From: Bryan Hanson [bryanh@mn.rr.com] Sent: Monday, February 03, 2003 10:10 AM To: rule-comments@sec.gov Subject: Rule S7-45-02 February 3, 2003 Via Electronic Mail Mr. 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, Release Nos. 33-8150; 34-46868; IC-25829; File No. S7-45-02 Dear Mr. Katz, I have reviewed with interest the recent discussions surrounding the so called ‘noisy withdrawal’ requirement the Securities and Exchange Commission has proposed for corporate lawyers. This proposal, specifically directed toward lawyers appearing before the SEC, is heavily opposed by many of the very individuals to whom this requirement is intended to apply – purportedly because it would inevitably result in ‘severe damage to the attorney-client relationship.’ On January 23, in response to such opposition, the Commission offered additional time for comment, and also requested comment on a proposed alternative where lawyers would never be required to ‘blow the whistle,’ but under certain circumstances would be allowed to do so. The original proposal is the better one. LAWYERS AFFECTED A fair discussion first requires a clear explanation of to whom this so-called ‘noisy withdrawal’ requirement actually is intended to apply. The answer is that it only applies to attorneys who practice before the Commission. ‘Practicing before the commission’ generally means those attorneys who have contact with the Commission and its requirements, including (but not limited to) advising publicly held companies with regard to their potential filings, actual filings, or decision not to file with the SEC. Generally, therefore, there is no application to other attorneys including those in the course of representing nonpublic corporations. Also, and importantly, there is no application of the ‘noisy withdrawal’ requirement where public companies have resolved a matter internally. The now approved ‘up the ladder’ requirements are such that it is unlikely, except in the most extreme case, that any lawyer will ever be put in a position to consider the possibility of withdrawing ‘for professional considerations’ – his or her ultimate responsibility under the original proposal. Hence, the ‘noisy withdrawal’ proposal does not affect hundreds of thousands of organizations and will never directly affect the vast majority of lawyers who practice in the United States. WHERE APPLICABLE There are important limitations as to what could ever be applicable to the ‘noisy withdrawal’ proposal. First, such requirement has no application where there is valid dispute over legality. An attorney is neither required nor permitted to act under this rule where any action is subject to reasonable legal interpretation, no matter how aggressive that interpretation. Second, except for disaffirming false statements already made, an attorney is never required or even allowed to give specific information to the SEC. The only information any attorney could ever share is that he or she resigned ‘for professional considerations.’ No matter how serious the concern, there is never any greater requirement or allowance. Third, and perhaps most importantly, such requirement only has application in situations where “the attorney reasonably believes that a [material violation of securities laws or material breach of fiduciary duty, etc.] is ongoing or is about to occur and is likely to result in substantial injury to the financial interest or property of the issuer or of investors” (“Material refers to conduct or information about which a reasonable investor would want to be informed before making an investment decision.”) In English, if a continuing action does not sufficiently affect the bottom line, there is no duty or even permission to act. Such, of course, reflects the ultimate concern of the SEC, which is not whether a publicly traded organization is acting completely legally in all respects – but the ultimate impact of its disclosures on potential or actual owners. Disclosure or lack thereof as to any ongoing violations otherwise regarded as “material” are not within the scope of this rule. (The rule doesn’t appear to contemplate the potential impact of a series of violations which are substantially detrimental to the bottom line only in the collective.) It’s clear that any ‘noisy withdrawal’ obligation is strictly fashioned to resolve the specific concerns of the SEC – and nothing more. THE CLIENT At the heart of any discussion on attorney-client privilege is the identity of the client. Exactly who is it the lawyer is representing? And by extension who holds any privilege? According to the rules, now partially approved, the ‘Issuer’ [of securities] is the client: the organization itself. The organization, however, is an ‘artificial person’ – a creature of statute. A corporation is created and defined by statutes of its state of origin. Even though a corporation stands on its own as a legal entity, it is innately subject to suggestion. It cannot make decisions or take any action except through the decisions of its agents, including those agents who are its officers and directors. A corporation might therefore be regarded as supremely vulnerable. It is this nature of a corporation – it being completely subject to its agents’ desires – that creates the need for a ‘whistle blowing requirement.’ As has been made excruciatingly clear as of late, officer/agents do not always serve their principal (the organization). If an attorney were to discover that an agent for a vulnerable natural person (human) were acting contrary to that person’s interests – for example if an accountant for a vulnerable individual were embezzling funds or falsifying important documents – a lawyer would be remiss to simply look the other way. Rather, that lawyer would be expected to represent his or her client’s interests. In the same way, if an officer/agent of an artificial person were found to be harming the corporation or materially misleading that corporation’s owners, a similar rule should apply. An attorney for a corporation must have some ultimate ability to act on behalf of a corporate client when all else fails. Such should neither be precluded nor optional. BACKGROUND MISCONCEPTIONS Despite verbal acknowledgment of “Issuer as Client,” opponents’ arguments still seem to too closely identify the interests of the organization with those of its officer/agents. Reasons given for the current opposition appear to have various flaws: · Most reasoning appears to assume that an artificial person must invariably hold the exact same right to counsel as a natural person. On the contrary, the rights of an artificial person are subject to a measure of variation inter alia statutorily by the state which defined it. · Some reasoning appears to be based on the misconception that officer/agents should benefit from a corporation’s veil of confidentiality even when those same officer/agents have clearly demonstrated a measure of corruption – that the label of officer must grant them ultimate privacy when they act against the interests of their principal (the corporation) – that the confidentiality rights of an officer are invariably fused with those of the organization itself. · Some reasoning appears to be based on the misconception that officer/agents who intend to harm the corporation are still acting at the behest of the corporation. · Some reasoning appears to be based on the misconception that an entity created by law can, except as an unwitting tool in the hand of another, intend controvert the law, or desire to injure itself or its owners. One very reasonable concern is that an attorney, by acting against a malicious officer/agent, might harm the client – the principal being liable for the agent’s actions. However, to set in stone a form of confidentiality where a lawyer is precluded from lifting a finger on behalf of his or her corporate principal is also a mistake. RESULT TO ORGANIZATIONS The most likely result of approval of a mandatory whistle blowing requirement is as follows: First, because most corporations – in stark contrast to the high profile cases of the recent past – tend to operate within the law, this ultimate requirement of a ‘noisy withdrawal’ will not directly affect their lawyers. Furthermore, there is almost no concern where there remains valid legal argument, however aggressive. The proposed whistle blowing requirement does not permit lawyer to comment in such a case. Neither would a lawyer raise public concern if he or she wants to continue representation, obtain additional clients, and/or continue a position as partner or associate in his or her firm. However, there may be organizations where a substantial problem will be found. In such a case it will be required that the lawyer who becomes aware of the specifically covered issues make extensive attempts to resolve the issues internally. The very presence of the approved internal review procedures should by itself reduce the number of problems which might require such review. And because these kinds of problems are not generally the result of a vast conspiracy over multiple corporate levels, issues are not likely to survive internal scrutiny. A ‘noisy withdrawal’ requirement would cause additional potency to an internal review process, in part because a lawyer who does not want to withdraw will be more likely to find ways to persuade errant officers to act according to their legal responsibilities. Considering the lawyer’s keen interest in compelling the organization to take appropriate action, which then becomes directly intertwined with that lawyer’s and even his or her firm’s ability to continue representation, the number of ‘noisy withdrawals’ is destined to be effectively zero. As for concern that a whistle blowing rule might cause confusion or harm to the substance of discussions between lawyers and corporate officers, those protected by the corporate confidentiality veil will soon learn they can discuss any legitimate concern, and that those very few troubles that could possibly result from honest discussion will invariably be resolved inside the organization. RESULT TO LAWYERS As for the lawyers themselves, the protections such a mandatory rule offers outweigh claimed detriments to the profession. First, the presence of the ‘noisy withdrawal’ option offers lawyers a clear opportunity to know they can take action should their client, the corporation itself, be directed to harm itself and/or its shareholders in violation of SEC regulations. Second, lawyers’ ethics are actually less at risk if the client’s officer/agents believe that both their current lawyers as well as any potential replacements are required to raise eyebrows in the event they become aware of continuing fiduciary breaches. PROBLEMS WITH THE ALTERNATIVE The alternative proposal, which offers whistle blowing only as an option is inadequate. Some have already argued that a company which has already failed to live up to its obligations is unlikely to report itself. The lack of an actual obligation on attorneys in such a situation also would ultimately make the ‘permissive’ option almost entirely fictitious. The lawyer who is not required to take action has more than ample reason not to do so. At that point where the ‘noisy withdrawal’ becomes an option, a lawyer will encounter certain resistances, often from his or her own firm which might be hesitant to lose a well paying client. In a permissive situation, an associate or partner may easily be talked out of taking action, especially where the lawyer is only allowed to give the faintest hint to allow the SEC to help the client corporation. When that is compared with the risk to hundreds of thousands of dollars in potential fees, the ‘noisy withdrawal’ is not the least bit attractive to a lawyer and his or her firm. Corrupt officers will know this. CONCLUSION It appears that despite all the opposition, the proposal of a mandatory ‘noisy withdrawal’ appears, if anything, weak. It is tempting to consider that in an egregious situation where a corporation is hijacked by self-interested officers, a lawyer should be required to take greater action than simply withdraw with a hint and a nudge. Such greater responsibilities, however, might give an attorney too much power. It is for the board of directors to make a corporation’s ultimate decisions, not the attorney. In those almost negligible number of cases which might survive internal review, a company‘s board will have ample opportunity to present its own perspective. However, if made mandatory, it appears the ‘noisy withdrawal’ as an ultimate act of corporate representation should almost never occur. Bryan M. Hanson, MBA Member of the Minnesota Bar (Separately, I concur with those who oppose linking representation of a corporation with representation of a corporation’s shareholders. Bankruptcy situations are only examples of where the interests of those two parties may diverge. B.H.)