December 18, 2002
Jonathan G. Katz
RE: Proposed Rules pursuant to Section 307 of the Sarbanes-Oxley Act of 2002 under File Number 33-8150.wp
Dear Mr. Katz:
I am writing to comment on the Commission's Proposed Rule for Implementation of Standards of Professional Conduct for Attorneys, 17 CFR Part 205 (the "Proposed Rules"). I appreciate the extraordinary efforts made by the Commission to prepare the Proposed Rules and the other interpretative rules required by the Sarbanes-Oxley Act (the "Act") in a compressed time period. Overall, I believe the Proposed Rules set forth a thoughtful and appropriate approach to the attorney reporting requirements mandated by the Act.
My perspective is probably quite different from that of many of the other commentators who will write regarding the Proposed Rules. I am generally aware of the broader issues that are likely to draw comment and I support the Comment Letter of December 12, 2002 written by Richard W. Painter, Visiting Professor of Law, University of Michigan Law School and Professor of Law, University of Illinois College of Law. I am writing, however, from my vantage point as someone who is deeply interested in the regulation of pension and welfare benefit plans under the Employee Retirement Income Security Act (ERISA).
As I explained in a recent article, the Act raised a number of issues for attorneys who practice employee benefit law. Dana Muir, Sarbanes-Oxley Section 307: No Mandated Disclosure of ERISA Fiduciary Breaches? 29, 49 Pension & Benefits (BNA, Dec. 10, 2002) (copy attached). The Commission addressed some of those issues in the Proposed Rules, such as whether the materiality standard would apply to fiduciary breaches as well as to securities law violations.
However, the Commission has not clearly addressed whether material violations of ERISA's fiduciary obligations would be subject to the requirements of the Proposed Rules. The Act requires reporting of a "violation of securities law or breach of fiduciary duty or similar violation . . ." In the Proposed Rules, the Commission defined breach of fiduciary duty to be "any breach of fiduciary duty recognized at common law, including, but not limited to, misfeasance, nonfeasance, abdication of duty, abuse of trust, and approval of unlawful transactions." The Proposed Rules do not contain a definition of the statutory reference to a "similar violation." This approach fails to provide attorneys who practice in the employee benefits area the guidance they require in order to understand their obligations under the Proposed Rules and the Act.
As currently drafted, it is unclear how the Proposed Rules would apply in the context of fiduciary breaches under ERISA. The Release does not explain the purpose underlying the Proposed Rule's definition of fiduciary duty. Perhaps the purpose was to establish an expansive definition that would reach all fiduciary breaches that would traditionally have been recognized at common law, whether the claims now would be brought as common law claims or under a specific statute such as ERISA. Or, perhaps the purpose was to narrow the definition to encompass only fiduciary breaches where plaintiffs can assert common law claims and to exclude all statutory claims. But, if this was the Commission's intent, the obligation of an attorney to report a "similar violation" would seem to require reporting of statutory violations such as ERISA fiduciary breaches. After all, many breaches of fiduciary duty under ERISA have counterparts in the common law, and, thus, are "similar violation[s]" to the common law violations of "misfeasance, nonfeasance, abdication of duty, abuse of trust and approval of unlawful transactions," which clearly do constitute fiduciary breaches under the Commission's definition.
If the Commission considers narrowly defining the types of fiduciary breach that would give rise to a reporting obligation, it should bear in mind two contrary indicators in the statute. First, as Professor Painter pointed out in his Comment Letter, the statute does not in any way limit its reference to "breach of fiduciary duty" and the references to "the public interest" and "protection of investors" militate for an expansive definition that would include material breaches of fiduciary obligation owed to pension plans, as well as to the participants and beneficiaries covered by those plans. Second, the Act's inclusion of "similar violations" as reporting events indicates an intent by Congress that both violations of securities law and breaches of fiduciary duty be broadly construed.
In closing, I reiterate my appreciation of the Commission's efforts to issue rules under Section 307 of the Sarbanes-Oxley Act that will enhance the protection of investors and the public.
This report was written by Dana M. Muir, Associate Professor of Business Law, University of Michigan Business School. Muir has an A.B. and J.D. from the University of Michigan, as well as an M.B.A. She is currently serving as a member of the Labor Department's ERISA Advisory Council.
Sarbanes-Oxley §307: No Mandated Disclosure of ERISA Fiduciary Breaches?
Does the Securities and Exchange Commission's recently proposed rule, ''Implementation of Standards of Professional Conduct for Attorneys'' exempt employee benefit attorneys from any obligation to report fiduciary breaches under the Employee Retirement Income Security Act?
The proposed rule1 is sure to generate a firestorm of discussion among attorneys, and employee benefit attorneys should be aware of the ways in which the proposed rule applies to them. Section 307 of Sarbanes-Oxley provides the SEC with authority to draft a rule requiring ''attorneys appearing and practicing before the Commission'' to ''report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof....''2
The statutory language posed a number of potential issues for benefit attorneys. Its reference to ''breach of fiduciary duty'' was broad enough to include ERISA fiduciary breaches in the mandated reporting requirements. Given the placement of the word ''material'' in the statute, it was not clear that an ERISA fiduciary violation would need to be material to give rise to a reporting obligation. The outcome depended on whether the word material would be read as modifying ''breach of fiduciary duty'' as well as ''violations of securities law.'' Finally, the phrase requiring reporting of ''similar violation[s]'' raised the question of what ERISA violations might be similar enough to fiduciary breaches or even to securities law violations to require disclosure as ''similar violation[s].'' For example, case law has generally established that a participant with a claim for benefits cannot also bring an ERISA claim for fiduciary breach. But, if the facts underlying the benefits claim would also suffice to establish a fiduciary breach, would the benefits claim constitute a ''similar violation'' and thus give rise to a reporting obligation?
The SEC addressed these and other questions in the recently proposed rule. First, in the definition of ''material violation,'' the Commission clarified that the materiality standard applies to all applicable violations, including fiduciary breaches and similar violations. Second, materiality is defined, as is generally true in other securities law applications, to be ''conduct or information about which a reasonable investor would want to be informed before making an investment decision.''3 Thus, a benefits-related violation that would not interest a reasonable investor need not be reported because such a violation would be immaterial. While this might seem to exempt from reporting all violations involving relatively small dollar amounts, materiality typically may be either quantitative or qualitative. If a violation with a small monetary value has implications for the credibility or integrity of management, a reasonable investor may well want to be informed of the violation before making an investment decision.
Attorneys Appearing and Practicing.
The statutory language of the Sarbanes-Oxley reporting obligation extends to ''attorneys appearing and practicing before the Commission... .'' While this language may appear to be quite narrow, it actually provides little comfort to practitioners whose work touches federal securities matters in any way. In past actions barring attorneys from SEC practice, the Commission has gone so far as to include ''render[ing] legal advice or represent[ing] a client as lawyer with respect to the federal securities laws.... .''4 The proposed rule similarly sweeps broadly in defining ''appearing or practicing before the Commission'' to include such actions as (1) participation in the preparation of any writing which the attorney would have reason to believe would be included as part of any document filed with the Commission, or (2) providing advice that information need not be included in any filed document.5
Most importantly for employee benefit attorneys, the proposed rule contains a definition of what constitutes a breach of fiduciary duty that is considerably narrower than the unrestricted language in the statute. Section 205.2(d) of the proposed rule provides that: ''Breach of fiduciary duty refers to any breach of fiduciary duty recognized at common law, including, but not limited to, misfeasance, nonfeasance, abdication of duty, abuse of trust, and approval of unlawful transactions.''6 By referring only to common law breaches, the definition appears to exclude all statutory violations such as violations of ERISA Section 404. The import, then, is that Sarbanes-Oxley does not require employee benefit attorneys to disclose ERISA fiduciary breaches.
Still, employee benefit attorneys should not rest too comfortably, at least not yet. First, the proposed rule does not define the term ''similar material violation,'' and the statute requires disclosure of similar violations. Might this be interpreted to include fiduciary breaches, including fiduciary breaches under ERISA, that are similar to those that are covered in Section 205.2(d)? After all, ''misfeasance, nonfeasance, abdication of duty, abuse of trust, and approval of unlawful transactions,''7 the common law examples cited in the definition, all have parallels in the employee benefits setting. Second, although it seems to be inconsistent with the Commission's intent, might the Section 205.2(d) definition be read to encompass any breach of fiduciary duty historically recognized by common law, including breaches with respect to trusts? Third, the question is sure to arise, at least in commentary, whether the proposed rules inappropriately narrow the statutory language.
Certainly benefits practitioners cannot afford to ignore the import of the proposed rules. The SEC made clear in its discussion that ''[t]he conduct of attorneys in practice specialties other than securities law will be covered by the proposed rule''8 where their practices fall within the definition of ''appearing and practicing'' before the Commission, and the attorney becomes aware of a material violation. Without the limitation of Section 205.2(d) of the proposed rule, however, the Sarbanes-Oxley provisions may have required reporting of ERISA fiduciary breaches in some instances, but not others. Consider the following examples.
1. Attorney W is the primary benefits attorney for Alpha Corp.'s pension plans. W worked on the conversion of Alpha's traditional defined benefit plan to a cash balance plan. During the implementation of the cash balance plan, W became aware that some of Alpha's communications with its employees about the cash balance plan were intentionally misleading. Those communications may constitute a breach of fiduciary duty under ERISA. Later, shareholders of Alpha successfully sought to include a shareholders' resolution on Alpha's annual proxy statement. That resolution calls for the reinstatement of the traditional defined benefit plan. W worked with Alpha on its response to the resolution. It would appear that W's proxy-related work would cause W to fall within the category of practicing before the SEC. Therefore, W might have had to report evidence of Alpha's potential ERISA fiduciary violation to Alpha's Chief Executive Officer or Chief Legal Counsel.
2. Attorney X filed an S-8 registration statement for securities to be granted through Beta Corp's executive stock option plan. Attorney X is aware that an agent of Beta committed a probable breach of ERISA's fiduciary obligations. That breach occurred under Beta's health care plan. The filing of the registration statement would cause X to be practicing in front of the SEC. The language of Sarbanes-Oxley appeared to require X to report evidence of the probable fiduciary breach to Beta's CEO or CLC. The fact that the fiduciary breach was totally unrelated to X's practice in front of the Commission appears to be irrelevant.
3. Attorney Y handles all of the securities-related work for Chi Corp. Attorney Z, a partner in the same law firm as Y, handles all of Chi's qualified plan work. Z does not provide Chi with any advice regarding federal securities law compliance. Z is aware of a probable breach of ERISA's fiduciary requirements by agents of Chi in the investment of plan assets. Y is unaware of this breach. Unless the SEC would impute Z's knowledge of the breach to Y or Y's appearance before the SEC to Z, neither Y nor Z appeared to have any obligation under Sarbanes-Oxley to report evidence of the fiduciary breach.
These scenarios help illustrate three potential anomalies about Sarbanes-Oxley's application to ERISA fiduciary violations. First, whether the unrestricted statutory language would have mandated disclosure of ERISA fiduciary violations would have depended largely upon whether an individual attorney practices or appears before the SEC rather than upon the severity or nature of the violation. This would have provided an incentive for practitioners to bifurcate securities and benefits practices, potentially leading to higher expenses for plans and to securities lawyers who are less knowledgeable about their clients' benefit plans.
Second, regulation of benefit plans is currently divided among DOL, IRS, and PBGC. The overlapping statutory provisions and allocation of authority creates complexities in plan compliance and reporting. DOL has general authority for interpreting ERISA's provisions on fiduciary obligations and IRS is responsible for assessing penalties for prohibited transactions. SEC enforcement of a reporting requirement for ERISA fiduciary violations would have increased the complexity and compliance costs for plans by involving one more agency in an already difficult arena. During the Nov. 6, 2002, hearing on the proposed rules, Chairman Pitt expressed his belief that reporting obligations should be limited to those that have a nexus with the SEC's shareholder protective function.
Third, at most the statutory language of Sarbanes-Oxley would have required reporting of one subset of potential ERISA violations-those involving fiduciary breach. It did not appear to reach any other violations of ERISA, such as nonpayment of benefits or interference with benefits under ERISA Section 510 unless those would constitute ''similar violation[s].'' This result does not appear to have been a considered decision on the type of violation that poses the most risk for the securities markets, investors, or plan participants. Instead, it was an arbitrary line that resulted from the application of Sarbanes-Oxley's generic language to the field of employee benefit regulation.
In sum, the statutory provisions of the Sarbanes-Oxley Act appeared to reach benefits lawyers who provide clients with securities law advice and become aware that a breach of fiduciary duty under ERISA has occurred, is occurring, or is about to occur. By excluding all but common law fiduciary breaches, the SEC appears to have exempted those ERISA violations from the definition of fiduciary duty. But, ambiguities remain and it would behoove employee benefit practitioners to follow the dialogue that Sarbanes-Oxley Section 307 and the proposed rule are sure to generate.
For more information on the proposed rule, see the SEC Web site: http://www.sec.gov/rules/proposed/33-8150.htm .
Copyright©2002 by The Bureau of National Affairs, Inc., Washington D.C.