CHADBOURNE & PARKE LLP
December 18, 2002
Mr. Jonathan G. Katz
Re: Sarbanes-Oxley Act § 307 - Implementation of Standards of Professional
Dear Mr. Katz:
We are submitting this letter in response to the solicitation by the Securities and Exchange Commission of comments on its proposed Part 205 rules governing professional conduct for attorneys who appear and practice before the Commission on behalf of issuers, as contained in Release Nos. 33-8150; 34-46868; and IC-25829 (the "Release").
We understand that Congress set an extremely short deadline for the Commission to adopt rules implementing Section 307 of the Sarbanes-Oxley Act of 2002. However, we have a number of concerns regarding the proposed rules. The issues we find most problematic are:
A. The Commission should not adopt the proposed noisy withdrawal rules.
We urge the Commission not to adopt (or at the very least, to defer consideration of) the proposed rules governing the noisy withdrawal of attorneys. The proposed noisy withdrawal rules exceed the Congressional mandate set forth in Section 307 of the Sarbanes-Oxley Act and go beyond Congressional intent. The Commission goes too far in proposing a regulatory structure under which the very lawyers who are retained to represent corporate clients could ultimately trigger a Commission investigation or damaging civil and criminal proceedings. On balance, we believe the proposed noisy withdrawal rules would not serve the interests of investors and would do more harm than good.
The impact of a noisy withdrawal may be severe to the issuer and to the investing public. A noisy withdrawal likely would lead to a Commission investigation, which may or may not be warranted, as well as attendant negative publicity, loss of investor confidence and decline in stock price or increased market volatility.
Requiring an attorney to announce to the Commission a withdrawal for professional considerations, together with disaffirmance of reports, reveals client confidences, which violates the fundamental tenet of confidentiality in the attorney-client relationship. By announcing a withdrawal to the Commission, an attorney signals that there may be a material violation, and by disaffirming documents filed with the Commission, the attorney tells the Commission where to find the material violation. Under the proposed rules, an attorney effectively would be compelled to reveal privileged communications or confidential information regarding the client's conduct that the attorney has learned in the course of representing the client, severely undermining the attorney-client relationship.
Currently, attorneys provide issuers with regular counsel to address issues before they become major problems or violations and to assist issuers in preparing filings to ensure compliance with applicable securities laws. However, without the client's trust that the attorney will keep the client's confidences, without the open communication between attorney and client that results from such trust, an attorney cannot effectively perform this function, and the quality of disclosure by issuers will suffer. It is precisely in areas of potential violations where issuers need the advice of attorneys most and where attorneys function most effectively as "gatekeepers" for the protection of their clients and of investors generally.
We also believe that adoption of the proposed rules may lead to unnecessary noisy withdrawals. With little to guide them, reasonable, well-meaning attorneys who appear and practice before the Commission would understandably often disagree as to when a noisy withdrawal is required (or permitted). In light of the process set in motion by, and the negative impact of, an unnecessary noisy withdrawal, it is unfair, counterproductive and against the best interests of investors for issuers to be forced to assume this risk.
We urge the Commission not to exceed the mandate set forth in Section 307 of the Sarbanes-Oxley Act. Noisy withdrawal is not required by Section 307 and, in our view, is contrary to Congressional intent. The Commission correctly acknowledges in the Release that in the floor debate over Section 307 Senator Enzi only supported rules that "would not require the attorneys to report violations to the SEC".1 However, the Commission then finds support for its proposed noisy withdrawal rules in stating that because Senator Enzi did not advocate an express prohibition of noisy withdrawal rules, he intended for the Commission to adopt its far-reaching proposal. We do not believe that this was the intent of Congress. To the contrary, Senator Edwards said that the Commission should adopt "a simple rule with two parts. No. 1, a lawyer with evidence of a material violation of the law 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 that 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."2 Senators Enzi and Corzine made statements to exactly the same effect. In the floor debate over Section 307, no member of Congress suggested that under Section 307 the Commission should require noisy withdrawal. The Commission simply should not, as a matter of policy, force lawyers into the role of the Commission's informants. The Commission goes too far in suggesting that its interest in its own procedures justifies such an intrusion into the attorney-client relationship or constitutes a basis to upset the time-honored relationship between attorneys and their clients.3
The proposed rules with respect to noisy withdrawal would interfere with established rules and guidelines regarding professional responsibility. Specifically, the proposed rules would conflict with the rules regarding the preservation of privileged information established by states, which have the authority to establish such rules. These established directives were created and enhanced through democratic processes and have been refined through years of examination and experience. We do not believe there is any legal or policy basis for the Commission to dictate whether counsel in a court proceeding must withdraw, even while a parallel Commission proceeding is ongoing. Withdrawal from representation of a party to a court proceeding generally requires the approval of the court because of the potential disruptive effects of attorney withdrawal to the parties and the judicial system. Under the proposed rules, an attorney could face Commission sanctions if the attorney is not permitted by a court to withdraw from representing an issuer. We believe the Commission should not intrude upon the field occupied by well-established state, federal and judicial regulation.
The Commission is not required by the Sarbanes-Oxley Act to adopt rules relating to noisy withdrawals by the January 26, 2003 deadline specified for adopting rules relating to up the ladder reporting. If the Commission is unwilling to abandon its proposed noisy withdrawal scheme, we urge the Commission at least to delay its implementation pending a longer period of study and comment and, if appropriate, to hold public hearings on the proposed rules.
B. The proposed rules should exclude from their scope attorneys who do not act in a legal capacity.
We believe the proposed rules should not include attorneys serving issuers in a non-legal capacity. Attorneys may be employed by issuers in a wide range of areas that do not involve substantive legal representation or the provision of substantive legal advice (e.g., attorneys employed in an issuer's business development, finance, investor relations, real estate and other groups and former practicing lawyers in non-legal senior executive positions). These employees would not consider themselves to be acting as attorneys representing an issuer, much less appearing and practicing before the Commission. Nor would anyone else. Common sense dictates that if a person's job function does not involve legal representation or the provision of legal advice, that person should not be held to the same standards, and subject to the same burdens and potential sanctions, as attorneys actively representing issuers before the Commission.
An attorney acting in a non-legal capacity also may not be as well informed with respect to the securities laws, fiduciary duties and other similar legal matters required to determine whether "evidence of a material violation" exists. As a practical matter, the reporting and recordkeeping requirements of the proposed rules would be unduly burdensome to any attorney acting in a non-legal capacity.
Applying the proposed rules to non-practicing lawyers arbitrarily expands the scope of the proposed regulations to individuals that Congress did not intend the Commission to regulate. In proposing Section 307 of the Sarbanes-Oxley Act, Senator Edwards explained, "[i]f you are a lawyer for a corporation, your client is the corporation".4 The attorney-client relationship is at the heart of Section 307, and there is no such relationship where a lawyer is not acting in a legal capacity. The enforcement cases cited in the Release as support for an up the ladder reporting requirement applied this principle only to attorneys who were acting in a legal capacity for the issuer. Including attorneys representing an issuer in a non-legal capacity is neither within the scope of Section 307 nor necessary for accomplishing its purpose.
C. In determining when an attorney is appearing and practicing before the Commission, a higher standard should apply than that the attorney "has reason to believe" that a writing which he or she prepared or participated in preparing will be incorporated into a filing or submission.
The proposed standard for determining when an attorney is appearing and practicing before the Commission sets too low a threshold and is too vague. The "has reason to believe" standard in proposed Rule 205.2(a)(4) could apply to almost any document prepared for an issuer or for a company that may become an issuer. It seems to be an even lower standard than the "reasonably believes" standard defined in the Release and used elsewhere in the proposed rules. For an attorney to be subject to the Commission's rules and related sanctions, fairness requires that the attorney know that his or her work actually will be submitted to the Commission. Indeed, read literally, proposed Rule 205.2(a)(4) provides that an attorney would be appearing and practicing before the Commission even if the document prepared by the attorney is not actually filed or incorporated into a document that is filed. We believe a more appropriate standard for determining when an attorney is appearing and practicing before the Commission under proposed Rule 205.2(a)(4) would require that the attorney be substantially involved in or substantially responsible for the preparation of a statement, opinion or other writing that the attorney knows will be filed with or incorporated into a registration statement, notification, application, report, communication or other document filed with or submitted to the Commission.
D. The Commission should reconsider application of the proposed rules to non-U.S. attorneys.
For the reasons discussed above, the proposed rules are especially problematic with respect to non-U.S. attorneys. Non-U.S. attorneys, who may have little or no knowledge of U.S. securities laws, should not be expected to identify material violations. We would expect many non-U.S. attorneys to have difficulty recognizing breaches of fiduciary duty and similar violations that are based on legal concepts in the many separate jurisdictions of the U.S. The problem is exacerbated for non-U.S. attorneys employed by issuers in non-legal executive or administrative capacities. Further, non-U.S. attorneys are subject to regulatory schemes that may involve conflicting rules and that are frequently structured quite differently from those found in the U.S. The Commission should not attempt to preempt foreign attorney practice rules, nor should it subject non-U.S. attorneys to the onerous task of reconciling their local rules and regulations with the proposed rules. We recommend that the Commission remove non-U.S. attorneys from the scope of the proposed rules to be adopted next month and give further and more careful consideration to whether, and if so how, the proposed rules should apply to them.
E. The Commission should clarify the proposed definition of "evidence of a material violation" in several respects.
The proposed definition of "evidence of a material violation" contained in the Release is overly vague. The success of the proposed standards of professional conduct for attorneys requires that attorneys appearing and practicing before the Commission be able to identify clearly evidence of a material violation. Confusion as to when an attorney is obligated to report up the ladder will undermine the Commission's efforts in this area and subvert the intent of Congress embodied in Section 307 of the Sarbanes-Oxley Act. Clarity is important because the proposed rules would require an attorney to make a materiality judgment with respect to any violation - often a difficult task.
The Commission invited comment on the standard to be adopted in the definition of "evidence of a material violation". In our view, the objective reasonable belief standard is inappropriate. We find particularly troubling the Commission's commentary that an attorney is not excused from reporting evidence of a material violation where the attorney "does not personally believe that a material violation has occurred, is occurring, or is about to occur".5 In fact, this scenario presents a strong argument for a subjective standard.
In the Release, the Commission itself implies that the standard should be interpreted subjectively. In its discussion of proposed Rule 205.3(b), the Commission states that "[t]he attorney's reporting obligation is not triggered until the attorney can be sure that the officer or employee will actually pursue an illegal course of action" (emphasis added).6 Later in the Release, the Commission writes that under the proposed rules noisy withdrawal is required "only when the attorney actually believes that the material violation of which the attorney reported evidence is occurring or is about to occur . . . " (emphasis added).7
In light of the sequence of events set in motion by a finding of evidence of a material violation, we suggest that merely a reasonable belief that there is or will be a material violation is not enough. We recommend that the Commission adopt a subjective standard that an attorney "knows" that a material violation has occurred, is occurring or is about to occur.
We appreciate this opportunity to comment on the Release, and would be happy to discuss any questions the Commission or its staff may have with respect to our comments. Any such questions may be directed to Edward P. Smith (212-408-5371), Philip L. Colbran (212-408-1122) or Thomas V. Sjoblom (202-974-5636).