Do lawyers report evidence of material violations up-the-ladder at the companies they represent, as the Sarbanes-Oxley Act and related regulations require? Have general counsel properly investigated those reports? Can we trust lawyers to be effective gatekeepers and stop corporate misconduct? The answers to these questions have long been elusive, because corporate wrongdoing is inherently sensitive and confidential, and the actions of elite research targets are hard to observe. As we approach the 20th anniversary of Sarbanes-Oxley, though, it makes sense to revisit these questions and to evaluate the impact of one of the statute’s most controversial provisions, Section 307. That section gave the U.S. Securities and Exchange Commission (SEC) sweeping authority to establish “minimum standards of professional conduct” that would enable it to discipline lawyers “appearing and practicing before the [SEC] in any way in the representation of [public] issuers.”
In a new paper, I argue that there is a strong case for imposing gatekeeping duties on lawyers. I also review the growing body of empirical studies that shed light on whether lawyers make good gatekeepers. Specifically, I contend that there can be significant economies of scope from imposing gatekeeping duties on lawyers. Economies of scope are “cost savings which result from . . . combining two or more product lines in one firm” rather than having two or more specialized firms produce each product line separately. (Diversified multi-product enterprises that operate several businesses—such as the manufacturer 3M Corporation—tend to enjoy significant economies of scope.) These efficiencies form the foundation of a gatekeeper’s capacity to monitor corporate affairs for the purpose of averting material law violations.
In my paper, I argue that both outside and in-house lawyers possess a form of proprietary know-how that can be usefully and efficiently exploited in the service of gatekeeping. Perhaps more than any other securities-market professional, lawyers are skilled and experienced at collecting, processing, and evaluating information that may indicate corporate misconduct. As a result, lawyers can perform some gatekeeping as a byproduct of their normal work, and it is efficient for regulators to add some gatekeeping obligations to the tasks that lawyers are already performing on behalf of their corporate clients.
Of course, the contention that imposing gatekeeping obligations on lawyers would be meaningfully efficient does not mean that lawyers will necessarily be effective gatekeepers. In light of the legal profession’s historical, guild-like resistance to regulation, including their resistance to the enactment of Section 307, do lawyers make effective gatekeepers? A growing body of empirical studies in the accounting and finance journals generally supports the notion that general counsel are effective (albeit conflicted) gatekeepers, who appear willing to police material illegalities but who also tolerate a good deal of aggressive and perhaps unethical conduct. The more limited evidence about outside lawyers suggests that they may be less likely to press their clients to comply with the law, opting instead to perform their strictly advisory role as neutral risk-assessors. Nonetheless, their involvement in disclosure matters appears to generate some salutary, longer-term effects, demonstrating perhaps a net benefit to public investors.
Section II of the paper briefly describes the traditional gatekeeping theory, the key elements of a gatekeeper enforcement strategy, and the principal attributes commonly ascribed to gatekeepers. It explains why the designation of lawyers as gatekeepers has been so controversial and argues that the case for imposing gatekeeping obligations on both outside and in-house lawyers is strong in light of the economies of scope available from adding gatekeeping to lawyers’ tasks. The paper then specifically addresses the potential efficacy of in-house lawyers as gatekeepers.
Section III of the paper surveys the recent empirical evidence in the accounting and finance literature investigating the effectiveness of general counsel and outside law firms as gatekeepers.
Section IV reviews the findings of one study, which highlighted the promising gatekeeping potential of board members with legal backgrounds. It raises the possibility that appointing lawyers to the board may offer the best strategy for promoting compliance within the firm and deterring corporate malfeasance. It calls for further research on the efficacy of these understudied legal gatekeepers.
This post comes to us from Professor Sung Hui Kim at the UCLA School of Law. It is based on her recent paper, “Do Lawyers Make Good Gatekeepers?,” available here.