California moves to restrict PE investment in law firms

California lawmakers have just approved legislation to heavily restrict private equity and other corporate investors from impacting the operations of law firms, potentially establishing the state as the third in the US to implement such restrictions this year, according to a Wall Street Journal report. Both the Senate and Assembly passed Assembly Bill 2305 unanimously, though a few lawmakers did not vote.

The bill now goes to Governor Gavin Newsom, who has until September 30 to decide whether to sign it. If the measure becomes law, it would prevent private equity firms, hedge funds, and other corporate investors from controlling the practice of law. Introduced in February by California Assembly member Ash Kalra, the legislation aims to prevent outside investors from exerting influence over legal practices.

Kalra contends that current rules have loopholes that allow financial investors to influence legal proceedings. Illinois and Colorado have already passed similar laws this year, while other states are debating the extent to which non-lawyer investors should be allowed to hold economic interests in legal practices. The targeted investment structures are modeled after those used in healthcare, where lawyers retain authority over legal decisions and client representation, while investors gain an economic stake and oversee business functions like finance, technology, marketing, and operations.

This arrangement is intended to comply with existing rules in most US states that prohibit non-lawyers from controlling the practice of law. However, critics argue that such structures can enable investors to exert indirect influence over legal decisions despite the formal separation between ownership and professional judgment.