December 18, 2002
Jonathan G. Katz, Secretary,
Dear Mr. Katz:
This letter respectfully requests that the Commission consider carefully the following comments on proposed Part 205, which would adopt rules to regulate the professional conduct of attorneys that practice before the Commission. These comments are provided on behalf of the Litigation Section of the State Bar of California. The Litigation Section represents more than 8,715 attorneys admitted to practice in California who represent clients in court, before administrative bodies (such as the Commission) and in alternative dispute resolution procedures. Membership in the Litigation Section is voluntary and funding for committee activities, including all legislative activities, is obtained entirely from voluntary sources.
The Section recognizes that Congress has given the Commission a mandate to adopt rules in this area on a shortened schedule. The Section agrees that maintenance of high levels of professionalism and ethics within the profession are essential to clients, to the administration of justice and the investing public. The Section commends the Commission's effort to draft thoughtful rules in light of Congress' and the Commission's mandate. The Section is concerned, however, that the proposed regulations depart from well-established precepts of legal ethics and rules of professional responsibility. These departures may adversely affect the relationship between clients and attorneys and create risks of harm to the investing public. Thus, we urge the Commission to consider adopting only the rules that are specifically mandated prior to January 26, 2003. Specifically, it would be prudent either not to adopt or to defer for further comment any rules that require (or permit) an attorney to withdraw and/or to notify the Commission that they have withdrawn "based on professional considerations."
We further ask the Commission to consider carefully the breadth of the requirements it proposes and the extent to which they could adversely affect both the nature of the attorney-client relationship and the operation of the adversarial system. These principles have been the foundation of Anglo-American law for more than 200 years. They deserve the respect of the Commission and the lawyers who seek to live up to their high ideals.
The Litigation Section is not in a position to comment on all aspects of the rules and thus focuses its comments on the manner in which the proposed rules may affect litigators in California as well as the administration of justice, particularly in the following four areas:
1. The degree to which the Commission's proposed rules may conflict with a California attorney's duties under California law.
2. The proposed requirements that an attorney disclose the existence of past, present or future material violations of the securities laws, or a material breach of a fiduciary duty.
3. The extent to which the proposed rules regarding disclosure and withdrawal will affect a litigation attorney's ability to zealously represent his client.
4. The need for clarity regarding how the obligation to withdraw, if adopted, affects other attorneys in a law firm.
I. Conflict with California Rules.
With the possible exception of attorneys admitted in New York, California attorneys will be the largest single group affected by the proposed rules. Therefore, the Commission should reconsider the proposal in light of possible conflicts between the proposed rules and the duties of California attorneys under California law.
Pursuant to principles of federalism and in deference to the long history of state regulation of the conduct of attorneys, the regulation of attorneys has previously been left almost exclusively to the states. California has a highly developed set of standards regarding professional conduct as well as specific mechanisms to enforce those standards. One critical aspect of the obligations of a California attorney is the obligation to maintain a client's confidences.
The statutory duty of a California attorney to protect the confidences of a client is clear and unequivocal. "It is the duty of an attorney: . . . (e) to maintain inviolate the confidence, and at every peril to himself or herself to preserve the secrets, of his or her client." California Business & Professions Code section 6068(e). While a California attorney has an equally significant obligation not to assist a client to commit a fraud, California has made clear that the knowledge of a past fraud, a present fraud or a potential future fraud is not a justification for disclosing the confidences of a client. State Bar of California Standing Committee on Professional Responsibility and Conduct, Ethics Opinion No. 1996-146 (1996).
The Commission's proposed rule would require at least two actions inconsistent with the obligations imposed by the California statute. First, a general counsel, whose company has created a qualified legal compliance committee, would be obligated to inform the Commission that his or her client, the corporation, has committed a material violation of the securities laws or a breach of fiduciary duty if the corporation fails to implement the recommendations of the committee. Part 205.3(b)(3). The Section believes that this would likely constitute the disclosure of the client's confidences. Second, every attorney who is subject to the proposed rules would be required under certain circumstances to make a "noisy withdrawal" if, after taking evidence of a material violation "up the ladder," the attorney did not receive what he or she considered to be an appropriate response. The Commission and others will understand a withdrawal "based on professional considerations" to signal the existence of a present or expected material violation. A California attorney cannot both disclose confidential information to the Commission and comply with her ethical and statutory duty under California law. As a result, if the Commission adopts the proposed rule, California attorneys in these situations are likely either to risk being disbarred in California or risk administrative, civil or criminal penalties imposed by the Commission. The Commission may therefore be creating a unjustifiable "Catch 22."
The Commission proposes that this dilemma is resolved because the Commission's rules preempt state law, including contrary state ethics rules. We are concerned that this may not be the case. Preemption is a power granted to Congress and does not occur absent a "clear and manifest" Congressional mandate. See Rice v. Santa Fe Elevator Corp., 331 US 218, 230 (1947); cf. Burks v. Lasker, 441 US 471 (1979). Section 307 of the Sarbanes-Oxley Act does not include an express mandate to adopt any rule that requires disclosure of a client's confidences to anyone outside the corporation. See section 307(2). The legislative history of Section 307 also suggests that its sponsors were focusing on "reporting up" and not "reporting out." (See 148 Cong. Rec. S65555, S6557 (July 10, 2002). Thus, the necessary prerequisites for preemption may not exist.
California's authority to regulate the practice of lawyers arises from powers separate from the Commission's powers. An attorney who complies with a Commission rule that is inconsistent with his or her professional duties risks discipline by the State Bar Court and the California Supreme Court. When disciplining lawyers, the California Supreme Court is not bound by the administrative practices of the Commission. Historically, California courts have strictly enforced the duties of attorneys under Business and Professions Code section 6088(e). As stated by Presiding Justice Shinn in People v. Kor, 129 Cal. App. 2d 436, 447 (1955): "The privilege of confidential communication between client and attorney should be regarded as sacred. . . . . Here the attorney was compelled to testify against his client under threat of punishment for contempt. Such procedure would have been justified only in case the defendant with knowledge of his rights had waived the privilege in open court or by his statements and conduct had furnished explicit and convincing evidence that he did not understand, desire or expect that his statements to his attorney would be kept in confidence. Defendant's attorney should have chosen to go to jail and take his chances of release by a higher court." An attorney may face the same choice from a California court if he or she is placed in circumstance in which he or she cannot comply with both California law and the Commission's regulations. Accordingly, we urge the Commission to consider carefully its actions before it adopts rules that may be inconsistent with California law.
II. The Requirement of Disclosure May Substantially Alter the Attorney-Client Relationship.
The adoption in every state of a requirement that attorneys maintain the confidences of their clients serves important legal policies. The law encourages individuals and corporations to obtain legal advice as a means of avoiding violations of the law and avoiding harm to others. Clients will not obtain accurate and complete legal advice unless they speak candidly with their attorneys. The current rules provide the breathing room needed to ensure that this occurs. As a result, counsel, who enjoy the confidence of their clients, succeed in persuading their clients to refrain from actions that harm the public in the vast majority of cases.
The requirement of a "noisy withdrawal" or other disclosure, as described in Parts 205.3(b)(4) or 205.4(d), may fundamentally shift the relationship between attorney and client. Clients might risk disclosure to regulatory authorities on occasions in which they seek legal advice but have an honest, albeit strong, disagreement with their attorney regarding the existence of a material violation or regarding the appropriate course of action to remedy a potential harm. The proposed rules may cause clients to perceive that they have four options, none of which is desirable: (1) clients may believe it is in their best interest not to seek legal advice; (2) clients could choose not to disclose all facts to their for fear that the attorney may perceive "evidence of a material violation," which could trigger an obligation to begin the reporting procedure; (3) clients could disclose all known facts and be forced to accept the lawyers' judgments regarding the existence of a violation and an appropriate response, whether or not that appeared to the clients to be good judgment; and (4) a client might choose to defend themselves against the Commission after their attorney has withdrawn and signaled his belief that a material violation is occurring or is imminent. If clients begin to "second guess" their relationship with attorneys and whether candor is the clients' best course of action, it would represent a fundamental shift to the historic and well-established attorney-client relationship.
The bedrock of the attorney-client relationship is the belief by clients that their attorneys are their advocates, their advisors and look out for their interests. The changes proposed by the Commission risk significant intrusion upon that relationship. The Section is concerned that this intrusion may erode the trust that clients repose in attorneys. When clients fear the consequences of candor with their attorneys, they will not receive candid, competent advice or adequate representation. The ill-advised and inadequately-represented issuer of securities could pose a risk to the investing public. Thus, the Section recommends that the Commission not adopt the requirement of "noisy withdrawal" or the obligations presented in the latter half of Part 205.3(b)(3).
III. Effect of the Rule on Zealous Advocacy by Litigation Attorneys.
Parts 205.2(a)(2) & (3) define the scope of the proposed rules to include attorneys who appear in functions frequently filled by litigation attorneys, including the representation of witnesses in an administrative proceedings at the Commission and representing a client in connection with an investigation by the Commission. These attorneys are required both by ethical rules and historic practice to provide zealous advocacy on behalf of their clients. The Commission has reaffirmed in its release that it does not intend to interfere with zealous or creative advocacy on behalf of clients. Nonetheless, the requirement of disclosure and withdrawal risk this injury.
The Commission should consider that, not infrequently, the attorneys that represent parties or witnesses in such cases before the Commission also represent the same clients in companion litigation, e.g. federal or state class actions or derivative lawsuits, and in other unrelated litigation. In those other actions, the attorneys owe their clients both a duty of zealous advocacy and a duty not to disclose their confidential information in a way that could injure the prosecution or defense of the separate proceeding. All of the foregoing are core principles of the adversary system, which has been a hallmark of the Anglo-American legal system for hundreds of years. They deserve the Commission's respect.
The proposed rules could substantially impede an attorney's effort to provide zealous and creative representation for clients. For example, an attorney who is in the process of representing a client before the Commission with respect to some matter, even a past or unrelated matter, might be forced to withdraw due to a disagreement regarding an unrelated potential future violation. If so, the client or witness would be left without any legal representation precisely at the moment when the client or witness is most in need of ongoing, competent legal advice.
Moreover, the withdrawing attorney would be obligated either by rule or by practicalities to withdraw from other related litigation. It is not practical to expect an attorney to advocate on behalf of a client in the defense of a securities-related matter when the attorney has made a "noisy withdrawal." Of course, it is possible that a court would not permit the attorney to withdraw, in which case both the client and the attorney would be in a very undesirable circumstance in connection with litigation over which the Commission has no jurisdiction. The Section urges the Commission to consider the impact of its proposed rules on these and similar circumstances.
IV. Imputation of Withdrawal from Corporate Attorneys to Litigation Attorneys In The Same Law Firm.
Finally, the Section addresses the lack of clarity in the proposed rules regarding the manner in which the withdrawal of one attorney affects other attorneys in a law firm. Frequently, the rules of professional conduct impute to an attorney's colleagues the knowledge and obligations of any single attorney in the firm. The proposed rules, however, are silent regarding how the obligation to withdraw affects an attorney's partners and colleagues. If the requirement to withdraw is imputed to all members of a firm, the collateral results could be quite significant and would likely exceed the authority given to the Commission.
If all members of a firm must withdraw from representing a client, a single corporate attorney's judgment could create an obligation for scores of litigation attorneys to withdraw from pending lawsuits, arbitrations or trials, whether the matters had any relationship to any publicly-held security or not. In many cases, withdrawal may not be permitted, such as where a court orders an attorney to continue the representation of a client in a litigation due to the prejudice that would result from withdrawal. The attorney would therefore face conflicting duties from different legal authorities. Moreover, the California Rules of Professional Conduct prevent an attorney from voluntarily withdrawing from litigation where it would result in material prejudice to the client. Thus, a lawyer might risk sanction either by the California State Bar disciplinary system or by the Commission.
Far beyond the impact to the lawyer, clients could be severely prejudiced by these results. Whether or not it is appropriate to require that a client take remedial action or risk a noisy withdrawal by its public securities lawyer, the penalties for failure to take appropriate remedial action should not include the risk of prejudice to other outstanding and unrelated litigation.
If the Commission proceeds with a rule requiring any form of withdrawal, the Section requests that the Commission make clear that the rules do not require withdrawal by attorneys handling unrelated litigation on behalf of the same client.
Given the extremely short time for comments, this letter is not a comprehensive analysis of all the issues that arise from Part 205 as proposed or all the ways in which the proposed rules may affect the administration of justice. The Section urges the Commission to consider carefully all comments provided to it. The absence of comment on other aspects of the proposed rules or on the comments of others should not be read to reflect any judgment on the issues.