Austin Lafferty, Vice President of the Law Society of Scotland, and Walter Semple, Law Society Council member, last week used the electronic pages of The Firm to discuss the coming “ABS tsunami”.
The highly esteemed gentlemen fail to see eye to eye on the role of the Society in how the profession got to this point, but each acknowledges the struggles which lie ahead, with Mr Lafferty bluntly saying “the core workstreams of many firms will be decimated, with obvious consequences.”
Conveniently for the days after 5th November, the blogger Guido Fawkes, normally one for hot-off-the-press political gossip, has written a piece about the role of the investment banks in the global financial crash, prompted by his having read the excellent and chilling “The Big Short” by Michael Lewis. Anyone wanting to understand the limitless greed and stupidity which brought the financial world to a halt should read Mr Lewis’ book.
Dealing with investment bankers, Guido, as a former investment banker himself, points out when the rot set in at the major institutions. He describes one of the problems as the fact “that investment banks were no longer partnerships; they were publicly listed companies, with shareholders who were not involved in day-to-day management. This has proved to be a disastrous form of capitalism, with owners who don’t know what the managers of their money are doing.”
Investment banking, till the early 1980’s, was carried out by partnerships made up of investment bankers. The capital in the firms, and the risks, were both the responsibility of the partners. As Guido says “the oldest and most experienced partners tended to have the most capital in the firm. This had a risk management effect greater than any Nobel Prize winning computer-calculated risk model, the old guy with the grey hair stood to lose everything when some testosterone charged 27 year-old trader bet the firm’s capital … The bosses’ desire to keep their retirement pots concentrated their minds”.
Stock market listing, and external ownership, such as that brought in by the Big Bang during the Thatcher years lead to a situation where the providers of the capital, and therefore those bearing the risk, were no longer in any control of that risk. Is it a coincidence that Collateralised Debt Obligations and the rest of the alphabet soup which made up the speculative “investments” at the root of the crash were financial instruments dreamed up by the corporate whizz kids on massive salaries, but who stood only to lose their jobs if they got it wrong, rather than everything they owned?
As Guido says “There is nothing moral in asymmetric markets where the risks are borne by others than those taking the risks.”
The Scottish legal profession faces an imminent and huge upheaval. As Mr Lafferty says, “The threat…is that the high street legal market will get hoovered up like the high street optical market has been, in which 80 per cent of the trade is owned by a tiny number of brand names.” As a profession, solicitors “need to be sales-savvy, market-alert, entrepreneurial” to avoid “having to watch as companies with increasingly bizarre names and brands try to elbow their less-qualified way into the market place. “
Mr Semple, expressing a concern going further than merely commercial and marketing matters, warns that “(The Law Society has) been presiding over a potential catastrophe for many solicitors in Scotland which was entirely avoidable. … The changes in the Legal Services legislation now require solicitors to act independently (rather than be independent)…This change will compromise the independence of solicitors who offer services to the public. External owners of legal service providers will not be directly bound by solicitors’ ethics. They will be motivated only by commercial interests.” (Emphasis added.)
I have no doubt that investment bankers, in the old days, were as a rule, as professional and ethical as solicitors. However, the passage of time, and the loosening of the direct connection between capital and risk, allowed corners to be cut, and edges to be shaved, all in the interest of profit. The creators of the wacky financial “instruments” described by Mr Lewis were not unethical either. But, as I mentioned above, is it coincidental that they were only created once the capital/risk link was broken, or at best severely stretched? Financial backers will want a dividend on their money – we are in a capitalist society after all, and pressures will inevitably increase on legal businesses under ABS to provide a good return on their investors’ capital. Over time, as with the investment banks, things are likely to slip.
Even although the ABS model to be applied here is not (yet) full flotation, the twin risks identified by Messrs Semple and Fawkes place the profession at great risk. The “liberalisation” of the financial markets too was intended to allow greater competition, and permit the investment banks to act outwith the hidebound old rules, whilst of course remaining true to their ethics, thus allowing them to increase their profitability, both for the banks themselves and their investors and backers. We can see, laid out in Mr Lewis’ book, and indeed on the news daily, where that led to.
Self-interest is a necessary human trait, and who could fault a partner at a big practice who sees the possibility of their business floating, with a huge windfall for the people lucky enough to be owners when the music stops? It seems inevitable that, as time progresses, the restrictions in place in the imminent ABS structure will fall away, as they are seen as being “anti-competitive” or still as leaving legal businesses at a “financial disadvantage” in raising capital, as compared with other professions. Full flotation will come in due time, even though there are probably only a handful of firms where, in reality, this will have any substantial direct effect. It is unlikely that, for example, even the best High Street one-man criminal practice will be able to have an IPO!
Mr Lafferty refers to the “ABS tsunami”. As we have tragically seen in real life, if a tsunami is already on its way towards you, then there is nothing which will stop it.
Random Thoughts Re Scots Law by Paul McConville 