to grips with more than the income tax basics, with the judicially imposed, pervasive statutory glosses, with legislative history and purpose, and with an understanding of judicial precedent, particularly in a system in which court decisions both governed and conflicted.
In light of history and needs it seems to me inevitable that the professional service market of tax practitioners should be a mixed one of lawyers and accountants. By and large, that mix has served society well, and it has not usually been necessary to distinguish between what is the practice of law and what is not in the tax field. The line has always been blurred, and I think it will remain so. Until relatively recently there has been a workable, common understanding of the areas of tax practice in which both professions can serve effectively and wisely and those in which the tax lawyers and the accountants should maintain more or less separate domains. At the extremes, litigation and the preparation of legal documents that would establish the rights and obligations of the parties and presumably help establish future tax law outcomes were clearly for the lawyers; financial analysis and tax accounting for inventories, for example, were clearly for the accountants. Both professions might prepare tax returns, although by mutual choice this has been mainly in the accountants’ domain. Both professions represented taxpayers before the IRS, as federal law contemplates, but in the more complex cases, those involving an intricate statutory provision, or an interpretation of arguably applicable case law, or where it was thought that litigation might ensue, the case was for the lawyer or for the accountant and lawyer jointly. Since accountants were authorized to handle matters before the IRS, it was inevitable that they would come to provide advice and give opinions as to whether a transaction or a proposed transaction would pass IRS muster. Despite the fact that accountants could practice in the Tax Court if they took and passed an exam, very few chose to do so.
The common ground is now strewn with stones. The Big Five in increasing volume and frequency are consulting and giving tax advice in transactional matters in which the tax law is complex and dependent on case law and legislative history. Their CPAs have been doing this and, more recently, they have been hiring lawyers in droves, making partners of some, who also participate in this work. Some of the Big Five have decided to have their lawyer partners and employees represent firm clients in the Tax Court. Arguably the lawyers may not do so. Because they have placed themselves under the control of the lay accountants, the argument goes that they may no longer appear in a court qua lawyers; since they have not taken the examination required of nonlawyers, they may not appear at all. I think that argument will and should fail, but that does not mean it is good for the legal system or society for the Big Five to be trying cases in a court, the Tax Court or any other. The Tax Court has just decided what may be the first case in which the taxpayer was represented by a lawyer in a Big Five firm. I will come to that case, Peoplefeeders, Inc. v. Commissioner, a bit later.
The Big Five want to practice law rather generally, including tax law, of course, and not just the aspects of federal tax law that they have always practiced. They want to absorb law firms within their accounting firms or to own law firms outright or in partnership with lawyers. Where the accounting firms absorb or own the law firms, it will, of course, be the CPAs who will dominate the firms by both their numbers and power. The lawyers will be under the control of the Big Five’s lay owners and managers who will stand between them and the clients, people in control who too often have shown that they are unfettered and unimpressed by the legal profession’s standards of professional conduct and its aspirations and traditions, including the important one that calls on lawyers to speak out and work for law reform and the improvement of the legal system. This aspect of the problem before you presents but one of the daunting concerns that I will discuss when I reach the question of the legal system’s values, their preservation and their state of prospective jeopardy.
The alternative hypothetical models that the Commission and its staff have constructed for consideration by the Commission’s witnesses have been very useful. They have helped me to concretize the various settings in which future law practice might take place, one of which maintains the status quo and four in which varying degrees of MDP are accomodated. As I noted earlier, the starting and ending points for me are the legal profession’s values, and the models have enabled me to consider each of the values that I think we should hold dear against each of the models in way that is not too abstract. The values which I think most important to American society, to the legal system, and thus to the profession are competence, confidentiality, loyalty, and service toward improvement of the law.
Competence. It goes without saying, although the Rules do say, that a lawyer must be competent to perform the legal tasks he undertakes. It is indeed the requirement of a formal and extensive legal education, built upon a college education, that goes a long way in justifying the legal restrictions on entry into the legal profession that exist everywhere in the United States. A lawyer sufficiently educated to become a member of a Bar will not lose his pedigree by working for a Big Five firm. But a lawyer’s education is a continuing one, not just through continuing legal education programs, but through his ongoing work with other lawyers in his firm and not just lawyers in his own specialized field. The tax law, for example, is laid on top of all of our economic activities and thereby on top of all the other fields of law, fields which the tax lawyer must recognize as relevant to his tax problem so that he can consult with his colleagues who specialize in, say, real estate or environmental law. He may recognize the connection on his own or as a result of the repeated collegial exchanges that occur in law firms, but then he must ask the colleague for collaborative advice as he goes about trying to solve or avoid a client’s tax problem. Will the tax lawyer in one of the Big Five, even if he is experienced enough to recognize a law link to another legal field, have available to him the legal personnel resources of lawyers in real estate or environmental law? I think it is doubtful. I also think it is problematic as to whether a tax lawyer, after years away from a full service law firm, will continue to recognize necessary law links, particularly new ones.
There is yet another problem that I think raises the competence question. It comes from the lawyer’s understanding about the subtlety and effect of factual distinctions on legal outcomes. In the first half of the ‘80s, still in the heyday of the era of abusive and aggressive tax shelters designed for high bracket individuals, the IRS had become increasingly alert, auditing and disallowing large numbers of tax shelter deductions that had been claimed by investors in limited partnerships that had been promoted and marketed to them for their presumed tax benefits. Many of the promotions were accompanied by opinion letters designed to give comfort to the investor. In that environment I was asked by the head of the National Tax Office of one of the Big Eight to consult with him, a CPA and lawyer whose whole career had been with the accounting firm. Tax shelter opinion letters that had been written by a number of the firm’s branch offices did not stand up. The concern then expressed to me was not what to do with the claims outstanding against the firm for malpractice, but what to do about the future. That sounded promising. Then the gentleman explained that what he wanted of me was a form of opinion letter that would have all the right words and that the National Office could then send to the branches for them to use without worry. Not at first believing what I heard, I questioned and pressed, but it came out as I have said - the firm wanted one shoe to fit all. That one might fantasize the possibility of such a form of letter is one thing, but to believe it was feasible or that any respectable lawyer would undertake to write one is another. Needless to say, I made it clear that I lacked the competence to draft such a letter. When I saw that a Big Eight firm would have such little understanding of the law or how law developed, or that with a benighted notion of efficiency a firm would choose to mass produce its work, rather than tailor it to a client’s needs, I came to understand as I never did before that there could be a competence level as low as I had just observed.
But maybe that was then and not now. Just two months ago, however, I attended a discussion in which a former high level Treasury tax lawyer, now a Big Five firm partner, explained why he liked working with his firm, but he expressed one point of dissatisfaction, that the tax lawyers and accountants are under continuing pressure to create new products for marketing to current and new clients. He noted that the Big Five are highly leveraged as a result (1) of a large number of low paid staffers and (2) the marketing and re-marketing of an ever growing inventory of products for which the bulk of the costs are sunk during development, and the 10 th client (buyer) will pay as much as the 1 st. The products are exposed to the clients’ outside lawyers only upon their signing confidentiality agreements. Stock products in 1999; stock opinion letters in ‘83' or ‘84. There’s a lot to be said about both. They can be marketed successfully. They can also produce disaster for clients and disdain for the legal (tax) system. They demonstrate a high level of incompetence. I worry about the one-shoe-fits-all mentality in firms in which lawyers are expected to practice competently.
The Peoplefeeders case, perhaps the first that the Tax Court has decided in which the taxpayer was represented by lawyers employed by one of the Big Five, supports one’s doubts about the wisdom of the Big Five’s sending their employees or partners, whether or not lawyers, to appear in court as taxpayer’s counsel. The court’s opinion leads this reader to infer a lack of competence on the part of the taxpayer’s representatives. Without going into the complex of bookkeeping entries and shenanigans that preceded the tax controversy, I will just say that the positions put forward for the taxpayer had no substance or merit . Ever the gentleman, Judge Swift did not say that. Instead, he dealt seriatim with each argument, giving each at least its due. His recitation of the facts, however, takes note of an important happening when it says that "... Partrick [one of the taxpayer’s principals] discussed the $1,417, 271 taxable gain with representatives of Arthur Anderson & Co., who informed Partrick that deductions could be generated" to offset the gain. Later Judge Swift states that during the "audit of petitioner’s ... tax returns, the accounting firm of Arthur Andersen represented petitioner... .representatives from Arthur Andersen met with respondent, discussed legal and factual issues, and later prepared and filed the protest and the [Tax Court] petition." Was it a lack of competence or something worse to assure a client that deductions could be "generated?" Was it incompetence that led to paper and money shuffling and the arguments made to support them? Was it incompetence that led the accounting firm and its lawyers to take the case to court, or was it that a competent, uninvolved tax lawyer would have declined to take the case, exposing to the client that it had not been well advised? The last question poses a possibility of conflict of interest between the accounting firm and its client. I will have more to say later about loyalty and conflict of interest. For now I only ask that the Commission consider the potential for serious impairment of lawyer competence when a lawyer moves to practice in an environment in which the practitioners may be accustomed to producing form opinion letters, selling "products" not designed for particular clients, and creating deductions without a basis for them.
Confidentiality. I will be very brief on this subject. The protection of client confidences is a duty with which every lawyer is familiar. Accounting firms approach the problem very differently. For me, the House of Lords opinion in Prince Jeffri v. KPMG sounds the necessary alarm. The Law Lords were persuasive in their reasoning, in rejecting a screen, and in enjoining KPMG from serving in litigation against the current adversary of its former client. That alone, however, does not say it all. What does is the rather arrogant and aggressive demand of KPMG that it just be trusted. It will protect all that needs protection. KPMG just thought it was irrelevant that Prince Jeffri, its former client, did not trust KPMG to keep his data from his adversary (KMPG’s current client). Fortunately, it was not irrelevant to the court. Yes, screens can work in limited circumstances. They must, however, be the exception to the rule . They must be carefully delineated. Especially because the Big Five are as large, as few, and as powerful as they are, the standards for confidentiality cannot be turned over to them. The House of Lords declined to do so, and so should we.
Loyalty. Conflicts of interest can arise when a firm represents two opposing clients. They can also arise between a firm and its client, when the client’s immediate interest and the firm’s financial interest, now or in the future, may be opposed. I have difficulty imagining a workable legal system in this country without firm-wide imputation. The suggestion has been made that one lawyer in a firm should be able to represent "his" client in litigation against the client of another lawyer in that firm. Why, it is asked, just because they are partners should they not be trusted, each to do his best for "his" client. I do not comprehend that world. It is not real. A lawyer writing a brief, with undivided loyalty to his client, will make a shambles of his opponent’s argument and brief if he can, even if it leads to the other lawyer’s public embarrassment. Our adversary system demands no less. I cannot conjure up a vision of the lawyer who will shred, trash, and make a shambles of his partner’s brief, even a partner in a firm so large that the one partner does not know the other. What does the victorious lawyer do to his firm’s and his own long run financial interest when he makes mince meat of his partner-opponent’s position, all in public, and he WINS, with the court’s writing an opinion that adopts his argument and credits him for it? The notion of dropping the rule of firm-wide imputation would, I think, lead to results we would find intolerable. Since we can foresee that outcome, we should not bring it on.
The SEC, I believe, is studying the question whether accounting firms should perform both the attest function and consulting function for the same corporate client. Because the attest function is performed for the benefit of the public, not for corporate management, the conflict-of- interest/loyalty issue is presented. The Commission should not avoid the problem on the assumption that the SEC will handle it. It is a major issue the Commission should face before lawyers who consult and advise on business affairs are encouraged or enticed to join an accounting firm for most of whose clients the firm certifies the annual financial statement. A similar conflict problem can arise when an accounting firm that has certified a financial statement has sold the client a financial "product" with presumed tax benefits, and then the accounting firm lawyers are given the job of contesting the IRS’s disallowance. The Commission should give serious consideration to proposing a rule that lawyers and the accounting firms with which they associate should not be permitted to perform consulting or tax controversy services for clients for which the firm performs the attest function.
Improving The Law. There is a long and worthy tradition and a standard that calls on lawyers to contribute to the improvement of the law, to law reform. Much of the work of the ABA, certainly of its Section of Taxation, is devoted to that. In 1980, I think it was, Bob Mundheim as General Counsel to the Treasury called a meeting of distinguised tax lawyers and a few tax law academics to discuss what might be done to stem the tide of abusive tax shelter promotions that were threatening to bring down the tax system. They were just too numerous for the IRS to deal with in a timely and effective way. Bob made it clear that he knew, as all the tax lawyers knew, that tax practitioners, lawyers as well as accountants, had contributed to the problem by giving opinions that were mostly gobbledy gook, but nevertheless enabled promoters to sell shelter investments by just flashing the letterhead of a major law firm or one of the Big Eight. The opinions were lengthy. The writers felt that they could avoid trouble when the shelter failed because their opinions were couched in legalese, fuzzy, and equivocal. The discussion led the tax lawyers to do something important and right. They instituted the movement within the ABA Tax Section that ultimately led to ABA Formal Opinion 346, imposing real standards on lawyers writing tax shelter opinion letters. Opinion 346 made a difference. The legal profession lived up to its promise. The AICPA, unfortunately, dragged its heels, going along only after the ABA had made its position clear and firm and the Treasury decided it would adopt the Opinion 346 standards in Treasury Department Circular 230.
I have cited only one example. There are many with which you are familiar in which lawyers have put their own financial interests to one side in order to help with needed law reform, to make parts of the legal system work better. Lawyers speak out on public issues. The studies and reports of local bar groups, the New York State Bar Tax Section, for example, have been instrumental in achieving improvements in the tax law and the Treasury’s Regulations. They have sometimes supported the Treasury in its opposition to narrow, unjustified taxpayer goodies that creep into proposals involving new legislation or regulations. I have seen AICPA Tax Division commentary, but they do not tend to be of that class. Amalgamation of law firms with accounting firms, particularly where the accounting firm culture is dominant, will not serve the country well if, as I fear, it will lead to the diminution or end of the lawyer’s role in the public interest.
Truth compels me to say that if I were King, and if I could reverse recent history without harm to the innocents among those who would be adversely affected, I would probably decree adoption of the Commission’s Model 1, what it describes as the status quo insofar as the Model Rules of Professional Conduct are concerned. But I am not King, and neither I nor you, the Commission, can undo the history of the last several years. I, therefore, doubt that our country will be able to enjoy the luxury of Model 1 for the indefinite future. The Commission, however, does have the power and, I hope, the will, to prevent Model 5 from becoming our professional way of life, the fully integrated firm that would include a firm of accountants that practices law with hired or owned lawyers, and without the requisite firm-wide safeguards for the fundamental values that have served America well. I do think that, with proper safeguards, with the preservation of firm-wide imputations that will assure competence, confidentiality, and loyalty, and with the assurance that lawyers are in control of the firm and thus likely to foster the traditional standards and traditions with respect to a lawyer’s obligation to work for the improvement of the law, it may prove possible to develop rules to permit greater accountant- lawyer affiliation than the Model Rules now countenance. The seeds may be there in Alternative Models 2, 3, and 4.