American Bar Association
April 2, 2003
Via E-mail - email@example.com
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-45-02
Release Nos. 33-8186, 34-47282; IC-25920; and
Release Nos., 33-8185; 34-47276; IC-25929
Implementation of Standards of Professional Conduct for Attorneys
Ladies and Gentlemen:
On behalf of the American Bar Association (the "ABA" or the "Association"),1 I am pleased to submit this letter in response to the request of the Securities and Exchange Commission for comments on its Proposed Rule and Final Rule to implement Section 307 of the Sarbanes-Oxley Act of 2002 (the "Act") that were released January 29, 2003. The Commission has (1) extended the comment period for the provisions proposed in November 2002 (in Release No. 33-8150) regarding an attorney's withdrawal, disaffirmance and notification to the Commission in certain circumstances following "up the ladder" reporting (a so-called "noisy withdrawal"); (2) proposed for comment an alternative approach that requires the attorney to withdraw and the issuer (rather than its attorney) to report to the Commission the attorney's written notice of withdrawal in certain circumstances ("company reporting");2 and (3) solicited additional comments on the final rule adopted to implement Section 307 regarding up the ladder reporting.
As the Commission is aware, the ABA Task Force on Corporate Responsibility, having evaluated testimony and comments from numerous sources in response to its Preliminary Report dated July 16, 20023, is in the process of preparing its Final Report, which is expected to make recommendations regarding strengthened corporate governance measures and to propose changes in the ABA's Model Rules of Professional Conduct (the "Model Rules").4 These recommendations are designed to increase corporate responsibility and enhance public trust in corporate integrity. A copy of the Final Report will be furnished to the Commission when it is available.
The views expressed in this comment letter, like those in the ABA December 18 comment letter, were prepared by the ABA Task Force on Implementation of Section 307 of the Sarbanes-Oxley Act of 2002 (the "Section 307 Task Force") and approved for release by the Executive Committee of the ABA Board of Governors. The members, liaisons, and staff of the Section 307 Task Force are listed in Appendix 1 to this comment letter.
The ABA commends the Commission and its Staff for their responsive resolution of many of the problems that commenters noted in the originally proposed up the ladder reporting provisions. We also appreciate the Commission's extension of the period to comment on the noisy withdrawal proposal that drew such extensive criticism from most of the commenters, and the Commission's decision to propose company reporting as an alternative to noisy withdrawal.
The comments in this letter address:
- The ABA's continued opposition to mandatory withdrawal and reporting out, whether in the form of the noisy withdrawal proposal or the company reporting alternative.
- Revisions that the ABA believes would be necessary if either form of mandatory withdrawal and reporting out were to be adopted.
- Clarifications that the ABA believes are still needed in the final rules dealing with up the ladder reporting, whether through rule change or interpretation.
We refer to the policy considerations set forth in the ABA's December 18 comment letter under the caption "Basic Concepts" beginning at page 7. These policy considerations continue to guide our response to the Commission's proposals, particularly as they relate to any reporting out requirement. Those most relevant are summarized as follows:
- Restoration of integrity and public confidence in our financial markets is imperative, and lawyers have a vital role to play in attaining this goal.
- The role of attorneys, as reflected in Section 307 of the Act, is to assist issuers and their officials to comply with the law and to act responsibly in the organization's best interests.
- In order to fulfill this role, attorneys must enjoy the trust and confidence of managers and the board so as to receive all information relevant to competent representation, without concern that the attorney's judgment may be compromised by conflicting mandatory obligations of a gatekeeper.
- Effective representation of organizational clients also requires that the client have reasonable confidence that the attorney-client privilege and client confidentiality will be preserved.
The subjects addressed in this letter begin on the following pages:
Table of Contents
- Proposed Rules for Withdrawal and Reporting Out
- Mandatory Withdrawal and Reporting Out Would Not
Serve the Public Interest
- Permissive Withdrawal and Reporting Out Protects the Public
Interest With Less Disruption
- The Company Reporting Alternative Suffers From the Same
Fundamental Shortcoming As Noisy Withdrawal
- Changes Are Needed If Either Approach to Mandatory
Withdrawal and Reporting Out Is Adopted
- Final Rules For Up the Ladder Reporting
- General Observations
- Further Clarification Is Needed
II. Proposed Rules for Withdrawal and Reporting Out
As the ABA explained in its December 18 comment letter, the noisy withdrawal provisions should not be adopted for reasons of policy and practicality.5 We will summarize the major considerations that cause us to believe that noisy withdrawal is not in the best interest of issuers and their investors; will explain why company reporting also would be undesirable; and will describe the changes that we believe are needed if the Commission were to adopt company reporting or noisy withdrawal. In sum, we believe that the Commission, in adopting up the ladder reporting and permissive reporting out, has struck the correct balance between protecting the interests of investors and preventing undue interference with the attorney - client relationship.
A. Mandatory Attorney Withdrawal and Reporting Out Would Not Serve the Public Interest
As the Commission is aware, the professional conduct rules in most jurisdictions permit, but do not require, an attorney to disclose client confidences to prevent a client's criminal or fraudulent conduct that is likely to result in substantial financial loss.6 We believe that permissive withdrawal and reporting out is far more effective in achieving the Act's purposes and serving the public interest than mandatory noisy withdrawal.7 As we noted in our December 18 comment letter8 and summarize here, the likely effects of mandating noisy withdrawal as originally proposed in Section 205.3(d)(1) would be to:
- Destroy issuers' trust and confidence in their attorneys by creating conflicts between the attorney's personal interest in avoiding civil litigation or potential state discipline and the desire of management to operate the business effectively.
- Encourage issuers to avoid consulting with attorneys on close issues or to withhold necessary facts when they do consult attorneys.
- Remove the flexibility attorneys need to have in order to counsel clients effectively on compliance with law in complex matters such as those involved in practicing before the Commission.
- Encourage premature withdrawal by attorneys in order to escape the mandatory noisy withdrawal threshold rather than encourage them to continue to counsel on difficult issues when the issuer most needs their services.
- Risk serious and unfair harm to the issuer and its shareholders and disruption in the market for the issuer's securities as a result of withdrawal and reporting out when further consideration might have proven the attorney wrong in believing a material violation would occur or had not been rectified.
B. Permissive Withdrawal and Reporting Out Protects the Public Interest With Less Disruption.
Most of the disruptive aspects and adverse consequences of mandating noisy withdrawal and reporting out by attorneys are avoided with a permissive reporting out rule, as adopted by the Commission in §205.3(d)(ii). Such a rule is less intrusive on the attorney - client relationship because the client knows that it can rely on the attorney's exercise of his or her professional judgment independent of concern over violating a mandatory federal rule of professional conduct. Without the discretion afforded by permissive reporting out, it is more likely that clients will view the attorney as a potential adversary and keep the attorney out of critical deliberations in which the attorney would have been able to counsel legal compliance.
Permissive withdrawal and reporting out also affords the attorney a better opportunity to achieve client compliance by allowing the attorney greater flexibility to continue to counsel compliance. Requiring the attorney to withdraw reduces the attorney's ability to work with the client to achieve the right legal compliance result.9
Furthermore, a permissive approach recognizes the reality that the situations that actually arise are highly complex and involve difficult judgments influenced by a variety of factors, including the content and circumstances of the situation and the consequences of the actions. These judgments must frequently be made on a real-time basis, when emotions are high and when critical facts may be unknown or unclear. These considerations are especially applicable to the situations confronted in practicing before the Commission, for example, the need to make factually based materiality determinations.
Mandated withdrawal and reporting out, on the other hand, is unlikely to reflect the complexity and variety of the situations that attorneys practicing before the Commission actually face.10 In addition, by subjecting attorneys to unwarranted after-the-fact reexamination of their judgments, mandatory withdrawal and reporting out deprives them of the freedom to apply the textured professional judgment that is required.
The effectiveness of a permissive rule should be assessed in the context of the corporate governance and accounting improvements that are taking place. We believe that these improvements, including up the ladder reporting by attorneys, will ensure that material violations will come to the attention of responsible corporate officials, including independent directors, so that violations not properly dealt with will be rare. It would be a mistake to fashion a mandatory withdrawal and reporting out regime in order to address the rare situation, particularly when the adoption alone of such a regime would have the potential to impede the ability of lawyers to effectively counsel legal compliance by clients. Effective legal counseling of public companies by their lawyers is critical to the operation of our securities regulatory system, which depends to a large extent on self-regulation through the active involvement of lawyers.
The existing system regulating attorney conduct, which largely utilizes the permissive approach, provides attorneys with the necessary tools to foster legal compliance by clients.11 Thus, there is no urgency to mandate noisy withdrawal rather than apply the permissive approach currently utilized by most states and included in the Commission's final rules.
C. The Company Reporting Alternative Suffers From the Same Fundamental Shortcoming as Noisy Withdrawal
The alternative proposed that would require a company to report when an attorney withdraws for "professional considerations" [new §205.3(d)] avoids some of the problems that are created for attorneys under a noisy withdrawal proposal, such as potential conflict with state professional conduct rules mandating confidentiality and exposure to civil liability.12 It does not, however, eliminate the fundamental policy concerns regarding interference with the attorney-client relationship, loss of attorney-client privilege, and interference with effective corporate governance that have been identified as shortcomings of the noisy withdraw proposal. For example, by mandating that the attorney withdraw, the company reporting alternative would significantly and adversely affect legal compliance by encouraging premature withdrawal and could be harmful to companies and their investors by provoking disclosure of withdrawal that was unwarranted. In short, it seems apparent to us that the ultimate decision whether or not to report a violation should be the province of the board and the independent directors fully advised by their attorneys, and that the rules now in place, including the final rules adopted by the Commission, afford the best protection for issuers and investors.
The company reporting alternative, by placing too much authority in the hands of an attorney to force company disclosure by withdrawing, distorts the proper allocation of roles between companies, acting through their boards and independent directors, and their attorneys. Even if the attorney is well-motivated, his or her judgment as to whether a material violation exists or whether it has been adequately addressed may be debatable or even wrong. As long as the matter has reached the proper level in the corporate governance structure through up the ladder reporting, the company, and not its attorney, should be entitled to make the disclosure decisions.13
Moreover, the standards under the rule proposals are too imprecise and uncertain to provide the basis for mandatory attorney withdrawal and reporting out, which can have such significant consequences for both issuers and attorneys.14 Among the potential uncertainties are (i) what is an appropriate response, especially when judgments as to materiality or the adequacy of remediation steps must be made; (ii) whether a "material violation" exists, which can involve uncertainty both as to what type violation is covered by "breach of fiduciary duty and similar violation" and how "materiality" is to be determined in the context of violations not involving misstatement or omission of a material fact; and (iii) whether a violation is likely to cause "substantial injury," which can require expertise that an attorney may not possess and factual determinations that an attorney may not be in a position to make.
In one important respect, the company reporting alternative could prove even more damaging to an issuer than would noisy withdrawal. Under the noisy withdrawal proposal, an attorney's report of withdrawal for professional considerations, though likely to prompt Commission inquiry, would not immediately be reported publicly.15 A company report on Form 8-K, 20-F or 40-F of its attorney's withdrawal, however, would become public almost immediately. This could result in serious, unwarranted disruption in the market for the issuer's securities and could seriously damage the issuer and its investors.16
D. Changes Are Needed If Either Approach to Mandatory Withdrawal and Reporting Out Is Adopted
If the Commission were to decide, despite the concerns and problems we have identified, that a mandatory withdrawal and reporting out rule was necessary, we view the company reporting alternative, if the issues discussed below are satisfactorily addressed, less intrusive than the noisy withdrawal proposal because it would avoid some of the problems that noisy withdrawal would inevitably create for lawyers, clients and the public.
1. Changes to the Company Reporting Alternative. The ABA's concerns regarding company reporting would be ameliorated somewhat were the corporate governance aspects of the final rule as now provided to remain in place. Specifically, we believe that a workable qualified legal compliance committee ("QLCC") alternative should be available to companies so that they are able to choose to retain control over their own disclosure decisions, acting through their independent directors, rather than ceding to attorneys the final decision whether or not to disclose. In order to be a workable alternative, the QLCC should have the authority, but not the obligation, to report to the Commission, as now provided in §205.2(k). Indeed, imposing a reporting obligation on the QLCC would be the equivalent of mandatory company reporting and therefore not a meaningful alternative. It also would discourage companies from forming a QLCC and would discourage qualified directors from serving on the QLCC. If attorneys have reported up the ladder to a QLCC, there should be a high level of confidence that the matter, having been brought to the attention of the proper independent body within the corporate governance structure, will be appropriately addressed without mandating that the QLCC report to the Commission.
For the same reasons, the provisions of the final rule [(§205.2(b)(3))] recognizing that the advice of counsel retained with the consent of the board or independent committee that the issuer has a colorable defense is an "appropriate response" should continue to apply in order to enable the issuer to defend itself and to limit appropriately the occasions when reporting out will occur.
Concern over shifting control of disclosure from the issuer to its attorney can be mitigated if a committee comprised of the independent directors can decide whether the standard requiring the issuer to report the attorney-client withdrawal has been met. The committee could be the QLCC or another independent committee. The issuer would not be required to report if the committee of independent directors determines either that, despite the report of evidence of a material violation, no such violation is ongoing or likely to occur, or that the response to the report has been appropriate and timely.
The committee of independent directors would, of course, be free to engage the services of independent counsel to advise it regarding these matters. The advice of independent counsel that a colorable defense can be asserted also should end any obligation to report the attorney's withdrawal.
At the very least, the company should have the alternative to report the attorney's withdrawal to the Commission without public disclosure in the first instance, rather than having to report the matter in a Form 8-K. The issuer thereby would be afforded an initial opportunity to convince the Commission of the correctness of the issuer's position either that no material violation was occurring or would occur, or that the response to the report was appropriate and timely, in which case needless disruption in the market for the issuer's securities would be avoided.
The Commission has requested comment on whether an attorney should be required to report to the Commission if the company fails to report. We do not believe such reporting should be required because it would create all the problems of noisy withdrawal discussed above. The requirement to report out would put the attorney in the position of substituting his or her judgment for that of the company's board and independent directors, and of disclosing confidential client information. As noted above in Section II.B., the permissive reporting rule adequately protects the issuer and its investors.
Other changes that would be necessary, if the Commission were to adopt the company reporting alternative, include the following:
- Mandating withdrawal and reporting out is too significant and severe an action to be subject to as sweeping a trigger as the Commission has proposed. It ought to apply only when the attorney's services would be used to assist the issuer in committing a crime or fraud, as provided in the Model Rules (see Model Rules 1.2(d) and 4.1). At the very least, mandatory withdrawal and reporting out should be required only if the violation is related to the representation.
- A higher standard for attorney withdrawal is necessary in order to assure that the issuer's interests are protected and it is effectively counseled in the matter. Casting the standard in §205.3(d)(1)(iii) in terms of substantial evidence that a material violation is ongoing or about to occur is an acceptable formulation, but the standard should conform to the Model Rules (see Model Rules 1.6(b)(2) and (3)) and require also that substantial injury is reasonably certain to occur as opposed to likely to occur.
- Because of the uncertainties surrounding the scope and meaning of the terms breach of fiduciary duty and similar material violation, any mandatory withdrawal and reporting out requirement should be triggered only by a material violation of securities law.
- The term reasonably concludes, although an appropriate standard, is not defined. It either should be defined or the term reasonably believes, which is defined in §205.2(m), should be used.
- The issuer should be required to inform the reporting attorney of the company's action in order to allow the attorney to determine the appropriate course of action, including reporting out on a permissive basis.
- The particular circumstances of investigation and defense counsel should be specifically addressed in any reporting out requirement so that they will not be required to withdraw if the provisions of §205.3(b)(6) or (7) are met.
- It is imperative that the Commission clarify in §205.3(d)(iii)(A) that the withdrawal requirement applies to representation by the attorney and the attorney's firm solely in the particular matter respecting which an appropriate response has not been timely received, not to representation of the issuer by the attorney or his firm in other matters. Otherwise, the issuer and its stockholders would face abandonment in other essential matters with no significant enhancement of securities law enforcement.17
2. Changes to Noisy Withdrawal. If the Commission were to proceed with noisy withdrawal substantially as originally proposed despite the serious concerns raised by the ABA and many other commenters, we have the following comments:
- The unreasonably short and prescriptive time periods set forth in §205.3(d) should be eliminated in their entirety or replaced by a reasonably promptly under the circumstances standard. It is impracticable to adopt such a short time period in any case, and a one-size-fits-all approach would lead to premature withdrawals. In addition, in many situations the issue in dispute is likely to be resolved if the independent directors have time to reflect and consult other counsel.
- The chief legal officer ("CLO") should be treated the same as any other attorney when using the QLCC alternative and should not be subject to a separate noisy withdrawal requirement as provided in §205.3(b)(3) of the original proposal.
- The standard for attorney withdrawal and reporting out required under §205.3(d)(iii) should be met only when there is substantial evidence that a material violation is ongoing and that the violation is reasonably certain to cause substantial injury, not when it is just likely to.
In addition, the comments in Section II.D.1. above regarding the need for a workable QLCC alternative, the need to narrow the circumstances when mandatory withdrawal and reporting is required, the need to recognize the special circumstances of investigation and defense counsel, and the need to clarify that withdrawal applies solely to the particular matter would need to be addressed under any mandatory noisy withdrawal provision.
III. Final Rule for Up the Ladder Reporting
A. General Observations
The final rule establishes standards for reporting material violations up the ladder that are significantly improved over those originally proposed. Many of the changes made reflect the Commission's thoughtful consideration of the comments the ABA and many others made suggesting changes to the earlier proposals. Some of the significant provisions that have been dealt with correctly are the following:
- The triggering standard under §205.3(b)(1) based on the attorney becoming aware18 of "evidence of a material violation" (as defined in §205.2(e)) is an appropriate standard if an objective standard is used.
- The approach to "appropriate response" as defined in §205.2(b) and the exclusion under §205.3(b)(6) of investigation and defense counsel from a reporting up the ladder obligation strikes the proper balance because the value of self investigation is recognized and the issuer's right to representation by counsel in defense of claims is protected, but at the same time the involvement of the issuer's board or independent committee is required.
- The definition of QLCC in §205.2(k), including the requirement that the committee have the authority, but not the obligation, to report to the Commission (as discussed in the Release at pp. 27 and 28), provides a workable corporate governance alternative that avoids discouraging qualified directors from serving.
B. Further Clarifications Needed
There remain, however, other provisions that should be either amended or clarified through appropriate interpretations.19 These include the following:
- We agree with the Commission that members of a QLCC should be independent, but we are concerned that application to a QLCC of the stringent standard of independence required by Section 301 of the Act for members of audit committees20 may deprive smaller non-listed issuers who do not have sufficient directors who meet that standard of the ability to use the QLCC alternative. The Section 301 standard also may cause other issuers to impose additional obligations on their already overburdened audit committees in order to use the QLCC alternative. These consequences could be avoided if the Commission either retains the non-management director standard contained in the definition of QLCC in §205.2(k) or uses the stock exchange standards for independent directors.
- We read the definition of appearing and practicing before the Commission in §205.2(a) to cover only those attorneys who both prepare a document that the attorney has notice will be filed as an exhibit to a filing and provide advice to an issuer regarding United States securities laws. We believe this is an appropriate narrowing of what constitutes appearing and practicing before the Commission for purposes of the rule, in recognition that non-securities specialists who do not in fact practice securities law should not be subject to the Commission's rule. We request that the Commission confirm this reading because of its vital importance to a wide range of non-securities lawyers whose only involvement may be preparation of agreements that they may know will be filed as an exhibit rather than providing securities law advice.
- We also request that the Commission clarify whether providing a response to an auditor's request for information in the ordinary course in accordance with the ABA's Statement of Policy21 or providing information in connection with a management representation letter results in an attorney appearing and practicing before the Commission under §205.2(a). We believe that these activities alone, which often involve numerous attorneys who do not consider themselves as providing securities law advice, should not subject an attorney to the Part 205 rules.
- The meaning of notice as used in clause (iii) of §205.2(a) should be clarified - e.g., does it equate to "knows" or "is aware" or does it have some other meaning?
- The ability of a non-securities specialist to satisfy his or her obligation by reporting a matter to a securities specialist (akin to the relationship between subordinate and supervisory lawyers set forth in §205.5) should be addressed.
- The Commission should clarify the status of attorneys for non-wholly owned public subsidiaries, recognizing that the attorney owes a duty to the subsidiary. As we read §205.2(h), an attorney for a controlled subsidiary would not be an attorney for the issuer parent if the subsidiary's interests differed from the parent's such that the attorney was not acting "on behalf of, or at the behest, or for the benefit of" the parent. It would be helpful if the Commission confirmed this interpretation. In addition, the Commission should limit "issuer" in the case of non-wholly owned subsidiaries to those that are consolidated and therefore most likely to affect the issuer's financial position, given that "control" can exist for securities law purposes without consolidation. See the Release addressing wholly-owned subsidiaries and non-public subsidiaries (at pages 13 and 14).
- The Commission should provide interpretive guidance as to the scope of the term breach of fiduciary duty (defined in §205.2(d)) within the meaning of "material violation" as defined in §205.2(i). As we suggested in the ABA December 18 comment letter, at page 20, in order to relate it to matters within the province of the Commission, breach of fiduciary duty under the rule should require financial harm to the issuer that has not been adequately disclosed to investors.
- We continue to believe that the duty to report evidence of a material violation under §205.3(b)(1) should be based on information relating to the representation. It would put attorneys in a difficult position to charge them with responsibility for matters unrelated to the representation, which, in many cases, may be outside the lawyer's expertise. An attorney, for example, may not be in a position to recognize a problem or, even if the attorney recognizes it, may be unable to assess the appropriateness of a response to matters not related to the representation. In addition, the range of violations that would trigger a reporting obligation by encompassing violations unrelated to the representation would increase reporting dramatically, putting further stress on the relationship of lawyers to companies and increasing the burdens on companies seeking to address legal compliance. Moreover, this increased burden from expanded reporting could distract attention from serious matters that should be given priority. If the Commission does not adopt our suggestion to limit the matters an attorney is required to report to those related to the representation, it should at least limit the information triggering a duty to report to information learned by the attorney in connection with the representation, as originally proposed. We note that §205.3(b)(i) has been changed from the original proposal without explanation. Requiring that an attorney draw conclusions and take action based on information that may come to him or her in a casual fashion outside a representation creates an unrealistic and unnecessary standard for requiring reporting.
- The Commission should make clear that the exclusion under §205.3(b)(6) and (7) from the obligation to report afforded counsel in conducting an investigation or a defense does not require that an actual proceeding be pending. This clarification is necessary in order to recognize the benefit of having companies undertake self-investigations and to encourage them to do so. The purpose of the rule would still be satisfied because the investigation must involve the board or an independent committee.
- To recognize that companies approach their legal compliance functions differently, the rules should include a definition of "chief legal officer" that provides companies with the flexibility to designate the person or persons who will serve in that role. Some companies may allocate responsibility based on subject matter; some may have a compliance officer separate from their general counsel.22
- The Commission also should clarify who the CLO is in a parent - subsidiary situation. The determination should turn on who is the "issuer" for purposes of the particular violation.
- The Commission should recognize, as it does in discussing an attorney's assessment of whether there has been an appropriate response (at p. 12 of the Release), that an attorney has flexibility in determining the steps to follow in the best interests of the issuer when assessing evidence of a material violation before reporting to the CLO, so long as any required report to the CLO is timely under the circumstances. The use of "forthwith" in §205.3(b)(1) unfortunately suggests otherwise. We recommend that §205.3(b)(1) be amended to change forthwith to reasonably promptly. Alternatively, the Commission should clarify that use of the term "forthwith" does not prevent the attorney from taking preliminary steps before the obligation is triggered.
- Instead of having to follow the rigid order prescribed by §205.3(b)(3) for reporting to the board level, attorneys should be able to report to the appropriate independent committee. The audit committee may not be the appropriate committee in all cases, e.g., when an issuer has a legal compliance committee (which is not a QLCC) or a specialized committee relevant to the particular matter (such as an environmental or nuclear affairs committee).
- The Commission should confirm that an attorney or the CLO may initiate the QLCC alternative under §205.3(c) and report a matter to the QLCC at any stage in the reporting process. This flexibility would make the QLCC alternative more acceptable to issuers and facilitate matters being reported to the QLCC.
- The Commission should recognize the appropriateness of special committees to deal with particular matters by permitting a QLCC to be formed at any time. The Release (at page 28 and note 87) gives no explanation for requiring that the QLCC be previously formed.23 We understand the Commission's desire to influence corporate governance structures and agree with the desirability of encouraging independent committees to address legal compliance matters. However, we believe that this is best done in other ways, such as stock exchange listing standards, Commission disclosure requirements or recognition of best practices. The attorney reporting rules should not be used in a way that fails to recognize the important role special committees formed for the purpose can have in dealing with legal compliance matters. One could imagine a matter that involved a member of the QLCC and therefore required a special committee.
- The standard in §205.3(d)(2) permitting an attorney to report to the Commission should be changed to reasonably certain, as in Model Rule 1.6(b), instead of may cause, in order to maintain the correct balance in protecting the client's interests and confidentiality. The "may cause" standard may be even lower than the "reasonably likely" standard required to trigger a report in the first instance under the definition of "evidence of a material violation" in §205.2(e).
- In order to allow law firms and law departments flexibility in establishing internal compliance procedures, such as reporting to a compliance attorney or compliance committee, the supervisory attorney to whom a subordinate attorney should be able to report under §205.5 in satisfaction of that subordinate attorney's obligation should include anyone designated a supervisory attorney and accepting that responsibility even though that person does not customarily supervise the subordinate attorney with respect to the matter.
- Additionally, as noted above, a non-securities specialist should be able to satisfy his or her obligation by reporting to a securities specialist, even though there technically may not be a senior - subordinate attorney relationship.
- §205.5 should be clarified so that a non-appearing foreign attorney cannot be a supervisory attorney unless the foreign attorney agrees to take on that responsibility.
- The Release (at p. 38) quotes the language the ABA recommended to avoid having a violation of Part 205 form the basis for a breach of a duty to a client. However, the safe harbor under §205.7 does not go far enough to encompass that concept. Because of the importance of having an effective safe harbor, we believe the Commission should include in §205.7 a concept similar to §52 of the Restatement of the Law Governing Lawyers, and recommend the addition of the following:
"Proof of violation of these Rules does not (1) give rise to an implied cause of action for professional negligence or breach of fiduciary duty, or (2) except for willful or reckless conduct, establish a standard of care that is relevant to prove professional negligence or breach of a fiduciary duty."
- The Commission should recognize the special problems the rule could create for non-securities specialists if the Commission were to apply its disciplinary rules (referred to in §205.6(b)) in a manner that barred the non-securities specialist from appearing and practicing before the Commission when such appearing and practicing, although incidental to the attorney's non-securities practice, was nevertheless essential to the ability to continue that practice. Although the Commission cannot foreclose this possibility, a statement by it that it recognizes the problems that would be created and would take them into account in enforcing the rule would provide comfort to non-securities specialists who are not familiar with the Commission's practices.
The Commission has made significant changes and improvements in its original up the ladder reporting rule required by Section 307 of the Act to produce workable requirements for attorneys to report within the organization. These requirements complement Model Rule 1.13 (some version of which is currently in effect in virtually all states), protect the public interest and recognize the needs of both investors and issuers, as well as those of attorneys who must comply. The final rule appropriately recognizes the importance of corporate governance as an essential part of an effective attorney reporting regime designed to ensure legal compliance. Although the ABA supports the Commission's changes to its original up the ladder reporting rule, we suggest changes to and interpretations of the rule which we believe will further improve its operation.
The Commission also has addressed the issue of reporting out by adopting as federal policy permissive reporting out by attorneys to the Commission. Permissive reporting out is already recognized by the overwhelming majority of states. We believe the combination of the up the ladder reporting requirements and permissive reporting out adopted by the Commission (with the changes we have suggested), coupled with the enhanced corporate governance systems being put in place, accomplish the Act's objectives of protecting investors and serving the public interest.
For the reasons discussed above, the ABA believes that imposing mandatory withdrawal and reporting out requirements, whether as noisy withdrawal or company reporting, is unnecessary and would neither improve investor protection nor serve the public interest. Rather, mandatory rules are more likely to harm the public interest by interfering with the attorney-client relationship and impeding effective legal counseling. In addition, they could weaken the protection of investors by preventing lawyers from effectively counseling legal compliance and by encouraging premature withdrawal by counsel.
Should the Commission nevertheless proceed with mandatory withdrawal and reporting out, we identify significant changes that we believe would be needed. We also urge that the Commission maintain a workable corporate governance alternative that companies can implement, both as encouragement for companies to adopt improved corporate governance systems and in order to allow companies to avoid the potentially adverse consequences of a mandatory withdrawal and reporting out rule.
The ABA appreciates the opportunity to submit these comments, both on the proposed rules and on the final rule before it becomes effective on August 5, 2003. We are available to meet with the Commission and its Staff to discuss these comments and the proposed and final rules, and to assist in their implementation. We also stand ready to work with the Commission, as we have with state and federal courts and other agencies, on an ongoing basis to develop appropriate rules governing the professional conduct of lawyers that serve the public interest.
Alfred P. Carlton, Jr.
President, American Bar Association
cc: Hon. William H. Donaldson
Hon. Paul Atkins
Hon. Roel Campos
Hon. Cynthia A. Glassman
Hon. Harvey Goldschmid
Giovanni P. Prezioso
Alan L. Beller
Director, Division of Corporation Finance
and Senior Counselor to the Commission
American Bar Association
Task Force on Implementation of Section 307 of
the Sarbanes-Oxley Act of 2002
The ABA Task Force on Implementation of Section 307 of the Sarbanes-Oxley Act of 2002, appointed by ABA President Alfred P. Carlton, Jr. in November 2002, is comprised of the following members, liaisons, and staff:
- M. Peter Moser, Chair of the ABA Task Force. Mr. Moser is of counsel to Piper Rudnick LLP, Baltimore, Maryland, and is a former Chair of the ABA Standing Committee on Ethics and Professional Responsibility. Mr. Moser has written articles on judicial conduct and professional responsibility and has taught these subjects at the University of Baltimore and University of Maryland Law Schools and in CLE programs. He has been Chair of the Maryland State Ethics Commission and of the Maryland Attorney Grievance Commission and was an Adviser to the ALI Law Governing Lawyers Restatement project. He served in the ABA House of Delegates (1978-2002), was ABA Treasurer and a member of the ABA Board of Governors and its Executive Committee. Mr. Moser is President of the American Bar Foundation and has been President of the Maryland State and Baltimore City Bar Associations;
- James H. Cheek, III. Mr. Cheek is a senior member of the law firm of Bass, Berry & Sims PLC, Nashville, TN. He served as Chair of the ABA Section of Business Law during 1998-1999 and currently serves as Chair of the ABA Task Force on Corporate Responsibility. He is a member of the Legal Advisory Committee of the New York Stock Exchange, having served as its Chair from 1989 to 1992. He also served as Chair of the Legal Advisory Board to the National Association of Securities Dealers from 1995 to 1997. He chaired the Federal Regulation of Securities Committee of the American Bar Association from 1986 to 1991. Mr. Cheek has served for a number of years as a member of the ABA Corporate Laws Committee which reviews and revises the Model Business Corporation Act. He is the Chair of the Securities Regulation Institute (San Diego) and a member of the Advisory Planning Committee of the annual PLI Securities Institute in New York and of the annual Ray Garrett Corporate and Securities Law Institute in Chicago. Mr. Cheek is also a member of the American Law Institute and a Trustee of the Securities and Exchange Commission Historical Society.
- The Honorable Barbara Kerr Howe. From 1988 until her recent retirement from the bench, Ms. Howe was an Associate Judge of the Circuit Court for Baltimore County, MD. Prior to 1988, she was a partner in a law firm engaged in general practice. Judge Howe currently serves as Chair of the ABA Standing Committee on Professional Discipline and as a member of the Professionalism and Professional Responsibility Committee of the ABA General Practice, Solo and Small Firm Section. In addition, from 1995-1998, she served as a member of the ABA Standing Committee on Professionalism. Judge Howe has also served as President of the Maryland State Bar Association (1996-1997), as a member of the Judicial Disabilities Commission of Maryland (1991-1995) and then as its Chair (1995), and as a director of the
Attorney Grievance Commission in Maryland (1983-1985), after having served on its Inquiry Panels for a number of years. She is also a former member and director of the American Judicature Society and the National Association of Women Judges and is currently a Fellow of the Maryland Bar Foundation and of the American Bar Foundation;
- Marvin L. Karp. Mr. Karp is a partner with Ulmer & Berne LLP in Cleveland, OH, Chair of the ABA Standing Committee on Ethics and Professional Responsibility, and a member of the ABA House of Delegates. Mr. Karp served as Chair of the ABA Section of Tort and Insurance Practice from 1990-1991 and as Chair of that section's Committee on Professionalism from 1987-1988. Mr. Karp also served as President of the Federation of Insurance and Corporate Counsel (1994-1995). In addition, he served the Cleveland Bar Association as President (1988-1989), as Chair of its Professional Responsibility Committee (1978-1979), as Chair of its Ad Hoc Commission on ABA Proposed Model Rules of Professional Conduct (1980-1982), and as Chair of its Special Committee on Professionalism (1987-1988). Mr. Karp has also served as a member of the Supreme Court of Ohio Special Committee on Creeds of Professionalism (1989-1990), and he currently is a Fellow of the American College of Trial Lawyers, International, the Academy of Trial Lawyers, and the American Bar Foundation;
- Barry Nagler. Mr. Nagler is the Senior Vice President, General Counsel and Secretary of Hasbro, Inc., one of the world's leading maker of games, toys and family entertainment products. Prior to joining Hasbro in January of 2000, Mr. Nagler spent twelve years with Reebok International Ltd., most recently as Senior Vice President and General Counsel, and six years with the Boston law firm of Foley, Hoag & Eliot. Mr. Nagler is a member of the national Board of Directors of the American Corporate Counsel Association, as well as a member of ACCA's Executive Committee and the incoming ACCA Advocacy Chair. In addition, he is a member of the Board of ACCA's Northeast Chapter;
- The Honorable Benjamin R. Civiletti. Mr. Civiletti has been Chairman of the law firm of Venable, Baetjer and Howard, LLP since July 1993 and a partner since 1981. He had been Managing Partner of that firm from 1987 to 1993. He previously served as Attorney General of the United States from 1979 to 1981. Mr. Civiletti is a director of several national and international corporations. He possesses a record of active service to the American Bar Association as a member of the House of Delegates and a former Chairman of the Litigation Section. He is also a member of numerous other professional and civic groups. He is a Fellow of the American College of Trial Lawyers and the American Law Institute.
- The Honorable E. Norman Veasey, liaison from the Conference of Chief Justices, is the Chief Justice of the Delaware Supreme Court in Wilmington, DE, an office he has held since 1992. Chief Justice Veasey also is the Chair of the ABA Special Committee on the Evaluation of the Rules of Professional Conduct ("Ethics 2000"), and from 1994-1995, he served as Chair of the ABA Section of Business Law. He was the President of the Conference of Chief Justices and the Chair of the Board of the National Center for State Courts during the 1999-2000 term. From 1957 until he took office as Chief Justice, he practiced law with the Wilmington, Delaware law firm of Richards, Layton and Finger, where he concentrated on business law, corporate transactions, litigation, and counseling. He served at various times as managing partner and the chief executive officer of the firm. During 1961-1963, he was Deputy Attorney General and Chief Deputy Attorney of the State of Delaware and from 1982-1983, he served as President of the Delaware State Bar Association. Chief Justice Veasey is a Judicial Fellow of the American College of Trial Lawyers and a Director of the Institute for Law and Economics at the University of Pennsylvania. He is also a member of the American Law Institute, the International Advisory Board of the Centre for Corporate Law and Securities Regulation and numerous other professional organizations.
- Leslie W. Jacobs, liaison from the ABA Board of Governors. Mr. Jacobs is a partner with Thompson Hine LLP in Cleveland, OH and is a member of the ABA Board of Governors, House of Delegates, and Task Force on Corporate Responsibility. He also has served as Chair of the Ethics and Professionalism Committee of the ABA Section of Antitrust, as the ABA Board of Governors' Liaison to the ABA Standing Committee on Professionalism, and as a member of the ABA Section Officers Conference Committee on Professionalism. In addition, Mr. Jacobs served on the American Law Institute's Members Consultative Group, Restatement of the Law Governing Lawyers (1996-1999). Mr. Jacobs was a member of the Ohio Board of Bar Examiners and Past President of the Ohio State Bar Association. He is a Life Fellow of the American and Ohio State Bar Foundations.
- Stanley Keller, liaison from the ABA Business Law Section. Mr. Keller is a partner with Palmer & Dodge LLP in Boston, MA, and is engaged in a business and securities law practice. He is chair of the Federal Regulation of Securities Committee of the ABA Business Law Section, co-chair of the Boston Bar Association's Task Force on Revision of the Massachusetts Business Corporation Law, and former chair of the BBA's Business Law Section, Corporation Law Committee, and Legal Opinions Committee. He is also a member of the TriBar Opinion Committee. Mr. Keller lectures for various continuing legal education organizations, and has authored and edited a number of articles and treatises on corporate and securities law matters, including "Massachusetts Business Lawyering," "International Securities Law Handbook" and "Massachusetts Limited Liability Company Forms and Practice Manual";
- Jan Lawrence Handzlik, liaison from the ABA Criminal Justice Section. Mr. Handzlik is a partner in the Los Angeles, CA office of Chicago's Kirkland & Ellis, where he specializes in white collar criminal defense and business fraud litigation. Mr. Handzlik has represented individuals and corporations throughout the United States in the full spectrum of white collar crime investigations and prosecutions, emphasizing complex financial, environmental, healthcare, securities fraud and regulatory matters. Before going into private practice, Mr. Handzlik served as an Assistant U.S. Attorney in the Fraud and Special Prosecutions Unit in Los Angeles. Most recently, he was Deputy General Counsel to the Rampart Independent Review Panel, a commission to study and report to the L.A. Police Commission on LAPD policies and practices in the wake of the Rampart Corruption Incident. Mr. Handzlik also served in the Christopher Commission and Webster Commission investigations of the LAPD following the Rodney King incident. Mr. Handzlik is the former Chair of the American Bar Association's White Collar Crime Committee, a nationwide group of over 700 white collar crime prosecutors and defense counsel. He currently serves on the Council of the American Bar Association's Criminal Justice Section. He lectures widely on many aspects of criminal and civil fraud, and has extensive experience conducting corporate internal investigations.
- R. Larson Frisby, legislative counsel, ABA Governmental Affairs Office, Washington, D.C., and Task Force Staff Director
- Robert D. Evans, Director, ABA Governmental Affairs Office, Washington, D.C.
- Jeanne P. Gray, Director, ABA Center for Professional Responsibility, Chicago, IL
- George Kuhlman, Ethics Counsel, ABA Center for Professional Responsibility, Chicago, IL
|1|| The ABA, with over 400,000 members, supports strong ethical standards. Its activities in this regard are summarized in its earlier comment letter filed with the Commission on December 18, 2002 in response to Release No. 33-8150 at page 2. This letter is available at sec.gov/rules/proposed s74502/apcarlton1.htm.
|2|| Our references to attorney withdrawal include, where appropriate, notice by an employed attorney of the inadequacy of the issuer's response.
|3|| The Preliminary Report is published at 58 Business Lawyer 189 (2002). The testimony and comments, along with the Preliminary Report, are available at http://www.abanet/buslaw/corporateresponsibility/home.html.
|4|| The views expressed in the Final Report do not represent the policy of the ABA until approved by the ABA House of Delegates or Board of Governors. Any recommended changes to the Model Rules are effective only when approved by the ABA House of Delegates.
|5|| ABA December 18 comment letter at pages 24-33.
|6|| In addition, in virtually all jurisdictions an attorney must withdraw from a representation if necessary to avoid assisting the client to commit a crime or fraud. In such circumstances, the attorney also may need to disaffirm documents in order to avoid assisting the client in a crime or fraud. See ABA December 18 comment letter at page 25 for a more complete discussion.
|7|| In our December 18 comment letter at page 24 we identified the legislative history of Section 307 of the Act indicating that Congress did not contemplate that the Commission would require reporting out by attorneys. We acknowledge that Congress in adopting Section 307 and Section 602 of the Act authorized the Commission to adopt minimum professional standards for attorneys in addition to reporting up the ladder. However, we believe that permissive reporting out as adopted by the Commission fulfills any Congressional mandate and is more consistent with Congressional intent than would be a mandatory reporting out requirement. See, e.g., note 11 in our December 18 comment letter.
|8|| At pages 26-27.
|9|| Comparisons have frequently been made between the requirements imposed on auditors and those imposed on attorneys. We believe it is important for the Commission, in considering mandatory withdrawal and reporting with respect to attorneys, to appreciate the critical distinctions between these two professions. As the United States Supreme Court stated in U.S. v. Arthur Young & Co. ". . . the private attorney's role [is] as the client's confidential advisor and advocate, a loyal representative whose duty is to present the client's case in the most favorable possible light. An independent certified public accountant performs a different role. . . . The independent public accountant owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. [It is the] `public watchdog'. . . ." 465 U.S. 805, 817-18 (1984). This distinction recognized the need to protect the sanctity of the attorney - client relationship and to preserve the candor and trust necessary for that relationship to exist. We also note that attorneys, unlike accountants prior to the Act's enactment, have been subject to extensive governmental regulation by state and federal courts.
|10|| See Crampton and Knowles, Professional Secrecy and its Exceptions: Spaulding v. Zimmerman Revisited, 83 Minn. Law Review 63, 118 (1998) (discussing merits of discretionary versus mandatory disclosure and expressing preference for discretionary approach because of the need to consider context and circumstance). See also Restatement of the Law Governing Lawyers (ALI 2000), §66, comment g (reasons for making disclosure discretionary).
|11|| In Release 33-3186 (at page 10), the Commission asks for information about the frequency with which attorneys, after reporting evidence of violations and receiving no appropriate response, engage in noisy withdrawals. An unscientific inquiry has identified instances where, in connection with securities law matters, attorneys have advised issuers of the need for disclosures and, in the face of opposition, informed the issuer that they would withdraw as counsel in the matter if proper disclosure were not made. In virtually all cases, the issuer made the disclosure. These positions were taken when withdrawal was permissive; noisy withdrawal proved unnecessary. Compliance with the existing rules of professional conduct also has led in-house counsel to refuse on ethical grounds to assist their employers in activities the attorneys believed to be unlawful as described in suits filed following allegedly retaliatory discharge. See, e.g., cases cited at note 2 in ABA Formal Opinion 01-424 (lawyer may disclose client information to the extent reasonably believed necessary in pursuit of a retaliatory discharge suit against her former client and employer).
|12|| These concerns would exist until there were a determination of the effectiveness of the Commission's effort to preempt inconsistent state rules. See ABA December 18 comment letter at pages 31-33.
|13|| The tension created by the substitution of a lawyer's judgment for the judgment of the client's board of directors is well illustrated by the decision in In re Union Carbide Class Action Securities Litigation, 648 F. Supp. 1322 (S.D.N.Y. 1986), dismissing an action on the ground that, as a matter of law, there had been no duty to disclose regulatory complaints and warning of violations at Union Carbide's Bhopal plant (before it exploded), where the company knew of the problems but had been taking steps to remedy them. One can imagine the difficulty a lawyer would have accepting the judgment call by a client's directors not to make disclosure under these circumstances, triggering withdrawal and disclosure, when in fact the directors should be entitled to reach what turned out to be a permissible nondisclosure decision.
|14|| Although these imprecisions and uncertainties may also exist under the reporting up the ladder rules and existing state court professional conduct rules, they do not create the same problems because reporting internally up the ladder has far less drastic consequences and permissive reporting out, which is applicable under the great majority of state court rules, permits the attorney to exercise professional judgment whether or not to report out.
|15|| Disaffirmance of a document, if necessary, might, of course, become publicly known.
|16|| At best, the investing public would speculate over the "professional considerations" prompting withdrawal. At worst, a cryptic explanation of the circumstances could mislead investors even more. In reality, a more complete discussion of the circumstances of the attorney's withdrawal would be necessary in order to provide adequate disclosure. This disclosure would likely result in a waiver of the attorney-client privilege as to the advice withdrawing counsel gave the issuer. That advice could also furnish a road map for litigation against the issuer even though it was not followed because it was debatable or simply wrong.
|17|| It would be especially problematic to require a firm to seek to withdraw from litigation at any time because of the unwarranted adverse impact on the issuer's lawsuit.
|18|| We understand that aware means "having knowledge; conscious; cognizant," as the Commission has noted regarding Rule 10b5-1. See Release No. 33-7881 (Aug. 15, 2000), note 105.
|19|| We recommend that the Commission consider using an FAQ with questions and answers as an effective means to provide interpretations.
|20|| Under Section 301 of the Act and the Commission's implementing rules (proposed in Release No. 33-8173 (January 17, 2003) and adopted on April 1, 2003), a member of the audit committee cannot, directly or indirectly, receive other than as a director any compensation or consulting fee or be an affiliated person.
|21|| Statement of Policy Regarding Lawyers' Responses to Auditors' Requests for Information, 31 Bus. Law. 1709 (1976).
|22|| As the Commission recognized in the Proposing Release, a person does not have to be an attorney to perform the requirements of a CLO under the rule.
|23|| We note that it is not clear what "previous" refers to; for example, is it before the alleged violation, the attorney's becoming aware of it, the report by the attorney to the CLO or the referral to the QLCC itself?