Oral Testimony of Dr. Hans-Jürgen Hellwig

The next speaker was Dr. Hans-Jürgen Hellwig, Vice-President, German Bar Association (DeutscherAnvaltVerein), a position he has held since 1994. He also heads the German Bar’s International Law Committee, is a member of its Parliamentary Assembly that adopted the Professional Rules of Conduct for Lawyers in 1997 (Berufsordnung für Rechtsanwälte, BORA) and is a Council Member of the International Bar Association. He uses the term MDP to describe a professional practice combination of lawyers and accountants and/or tax advisors. Point 1) A lawyer who is a member of the Bar (Rechtsanwalt) is an ‘independent organ of the administration of justice’, to whom the Legal Advice Act (Rechtsberatungsgesetz) gives a monopoly to handle legal matters of third parties. The purpose of the monopoly is to assure the public a high quality of legal advice. Although historically tax advisors were always permitted to give advice on tax law until the Legal Advice Act they, along with accountants, were not legally permitted to give legal advice (although in practice they did- for example, drafting of company articles of association and partnership agreements). Under specific provision of the Legal Advice Act accountants and tax advisors have 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’ and they have interpreted this ‘within the framework of an existing mandate’ language broadly to mean the general client relationship as they attempt to generate legal work from the client relationship. Point 2) German law permits MDPs between lawyers, accountants and tax advisors. The right to set up a MDP derives from the freedom of profession, protected in Article 12 of the German Constitution; it is now specifically recognized in the German Lawyers Act (Bundesrechtsanwaltsverordnung, §59a). The many small MDPs in Germany which have lawyers, accountants and/or tax advisors as partners do not seem to raise a problem with independence, confidentiality and conflicts avoidance, but these problems seem to have arisen with the growing expansion into legal advice, especially by the Big Five. Often run by consensus of the partners who very often belong to the same family these small MDP firms do not suffer from outside influence or the question of who dominates as is often the case with the large MDP firms who are members of the Big Five international networks. Lawyers employed by an accounting firm are subject to the laws and regulations applicable to lawyers provided they are members of the bar (Rechtsanwalt); if they have completed their legal education but are not members of the bar, they cannot call themselves ‘Rechtsanwalt’ and are not subject to lawyer regulation, including the prohibition against conflict of interest. All of the Big Five have legally independent law firms associated with them, mostly a limited liability company which is a spin-off of lawyers from the accounting firm. (In Spain, France and England major independent law firms have joined the Big Five network but this has not happened yet in Germany, it is however only a question of time. These law firms include the name and the logo of the accounting firm in their name and describe themselves as members of the accounting firm’s international network.) The separate law firm can charge higher fees because the fee level for legal work is usually higher than for accounting work. Point 3) In general, both the accounting firm and associated law firm sometimes share office, telephone lines and staff; an inquiry letter to the accounting firm might be answered by the law firm, if appropriate; and the accounting firm’s new assignment proposal might include legal services for a package price or at a discount. Other known interaction includes the accounting firm suggesting that the client retain the legal arm or an associated law firm in order to ease the unqualified opinion on the financials, or the client giving the accounting firm a particular legal question with balance sheet relevance in order to prejudice the audit work. Basically nothing is known about the internal relationship between accounting firm and associated law firm. If the relationship is similar to the structure of the various national companies within the Big Five’s international network it would mean there is a profit sharing in the form of referral fees, service fees and other charges that are adjusted from time to time. Although the Professional Rule of Conduct for Lawyers (§27 BORA) mandates that third parties not share in the economic results of the work of a lawyer unless they exercise their profession jointly with the lawyer, the reality is different. Also the top lawyers in the associated law firm (or the legal department of the accounting firm) are also partners in the international accounting firm organization thereby ignoring national boundaries to bring all partners under one roof. Point 4) All of this leads to the critical issue of independence. The German Accountants Act (Wirtschaftsprüferordnung, §28) requires the majority of managing partners (capital and voting rights) to be accountants to ensure accountant independence, a requirement dating back to the 8 th EC Directive on Company Law. The Tax Advisors Act requires similar majority requirements for tax advisors. No such majority requirement exists for a law firm. Consequently accountants and/or tax advisors can dominate a MDP law firm while lawyers can never dominate a firm of accountants or tax advisors. When this inequity was brought to the attention of an EC Commissioner he explained that European law protects the independence of accountants to ensure impartial audits of companies with cross-border trade (across national lines) upon which the EC must rely. Again raised by the German Bar Association in the Price Waterhouse/Cooper & Lybrand merger proceedings the EC indicated only market effect could be taken into account and lawyer independence was a matter for member states. The risk to auditor independence from general consulting or legal work seems to be addressed in a Green Book on Auditors, but this European Commission project is no longer being pursued as, under the so-called subsidiary principal subsequently added to the EC Treaty, the issue seems to be referred to the member states. The Amendment of 1998 of the German Lawyers Act introduced detailed provisions on law firms in the form of limited liability companies. According to the Act a limited liability MDP company can call itself a law firm only if lawyers constitute the 3 majorities (managing partners, capital and voting rights), an accounting firm only if the majorities are with the accountants, and a tax advisory firm if the majorities are with the tax advisors. Thus inconsistencies exist and at the moment a limited liability MDP company can be a law firm and an accounting firm at the same time only if a sufficient number of professionals qualify as both lawyer and accountant. Point 5) Lawyers, accountants and tax advisors in Germany are subject to basically the same obligation of confidentiality and enjoy the same right to refuse testimony. Contrary to the situation in other countries, such as the Netherlands for example, auditors in Germany are not obligated to disclose to authorities problems they find in the audit (there is no conflict between the confidentiality obligation of one profession and the disclosure obligation of the other). Point 6) Treatment of conflicts of interest, however, are markedly different. A lawyer’s prohibition against representing conflicting interests (Lawyers Act/§43a para. 4BRAO, Professional Rules of Conduct/§3 para. 1, Criminal Code/§156) applies to the entire firm. That is, no lawyer within the same firm may work against the other. According to the majority view, the term means an actual conflict not a potential one. A client cannot waive compliance with these conflict of interest rules as the lawyer as an ‘organ of the administration of justice’ serves the interest of the public at large. The interest of the public at large pertains to the independence of the individual lawyer and to the integrity of the bar as an indispensable part of a fair system of justice. It is only possible for the client to give a joint mandate or exclude the area of conflict from the mandate. There is no statutory prohibition against representation of conflicting interests for Tax Advisors; the prohibition is only in the ethics rules and these provide an express exemption for client waiver. For Accountants the Accountancy Act conflict prohibition provision, wherein he is prohibited to act if there exists concern that he may be prejudiced (§49), is concerned primarily with audit work (not business consulting, accounting or legal advice). The Professional Rules of Conduct for Accountants provide in the conflicts prohibition express authority for client waiver. Neither accountants nor tax advisors who give legal advice in a conflict situation, without the consent of the clients, commit a punishable offense or misdemeanor. Violation of the conflict prohibition is criminal only for lawyers. He gave as an example a large M&A bidding process in which three of the bidders used the same German firm of the Big Five (different teams from different offices) for the legal and financial due diligence work based upon client consent of conflicting representation and Chinese walls. "There’s nothing that ruins good morals as fast as bad examples." Commenting on a comparable bidding process where two bidder were represented for all legal work and due diligence by the same law firm based on client consent and Chinese walls, he described as a potential nightmare one of the client’s challenge in court or before the antitrust authorities the victory of the other in the bidding process. Point 7) The Parliamentary Assembly in adopting the Professional Rules for Lawyers, recognizing that lawyers ethics rules are stricter than accountants, tried to address the fact that they could not subject accountants and tax advisors working in a MDP with lawyers to the obligations incumbent on lawyers. Section 30 of the Rules allows a lawyer to work in a MDP with other professionals only if these other members comply with lawyers ethics. Also §30 of the Rules requires that a lawyer working in a joint professional organization ensure that the organization comply with the lawyers ethics rules. These rules, applicable to lawyers who are admitted to the bar, exist on paper but not in reality. How can the lawyers, in an existing MDP, force the nonlawyers to comply with the Lawyers Rules of Conduct if they represent the minority among the partners or are only employees of the firm? The need to have the ethics rules of the various professions in a MDP harmonized, especially in the areas of confidentiality and conflicts, is thus apparent. Dr. Hellwig commented upon the undesirable result of allowing the more lenient standards of accountants and tax advisors to lower those of the lawyer which derive from the lawyer’s role as collaborator in the administration of justice. To obtain the needed harmonization of relevant statutory and rules of conduct provisions and to avoid the risk of lowering the standards for lawyers to preserve the proper administration of justice the German Bar Association has been in touch with the Ministry of Justice that looks after lawyers. The Ministry of Economics looks after accountants and the Ministry of Finance looks after tax advisors; these three ministries, each of which is trying to protect his charge, should generate some discussion. Point 8) Dr. Hellwig also spoke to the role of accountants as auditors in Germany. The German Supreme Court in the Allweiler case (BGHZ 135,260/ April 21, 1997) concluded that an accountant who gave business, legal, tax or accounting advice to a company is not thereby disqualified to audit the company’s financials and opine thereon. The Court determined that non-auditing activities, as long as limited to advising, are not harmful to the auditing function because the company decides whether or not to follow the advice. The decision ignores that auditors review, in addition to financial figures, management’s report to shareholders and the adequacy of the company’s risk control systems. Dr. Hellwig commented that the effects of the Allweiler case may not be limited to Germany as more and more German companies are listed on the New York Stock Exchange and must submit their audited financials to the SEC. He wonders whether the SEC will accept the more lenient German standards on professional independence or insist on the stricter US standards. He also mentioned the bankruptcy of Bremen Vulcan, the shipyard company group owned by the city of Bremen, which engaged as its consultant the same Big Five firm that did its audit. City government funds had been pumped for decades into this group and their loss in the bankruptcy precipitated a City Parliament inquiry that strictly criticized this accounting firm conflict.

Additional points were addressed. Legal malpractice litigation is not as prevalent in Germany as in the U.S. but it is increasing. There does not seem to be much empirical data regarding demand for ‘one-stop shopping’. To his knowledge the English research institution, CSS, has recently conducted a field study in Germany. Based on experience he believes the one-stop shopping approach offers advantages to the less sophisticated client. He quoted a director of a large company as saying, on balance one-stop shopping "serves the interest of the accounting firm more than the interest of the client firm." Of course, a less sophisticated and less demanding client would view this issue quite differently. Accounting firms benefit from the inside track on the acquisition of engagements because of their role as auditors and from the combination of accounting and legal work that may enhance the quality of work. In Germany the rules that apply to imputation of knowledge within a MDP are not specific to the professions in question but derive from the general rules applicable to imputation of knowledge within companies under private law or within organizations of public law, such as authorities. Originally there was imputation between the first and second level of management, the level of managing directors or partners and the level below in both ways. Whoever had gained the knowledge, that knowledge was imputed to everybody else in the organization. The modern doctrine, rather than looking to the level within the hierarchy, looks to the nature of the information. Information that because of its importance in the orderly conduct of business should be recorded in writing and should be available to everyone in the organization is imputed. Imputation, in this sense, does not mean that there is an obligation or right of disclosure to any other client so that clearly the statutory confidentiality obligations take priority. The questions of whether a partner may - or is obligated to - use knowledge he actually gains or is imputed to him from another partner for the benefit of his client and whether Chinese walls within a firm stop imputation have not been decided in Germany. Dr. Hellwig’s recommendations to the Commission are: 1) in considering whether and to what extent to lift the ban on MDPs they should look to the function of lawyers within the legal system and in society, specifically the need to protect the independence of the legal profession; protection from competition is irrelevant. 2) if the decision is to lift the ban they should address the problems that would potentially follow therefrom: i) lawyer independence should be maintained - possibly requirements of majority for lawyers and protection against domination by contracts or other means, ii) auditor independence should be assured - assure no audit work is done in an MDP (a side effect would be elimination of the inside track advantage of the accounting firm) or, in the alternative, assure that legal work and audit work not be performed in parallel for the same client and his group companies, [the task is really for lawyers, who have the wider responsibility, as in Dr. Hellwig’s experience accountants don’t worry] and iii) assure that the professional ethics statute and rules of conduct of the various professions are harmonized to the greatest extent possible before the ban is lifted [make completion of such harmonization the precondition for lifting the MDP ban in any given state]. They should also consider that the frontrunners of the MDP movement, the Big Five, are operating as global networks and certain foreign member firms in the networks are subject to more lenient independence standards, giving the MDP issue an international as well as national connotation. [the question is similar to whether the SEC accepts opinions on financials from accountants in countries with more lenient independence standards.]

Dr. Hellwig explained to Mr. Wander that he expressed no preference but merely described the situation: separate law firm (partnership or company with limited liability) or under one roof MDP. The Big Five have decided to take the avenue of separate firms because of cultural reasons; they had also encountered internal problems with a MDP. On the accountancy, auditing side there was a very high pyramid, on the legal side there was, at best, two maybe three layers, thereby creating title, salary, recruiting (career) problems. The better, brighter associates want more independence, they want to work in smaller units. That’s why everything with the Big Five in Germany started with the spin off of lawyers from accountancy firms. When the European Commission in Brussels has bidding procedures for mandating legal work accountancy firms usually win, a fact that Dr. Hellwig attributes to fierce price competition or ‘dumping’. He considers the situation in Germany to be the same as with accounting firm lawyers doing tax work in the U.S. as accountants and tax advisors draft legal work and just get the law firm to sprinkle holy water on it. In response to Professor Hazard’s question regarding self designation by lawyers Dr. Hellwig said that accounting firms have an incentive to use lawyers who are not members of the Bar as they can work in clear conflict situations and the public does not understand that the legally trained who are not members of the Bar (in U.S. would not be a lawyer or would be in "inactive" status) cannot call themselves lawyers (they are called ‘assessors’) and need not follow the ethics provisions. The public with its strong belief in the impartiality and independence of the lawyer does not distinguish whether or not the lawyer is admitted and merely sees the matter as a legal transaction. What is at risk is the appreciation of the public for the high value of the conflict rules and the compliance with them by the legal profession. He presented as an example of outside influence on a lawyer a law firm associated with one of the Big Five where the lawyer had to resign from a mandate, which of course did not please the client, because the continuation of the mandate was not considered to be in the interest of the Big Five firm at large. This element of influence is applicable only in the Big Five context. He also felt that the clients who had given consent to the Big Five team that represented competitor bidders in the M&A probably did not realize that they could not later challenge the bidding process. He explained to Ms. Lamm that the Ministry of Justice admits lawyers to the bar and the local bars administer discipline. He is not aware of any discipline being administered against an accounting firm lawyer and said that where a lawyer delivers legal services in a conflict situation a client could challenge the fee and maintain that the engagement mandate is void, but that situation is rare. Asked by Mr. Nelson whether over the 10-15 years of development of the MDP phenomenon in Europe there has been an effect on the qualitative reputation of the legal profession as a social institution he said ‘yes’, that lawyers are at risk of being looked at as commercial purveyors of the practice of law, overcommercialization of law threatens to produce businessmen trading law. He clarified to Mr. Mundheim that Ramon Mullerat’s law firm, or at least the Madrid office, was affiliating with a Big Five network, he thinks it’s PricewaterhouseCoopers. He told the Chair that the very top independent law firms are simply better and will continue to have access to the top law candidates and that the small firms that are MDPs find the accumulation of expertise helpful; however, particularly the small and medium sized law firm are being hit by the competition from the lawyers in the Big Five branch offices in all major German cities. The problem is that the MDP phenomenon, along with other matters, must be kept in balance (things are not in balance as the lawyer rules of conduct are not being respected). In the Big Five networks lawyers are being run over.