December 18, 2002
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. 33-8150.wp – Proposed Standards of Professional Conduct for Attorneys
Dear Mr. Katz:
Clifford Chance is submitting this letter to comment upon the proposed 17 CFR Part 205 described in Release No. 33-8150 (the "Release"). This is one of two letters Clifford Chance is submitting. It contains comments about proposed Part 205 that are applicable in general, and particularly with regard to United States lawyers who practice law in the U.S. The other letter responds to the request in the Release for comments regarding the effect the proposed Part 205 would have upon a multinational law firm, and discusses the effects the proposed Part 205 would have upon non-U.S. lawyers and upon U.S. lawyers who practice law in countries other than the U.S.
Initially, we would like to make some general comments about proposed Part 205:
- We agree fully that the obligations of a lawyer retained by a corporation or other entity are to the company, and in particular to its Board of Directors or similar body, not to the company’s management. Accordingly, we agree with the basic "up the ladder" concept embodied in Section 307 of the Sarbanes-Oxley Act of 2002 ("SOX Act") and in proposed Part 205. We do not believe, however, that a lawyer for a company has an obligation to investors or potential investors in that company, including individual shareholders. Therefore, we do not believe it is appropriate for the Commission to attempt to impose upon lawyers for a company an obligation to provide information to persons outside the company, including the Commission and the investing public. Nor do we believe the SOX Act mandates, or authorizes, the Commission to impose obligations of that type.
- Proposed Part 205 provides in Section 205.3(b) that an attorney does not reveal client confidences or secrets or otherwise protected information by communicating information related to an issuer to the issuer’s officers or directors. It provides in Section 205.3(d)(3) that the notification to the Commission prescribed by Section 205.3(d) does not breach the attorney-client privilege. It provides in Section 205.3(e)(3) that where an issuer, through an attorney, shares information with the Commission pursuant to a confidentiality agreement, such sharing of information shall not constitute a waiver of any otherwise applicable privilege or protection as to other persons. To the extent those provisions are intended to be statements of fact, there is no need to include them in a Commission rule. To the extent they are intended to preempt or otherwise overrule provisions of state law (or of laws of other nations), we believe the provisions go beyond both the Commission’s general rule making power (see The Business Roundtable v. SEC, 905 F.2d 406 (D.C. Cir. 1990)) and any powers granted to the Commission in the SOX Act.
- The Release states (page 48) that a Commission rule permitting disclosure would appear to preempt a state’s rule forbidding disclosure. It states (page 57) that the Commission is considering whether Part 205 would preempt state laws relating to attorneys’ conduct, including those relating to maintaining client confidences. While it is possible that the SOX Act could have preempted state rules regarding attorneys’ obligations to their clients, there is nothing in the SOX Act that mandates or authorizes the Commission to impose obligations on attorneys beyond reporting to the Board of Directors. The Commission acknowledges in the Release (pages 7 and 40) that the proposed rules go beyond what is required by the SOX Act. The SOX Act authority cited in the Release for the "noisy withdrawal" requirements and similar requirements is the authority to adopt regulations "for the protection of investors." (Page 50). Virtually every Federal administrative agency has similar authority in the area under its jurisdiction. We know of no precedent for permitting a Federal administrative agency to override the attorney-client privilege, and we believe it would be extremely dangerous if that were permitted.
- Not only do the aspects of proposed Part 205 that require attorneys for a company to provide information to people outside the company about communications with people within the company go beyond anything required or contemplated by the SOX Act, but they would impair the very relationship between attorneys and issuers that enables them to exert the influence that Section 307 seeks to promote. Faced with the possibility that attorneys who discover possible problems may have to disclose the existence of problems to the Commission or others, companies would do everything they could to be sure attorneys do not discover anything they might view as evidence of problems. The frankness by company personnel that lets attorneys make judgements on matters such as disclosure requirements and corporate responsibilities would inevitably be substantially reduced. Further, attorneys themselves would be tempted to avoid being exposed to information that could confront them with conflicts between their obligations under Part 205 and their obligations under state (or foreign) laws and rules governing professional conduct.
- If the Commission believes that it should continue to pursue the concept of requiring "noisy withdrawals," or other acts that will disclose attorneys’ communications with their clients, we believe that concept should receive far more debate and consideration than can take place within the period before January 26, 2003, the date by which the Commission is required to adopt rules under Section 307 of the SOX Act. Therefore, we believe the Commission should limit the rules it adopts by the January 26, 2003 deadline to those that are required by the SOX Act – i.e., rules relating to attorneys’ responsibilities to report matters within a company, including reporting "up the ladder" to its Board of Directors. If it wants to do so, the Commission can at a later date consider expanding those rules.
Proposed Part 205 will seriously impact the practice of law both by lawyers practicing in the corporate and securities area and by lawyers who represent clients in investigations by the Commission and similar matters. However, the effects upon those two types of lawyers will differ in substantial respects. Therefore, our specific comments are divided into comments regarding proposed Part 205 from the point of view of a corporate or securities lawyer and comments regarding proposed Part 205 from the point of view of a lawyer involved in activities such as representing clients in connection with Commission investigations, or investigating, in the context of litigation or otherwise, possible violations of law.
Specific Comments Regarding Effects of Proposed
Part 205 on Corporate and Securities Lawyers
- Under proposed Section 205.3(b), an attorney who becomes aware of evidence of a material violation of securities laws or evidence of a breach of fiduciary obligations must report that evidence to the issuer’s chief legal officer or to both its chief legal officer and its chief executive officer, and ultimately to its Board of Directors or to a Board committee (unless the issuer has a qualified legal compliance committee to which the attorney can report). Proposed Section 205.3(b)(2) would require an attorney who reports evidence of a material violation to document the report and the response to it. Section 205.3(b)(8) requires that if the attorney reasonably believes the issuer has not made an appropriate response to the attorney’s report, the attorney must explain his or her reasons for believing that to the issuer’s chief legal officer, chief executive officer or directors and must document the response or absence of a response.
Section 205.3(e) says that any report or record of a report or of a response may be used by an attorney in connection with any investigation, proceeding or litigation in which the attorney’s compliance with Part 205 is in issue. That creates a threat that the Commission or someone else could obtain information about what the attorney may have discussed with his or her client and the attorney’s view of how the client responded, simply by beginning an inquiry into whether the attorney prepared the required documentation, and in that inquiry requiring the attorney to turn over the documentation so the investigator can review its adequacy. Indeed, it is difficult to think of a reason for requiring attorneys to document their compliance with the "up the ladder" reporting requirements other than so the Commission can obtain that documentation and use it against the attorneys’ clients. Attorneys do not need a Commission requirement in order to decide how to protect themselves. They can decide for themselves whether to make contemporaneous records of "up the ladder" reports. We strongly urge that all requirements that an attorney document communications with his or her client be deleted.
- Proposed Section 205.3(b) requires an attorney to report "evidence of a material violation" of securities laws or of fiduciary obligations. Proposed Section 205.2(e) defines "evidence of a material violation" to mean information that would lead an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur. The Release states (page 17), "An individual attorney is not excused from reporting evidence of a material violation on the grounds that he or she does not personally believe that a material violation has occurred, is occurring, or is about to occur." This creates an Alice in Wonderland situation in which an attorney is required to report something the attorney does not believe happened or does not believe was a violation of law, because another attorney might reasonably disagree. Taken to an extreme, this could require an attorney who advises an issuer’s Board of Directors that, in the attorney’s view, something the issuer wants to do is lawful, but who tells the Board that other attorneys might disagree, to withdraw from representing the issuer because the issuer followed the attorney’s advice and took the action that the attorney said he or she believed was lawful.
We understand that the Commission does not want an attorney who is accused of not fulfilling his or her obligations under Part 205 to be able defend simply by saying that that attorney did not believe there had been a material violation. However, we think the proposed requirement that attorneys report evidence of material violations the attorneys do not think occurred will seriously impair attorneys’ ability to maintain credibility with their clients. This, in turn, will impair the ability of attorneys to exert the positive influence which the Commission, rightly, believes lawyers should exert.
- Whether there is "evidence of a material violation" will require both a determination of facts and a determination of law. It is not realistic to ask lawyers to report "up the ladder" unconfirmed suspicions of facts. We believe attorneys should only be required to make reports if they obtain actual knowledge of facts that they believe constituted or will constitute material violations of securities laws or breaches of fiduciary duties, or that they are clearly unreasonable (akin to reckless) in not believing constituted or would constitute violations of securities laws or breaches of fiduciary duties.
- Proposed Section 205.2(a)(4) includes in the definition of "practicing before the commission" preparing or participating in the process of preparing any writing which the attorney has reason to believe will be filed with or incorporated into any document filed with the Commission. That would include drafters of material agreements who may not even be aware that their clients file materials with the Commission (such as a lawyer specializing in intellectual property who drafts a technology agreement that, unbeknownst to the intellectual property lawyer, his or her client is required to file as an exhibit to a report under the Securities Exchange Act). Proposed Section 205.2(a)(f) defines representation of an issuer to include acting at the behest, or for the benefit, of an issuer, whether or not employed or retained by the issuer. Each of these definitions exposes to obligations under proposed Section 205.3 attorneys who have no material relationship to a company’s disclosures or the fulfillment of fiduciary obligations by the company’s directors or officers. We believe Section 205.2(a)(4) should be limited to attorneys who participate in a material way in the preparation of documents filed with, or submitted to, the Commissioners, the Commission or its staff.
- Proposed Section 205.2(i) defines a material violation to include a material breach of fiduciary duty. Proposed Section 205.2(d) defines a breach of fiduciary duty as "any breach of fiduciary duty recognized at common law." There are many breaches of fiduciary duty recognized at common law that have nothing to do with anything with which the SOX Act is concerned, and in particular have nothing to do with anything with which Section 307 is concerned. If, for example, a bank that is the trustee under a testamentary trust favored the income beneficiaries over the remainder beneficiaries, that could constitute a breach of fiduciary duties recognized at common law, but it is not the type of breach of fiduciary duty with which the SOX Act is concerned. Conversely, some fiduciary duties of corporate directors or officers arise under state corporate statutes, not under common law.
We suggest that the breaches of fiduciary duties to which Part 205 applies be limited to fiduciary duties of directors or officers of companies to the companies or their owners.
- Under Section 205.3(c), if an issuer establishes a qualified legal compliance committee of its Board, an attorney can discharge all his or her responsibilities under proposed Part 205 by reporting evidence of material violations to that QLCC. However, a Board committee will only be a qualified legal compliance committee if it consists entirely of non-employee directors who have essentially unlimited authority to require the issuer to take steps to remedy possible material violations of securities laws or of fiduciary obligations and who are personally responsible for reporting to the Commission any violations of securities laws or breaches of fiduciary obligations, if the company fails in a material respect to take any remedial steps required by the committee.
We suggest that requiring non-employee directors to determine whether there have been violations of securities laws or fiduciary obligations and what remedial steps the issuer should take with regard to them, and requiring non-employee directors to determine whether the issuer has adequately taken required remedial action, and if not, to report the possible material violations to the Commission, imposes a personal burden on those non-employee directors that goes far beyond anything that can reasonably be requested of them. Typically, non-employee directors receive only modest compensation for serving as directors, and are very much concerned that their service as directors not expose them to personal risk. We think companies will have great difficulty finding non-employee directors who will be willing to serve on QLCCs. Further, if companies can find people to serve on QLCCs, fear of personal criticism or personal liability will undoubtedly lead most QLCC members to feel that when there is even a minor possibility that there was a material violation, they should assume there was one and require the harshest possible remedial action, and when there is even a minor doubt about the completeness of the issuer’s remedial action, they should report the possible material violation to the Commission.
We believe the idea of a committee of independent directors that has responsibility for receiving information from the issuer’s chief legal officer or its outside attorneys about significant compliance issues and making recommendations to the Board of Directors about steps that should be taken is a good one. However, we do not believe non-employee directors should be placed in a position where they have to determine remedial actions that must be taken by the issuer or must report to the Commission possible violations of law.
- Section 205.5(d) permits a subordinate attorney who reasonably believes that a supervisory attorney to whom he or she has reported evidence of a material violation to, among other things, give written notice to the Commission that the subordinate attorney has withdrawn from representing an issuer based on professional considerations and disaffirm to the Commission any opinion, document or other item that was submitted to the Commission that the subordinate attorney assisted in preparing and that the subordinate attorney reasonably believes is or may be materially false or misleading. This raises all the concerns described above about the impact of the "noisy withdrawal" concept on the attorney-client privilege. However, it poses the further problem that a subordinate attorney whose job is in danger may attempt to force the subordinate attorney’s law firm to continue the subordinate attorney’s employment or pay the subordinate attorney substantially increased termination pay by threatening to make disclosures to the Commission that the supervisory attorneys believe are not correct, but that could substantially injure the law firm’s client even if they are ultimately shown to have been unjustified. Normally a subordinate attorney’s obligations with regard to the attorney-client privilege would prevent this from occurring. The Commission should not attempt to create a means by which an unhappy subordinate attorney could circumvent the restrictions imposed by the attorney-client privilege or other ethical restrictions, and by doing so injure law firm clients. Even if the "noisy withdrawal" concept remains, Part 205 should not do anything with regard to subordinate attorneys, other than to require them to report evidence of material violations to the applicable supervisory attorneys.
- The Release states that Part 205 is not intended to create a private right of action against an attorney based on compliance or non-compliance with its provisions (page 56). It says that nothing in Section 307 creates a private right of action against an attorney and that statements by the sponsors of that provision unequivocally demonstrate that there was never an intention to create a right of action by third parties for violation of the rule (page 56 at note 81). Nonetheless, we believe Part 205 should contain an express statement that the Commission will have exclusive jurisdiction with regard to violations of Part 205 and that there will be no private right of action for violation of Part 205 or Section 307 of the SOX Act. We are concerned that, absent such a provision, despite the Commission’s intention, Part 205 may become the basis for suits against issuers’ lawyers every time it is discovered that an issuer may have violated the securities laws or its officers or directors may have breached their fiduciary obligations.
- As described above, any requirement that an attorney for a company provide information about communications with people within the company (including its directors) to the Commission or anybody else outside the company creates a potential conflict with state laws and rules governing conduct by attorneys. While the Commission can create a safe harbor that precludes private suits arising under Part 205 or Section 307 of the SOX Act, the Commission cannot create a safe harbor that protects attorneys who comply with Part 205 from disciplinary proceedings by the agencies that enforce state rules of professional conduct, or private suits, for having violated state rules by complying with Part 205. That is one of the many reasons why Part 205 should not contain any provisions that require attorneys to provide to anyone outside a company information about communications between the attorneys and the company or its directors, officers or employees.
Specific Comments Regarding Effects of Proposed
Part 205 on Lawyers Representing Clients with Regard
to Investigations or Litigation
The comments above apply with even greater force in the context of a lawyer representing a company in an investigation or litigation than they do with regard to a corporate or securities lawyer. A corporate or securities lawyer is primarily an advisor to a company. A lawyer who represents a company in connection with an investigation or litigation is an advocate for the company. Applying the proposed Part 205 rules discussed above to lawyers engaged as advocates would essentially destroy their ability effectively to carry out their role. Indeed, we believe applying a number of the proposed Part 205 rules to lawyers who represent companies with regard to Commission investigations or in similar situations would deprive companies of the right to counsel to an extent that would raise significant Constitutional issues, as well as issues under the Administrative Procedure Act.
Our specific comments about the effects of proposed Part 205 rules on lawyers who are retained in connection with investigations or litigation are as follows:
- The Release reads the Section 205.2(a) definition of "appearing and practicing before the Commission" more narrowly than the language of the proposed rule itself. The definition reaches lawyers involved in "any business" with the Commission, including communications with the Commission staff. Section 205.2(a) makes no exception for communicating with the Staff in the course of pending litigation or investigations that may lead to enforcement actions. The Release states that litigation against the Commission is excepted, because the issuer is not transacting business with the Commission. Section 205.2(a), however, defines "appearing and practicing before the Commission" on the basis of the attorney’s actions, not the issuer’s. Therefore, unless Section 205.2(a) is clarified, Part 205’s reporting and documentation obligations will, on their face, encompass the defense of pending or threatened litigation as well as Commission investigations.
- Proposed Part 205’s requirement that an attorney report, and possibly withdraw because of, "evidence of a material violation" requires an attorney retained to present a company’s position constantly to assess the "evidence" of a possible violation and to evaluate the appropriateness of the issuer’s response based on that lawyer’s estimation of its effect on a group of non-clients (investors). This would make the attorney judge and jury at the same time the attorney is the company’s advocate. These roles are totally inconsistent.
- We do not believe the Commission should mandate anything about how a lawyer representing a company in connection with a Commission investigation or litigation should communicate with the lawyer's client. That includes imposing an "up the ladder" reporting requirement. Obviously, Boards of Directors are very much interested in Commission investigations or litigation involving their companies. Therefore, in most instances the attorneys who represent companies with regard to investigations or securities litigation keep the companies’ Boards informed about significant information bearing upon the subject of the investigations or litigation, either directly or through the companies' internal legal officers. However, there are times reporting or remedial action are not appropriate.
This is readily illustrated in the context of a joint defense. In the vast majority of instances, when a Commission investigation is under way, it is essential that counsel for the company and counsel for individual officers, directors or employees cooperate fully with one another. The question of whether the issuer has violated the securities laws almost always turns on facts that are also relevant to the potential liability of individual officers, directors or employees. The lawyers for each of them must be able to communicate candidly and fully with counsel for the others of them, without the fear that communications among counsel will trigger reporting, documentation and withdrawal steps such as those mandated by proposed Part 205. Confidential communications among counsel for parties with substantially aligned positions is the essence of the privilege for counsels of the defense. Accordingly, even an up the ladder reporting requirement is inappropriate with regard to an attorney retained to represent a company in connection with an investigation or litigation.
We realize that Section 307 requires the Commission to adopt rules setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission "in any way" in the representation of issuers. Therefore, we recognize that the Commission would have difficulty exempting entirely lawyers who represent issuers in connection with Commission investigations. However, we believe the Commission could make it clear that an attorney advising or representing a company in connection with a Commission investigation or in connection with any other matter that presents a likelihood of resulting in administrative proceedings or litigation will be exempted from any requirement to report information if the attorney reasonably believes that reporting the information would impair the attorney's ability to determine all the facts that are relevant to the matter being investigated or would otherwise impair the attorney's ability to gather relevant information and be an effective advocate for the company.
- We have noted above our concerns about the requirements in proposed Part 205 that an attorney document communications between the attorney and his or her client and the client’s responses. The problems raised by the possibility that the Commission or anyone else might be able to obtain documentation of communications between an attorney and his or her client, or responses by the client, are even more severe with regard to an attorney retained in an advocacy capacity than those raised with regard to attorneys retained to give corporate or securities advice. The advocate’s function is to provide a client with the best defense available that is consistent with the facts and the law. An essential tool in doing this is to be able to obtain and maintain information on a confidential basis and to present the relevant information in the way that is most favorable to the advocate’s client. That would not be possible if the advocate were required to document what the advocate found and there was a possibility that that documentation could become available to a government agency that is investigating the company or to somebody else whose interests might be adverse to those of the company.
- We have described above our strong belief that it is not appropriate for the Commission to attempt to impose upon lawyers for a company any obligation to provide information to persons outside the company. Thus, we are opposed to the "noisy withdrawal" concept embodied in proposed Part 205. However, even if the "noisy withdrawal" concept remained in Part 205 with regard to lawyers who advise companies with regard to corporate or securities matters, it is essential that it be removed with regard to lawyers who act as advocates for companies. It is a core part of our legal system that a person is entitled to vigorous advocacy, even if the advocate personally believes the client has not acted properly. Neither the Commission nor, we believe, Congress has the power to take away that right. Yet the "noisy withdrawal" concept (or any withdrawal requirement) would do just that.
- If any obligation is imposed upon an attorney who represents a company with regard to a Commission investigation or similar matter on the basis of "evidence of a material violation," the obligation must be based on the attorney's actual belief, not what an attorney could reasonably believe. Presumably, most investigations don’t go beyond a preliminary stage unless there is information that could lead an attorney reasonably to believe that a material violation has occurred, is occurring or is about to occur.
- The problems that can be caused by giving an unhappy subordinate attorney the ability to disclose to the Commission information that may be harmful to a law firm’s client are multiplied when the subordinate attorney has been working on representation in connection with an investigation or other adversarial, or potentially adversarial, proceeding. Authorizing the unhappy subordinate to ignore the normal strictures of the attorney client privilege would enable the subordinate seriously to undermine the client’s efforts to have its position presented effectively.
- The proposed Part 205 would, in sum, have a number of effects that are incompatible with an attorney’s role as an advocate. It may require advocates to come to premature conclusions on the basis of conflicting or ambiguous evidence in order to comply with the rule’s reporting and documentation requirements. It would direct advocates to act in the interests of non-client investors. It would impede an attorney’s ability to work cooperatively with lawyers representing clients with allied interests. Communications with individual defendants and witnesses essential to the discovery of facts and the discharge of the attorney’s duties as an advocate would be chilled by fear that the attorney will be obliged to report confidential discussions. In short, the advocate’s ability to assess the merits of a defense on the basis of candid client communications and aggressively present the client’s positions would be severely impaired.
In view of what is said above, we respectfully urge that the following changes be made to the proposed Part 205:
- Remove the reference to shareholders from Section 205.3(a).
- Remove Section 205.3(d) and the references to it in Section 205.5(d). At most, replace the those provisions with a requirement that if an attorney determines that an ongoing or future transaction involves a material violation of the securities laws, the attorney must take all reasonable steps to ensure that the client will not use (or will not continue to use) any opinion or other document that purports to express or describe views of the attorney or otherwise associates the attorney with the transaction.
- Remove all references in Part 205 to whether provisions of Part 205 breach or waive the attorney-client privilege or other client privileges or otherwise violate state ethical standards.
- Remove Sections 205.3(b)(2) and 205.3(b)(8) and any other provisions that require attorneys to document communications with clients or clients’ responses.
- Revise Section 205.2(e) to define "evidence of a material violation" to mean facts known by the attorney that lead the attorney to believe that a material violation has occurred, is occurring, or is about to occur, or that would cause the attorney to be clearly unreasonable in not believing that a material violation has occurred, is occurring, or is about to occur.
- Limit Section 205.2(a)(4) to attorneys who participate in a material way in the preparation of documents filed with, or submitted to, the Commissioners, the Commission or its staff.
- Modify Section 205.2(d) to define breach of fiduciary duty as a breach of fiduciary duty recognized at common law or arising under an applicable state statute relating to governance of corporations or similar entities, regarding fiduciary obligations of directors or officers of companies (or persons performing similar functions) to the companies or to the owners of the companies.
- Eliminate the concept of a qualified legal compliance committee, and replace it with the concept of a Board committee consisting entirely of independent directors to whom attorneys retained by the company, or attorneys employed by the company, could report evidence of material violations and which would be responsible for recommending to the Board of Directors steps that should be taken with regard to those material violations. Because of the change in functions of the committee, reporting to the committee should not relieve an attorney of any other obligations the attorney may have under Part 205.
- Remove Section 205.5(d).
- Add a new provision to Part 205, stating that (a) the Commission will have exclusive jurisdiction to enforce, or impose sanctions for violations of, Part 205 and (b) there will be no private right of action for violations of Part 205 or of Section 307 of the SOX Act.
- Revise Section 205.2(a) to, at the very least, state that "appearing and practicing before the Commission" does not include representing or advising clients in litigation against the Commission.
- Modify Section 205.3(b) to state that an attorney who is representing a client in connection with a Commission investigation or any other governmental investigation or adversarial proceeding need not report evidence of a material violation obtained by the attorney if the attorney believes that doing so would impair the attorney’s ability to gather relevant facts or to be an effective advocate for the client.
We have made no comments in this letter regarding the special concerns that would be raised by application of proposed Part 205 to non-U.S. lawyers or to U.S. lawyers who practice law in countries other than the U.S. As noted above, Clifford Chance is submitting those comments in a separate letter.
We appreciate the opportunity to submit comments regarding proposed Part 205.
Very truly yours,