Wednesday, January 4, 2017

Should Venture Capitalists Compete with Law Firm Partners and Judges? (Michael Simkovic)

A partner in a prominent San-Francisco-Bay-area venture capital firm recently told me, “The tech sector is eating the world.  The menu is full of inefficient legacy industries.” 

The thesis of USC Professor Gillian Hadfield’s new book, Rules for a Flat World, is that the legal profession should be near the top of the menu.  Hadfield argues that law is overly complicated, expensive and inefficient.  This is because lawyers have monopolized the practice of law, locking out more efficient, technologically empowered, venture-capital backed competitors.  These competitors—software engineers backed by venture capital money, perhaps in cooperation with lawyers and paralegals—could hopefully improve quality, reduce costs, and generally run circles around overly conservative law firms and inefficiently subscale solo practitioners.

This book will engage venture capitalists and entrepreneurs, established legal technology companies, individuals interested in regulation of the legal profession, and more broadly, those who study privatization and deregulation.

She raises important questions about which regulations of the legal profession protect consumers or serve other legitimate public policy goals and which might be merely protectionist.  She targets prohibitions on practice of law within a corporation and prohibitions on profit-sharing with non-lawyers.  Without such regulations, it would be easier for non-lawyers to invest in and make high level decisions for legal services providers.  Non-lawyers might place more trust in technology than lawyers and might be more open to new business models.

Hadfield’s analysis focuses on the aspects of law that are an economic service (she describes it as “economic infrastructure”). Hadfield is primarily focused on commercial and corporate law.  Hadfield notes that while criminal law may be more salient in popular culture, since the time of Hammurabi, most law has been about money, property rights, risk allocation, and supporting business activity.

Hadfield argues that if companies such as Westlaw, Lexis and Legal Zoom could hire lawyers to provide customer support directly to end-users, these companies could improve the appeal of their offerings and more easily compete with small and solo-practitioners.  Moreover, these companies would have economies of scale and efficiencies that solo practitioners cannot readily match.  Because of these efficiencies and expansion of the legal market to under-served populations, lawyers working for incorporated legal services providers would not necessarily earn less than solo practitioners currently earn, although lawyer-employees would have substantially less autonomy than lawyer-owners.   

Hadfield’s critique is deeper than I have suggested thus far.  She argues that technology companies should not simply compete with lawyers to help clients navigate our existing legal system, but rather technology companies should also design competing legal and regulatory systems, which businesses could opt into.  Government regulators could set standards that private regulatory providers would need to meet or else lose their license to regulate, but the role of government would be greatly diminished and the flexibility afforded to businesses—who would choose which regulator they wish to be regulated by—would be greatly enhanced.  Hadfield calls this “Super-Regulation.”  Hadfield’s discussion of this proposal echoes debates surrounding the efficiency and fairness of binding arbitration and self-regulation. 

Hadfield is careful to note that:

“Weak government oversight of private regulators— like weak government oversight of the operators of private prisons or highways— could quickly gobble up the potential benefits of harnessing market incentives to develop better, simpler, less costly, and more effective regulatory systems.”

She notes the need for Super-regulators to be mindful of concerns like consumer protection or environmental protection that might not be a very high priority for the businesses that choose their own regulators. Hadfield also emphasizes that business people should not view law and regulation purely an impediment to business, but rather as a necessary facilitator, like roads or an electricity grid (returning to the infrastructure metaphor).

Nevertheless, the book is written from a perspective which assumes that markets will generally outperform government.  This perspective suggests that bidding out traditional government functions to private contractors and increasing competition will improve efficiency.  Hadfield tends to concludes that delays in the development and adoption of new technologies are due to inefficient regulation rather than inherent problems with the quality, reliability or safety of the underlying technology. 

Hadfield is nuanced and thoughtful, but her theoretical approach may not convince those who do not already accept free-market premises, are skeptical of deregulation or privatization, believe that the government’s institutional knowledge and capacity to regulate and evaluate regulations will atrophy if it is less directly involved in regulation and interacting with market participants on a day-to-day basis, or who worry about how technology giants could abuse their power. 

One empirical highlight of the book is Hadfield’s discussion of a “secret shopper” experiment in the UK comparing error rates in Wills by the license category of the preparer and finding little evidence that licensing reduced errors.  I wish that Hadfield had expanded the discussion of empirical evidence for deregulation and licensing, especially in the context of the legal profession.  My own reading of the economics literature is that the case for regulation and licensing is often context specific, and it is difficult to broadly generalize on theoretical grounds.

With respect to political economy, the tech giant Intuit (makers of Turbo Tax), successfully lobbied against the federal government providing taxpayers with simplified pre-filled tax forms and tax liability estimates using information the government already has.  Intuit argued that prefilled forms would discourage taxpayers from fully taking advantage of deductions and credits.  Critics have suggested that Intuit was protecting its investment in managing tax complexity by preventing the government from creating a competitive, simple and free option.

Where Intuit succeeded in maintaining individual tax compliance complexity, collective action problems would likely have precluded small accountants and tax lawyers from mounting anywhere near as effective a lobbying campaign. 

Given network effects and the tendency of the largest technology companies to achieve long term competitive advantages (i.e., to become de facto monopolies or oligopolies), it seems likely that a consolidated VC-backed legal tech giant would have more market power and more political clout than our fragmented legal services providers of today could ever hope to achieve.  Anti-trust law may have curbed some of Microsoft’s sharp-elbowed business practices, but self-interested lobbying is not constrained by anti-trust law.  To the contrary, recent Supreme Court decisions suggest that lobbying is Constitutionally protected free-speech.  Empirical studies suggest that lobbying is a highly profitable investment of corporate resources.

If we are afraid that competing, subscale lawyers have distorted the legal system to serve their interests, should we be concerned that a consolidated, dominant legal tech giant might more easily overcome opposition and distort the legal system in even more self-serving ways?

Caveats notwithstanding, for those with an eye on legal technology, venture capital, and regulation of the legal profession, Hadfield’s Rules for a Flat World will be a thought-provoking read.

Guest Blogger: Michael Simkovic, Law in Cyberspace, Legal Profession, Web/Tech | Permalink