Q&A with Daniel Martin Katz: The finance of law

Lawyers need to pay more attention to the financial industry, do better at predicting and pricing risk for their clients, and limit their own exposure to swings in the business cycle. Daniel Martin Katz, an associate professor of law at Illinois Tech – Chicago Kent College of Law, sat down with Senior Editor Yves Faguy to discuss some of the lessons fintech offers for the future of law.

CBA National: You say we are beginning to see the financialization of legal services. What do you mean by that?

Daniel Martin Katz: So in one bucket we’re seeing fintech removing meaningless frictions from various types of financial processes, by trying to work around banks – in mortgage underwriting, and peer-to-peer lending, that sort of thing. In the other bucket, there’s what we previously thought of as exotic risks or uncharacterizable risk. With data analytics, we’re able to predict or characterize them. There are aspects of those two branches in law. Financialization [of legal services] deals mostly with the risk part – predicting risk, which is a big thing that enterprise lawyers in particular do for people.

N: So legal tech is going to remove friction the way fintech has?

DMK:   People have been more successful at carrying that off in fintech than they have in legal tech because with fintech, it turns into money pretty fast. In legal tech it’s a lot harder because a lot of legal intermediaries are required, like courts. It’s hard to hack around court processes. Not impossible, but it’s challenging. But a large part of the things that lawyers do has borderline nothing to do with courts.

N: You also talk about legal services are a form of insurance.

DMK:   It’s just insurance, but with questionable underwriting. So the question is, can I be better on underwriting? So if I go to my lawyer and say, “Predict what’s going to happen in a matter,” what is the performance predictor over time? What actuarial model supports the predictions that are going on? Could that market model be improved? But you can’t even answer those questions. If you can answer them, you’d be saying “Well, if I can predict cases better than other people, so how do I convert that into money or into financial success?

N: Any examples?

DMK: Take litigation finance. People say, “Well let’s just treat litigation as an asset class. If I can predict it better than the counter-parties, they’ll just sell that asset to me.” Because if the other person doesn’t really know how to price it, and you do, then you can make a pretty big spread on the difference in information, right? That’s already a thing. That’s not like a fantasy. It’s a growing thing.

N: So how should law firms approach the financialization of legal services?

DMK: Think of it this way. Every seven years the bankruptcy practice [in a law firm] is super high. But it’s cyclical with the economy and so you would love to capture that upside every seven years. But then you don’t want to be overly exposed when there’s growth. So if you’re running a law firm, you’re really a portfolio manager who is exposed to various forms of events. Take a law firm in Houston, just as an example. You’re very exposed to the price of oil and one client type. If all you owned was oil stock, then your broker will be like “Yeah man, you’ve got to diversify your portfolio”, right?

N: But many firms do have diverse practices.

DMK:   Yes but I think some of them haven’t really analyzed how exposed they are to certain classes of events occurring. You’d have to be able to do a pretty robust foreign analysis of your business and really understand how revenue in your business is affected by macro economic trends. You need an economist there or somebody with that type of skill set. You need to move towards a more crowd-based position in data and statistical prediction of a whole range of outcomes, not just litigation but transactions, regulatory outcomes and a whole bunch of other things. Instead firms are putting their finger in the air with one person’s expertise. They need to bring the tools that actual underwriters bring to bear.