Ethics
and “Accounting for Lawyers”
Annual Business Law Seminar
Utah State Bar Business Law Section
May 20, 2014
Professor Christian Johnson
S.J. Quinney College of Law
(C.P.A. – inactive Texas)
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Laundry List – Rules of Professional Conduct
Ethical Issues for the Transactional Lawyer
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Who do they apply to?
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Outside counsel
In-house counsel
Attorney’s that aren’t members of Utah bar
Attorney’s that are “inactive” or don’t practice
Conflicts of Interest
Compensation
Failing to Act Competently
Confidentiality and Failing to disclose
Work product (transactional documents) or legal opinions (closing opinions)
– Used to commit fraud or crimes
– Result in false disclosures or misrepresentations
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When to resign
Who to tell (“up the ladder” reporting)
Reporting the misconduct of others
Multi-jurisdictional issues
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Case Study
Charles Keating & Lincoln S&L
• Lincoln Savings & Loan Association v. Wall
• D.C. U.S. District Court – 1990 – 743 F.Supp.
901
• Revenue Recognition Problem
• $2.6 Billion cost to taxpayers
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Parties
• Litigation: Seeking to regain operational control
of Lincoln Savings & Loan Association
• Plaintiffs
– American Continental Corporation – Ohio Corporation
based in Phoenix
– Lincoln Savings & Loan Association
• California chartered S&L
• Wholly owned subsidiary of ACC
• Deposits insured by FSLIC (cousin of FDIC)
• Defendant: OTC (Office of Thrift Supervision)
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Background
Lincoln is placed in Conservatorship
• Regulator appointed a conservator in April 1989
• Basis for appointment:
– Lincoln was in a “safe and unsound condition to
transact business”
– There was a “substantial dissipation of assets or
earnings due to . . . violations of law, rules or
regulations, or to any unsafe or unsound . . .
practices.”
• Conservator is appointed ex parte
• May seek judicial review of appointment
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Defendant’s Position
• Lincoln was at all times managed and
operated on a sound financial basis
• Regulators’ actions were arbitrary and
capricious
• Regulators’ actions precipitated Lincoln’s
severe financial crisis
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History
• Charles Keating acquired Lincoln in 1984
• Moved business to Phoenix
– Reduced single family loans in California
– Made direct investments in equity securities
– Purchased “high yield-high risk” bonds
– Equity participations in emerging businesses
– Loans to individuals in speculative activities
– Keating negotiated deals even though not an
officer
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Wescon Transaction
• Direct investment by Lincoln
• Development of Estrella Project
– 20,000 acres outside Phoenix
– 8,500 acres called Hidden Valley
• Lincoln sold 1000 acres of Hidden Valley to
West Continental Mortgage and Investment
Corporation (“Westcon”)
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One thousand acres of
Hidden Valley raw land
Lincoln
(seller)
$3.5MM Loan from
Lincoln to Garcia
WesCon
(Buyer)
$3.5 Million Down payment +
Non-recourse Note $10.5 million
Loan from Garcia
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$3.5 MM Loan from
Garcia to Wescon
Gain on Sale for Lincoln
for Wescon Transaction
• Sales Proceeds • Less: Cost of 1000 acres Gain on Sales
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$14 million
$3 million
$11 million
(Short Term) Advantages of Gain
• Boosts profitability of Lincoln and
consolidated entities
• Boosts Lincoln’s “regulatory capital” for
regulatory purposes
• Artificially Boost “Fair Market Value” of
remaining property
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Bank Balance Sheet
Capital Ratios
• Cash
20MM
• Perf Assets 800MM
• Troub Assets 150MM
• Deposits 800MM
• Other Liabilities 100MM
• Capital 100MM
– (may not get repaid)
• Other Assets 30MM
• Totals 1 Billion
• Totals 1 Billion
• 100/1,000 = 10%
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Loans Require Write-Off
Effect on Ratios
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Cash
20MM
Perf Assets 800MM
Troub Assets 150MM
Write Off (70MM)=
– Net 80MM
• Other Assets 30MM
• Totals 930MM
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Deposits 900MM
Capital 100MM
Loss
(70MM)
Net Cap 30MM
Totals 930MM
• 30/930 = 3.22%
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Increasing and Decreasing
Bank Capital
• Increases to Capital
– Shareholder contributions of capital
– Income from operations
– Gains from selling property
• Decreases to Capital
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Dividends (pay out of earnings)
Distribution of Capital
Losses from operations
Losses from selling property
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Problems with Sale
(Find the Fraud)
• Lincoln Appraisal - $9 million versus $14 million
• Wescon
– Net worth of only $31,000
– No intention of developing property
– Testimony: acting as “straw man” for Garcia (head of
E.C. Garcia & Co.)
– $3.5 million came from loan by Garcia to Wescon
– Garcia assumed Wescon’s obligations
• Neither Wescon nor Garcia made any payments
to Lincoln
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Problem with Garcia
• Garcia was a heavy borrower from Lincoln
• $30 million outstanding loans from Lincoln
• Garcia not interested in developing Hidden
Valley
• Didn’t want to jeopardize $20 million loan
being negotiated with Lincoln
• $20MM loan and Wescon Transaction closed
on the same day
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One thousand acres of
Hidden Valley raw land
Lincoln
(seller)
Wescon
(Buyer)
$3.5 Million Down payment +
Non-recourse Note $10.5 million
$3.5MM Loan from
Lincoln to Garcia
Loan from Garcia
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$3.5 MM Loan from
Garcia to Wescon
Problems with Non-recourse Sale
• Only recourse is to foreclose on property
• No personal recourse to Wescon or Garcia
• Property is not income producing
– no rentals to pay interest
– Other costs (taxes, improvements, etc.)
• Could sell “lots” to meet interest payments
– (no intention to develop property)
– Time lags – development difficulties
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Critique of Accountants by Court
• Blindly followed abstract accounting principles
• Should determine if transaction makes
economic sense
• Must look for economic substance
• Skeptical if audit trail is lacking
• Skeptical if audited entity has failed to comply
with record keeping requirements
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How are Transactional Lawyers
Involved in Ethical Concerns?
• Lawyer Work Product/Services
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General counsel (in house) and Outside Counsel
Property Sales Documentation
Loan documentation
“Closing” Legal Opinions
• Transaction Approvals
– Board of Director Meetings & minutes
• “Water Cooler” Knowledge
• Questions from the Accountant
• Right Hand knowing the Left Hand
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Ethical Issues for Transactional Lawyer
• Utah Rules of Professional Conduct
– Obligations to Client (i.e. the Company)
– Obligations to third party
• Sarbanes Oxley - Publicly Traded Entity
– Obligations to SEC
– Obligations to Utah Securities Commission
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Banking Regulator
• If state chartered – Utah Department of Financial
Institutions
• If Federally Chartered – Office Comptroller of the
Currency
• If Insured Deposits (state or Federal) - FDIC
• Possible Actions
• Civil Penalties
• Criminal referral to justice department (derivative action)
• Banned for life from practice with banks
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Utah Rule 4.1. Truthfulness in
Statements to Others
• In the course of representing a client a lawyer
shall not knowingly:
• (a) Make a false statement of material fact or
law to a third person; or
• (b) Fail to disclose a material fact, when
disclosure is necessary to avoid assisting a
criminal or fraudulent act by a client, unless
disclosure is prohibited by Rule 1.6.
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Utah Rule 1.6. Confidentiality of
Information
• (b) A lawyer may reveal information relating to the
representation of a client to the extent the lawyer
reasonably believes necessary:
• (b)(2) to prevent the client from committing a crime or
fraud that is reasonably certain to result in substantial
injury to the financial interest or property of another and in
furtherance of which the client has used the lawyer’s
services;
• (b)(3) to prevent, mitigate or rectify substantial injury to
the financial interests or property of another that is
reasonably certain to result or has resulted from the client’s
commission of a crime or fraud and in furtherance of which
the client has used the lawyer’s services;
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Utah Rule 1.13. Organization as a
Client (“Up the ladder”)
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(b) If a lawyer for an organization knows that an officer, employee or other person associated
with the organization is engaged in action, intends to act or refuses to act in a matter related
to the representation that is a violation of a legal obligation to the organization, or a violation
of law that reasonably might be imputed to the organization, and that is likely to result in
substantial injury to the organization, then the lawyer shall proceed as is reasonably
necessary in the best interest of the organization. Unless the lawyer reasonably believes that
it is not necessary in the best interest of the organization to do so, the lawyer shall refer the
matter to higher authority in the organization, including, if warranted by the circumstances,
to the highest authority that can act on behalf of the organization as determined by
applicable law.
(c) Except as provided in paragraph (d), if,
(c)(1) despite the lawyer's efforts in accordance with paragraph (b), the highest authority that
can act on behalf of the organization insists upon or fails to address in a timely and
appropriate manner an action, or a refusal to act, that is clearly a violation of law, and
(c)(2) the lawyer reasonably believes that the violation is reasonably certain to result in
substantial injury to the organization, then the lawyer may reveal information relating to the
representation whether or not Rule 1.6 permits such disclosure, but only if and to the extent
the lawyer reasonably believes necessary to prevent substantial injury to the organization.
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Utah Rule 1.16. Declining or
terminating representation
• (a) Except as stated in paragraph (c), a lawyer shall not
represent a client or, where representation has
commenced, shall withdraw from the representation of a
client if:
• (a)(1) the representation will result in violation of the rules
of professional conduct or other law; . . .
• (b) Except as stated in paragraph (c), a lawyer may
withdraw from representing a client if: . . .
• (b)(2) the client persists in a course of action involving the
lawyer’s services that the lawyer reasonably believes is
criminal or fraudulent;
• (b)(3) the client has used the lawyer’s services to
perpetrate a crime or fraud;
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