Document Type


Publication Date



Not infrequently, managers of public companies propose to do thingsrearrange their operations, restructure assets and liabilities, sell and buy property-solely for the purpose of achieving accounting effects they desire. Most often they want an increase in current reported earnings per share, though sometimes they prefer a current decrease in the earnings they would otherwise report when it will allow them to show a smoothly increasing pattern of earnings in the future.

Sometimes the desired effects require outright lying or violations of Generally Accepted Accounting Principles (GAAP), in which cases the maneuvers are plainly illegal. But even where they do not involve lying or GAAP violations, "earnings management" activities are at best wasteful and at worst misleading. Why should lawyers assist in them? Why do the bar or the courts not adopt a maxim that, where it appears that a manager's sole or dominant purpose in undertaking an activity is to achieve favorable accounting effects (that is, accounting effects that make management look good), the lawyer has a duty to advise against and refuse to assist it? Another way to frame the principle would be to insist that management articulate a prima facie plausible business purpose for an activity for which it asks the lawyer's assistance.1

Although earnings management has come in for a good deal of criticism lately, 2no one has suggested that lawyers have any duty as broad as this one. Lawyers routinely assist with various kinds of earnings management. So Steven Schwarcz seems to reflect the prevailing assumption among practitioners in arguing that such assistance should not be regarded as presumptively wrongful.3 Nevertheless, there is a substantial argument that a rule of presumptive prohibition would be most consistent with both the securities laws and the lawyer's fiduciary duty to her corporate client.

Considering the arguments against professional assistance to earnings management may shed some light on Schwarcz's analysis of lawyer opinions in structured-finance and other transactions. This is a pioneering contribution, but it disappoints on precisely the point to which its title draws attention-in delineating the "limits" of the lawyer's discretion to assist the corporate client. We can all agree with Schwarcz that lawyer assistance to transactions involving explicit deception is inappropriate.4 At the other end of the spectrum, Schwarcz is only slightly more controversial when he argues that a lawyer should not be prohibited from assisting a lawful leveraged buyout just because it entails loss of jobs. 5 But if we are concerned with "limits," we should focus on activities that are less obviously illegal than the former but more directly implicate the lawyer's expertise and responsibilities than the latter. Earnings management is an especially fruitful example.

Schwarcz's main reason for opposing presumptive prohibition of assistance to earnings management activities is that such activities are not categorically illegal.6 If we think they are bad, he says, then we should just ban the underlying transactions before limiting lawyers' discretion to assist them.7 So the "limit of lawyering" turns out to be the law. I find both the premise and the conclusion of this argument more ambiguous and debatable than Schwarcz does. Before we locate the limits of lawyering in the "law," we need to explain what we mean by law, and this requires consideration of some issues that Schwarcz elides. And when we turn to the relevant doctrine, the case for a presumptive prohibition of earnings management, while not beyond debate, seems considerably stronger than Schwarcz allows. I consider these points in turn.