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    A lawyer dreamed of disrupting the legal industry with private equity. It turned into a nightmare.

    Getty Images; Alyssa Powell/BI

    Arizona opened the doors for outside investors in law firms, and Steve German had high hopes.But he says his co-owner, 777 Partners, was hit by scandal and didn’t invest millions it promised.German also regulates law firms with outside investment, and says they’re being “abused by hedge funds.”

    Two years ago, Steve German was optimistic.

    He’d done well for himself as a trial lawyer in Phoenix, suing insurance companies on behalf of workers who were denied benefits. And he’d just launched a new venture with Miami investment firm 777 Partners that he hoped would revolutionize the legal business.

    Arizona had recently begun permitting non-lawyers to invest in law firms, which is banned in nearly every other state. German seemed poised to ride the wave of deregulation and build what he’d later describe as “generational wealth.”

    State bar associations have long restricted lawyers from selling stakes in their firms to outside investors, out of a desire to protect consumers from bad advice, to keep financiers from distorting firms’ ethical obligations to their clients — and to keep profits in the hands of lawyers. That meant that firms basically had to eat what they kill: any investments in marketing, technology, or building cases had to come from client fees or the firm’s cut of jury awards and settlements.

    Allowing private equity riches to pour into law firms was a potential game-changer. When he spoke to Business Insider in 2022, German excitedly described how he might use 777’s money to take lower fees and allow clients to designate charities they’d like to benefit. He was making connections with referral sources and said he’d hired BerlinRosen, one of the better-known PR firms that works with plaintiffs’ lawyers.

    “It was something that was revolutionary in many ways, and it was something I saw as a way to do good,” German recalled. The firm, called Scout Law Group, was one of the first such firms — known as an alternative business structure, or ABS — to be approved by state regulators.

    “The ABS program reminds me of when Uber first came to town and everyone was like, ‘oh my god, that’s crazy,'” said Andy Kvesic, who serves on the state committee that approves ABS applications.

    German’s optimism was short-lived. Before 2022 came to an end, his relationship with 777 had begun to sour amid disputes over funding. Now, German has become a vocal critic of Arizona’s hands-off approach to regulating these new entities.

    German said 777 didn’t supply money on the terms or timeline it promised and planned. While he got some funding and was able to build a portfolio of about 300 to 400 cases, German said the millions that his partner had promised never flowed. He had to whip out his own checkbook to pay vendors and employees, he said in a lawsuit filed in April alleging fraud, breach of contract, and unpaid wages. It’s one of several lawsuits involving 777, which, according to Semafor, has also been under Justice Department scrutiny.

    777 has not yet filed an answer to German’s complaint. The firm did not respond to a request for comment.

    He first decided to resign from Scout last summer, a few months after the firm and its leaders filed licensing paperwork with state regulators that he said he now believes was incomplete. But he told Business Insider that after he forwarded his “break-up letter” to state regulators, he came to regret the decision; it touched off a bar investigation and resulted, for a period, in the suspension of Scout’s license. He ended up rescinding the resignation and sticking around until 777 picked a new compliance lawyer in December, he said.

    After all that, he expected that the firm and its new leaders’ license application would be closely scrutinized. He said the steady drumbeat of negative reporting made it clear that 777 hadn’t been upfront about the controversies it was involved in.

    But, he said, the committee that reviews ABS applications renewed Scout’s license with barely any discussion. German also sits on the committee, and he was recused from the decision. But he said that and subsequent board decisions, like giving a pass to a lawyer who failed to mention that he’d been suspended in another state, unsettled him.

    “What we’re doing is sending the wrong message,” he said. “What we’re saying is, don’t disclose your bad stuff.”

    Regulators approved 777 Partners despite litigation, DOJ probe

    German isn’t the first business partner to sue 777 Partners, and he may not be the last. After the firm began investing in soccer clubs, Brazil’s news outlet O Globo reported that one of its owners, Josh Wander, was until 2018 on probation for a cocaine-related charge. (At the time, 777 called it “ancient history.”) The firm’s reliance on insurance premiums, which are normally invested conservatively to ensure future claims can be paid, to fund its risky bets in sports teams and other speculative investments was unearthed by Semafor, and insurance regulators and business partners have been asking questions and filing lawsuits.

    But German said on some level, it’s about more than money. Revelations about 777’s other business lines — for instance, its work with online payday lenders that charge sky-high interest rates and pay Native American tribes to use their sovereign immunity as a legal shield — repulsed him when he learned about them last July after reading about it in the soccer publication Josimar, he said.

    Asked how he didn’t know about the controversies until 2023, German said he’d asked Steven Pasko, one of 777’s principals, if they were the subject of any lawsuits while he was filling out ABS licensing paperwork, and he had denied it. He said he still didn’t know how the controversies didn’t come to the attention of ABS committee staff.

    “These people are the exact opposite of who should be approved,” he said. “We’re supposed to be looking out for the public interest, and we’re letting in guys who are sued for RICO?”

    ABS committee minutes show that Scout’s renewal application passed 5-1, with two recusals and two absences. According to the committee’s most recent annual report, 25 new entities got a green light last year; one application was denied. The number of complaints jumped from zero in 2022 to 24 in 2023, though no discipline was imposed on any of the four entities that were the subject of complaints.

    Lynda Shely, an Arizona legal ethics lawyer who is also a member of the committee, said she would not comment specifically on German’s dispute with 777 and Scout, which she has advised. She was also recused from the vote on Scout’s renewal application. But she pushed back on the idea that Arizona was being too permissive, saying many applications don’t even make it to a vote because of the heavy scrutiny applied by committee staff. Funding and marketing firms were cutting deals with law firms in non-public arrangements for years before Arizona changed its rules, she added.

    “There’s a whole lot of disclosure that occurs through our model,” she said. “There’s more transparency about the relationship with an ABS.”

    As Business Insider reported in 2022, Arizona’s ABS structure has unleashed a wave of experimentation. In some entities, lawyers and accountants are working side-by-side to serve clients better, and in others, technologists are helping traditional law firms work more efficiently, with the potential to share in the upside. Advocates see it as a way for lawyers to sell packages of valuable services, instead of selling billable hours.

    But one of the most common uses of an ABS has been for personal-injury and mass-tort attorneys to team up with funders and marketers more directly than is possible under legal ethics rules in other states.

    Defenders of traditional law firm structures say lawyers take an oath to do what’s best for their clients. They argue that involving outside funders in firm management creates a risk that profits come first and clients come second.

    But some advocates for systems like Arizona’s say those risks can be managed by requiring lawyers to have the final say, keeping a close eye on the new firms, and taking complaints seriously. They say there’s nothing wrong with lawyers using outside money to reach more injured clients, who may not know where to turn when facing medical bills from car wrecks and dangerous drugs.

    “So far, it is a success,” said Shely. “Like any new program, [we] will have growing pains and need to adjust and tweak things as we go.”

    For much of 2023, German said, he expressed his discontent with 777’s leadership, including its general counsel Ed Gehres and its chief financial officer Damian Alfalla. He said he had conversations with other investors about buying 777’s stake in Scout, but the talks ultimately went nowhere. He said other investors wanted to borrow money against Scout’s unearned contingency fees, which could have made it impossible for those clients to find a new lawyer if they had to leave Scout for some reason.

    Gehres and Alfalla didn’t respond to emails seeking comment.

    In the wake of his own dispute with 777, he said he has become alarmed by the permissive approach the state has taken toward licensing and thinks more scrutiny is needed. He said he still believes that the ABS model has the potential to fill gaps in the legal marketplace, but he said greenlighting any applicant — many of which have little connection to Arizona — is a mistake.

    Allowing outside investment into law firms, he said, “is a privilege. It serves a purpose for access to justice. It’s not for a billionaire equity fund to use to game the process.”

    Read the original article on Business Insider

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