April 2, 2003
Transmitted by email on April 2, 2003, to: firstname.lastname@example.org
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
Re: Implementation of Standards of Professional Conduct for Attorneys, File No. S7-45-02
Dear Mr. Katz:
Reference is made to (1) Release Nos. 33-8185; 34-47276; IC 25929 (File No. S7-45-02) issued by the Securities and Exchange Commission on January 29, 2003, adopting a rule as Part 205 in 17 CFR (hereinafter referred to as the "Rule"), on Implementation of Standards of Professional Conduct for Attorneys, pursuant to Section 307 of the Sarbanes-Oxley Act of 2002, and (2) Release Nos. 33-8186; 34-47282; IC 25920 (File No. S7-45-02), also issued by the Commission on January 29, 2003, proposing certain alternate additions to the Rule concerning withdrawal from representation of issuers (hereinafter referred to as the "Proposed Rule").
In response to the Commission's invitation for comments on both the Rule and the Proposed Rule, the nine law firms that have signed this letter are jointly filing the comments set forth below. In making these comments, we commend the Commission and its staff for the constructive manner in which they have responded to the numerous comments submitted on the Rule as originally proposed, and offer comments on only the following issues raised by the Rule and the Proposed Rule,* clarification of which we believe will give necessary guidance to the bar, and assist the Commission and its staff in administering the Rule:
- What is the scope of an attorney's obligation to respond to evidence of a material breach of fiduciary duty arising under United States federal or state law, or a similar material violation of any United States federal or state law?
- What should be the circumstances either requiring or permitting an attorney to withdraw from representation of an issuer in the event the attorney does not receive an "appropriate response" to a report of evidence of a material violation?
- When an attorney withdraws from representation of an issuer, how should that event be communicated to the Commission or its staff?
What is the scope of an attorney's obligation to respond to
evidence of a material breach of fiduciary duty arising under
United States federal or state law, or a similar
material violation of any United States federal or state law?
Section 205.3(b)(1) of the Rule requires an attorney appearing and practicing before the Commission in the representation of an issuer to report evidence of a "material violation" by the issuer or by an officer, director, employee or agent of the issuer, to the issuer's chief legal officer, or to the chief legal officer and chief executive officer. Section 205.2(i) defines "material violation" to mean, inter alia, a material breach of fiduciary duty arising under United States federal or state law, or a similar material violation of any United States federal or state law. Section 205.2(d) defines "breach of fiduciary duty" to mean any breach of fiduciary or similar duty to the issuer recognized under an applicable federal or state statute or at common law, including but not limited to misfeasance, nonfeasance, abdication of duty, abuse of trust and approval of unlawful transactions.
The potential scope of an attorney's obligation under these provisions to report and receive an appropriate response could be construed to be quite sweeping both as to attorneys who are subject to such an obligation, and the events or non-events that would trigger action:
- Does the Rule include actions (or inactions) that have nothing to do with the attorney's responsibilities connected with appearing and practicing before the Commission in the representation of an issuer? Section 205.3(b)(1) does not require such a causal connection. Accordingly, if some possible misfeasance or nonfeasance comes to the attention of an attorney, or his or her supervisors under Section 205.4, that evidence of a material violation has occurred, within the meaning of Section 205.2(d), would that attorney and his or her supervising attorneys under Section 205.4 have a personal obligation to take steps to obtain an "appropriate response"?
- Would the Rule limit the attorney's responsibility to determining whether the types of disclosures have been made that are currently required in filings with the Commission, referred to in our earlier comment letter, dated December 17, 2002, on the Rule as it was then proposed? It is not clear what the standard of materiality would be in this type of case, and whether it would be limited to matters that are of material financial interest to investors, or would also include issues reflecting on integrity of, or care exercised by, even lower-level employees or agents of the issuer, whether or not having any material financial consequence to the issuer.
- Would a breach of fiduciary duty include perceived breaches of fiduciary duty by lower echelon employees and third-party agents of the issuer, including misuse of supplies or facilities of the issuer?
- Would a breach of fiduciary duty include perceived breaches of the duty of care as well as self-dealing transactions? Would an issue as to whether the board of directors itself properly exercised its duty to monitor the business and affairs of the issuer be covered by the Rule? In such event, receipt of an "appropriate response" from the board would seem unlikely.
- In cases involving defective disclosure documents, an appropriate response may simply involve correcting the document. In determining whether an "appropriate response" has been received within the meaning of Section 205.2(b)(2) in case of a breach of fiduciary duty, would the attorney be required to obtain a prompt and satisfactory explanation as to whether the particular officer, director, employee or third-party agent was to be sued, discharged or otherwise appropriately dealt with? If an initial appropriate response would be a statement that responsible persons at the issuer were investigating the matter, what duty would the attorney have to follow the course of the investigation?
The foregoing is not intended to be an exclusive list of the types of questions that are likely to arise in attempting to comply with the obligations imposed by the Rule on attorneys in connection with breaches of fiduciary duty, but it leads us to recommend that the Commission at a minimum issue an interpretive release that will give guidance to the bar and the Commission staff as to how the Commission intends to administer those provisions of the Rule that deal with breaches of fiduciary duty, as defined in Section 205.2(d). The Commission should also consider whether to adopt a definition of materiality that would directly address the questions noted above on the scope of an attorney's responsibility when dealing with evidence of a breach of fiduciary duty.1
What should be the circumstances either requiring
or permitting an attorney to withdraw from
representation of an issuer in the event the attorney
does not receive an "appropriate response"
to a report of evidence of a material violation?
We commend the Commission and its staff for considering alternatives to the "noisy withdrawal" provisions included in the Rule as originally proposed, and prefer the alternative approach proposed in the Proposed Rule. However, this proposed alternative still provides for mandatory withdrawal in all cases where an attorney concludes that he or she has not received an appropriate response. We are still of the belief, expressed in Section III of our earlier comment letter, dated December 17, 2002, on the Rule as originally proposed, that Section 205.3(d)(1) should provide for mandatory withdrawal only where an attorney knows that the issuer is engaged in fraudulent conduct or willful violation of the federal securities laws that would trigger criminal sanctions under Section 24 of the Securities Act of 1933 or Section 32(a) of the Securities Exchange Act of 1934, and where the attorney's services are being or have been used to assist the commission of such fraud or willful violation; and that otherwise withdrawal should be permissive. We come to this conclusion for the following reasons:
- The proposed requirement of mandatory withdrawal in Section 205.3(d)(1) goes significantly beyond existing rules of professional conduct in almost all jurisdictions by requiring withdrawal in the absence of evidence of fraud or criminal conduct. To the extent Section 205.3(d)(1) applies to any material violation of securities laws, in the case of defective registration statements under the Securities Act of 1933, no showing of fraud or even negligence is necessary, and in the case of defective proxy statements under Section 14 of the Securities Exchange Act of 1934, only a showing of negligence is required under existing case law. Furthermore, as noted in Part I of this comment letter, the scope of breach of fiduciary duty may be so broad that it will sweep in both negligent misfeasance and nonfeasence under circumstances that normally would not require an attorney to withdraw from representation of a client under applicable rules of professional conduct.
- The requirement of withdrawal under Proposed Rule 205.3(d)(1) if the attorney reasonably concludes that there is substantial evidence of a material violation may conflict with the deference accorded contrary judgments of management in the ABA's treaty with the accounting profession governing lawyers' responses to auditors' requests for information, which the legal and accounting professions have been following since 1976. Under this treaty, where there has been no manifestation by a potential claimant of an awareness of and present intention to assert a possible claim, the client makes the determination as to whether it is probable that a possible claim will be asserted, that there is a reasonable possibility that the outcome (assuming such assertion) would be unfavorable, and that the resulting liability would be material to the financial condition of the client. Only if the attorney has formed a professional conclusion that the client must disclose a contingent liability and so advises the client, and the client fails to disclose, will the attorney have an obligation to withdraw from the engagement. If the Proposed Rule is to address withdrawal, we suggest that a rule providing for permissive withdrawal at the option of the attorney except in cases of fraud or willful violation of law, rather than mandating withdrawal in all cases, is more consistent with the approach taken in the ABA treaty. In any event, we suggest that, at a minimum, the Commission include in its adopting release or by interpretive release that no change is contemplated in the responsibilities imposed on attorneys by the ABA's Statement of Policy Regarding Lawyers Responses to Auditors' Requests for Information, originally adopted in 1976.
- As noted in our prior letter of comment, dated December 17, 2002, often disclosure decisions must be made under extreme time pressures, when opinions as to disclosure may differ, and a rule that requires an attorney to withdraw under such circumstances could work to the disadvantage of both an issuer's current investors and those making or considering investment decisions on the basis of premature disclosures.
- The requirement of mandatory withdrawal may create problems when a law firm is representing an issuer in litigation, and under Section 205.3(b)(1) an attorney in that firm is required to withdraw. Under such circumstances, proposed rule 2.05(3)(d)(2) recognizes that an attorney may be required to seek leave to withdraw, but does not address the extent to which the attorney may be required under applicable court rules to give specific reasons for required withdrawal, which could be harmful to the client. Furthermore, Section 2.05(3)(d)(2) does not recognize the possibility that the attorney in a law firm that represents a client in litigation may not be the same attorney who is appearing and practicing before the Commission. Does Section 205.3(d)(2) contemplate that the law firm could continue to represent the client in litigation even if the attorney representing the client in S.E.C. matters would be obligated to withdraw?
The foregoing reasons are intended to be only illustrative of the problems that may arise if withdrawal is mandated in all cases rather than being made permissive except in cases where the attorney knows that the client is engaged in fraudulent conduct or willful violation of the federal securities laws, and where the attorney's services are being or have been used to assist the commission of such fraud or willful violation. The flexibility afforded by a rule that makes withdrawal permissive rather than mandatory (except in the limited circumstances noted) will in our judgment better serve investors and issuers by not placing attorneys in a position where, in case of doubt, they will be obligated to withdraw from a representation.
When an attorney withdraws from representation
of an issuer, how should that event be
communicated to the Commission or its staff?
We believe that the Commission's alternative approach in the Proposed Rule to "noisy withdrawal" to permit the attorney to notify the issuer rather than the Commission is a significant improvement over the Commission's original proposal for public disaffirmance of a tainted disclosure document. However, the Commission's proposal in Section 205.3(e) that the issuer report an attorney's withdrawal on Form 8-K (or comparable form) carries substantial risks of misleading investors, as the public will not be in a position to gauge the seriousness of such a withdrawal on the issuer's overall financial condition and results of operations. It is possible that a withdrawal could be triggered by a dispute over job performance by an in-house counsel that also involves a claim of wrongful termination. Compare General Dynamics Corporation v. Supreme Court, 7 Cal. 4th 1164, 987 P2d 487 (1994). Without further adequate explanation for an attorney's withdrawal (which may not be possible for the issuer to supply due to concerns over defamation, disclosure of privileged communications or other factors), investors may conclude erroneously that the issuer's financial condition is far worse than is in fact the case. For that reason, we suggest that the Commission revise Section 205.3(e) to provide that the issuer may at its option either notify the Commission staff or file a Form 8-K disclosing the fact of the attorney's withdrawal. If the issuer elects to notify the Commission staff of an attorney's withdrawal, the issuer should be prepared to discuss candidly with the Commission staff the circumstances surrounding withdrawal so that an informed decision can be made by the Commission staff that it would not be appropriate for the issuer to make a public disclosure or for the Commission staff to begin an informal investigation of the matter. If the issuer is not in a position to have such a discussion with the Commission staff, then it must be prepared to face the consequences of an investigation.
Should the Commission or its staff have any questions concerning any of the comments contained in this letter, representatives of the firms signing this letter can be reached at the telephone numbers and email and mailing addresses shown below.
|Marshall L. Small
Morrison & Foerster LLP
425 Market Street
San Francisco, CA 94105-2601
Phone: (415) 268-7161
|Robert A. Epsen
Heller Ehrman White & McAuliffe LLP
333 Bush Street
San Francisco, CA 94104-2878
Phone: (415) 722-6042
|Nathaniel M. Cartmell III
Pillsbury Winthrop LLP
50 Fremont Street
San Francisco, CA 94105-2228
Phone: (415) 983-1570
Farella Braun + Martel LLP
235 Montgomery Street, 30th Floor
San Francisco, CA 94104
Phone: (415) 954-4453
|Brian L. Forbes
Gray Cary Ware & Freidenrich LLP
4365 Executive Drive, Suite 1100
San Diego, CA 92121-2133
Phone: (858) 638-6842
|Ann Yvonne Walker
Wilson Sonsini Goodrich & Rosati,
650 Page Mill Road
Palo Alto, CA 94304
Phone: (650) 320-4643
|John C. Unkovic
Reed Smith LLP
435 Sixth Avenue
Pittsburgh, PA 15219
Phone: (412) 288-3131
|William J. Wernz
Dorsey & Whitney LLP
50 South Sixth Street, Suite 1500
Minneapolis, MN 55402-1498
Phone: (612) 340-5679
|Thomas J. Igoe, Jr.
Thelen, Reid & Priest, LLP
40 West 57th Street, 26th Floor
New York, NY 10019-4097
Phone: (212) 603-2110
cc: Hon. William H. Donaldson, Chairman
Hon. Paul S. Atkins, Commissioner
Hon. Roel C. Campos, Commissioner
Hon. Cynthia A. Glassman, Commissioner
Hon. Harvey J. Goldschmid, Commissioner
Giovanni P. Prezioso, General Counsel
Meyer Eisenberg, Deputy General Counsel
Alan L. Beller
|*|| These are by no means the only issues that the firms signing this letter believe are presented by the Rule and the Proposed Rule, nor are the comments in this letter the only comments that the signatory firms might have relating to the issues commented upon. Some signatories to this letter believe that the Commission should not address in the Rule the issue of withdrawal from representation of issuers, but if the Rule does address withdrawal, all signatories agree that withdrawal should be limited to the matter involved and should be permissive except where existing rules of professional conduct mandate withdrawal. All signatories also agree that the Rule should not require the attorney or the issuer to notify the Commission of such a withdrawal, except where existing rules of professional conduct obligate an attorney to notify third parties of the withdrawal where the attorney's services are being used or have been used to assist the commission of a fraud or willful violation of law.
|1 || We recognize that, in the release adopting the Rule, the Commission indicated that the final Rule does not define the word "material" because that term has a well-established meaning under the federal securities laws (citing the Basic, Inc. v. Levinson and TSC Industries v. Northway opinions in the U.S. Supreme Court), and that the Commission intends for that same meaning to apply under the Rule. However, the focus in those cases was on the necessary disclosure to investors for the purpose of making investment or voting decisions, and not on the obligation of attorneys to report up the ladder possible common law breaches of fiduciary duty. Furthermore, because the attorney will be obligated to withdraw under proposed Rule 205.3(d)(1)(iii) only where a material violation is ongoing or is about to occur and is likely to cause substantial injury to the financial interest or property of the issuer or of investors, we suggest that the Commission make clear that the attorney has no duty to "report up" a breach of fiduciary duty unless it is likely to cause substantial injury to the financial interest or property of the issuer, and to clarify whether "substantial injury" has a meaning different from normal tests for materiality when determining whether to make public disclosure of contingencies.