Boston Bar Association
16 Beacon Street
Boston, MA 02108
Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
December 18, 2002
Re: Release No. 33-8150.wp; File No. S7-45-02
Dear Secretary Katz:
The Boston Bar Association (BBA) welcomes the Sarbanes-Oxley Act's attempt to address the conduct of securities lawyers in its efforts to restore investor confidence in the nation's securities markets. The BBA also endorses, with a few important exceptions, proposed Commission rules implementing the Act. We support rules encouraging lawyers representing public entities to safeguard the interests of organizational clients (and the shareholder owners of those clients) by requiring counsel to be alert to corporate misconduct and to take preventive or remedial action in response to wrongdoing by constituents of client organizations. The Commission has invited commentary on the rules proposed in Release 33-8150, and this letter responds to that invitation in four discrete areas.
We also note, before reaching our substantive comments, that the time frame for responding to these significant rules and commentary has been painfully short, and has made it difficult to give them the kind of careful and comprehensive scrutiny they deserve. Please accept our comments with that limitation in mind. While we recognize that the time constraints to some extent have been dictated by Congress, we urge the Commission to continue the dialogue with the organized bar concerning these rules, even after they are promulgated.
Summary of Recommendations. First, the BBA opposes the mandatory "noisy withdrawal" provisions included in the proposed rules. The Sarbanes-Oxley legislation did not require any reporting by lawyers outside of the organization, and the obligation upon lawyers to do so that is inherent in mandatory "noisy" withdrawal represents a dramatic change in lawyers' responsibilities and a serious blow to an attorney's ability to represent organizational clients effectively.
Second, the BBA recommends that the Commission make clearer and more explicit the kind of knowledge necessary to trigger both the "up the ladder" reporting as well as the "noisy withdrawal" mandate. In doing so, the Commission ought to make much more clear the understanding, implicit in the rules, that a lawyer will not have violated the act unless the lawyer has the kind of knowledge of reliable facts which, at the time in question, would lead a reasonable lawyer familiar with securities law to conclude, and not merely suspect, that a material violation of the securities laws has occurred, is occurring, or is about to occur.
Third, the BBA asks the Commission to confirm that a lawyer who does not practice in any fashion before the Commission but whose reports to the client concerning events that might be material for securities law disclosure purposes and might trigger the client's filing or disclosure obligations is not "practicing before the Commission" for purposes of these rules simply because of such a report.
Finally, the BBA recommends that the Commission make it clear, by an addition or modification to Section 205.2 Definition (a)(5), that attorneys engaged to give advice to inside and outside counsel as individuals, i.e., to give legal advice to such individual clients regarding their personal Sarbanes-Oxley duties and responsibilities as counsel to an issuer, are not thereby deemed to be "practicing before the Commission" by undertaking such an engagement. Alternatively, the BBA urges the Commission to provide that that such advisory counsel do not themselves have any up the ladder or noisy withdrawal obligations, in contrast to those of the attorney client being advised.
We now address each of these recommendations in greater depth.
"Noisy" Withdrawal. Section 205.3(d) of the Commission's proposed rules requires any retained lawyer whose "up the ladder" reporting of material misconduct has not led to an appropriate response from higher-ups to withdraw from representation of her client and to notify the Commission that her withdrawal is "based upon professional considerations." This obligatory "noisy" withdrawal changes the responsibilities for lawyers in Massachusetts, and in most, if not all, other jurisdictions as well. The BBA recommends that the Commission remove any such mandate from its rules.
The BBA believes that a requirement of withdrawal and public, external notification of suspected wrongdoing will lead to serious difficulties for lawyers and clients alike, including erosion of the confidentiality obligation which a lawyer owes to her client, altering irrevocably the trust relationship between client constituents and the client's lawyer, and interfering in a lawyer's opportunity to counsel a representative of a client regarding good faith questions of compliance. Given that the Sarbanes-Oxley legislation does not require this dramatic step, and given the exceedingly short time frame for organizations such as ours to assess the implications of the proposals, the BBA urges the Commission to eliminate any such requirements from its rules.
The BBA further notes that the noisy withdrawal provisions as written casts too wide a net. For instance, Section 205.2(a)(2) and (3), along with Section 205.3(d)(1)(I)(A) and (B), demonstrate that the Commission intends its noisy withdrawal obligation to apply to a lawyer who has learned about a past material violation of the Act that continues to have or will have a material impact and effect, even if the lawyer in question (and her law firm) had no involvement at all in the past violation, and even if the lawyer has been engaged precisely to advise the issuer client about the past conduct. The requirement as just described will have a serious adverse effect on the goals of the proposed rules and of the Sarbanes-Oxley Act.
The concern is this: An entity whose officers uncover past, completed questionable conduct will, one assumes, desire to obtain thoughtful, independent counsel regarding the implications and legal effect of the past acts. If those organizational constituents know that the lawyer they choose may reach a conclusion that she must ultimately disclose publicly, through mandatory noisy withdrawal, a conclusion that the past acts in fact qualify as a "material violation" because they are ongoing, the constituents will be far less likely to engage counsel about the organization's responsibility. Indeed, were the organization to consult two lawyers, one of whom concludes that the past activity qualifies as a material violation involving continuing harm and one of whom concludes to the contrary, the rules as drafted likely will require the former lawyer, in the end, to report her conclusions to the Commission even if a different lawyer has offered different advice to the client. The chilling effect on organizational behavior when faced with past, completed conduct is apparent. Creating disincentives to organizations' obtaining the best legal advice, we trust, is not the Commission's goal, and to the degree that the rule as devised will have that effect, it is unwise.
Clarifying the Standard of Knowledge. Section 205.2(e) makes clear that the Commission intends to adopt an "objective," reasonable lawyer standard for triggering the obligations contemplated by the regulatory scheme. The Boston Bar Association recommends that the kind of knowledge necessary to trigger the lawyer's obligations be spelled out more clearly. In such a clarification, the Commission should confirm that a lawyer obligated to report "up the ladder" must actually be aware of reliable information which would persuade, rather than suggest to, a reasonably prudent and competent lawyer that a material violation is present, and that the reasonableness of the lawyer's belief must be measured with full consideration of the context, at the time he is making his determination, of that lawyer's actual situation. The standard should not be one of hindsight.
The gravity of this concern is apparent. Consider a lawyer who, under the proposed rules, encounters a document which, if true, would evidence a material violation of the Act. The lawyer, though, has no independent knowledge of the reliability of the document or its author. Until the lawyer is persuaded that the document accurately reports the facts, the lawyer should not be required to report, even up the ladder (although he might choose to do so). The rules as drafted imply that the lawyer has no mandatory obligation to report in such a situation, but unless clarified, the lawyer, operating defensively, may feel compelled to take steps that he otherwise would consider imprudent or inappropriate, just to be safe.
The clarification requested by the BBA does not, we believe, change the thrust of the rules. Once clarified, the rules will operate as intended, to require action by lawyers who "reasonably believe" that what is before them is evidence of a material violation.
The Status of Non-Securities Lawyers Who Report Material Adverse Information to an Issuer. The Boston Bar Association is concerned that the Rules as drafted create serious confusion concerning the status of a lawyer who provides some discrete service to an issuer but whose responsibilities to the issuer do not relate to any Commission proceeding or application of the securities laws. By one reading of Section 205.2(a)(4), that lawyer is "appearing and practicing before the Commission"; by another, more sensible reading she is not. The Commission should amend the definition in Section 205.2(a)(4) to confirm that such a lawyer is not covered by these rules.
Consider a simple and not far-fetched hypothetical:
Attorney Leslie Espinoza is a small firm lawyer practicing in Quincy, Massachusetts. Her practice is dominated by conveyancing work, and her reputation as the best real estate lawyer in town is well established. A multinational, publicly traded corporation, Empire Resources, Inc. (ERI), hires Espinoza to oversee the sale by ERI of valuable land it owns in Massachusetts. While working on the transaction, Espinoza learns that ERI's employees have disposed of toxic waste on the land in question that may trigger a potential liability that might be "material" to ERI. Espinoza reports her findings to ERI's Charlotte, NC headquarters.
Because her report might well trigger ERI's obligations under the securities laws, a strained reading of Section 205.2(a)(4) would cause Espinoza to be a lawyer "appearing and practicing before the Commission," even if she has never encountered the SEC and has little understanding of, and no experience with, the federal securities laws. That reading makes no sense, of course. It is unfair to the lawyer and would likely discourage non-securities lawyers from reporting material adverse information to their public clients. The Commission ought to clarify its rules to make that conclusion unambiguous.
Of course, Espinoza also will have to consider her own obligations under her state's ethics rules concerning notification to her client of evidence of wrongdoing, or of a breach of fiduciary duty. See ABA Model Rule 1.13(b). But to require her to comply with the mandatory, serious procedures applicable to securities lawyers would serve no independent purpose.
Definition of Appearing and Practicing Before the Commission. Section 205.2 of Release 33-8150 defines "appearing and practicing before the Commission" to include "(5) [a]dvising any 'party' that: (i) [a] statement, opinion, or other writing need not or should not be filed with or incorporated into any registration statement, notification, application, report, communication or other document filed with or submitted to the Commissioners, the Commission, or its staff; or (ii) [t]he party is not obligated to submit or file a registration statement, notification, applications, report, communications or other document with the commission or its staff." While it is not clear that the Commission intended that the term "party" to refer to anyone other than an issuer or counsel to an issuer, unless modified, or clarified, we are concerned that the word "party" may be read to comprehend counsel engaged to provide legal advice to individual securities attorneys concerning their personal duties and responsibilities under the Commission's rules in responding to evidence of material violations of the securities laws. Such a reading adds no incremental value to issuers and their shareholders. On the contrary, it will significantly reduce the likelihood that issuer's counsel will seek such advice on critical matters from special advisory counsel because the consequence of seeking such advice would be to remove from the seeking attorney the exclusive ability to respond to Sarbanes-Oxley as she or he ultimately determines, while assisted by impartial legal advice from counsel not having any responsibilities to act upon any disagreement with the final decision of the client attorney seeking the Sarbanes-Oxley advice. It would also discourage lawyers accustomed to advising securities lawyers concerning their professional responsibilities, who are often not securities lawyers themselves, from providing such impartial legal advice.
Thank you, and if you have any questions about these comments, please contact the undersigned at firstname.lastname@example.org.
Very truly yours,
Joseph L. Kociubes
Boston Bar Association