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A lawyer's inside knowledge of a former corporate client's business secrets precludes the lawyer from making a substantial investment in a startup that will compete with the ex-client, the Texas bar's ethics committee advised in April (Texas State Bar Professional Ethics Comm., Op. 626, 4/13).
Such an investment would amount to using the former client's confidential information to its disadvantage and could reveal information gained during the representation by signaling the lawyer's assessment of the former client, the committee reasoned.
The opinion centers on a lawyer who represented a corporation in several matters, including its sale to another entity.
During the attorney-client relationship, the lawyer had access to nonpublic information about the client's business, including proprietary data that give the company a competitive advantage in its field. The representation ended with the sale, but the corporation is still engaged in the same business.
Several months after the sale, the lawyer makes a “significant investment” in a new corporation that he knows will compete with his former client. The lawyer is not involved in organizing the new entity or formulating its initial business plan, nor does he represent the business or participate in its management or operation.
The committee concluded under these facts that the lawyer's investment is ethically out of bounds. (See box.)
The committee grounded its conclusion on Rule 1.05 of the Texas Disciplinary Rules of Professional Conduct, which addresses a lawyer's confidentiality obligations to former clients as well as current clients.
In particular, the committee advised that the lawyer's investment in the new corporation will violate Rule 1.05(b)(3), which forbids a lawyer to use an ex-client's confidential information to its disadvantage unless the former client consents or the confidential information has become generally known. (ABA Model Rule 1.9(c)(1) contains a similar prohibition.)
The committee emphasized that the lawyer's confidential information about the former client was part of the knowledge he used in deciding to invest in the competing startup business. That business will use the funds invested by the lawyer to its own advantage and, because it competes with the lawyer's former client, this use of the lawyer's funds will be to the ex-client's disadvantage, the panel reasoned.
The committee also invoked Rule 1.05(b)(1), which forbids a lawyer to reveal a former client's confidential information except as permitted or required by other parts of the rule. (Similarly, Model Rule 1.9(c)(2) prohibits lawyers from revealing an ex-client's confidences except as permitted or required by ethics rules.)
The committee found that the lawyer's investment in the new corporation could violate this rule because the investment decision may reveal to interested persons his assessment of the ex-client, which was based on confidential information he obtained in representing the corporation.
In providing its advice, the committee noted that no exception in the confidentiality rule applied and that the former client did not provide consent to disclosure of its information. The lawyer's duty of confidentiality to the ex-client was not diminished by the fact that the corporation has new owners following the sale, the panel added.
Texas Panel's Investment Advice
Texas Ethics Op. 626 states: “Under the Texas Disciplinary Rules of Professional Conduct, a lawyer who had formerly represented a corporation in circumstances where the lawyer came to possess confidential proprietary information of the client corporation relating to the former client's competitive position in its market is not permitted to make a significant investment in a new business that the lawyer knows will compete with the former client's business at a time when the confidential information concerning the former client remains relevant to the former client's current business. The prohibition will no longer apply when confidential information possessed by the lawyer with respect to the former client ceases to be relevant to the current business operations of businesses competing with the former client.”
The committee emphasized that the size of the lawyer's investment was substantial to the new company. The decision to invest might not violate Rule 1.05 if it were a small portion of the total amount invested in the new company and other investors were ready to contribute the same amount if the lawyer did not, the panel explained.
It also stressed that the information the lawyer had gained about his former client was relevant to the new company's business at the time of the investment.
The relative significance of an investment and the continued relevance of a lawyer's inside information must be evaluated based on the facts of a specific situation, the panel advised.
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