America's Community Bankers
April 7, 2003
Jonathan G. Katz
Re: Implementation of Standards of Professional Conduct for Attorneys
File No. S7-45-02; 68 FR 6324 (February 6, 2003)
Dear Mr. Katz:
America's Community Bankers (ACB)1 is pleased to comment on the proposed rule issued by the Securities and Exchange Commission (SEC) to adopt additional standards of professional conduct for attorneys.2
On January 23, 2003, the SEC adopted final rules adopting standards of professional conduct for attorneys,3 as required by section 307 of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley).4 The final rule requires attorneys who appear and practice before the SEC to report evidence of a material violation of securities laws, material breach of fiduciary duty, or similar material violation by an issuer, first to the chief legal officer of the company and, if no appropriate response is received, to the audit committee, another committee of independent directors, or the full board. The SEC had proposed, but did not adopt, a requirement referred to as a "noisy withdrawal." Under that proposal, if the attorney did not receive an appropriate response after he or she fulfilled the up-the-ladder reporting requirement, the attorney would be required to send notice to the SEC withdrawing from representation and disaffirming certain documents or filings with the SEC for ongoing violations or violations that were about to occur. For past violations, a "noisy withdrawal" would have been permissive rather than mandatory.
The SEC did not adopt the "noisy withdrawal" proposal when it adopted the other attorney professional standards because of the amount of debate and controversy generated by the proposal. Since the "noisy withdrawal" requirement was not mandated by Sarbanes-Oxley, unlike the other proposed attorney standards that had to be in place by a certain date, the SEC extended the comment period on the proposal. In addition, the SEC proposed an alternative to the "noisy withdrawal" requirement. Under the alternative, an attorney would have to withdraw from representation under a more narrow set of circumstances. If the attorney withdrew under the rule, the company, and not the attorney, would have to report the withdrawal to the SEC on a Form 8-K.
As we indicated in our previous comment letter on the original proposal to adopt professional standards for attorneys, ACB opposes the "noisy withdrawal" proposal. The proposal would conflict with the intent of Congress and raise issues under state professional codes of attorney conduct and the attorney-client privilege. Most importantly, the requirement would adversely affect the ability of a company's officers and employees to have a candid relationship with the attorney when issues arise, depriving the company of the right to obtain the best possible advice and advocacy from the attorney.
We believe the alternative of having the company report the attorney withdrawal to the SEC is a better approach. We do not believe, however, that notice of the withdrawal should have to be reported on a Form 8-K. If an attorney arrives at the point where he or she needs to withdraw from representation under the rule, it seems clear that there would be a serious disagreement between the attorney and the company over what is required under the securities laws. Therefore, a company should be able to present the disagreement to the SEC on a confidential basis, and work with SEC staff in resolving the matter. No useful purpose would be served by altering investors to a disagreement between an attorney and the company's officers and directors. If the SEC determines that the company is incorrect and a violation of the securities laws has occurred, is occurring or is about to occur, the SEC would be in a position to work with the company, or take enforcement action if necessary, and require the company to disclose the issue to investors.
The "noisy withdrawal" proposal would require a retained attorney who did not get an appropriate response to a report of evidence of a material violation that is occurring or about to occur, and who reasonably believes that the violation is likely to result in substantial injury to the financial interest or property of the issuer or its investors, to file a notice with the SEC withdrawing from representation and disaffirming certain documents. If the attorney's report is with regard to a past material violation, the withdrawal and disaffirming of documents is permissive rather than mandatory. In-house counsel would not be required to withdraw, but would have to file a notice with the SEC disaffirming documents.
We agree with the SEC that instances where a "noisy withdrawal" would be required should be rare. However, the "noisy withdrawal" requirement is not required by Sarbanes-Oxley and appears to conflict with the express intent of Congress. Senator Edwards, who proposed section 307 of Sarbanes-Oxley, said that the SEC was to make a "simple rule with two parts. No. 1, a lawyer with evidence of a material violation has to report that evidence either to the chief legal counsel or the chief executive officer of the company. No. 2, if the person to whom the lawyer reports doesn't respond appropriately . . . , that lawyer has an obligation to go to the audit committee or to the board. It is that simple."5 Furthermore, Senator Enzi, a key sponsor of section 307, made it clear that the provision "would not require the attorneys to report violations to the SEC, only to corporate legal counsel or the CEO, and ultimately, to the board of directors."6
Putting aside the fact that the "noisy withdrawal" was not required by Congress, adoption of this proposal on the SEC's own initiative would have adverse consequences detrimental to investors. The proposal would have an adverse impact on the relationship that directors, officers and employees have with the company's attorneys. While it is true that the attorney's responsibility is to the company and its shareholders, the practical reality is that the attorney must deal on a regular basis with the company's representatives in meeting the requirements of the securities laws. There is no requirement that legal counsel be involved in the preparation of periodic reports and other documents that are filed with the SEC. The "noisy withdrawal" requirement may result in the exclusion of the attorney from participation in the reporting process, resulting in less, rather than better, compliance with the securities laws and regulations. Even if attorneys are involved in the process, the rule will discourage frank and open discussion among the company's representatives and the attorneys if there is a constant fear that an attorney may report to the SEC if disagreements are not resolved in what the attorney views as an appropriate manner. These same adverse results would be avoided if officers and employees knew that any disagreements or issues would be settled internally.
The "noisy withdrawal" requirement also raises serious issues under state professional codes of attorney conduct and the attorney-client privilege, which were outlined quite thoroughly in comment letters on the initial proposal filed by the American Bar Association, other bar associations, law firms and attorneys.
Under the alternative proposal, a retained attorney who does not receive an appropriate response after completing the up-the-ladder reporting requirement would have to withdraw from representation and notify the issuer in writing that the withdrawal is based on professional standards. Withdrawal would be required only when the attorney reasonably concludes that there is substantial evidence that a material violation is ongoing or about to occur and is likely to cause substantial injury to the financial interest or property of the company or its investors. An attorney employed by the issuer would be required, under those circumstances, to cease participating or assisting in any matter concerning the violation and notify the company, in writing, that the attorney believes that the issuer has not provided an appropriate response. Neither the retained nor employed counsel is required to notify the SEC or disaffirm documents. In addition, an attorney is not required to withdraw or cease participation or assistance in a matter if the attorney would be prohibited from doing so by order or rule of a court, administrative body, or other authority with jurisdiction over the attorney after the attorney has sought leave to withdraw or cease participation.
An issuer who receives written notification from an attorney under this alternative proposal would be required to report the receipt of such notification and the circumstances related to the notification to the SEC on Form 8-K within two business days.
While ACB favors this option over the "noisy withdrawal" proposal, we do not support the requirement that the company notify the SEC of an attorney's withdrawal or termination of participation or assistance on a Form 8-K. The company should be able to provide this information to the SEC on a confidential basis until the agency has a chance to review the matter and determine whether there is an issue under the securities laws. At that point, the SEC would be in a position to require disclosure to investors and to take any action against the company that the SEC felt was necessary or appropriate. This would meet the SEC's goals of having an attorney's concerns about potential violations of the securities laws treated seriously at the company and brought to the attention of the SEC, when necessary, without alarming investors if it turns out that no violation exists or is likely to occur.
The SEC is specifically seeking comment on whether an issuer should have to disclose an attorney's written notification if a committee of independent directors of the issuer's board determines, based on the advice of counsel that was not involved in the matters underlying the reported material violation, that (i) the attorney acted unreasonably in providing such notification, or (ii) the issuer has, subsequent to such written notice, implemented an appropriate response. ACB does not believe that reporting to the SEC should be required in these cases. If a company and its attorney can not resolve a dispute over the application of the securities laws, then the company should be able to get a second opinion from an independent attorney who is retained to review the situation. If the second attorney does not agree that there is a problem, or if the second attorney believes that responsive actions taken by the company were appropriate, then that should conclude the matter without any notification to the SEC. In these circumstances, the company should inform the attorney who terminated representation, participation or assistance of the outcome and the rule should make clear that the attorney providing notice to the issuer has no further obligations under the rule.
In a related question, the SEC seeks comment on whether an issuer should not have to disclose an attorney's written notification if a committee of independent directors makes the foregoing determinations on its own without the benefit of a review by outside counsel. We believe that this was the result expected by Congress in passing section 307 of Sarbanes-Oxley and is what would occur under the professional standards for attorneys adopted in January. The final up-the-ladder reporting by an attorney is to an audit committee or another committee made up of outside directors. If there is no such committee, reporting is made to the entire board. The rule also allows for the use of a qualified legal compliance committee, which would be made up of independent directors. In order to ensure an independent decision by the directors, the SEC could require that if there is no audit committee or other committee of independent directors, the board should make the determination as to whether the attorney acted unreasonably or whether the company responded appropriately based solely on the views of the independent directors.
ACB believes that the up-the-ladder reporting is sufficient to ensure that an attorney's concerns are addressed by the appropriate representatives of the company. Any rule that could result in the attorney or the company informing the SEC about a dispute over compliance with the securities laws could have the unintended consequences of limiting the attorney's role in securities law matters. An adversarial relationship between the company's representatives and its attorneys would be created to the detriment of investors if attorneys are excluded from important meetings and discussions. The rules adopted in January meet the intended goals of section 307 of Sarbanes-Oxley by no longer allowing attorneys to sit by silently when securities law issues arise. The rule requires the attorney to be proactive in helping ensure that the proper company representatives are informed of the issues and are encouraged to take appropriate action. That should be all that is required.
If the alternative proposal of requiring the company to report an attorney's notification to the SEC is adopted, we question whether it should appear in a rule addressing attorney standards. If, in fact, the attorney's responsibility is completed once the attorney fulfills the up-the-ladder reporting requirement, then that should be what is addressed in Part 205. To the extent that there are obligations on the issuer that continue after the attorney has fulfilled his or her responsibilities, those requirements would more properly appear in regulations that address the obligations of issuers.
ACB appreciates the opportunity to comment on this important matter. If you have any questions, please contact the undersigned at (202) 857-3121 or via e-mail at firstname.lastname@example.org, or Diane Koonjy at (202) 857-3144 or via e-mail at email@example.com.