Utah Bar Journal

This article will compare the traditional approach of the fiduciary duty of loyalty with the "new" modern approach, how the two approaches relate to the Rules of Professional Conduct, and how they apply to the estate planner who has a personal interest in the insurance products his clients purchase.

The Fiduciary Duty of Loyalty
"A [fiduciary] is held to something stricter than the morals of the marketplace. Not honesty alone, but the punctilio of honor the most sensitive, is the standard for behavior." This statement from Judge Cardozo has long been the recognized and repeated as the classic statement for the legal principle of fiduciary duties. The fiduciary duty of loyalty requires constant fidelity.

A fiduciary must put aside his private gain or personal interest whenever his interest conflicts with the interest of the one he is bound to protect. Judge Cardozo made it clear that uncompromising rigidity was the attitude of the courts when considering the rule of undivided loyalty and that the fiduciary's level of conduct must be higher than that "trodden by the crowd."

Now, however, some seem content to rely on the disintegrating "morals of the marketplace" for the standard by which fiduciary duties are met. The traditional rule, that the fiduciary is to act in the best interest of the beneficiary, is slowly being replaced by a new test that requires affirmative bad faith or intentional misconduct. This new test reduces the legal standard of the fiduciary to nothing more than avoiding unfair treatment. The traditional rule would say that if an attorney receives a commission from the sale of life insurance products with which to fund an estate plan he created, he has breached his fiduciary duty, regardless of damage to the client, and must disgorge all the profits made in the transaction. Modern trends, however, say that if the attorney discloses the self-dealing, gets the client's consent and the transaction is fair and reasonable, then no breach has occurred and it is acceptable for him to keep the profits.

Has the evolution of the fiduciary duty of loyalty led to a better method of serving the client's interests? Has the evolution exposed the attorney to any negative effects? What role do the Rules of Professional Conduct play in making these determinations?

The Rules of Professional Conduct
Utah Rule of Professional Conduct 1.7 asks the lawyer to evaluate whether a conflict exists between his interests and the interests of his client, and allow him to overcome the conflict if he reasonably believes that it will not adversely affect his representation of the client and he has disclosed the conflict and has received the client's consent.

Utah's Rule 1.8 says that a lawyer's participation in business transactions with his client should only be conducted when the lawyer's interest is fair and fully disclosed and consented to by the client after the client is given reasonable time to seek independent advice. Many of the difficult ethical problems lawyers face arise from a conflict between their duty to the client and their efforts to earn more money. The comments to Rule 1.7 mention the lawyer's need for income as an important factor in the lawyer's inability to give detached and disinterested advice. With the desire for more money being a key factor leading to ethical violations, lawyers getting into non-legal business ventures such as selling insurance may be starting down the "slippery slope" that leads to other ethical violations.

The professional rules in most states have adopted the "new" standard of fiduciary duties, stating that if the attorney discloses and the client consents then it is permissible to have a personal interest contrary to the client's, as long as the lawyer believes he can still adequately represent the client. The traditional view of the fiduciary duty of loyalty, in comparison, says that if the conflict exists the attorney is to act in a disinterested manner in the client's interest - and that conduct deviating from that standard results in liability, regardless of the fiduciary's motive or intent.

Why are standards for the fiduciary duty of loyalty being reduced? Why do the professional rules conform to the "new" standard and not the standard as defined by Judge Cardozo? It seems the "morals of the marketplace" have degraded the fiduciary duty of loyalty and the professional rules have adopted those same morals. Given the current distrust of lawyers and the litigious society we live in, however, would not the wise lawyer practice with a standard of undivided loyalty and conduct himself in a manner higher than that "trodden by the crowd"?

Most states have adopted a standard that if the transaction is fair and reasonable, and if the there is disclosure and consent, the practice of selling insurance is not unethical. Utah State Bar Ethics Advisory Opinion, No. 99-07, states "the lawyer should commence the analysis of these issues with a strong concern that the lawyer may exert undue influence over the client or that the duty of loyalty could be impeded. In addition, the lawyer must consider other relevant factors before determining that it is appropriate to receive a commission from an investment advisor to whom a referral is made." Utah, like most states, allows the attorney to determine if the conflict is of such magnitude that it cannot be overcome without affecting the representation of the client. Advisory Opinion No 99-07 says:

It will be very difficult for a lawyer to maintain independence while taking a percentage of an investment broker's services due to a client referral. Individual lawyers involved in this type of situation are permitted to consider all of the facts and reach a determination whether a conflict of interest exists. As long as such a determination meets the specific requirements of Rules 1.7 and 1.8 and is objectively reasonable in view of concerns expressed in this Opinion, there will be no ethical violation.1

Most state, including Utah, acknowledge the practice of estate planners selling insurance as being in the "gray" area of ethics, associated with great risks and possibilities for self-dealing, but they allow the attorney discretion in the decision making as long as he conforms to the rules as stated above.

Despite its acceptance, the practice of serving in such a dual capacity is at its foundation a conflict of interest and a violation of the principles against self-dealing as long established in fiduciary law. Yet, only New York and Rhode Island have been identified by the author as agreeing with the traditional view of fiduciary duties and completely prohibiting estate planners from selling life insurance products to their clients. New York concluded that:

A lawyer engaged in estate planning may not recommend or sell life insurance products to the lawyer's estate planning clients if the lawyer has a financial interest in the sale of the particular products. That is because the lawyer's financial interest would be reasonably likely to interfere with the lawyer's independent professional judgment in advising the client how best to satisfy his or her financial needs in the context of trust and estate planning. Although [the Rules of Professional Responsibility] would allow the lawyer to engage in business dealings with a client, subject to client consent, when it is "obvious" that doing so will not impair the lawyer's independent professional judgment on behalf of the client, we concluded that it would never be obvious that the lawyer's professional judgment would be unimpaired by his or her self-interest when the lawyer, in the role of lawyer, advises a client to purchase products from the lawyer, in the role of insurance broker.2

The New York opinion made it clear that there is a great possibility the "lawyer might give the client different or inferior legal advice due to [a personal] financial interest."

The committees in Rhode Island and New York agree that the conflict is too great to be adequately overcome through disclosure and client consent. The Rhode Island committee said:

There could be no meaningful consent by the client where the estate-planning lawyer has a separate interest in selling insurance. The client is entitled to rely on, and the lawyer is obligated to provide, independent professional judgment. [Therefore], a lawyer may not solicit or accept a client's consent to such a direct and substantial conflict [of interest].3

The Role of Disclosure - Is it Enough?
New York and Rhode Island have safeguarded clients' interests by declaring that no amount of disclosure will overcome the seriousness of the conflict. Utah, like most other states, says that by disclosure and consent the attorney can overcome this conflict. So who is right?

Unfortunately, the requirement for disclosure is not regulated in any way to ensure that the client has a substantial understanding of the material facts. In the Illinois case of In re Chernoff,4 an attorney arranged a real estate deal for his clients in which he had a personal interest. One of the documents the clients signed revealed that the attorney was an interested party in the transaction. Apparently the attorney felt that having one of the papers on the pile of closing documents disclosing that he was a party to the transaction was good enough to fulfill his disclosure requirement.

The clients maintained throughout the ordeal that they had no knowledge of their attorney's personal interest. They suffered a financial loss and disciplinary action was taken against the attorney in the form of a six-month suspension. The court said although one of the documents that the clients signed revealed the lawyer's interest, this revelation fell far short of the degree of disclosure required in a transaction between attorney and client.

Disclosure, if the only method used to protect the client's interests, must be safeguarded so that it is more than simply an informal passing of information. The client must be assured that he has been informed of every personal interest that the lawyer has in the transaction, the nature of the compensation and the possible ramifications of such a conflict of interest. Only then can the client's consent be considered informed.

Common Business Sense
Is it a good long-term business strategy to sell insurance to estate planning clients? Or, is the offering of insurance products a service which clients consent to because it benefits them? Truett Cathy, founder of Chick-Fil-A, now with over a thousand restaurants, talks about loyalty as one major key to business success. He says: "the Loyalty effect, the full range of economic and human benefits that accrue to [businessmen] who treat their customers in a manner worthy of their loyalty, is at the core of most of the truly successful growth companies in the world today."5 The wise attorney will realize that good business sense tells us that complete loyalty to the client is the prudent course for successful business because if a client feels he is treated unfairly he can, and will, go elsewhere for his legal services.

An excellent example is the recent lawsuit filed against Jonathan Blattmachr, one of the nation's most influential estate planners, accusing him of breach of contract, negligent misrepresentation and violation of his duty of loyalty.8 The suit brought by Charles Benenson, a New York Real estate mogul, accuses Mr. Blattmachr of approaching the Benensons with a estate planning technique that would require the purchase of a $60 million dollar insurance policy from a salesmen Mr. Blattmachr introduced to the clients. The purchase would eventually pay a sales commission of $4.4 million. The Benenson's say that commission is twice what they were told, and that they could have purchased a private placement policy with commissions of only $600,000. The suit accuses Mr. Blattmachr of not disclosing the conflict of interest with the insurance brokers. For relief, the suit seeks $1.5 million in damages, plus a return of the $970,000 paid in legal fees for Mr. Blattmachr's opinion letter, plus punitive damages. Mr. Blattmachr and his firm, Milbank Tweed Hadley & McCloy, call the lawsuit "patently absurd" because it characterizes Mr. Blattmachr as having played the role of an insurance salesman when he "had nothing to do with the Benenson's choice of insurance products."

The outcome of this lawsuit is undecided, but we do know that Mr. Blattmachr will have the burden to prove he was not involved in the purchase or recommendation of the life insurance product. That may be a hard burden to prove. We can also assume that it is a headache that could have been avoided by adherence to the traditional fiduciary duty of loyalty, regardless of what the professional rules may allow.

Malpractice Insurance Coverage
An attorney assuming this dual role of estate planner and insurance salesperson must also consider the possibility that his malpractice policy will not cover his investment advice. If an attorney if found liable for advising a client regarding the purchase of insurance, it is possible the malpractice insurer will argue that the attorney's responsibility was to draft the estate plan, not to fund it. Of course if the attorney is the licensed insurance broker and not just in a referral agreement with a broker, he could purchase additional insurance to cover any insurance mistakes; but if the attorney's conduct constitutes fraud, that insurance will not be available and the attorney might suffer the consequences of malpractice liability that is not covered by his insurance carrier.

Conclusion
Will attorneys conduct themselves in these types of business relationships with an honest, complete and unwavering loyalty to the interests of the client, or do we need to use the law to encourage and, if necessary, compel them to conform to a level above the morals of the marketplace?

Considering the factors mentioned above, including the slippery slope of ethical violations and malpractice liability, it seems the prudent lawyer will decide against serving in this dual capacity. A lawyer is in a position of great trust and advantage, a position that can influence serious decisions in the most subtle ways. If an attorney is giving advice based upon any personal interest, that advice must be viewed as self-serving because it is fraught with risk for undue influence. There is also a great risk that the desire for more money will begin with these sorts of transactions and lead to other, more serious, areas of ethical violations, loss of clients and possible lawsuits.

"Great care must be exercised to avoid irresponsible charlatans motivated primarily by a desire to increase income"7 but, even more importantly, great care must be taken to protect the responsible lawyer who is enticed by money to risk his livelihood.

Great care should be exercised by each attorney, deciding to practice his or her profession with nothing less than "punctilio of honor the most sensitive" and morals above that of the "marketplace," because that is the duty owed to the client - regardless of what the professional rules may allow.

1. Utah State Bar, Ethics Advisory Opinion Committee, No. 99-07, 5 (1999).

2. New York Commission on Professional Ethics, Opinion 619 (1991) at 2.

3. Rhode Island Supreme Court Ethics Advisory Panel, Opinion 96-26 (Nov. 1996). See also the State Bar of Arizona, Opinion No. 99-09, 4-5, (Sept 1999).

4. In re Chernoff, 438 N.E. 2d 168 (Ill. 1982).

5. Professor Frederick Reichheld, Cathy, vi (2002). (See also, Dr. Richard E. Hattwick, Profile on S. Truett Cathy: The Chick-Fil-A Story, www.secretsofsuccess.com/people/cathy.html)

6. David C. Johnston, Wealthy Family is Suing Lawyer Over Tax Plan, The New York Times, Section C; Column 5; Business/Financial Desk; Pg. 1. (July 19, 2003).

7. Lyman W. Weltch, Action is Needed in Response to Changes in Fiduciary Investment Duty, 18 ACTEC Notes, 85 (1992).