Anthony J. Horan
Office of the Secretary
December 20, 2002
Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549-0609
Attention: Mr. Jonathan Katz,
Re: File No. 33-8150.wp
Ladies and Gentlemen:
J.P. Morgan Chase & Co. ("JPMC") is pleased to have this opportunity to comment on the Commission's proposed Rule 205 (the "Proposed Rule"). The Proposed Rule establishes standards of professional conduct for attorneys appearing and practicing before the Commission on behalf of issuers, as required by Section 307 of the Sarbanes-Oxley Act of 2002 ("Section 307"). JPMC and its subsidiaries are interested in mechanisms for promoting compliance with securities laws on many levels. JPMC is an issuer of securities; many of its subsidiaries are users of the financial statements of public companies; and certain of its subsidiaries are regulated companies referred to in the preamble to the Proposed Rule (the "Preamble"), including an adviser to registered investment companies and an underwriter and dealer in securities.
JPMC supports the stated goal of Section 307, i.e. to require an attorney to report evidence of a material violation of securities law or breach of fiduciary duty to the chief legal officer ("CLO") or chief executive officer ("CEO") of a public company, and, if the CLO or CEO does not respond appropriately, to report the evidence to the Board of Directors of the company or an appropriate committee of the Board. Our corporate rules of conduct obligate all of our employees worldwide to report violations of laws or regulations to the Legal and Compliance Department, and to report matters involving fraudulent acts, including personal dishonesty by an employee, to the Fraud Prevention and Investigation Unit of our General Auditing Department. If it seems that an official at a high level of the firm is involved, the employee is required to advise our General Auditing Department. We believe that a robust internal reporting requirement is a key tool in ensuring that our company remains in compliance with applicable law.
We have a number of comments, however, on specific provisions of the Proposed Rule, which we hope the Commission will consider. We are also aware that many bar associations and trade associations are commenting on such issues as the effect of the rule on the authority of the Board of Directors to determine the best interests of the corporation, the effect of the rule on foreign attorneys, whether a rule of the Commission that exceeds the Congressional mandates for an "up-the-ladder" reporting requirement can preempt state ethical requirements adopted by the courts of each state, and whether an interpretation by the Commission of attorney-client privilege can preempt state law requirements of attorney client privilege or supersede the Federal Rules of Evidence. Consequently, we will focus in this letter principally on issues of interest to corporations and their in-house lawyers.
Rule 205.3, captioned "Issuer as client", states that an attorney appearing and practicing before the Commission in the representation of an issuer represents "the issuer as an organization and shall act in the best interest of the issuer and its shareholders". We agree completely that a lawyer for a corporation represents the corporation. We believe, however, that the statement that such lawyer must act in the best interest of both the issuer and its shareholders introduces confusion and should be deleted.
The lawyer ethics codes have long recognized that corporate lawyers' responsibilities are to their corporate clients, and not to any constituency of those clients, including officers, directors or shareholders. See NY EC 5-18 ("A lawyer employed or retained by a corporation or similar entity owes allegiance to the entity and not to a shareholder, director, officer, employee, representative, or other person connected with the entity.")(emphasis added); MR 1.13 ("A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents.")1
Indeed, it may be impossible for a lawyer to determine what is in the "best interest" of the corporation's shareholders, since shareholders may have differing interests. Some will have long-term economic interests, others will have much shorter-term interests. Ultimately, most corporate laws assign responsibility to the Board of Directors to determine what constitutes the best interests of the corporate entity. See, e.g. Delaware General Corporation Law, Section 141; N.Y. Business Corporation Law Section 701 (A corporation shall be managed by its board of directors). We do not believe it is the place of the corporation's lawyers to second-guess the reasonable business judgment of the directors of the corporation.
Section 307 clearly directs the Commission to adopt rules regarding the reporting of violations of securities law and breaches of fiduciary duty "up-the-ladder" within the corporation, i.e. to the CLO, the CEO and the Board of Directors or a committee of the Board.
Section 205.3 in two different circumstances would require a lawyer to disclose or signal information outside the corporation. First, Section 205.3(b)(3) requires the CLO who determines that a violation has occurred to take any necessary steps to ensure that the issuer adopts appropriate remedial measures including appropriate disclosures, and/or imposes sanctions and/or rectifies any material violation. Moreover, if the issuer fails in any material respect to take any remedial measure recommended by a qualified legal compliance committee, then the CLO must notify the Commission that a material violation has occurred and disaffirm in writing any documents that the issuer has submitted to or filed with the Commission that the CLO believes are false or materially misleading. Second, Section 205.3(d) requires a reporting lawyer to engage in a noisy withdrawal from representation or noisy withdrawal of opinions and representations and documents filed with the Commission.
Even though the standards for these "over-the-ladder" disclosures or signals are higher than the standards for disclosure within the corporation, we believe that these provisions of the proposed rule are unwarranted by Section 307. They go beyond the express language of the statute and the legislative history. They would significantly change the responsibilities of corporate lawyers, giving them responsibilities to the Commission that are far beyond the professional obligations given to lawyers under the lawyer ethical codes. They would undermine the relationship between corporate lawyers and their clients and, ultimately, risk having lawyers excluded from participation in the very deliberations where their presence can ensure compliance with law and fiduciary principles. Finally, if applied to lawyers hired to defend a corporation from a charge or civil or criminal wrongdoing, they might deprive the corporation of the effective assistance of counsel in demonstrating compliance with the law.
a. An up-the-ladder reporting requirement is consistent with the lawyer codes of professional responsibility. The attorney-client relationship in the U.S. is based on open communication, fostered by the obligation of the lawyer to protect the client's confidences. See, e.g. NY EC 4-1:
"Both the fiduciary relationship existing between lawyer and client and the proper function of the legal system require the preservation by the lawyer of confidences and secrets of one who has employed or sought to employ the lawyer. A client must feel free to discuss anything with his or her lawyer and a lawyer must be equally free to obtain information beyond that volunteered by the client. A lawyer should be fully informed of all the facts of the matter being handled in order for the client to obtain the full advantage of our legal system. . . . The observance of the ethical obligation of a lawyer to hold inviolate the confidences and secrets of a client not only facilitates the full development of facts essential to proper representation of the client but also encourages non-lawyers to seek early legal assistance."
See also MR 1.6, Comment 2:
"A fundamental principle in the client-lawyer relationship is that, in the absence of the client's informed consent, the lawyer must not reveal information relating to the representation. . . . This contributes to the trust that is the hallmark of the client-lawyer relationship. The client is thereby encouraged to seek legal assistance and to communicate fully and frankly with the lawyer even as to embarrassing or legally damaging subject matter. The lawyer needs this information to represent the client effectively and, if necessary, to advise the client to refrain from wrongful conduct. Almost without exception, clients come to lawyers in order to determine their rights and what is, in the complex of laws and regulations, deemed to be legal and correct. Based upon experience, lawyers know that almost all clients follow the advice given, and the law is upheld."
As the Commission notes in the Preamble, corporate lawyers' responsibilities are to their corporate clients, and not to any constituency of those clients, including officers, directors or shareholders. See NY EC 5-18, MR 1.13 (quoted above). An up-the-ladder reporting requirement is entirely consistent with this traditional view of lawyer responsibilities.
b. The statute and legislative history in no way suggest that the Commission should require reports outside the company. The language of Section 307 clearly requires a lawyer to report evidence of misconduct by the corporation or any agent thereof (1) to the CLO or the CEO , and (2) if they do not respond appropriately, to the audit committee of the Board or another committee of the Board comprised solely of independent directors. It does not contemplate reporting outside the company. The legislative history is to the same effect. As Senator Edwards described the reporting requirement, "It is basically going up the ladder, up the chain of command. . . . You report the violation. If the violation isn't addressed properly, then you go to the board." 148 Cong. Record at S6552. Senator Enzi concurred: "When their counsel and advice is sought, attorneys should have an explicit, not just an implied, duty to advise the primary officer and then, if necessary, the auditing committee or the board of directors of any serious legal violation of the law by a corporate agent. . . . It is all within the corporation. . . . The amendment that I am supporting would not require the attorneys to report violations to the SEC, only to corporate legal counsel or the CEO, and ultimately, to the board of directors." Id. at S6555. Senator Corzine's interpretation of the amendment that added Section 307 was the same: "When lawyers know of illegal actions by a corporate agent, they should be required to report the violation to the corporation. . . . [W]e need to ensure that lawyers who know of illegal acts report those acts to the board of directors which represent those shareholders." Id. At S6556.
There is no indication in the legislative history that Congress expected lawyers to make disclosures outside the corporation. Given the serious effect that such disclosure would have on the attorney-client relationship, we believe the Commission should refrain from adopting such an outside-the-corporation disclosure requirement.
c. The provisions of Rule 205.3(d)(2) authorizing or requiring disclosure of confidential information outside the corporation go beyond what is permitted under the attorney ethics codes, which were designed to balance the desire for compliance with law with the objective of encouraging clients to consult with lawyers.
Under the Proposed Rule, if the lawyer has reported evidence of a material violation that occurred in the past and is likely to have resulted in substantial injury to the financial interest of investors, and the lawyer does not receive an "appropriate response", he or she is permitted to make certain disclosures outside the corporation. If the lawyer is a retained attorney he or she may (i) withdraw and (ii) notify that Commission that the withdrawal was "based on professional considerations", and disaffirm to the Commission any opinion, document, affirmation, representation, characterization or the like in a document filed with the Commission that the attorney has prepared or assisted in preparing. If the lawyer is an employed attorney, he or she may notify the Commission that he or she disaffirms any such opinion, representation or document that the attorney prepared or assisted in preparing. If the violation reported by the lawyer is not past, but rather continuing or future, the "noisy withdrawal" provision is not permissive, but mandatory.
By contrast, under the Code of Professional Responsibility in New York, a lawyer may reveal the intention of the client to commit a crime and the information necessary to prevent the crime. NY DR 4-101(C)(3). Revelation of non-criminal violations of law is not permitted. See, Wolfram, Modern Legal Ethics, Section 12.6 at 669 (West 1986) ("The quoted permission to disclose applies only to a client "crime" and not to an injurious client act that violates no criminal law. . . .").
In general, lawyers are not permitted under the lawyer ethics codes to reveal client confidences that relate to past conduct of the client where disclosure would be detrimental to the client. See, e.g. NY DR 7-102(B)(1) ("A lawyer who receives information clearly establishing that the client has, in the course of the representation, perpetrated a fraud upon a person . . . shall promptly call upon the client to rectify the same, and if the client refuses or is unable to do so, the lawyer shall reveal the fraud to the affected person . . . except when the information is protected as a confidence or secret." (emphasis supplied); MR 4.1 ("In the course of representing a client a lawyer shall not knowingly fail to disclose a material fact when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client, unless disclosure is prohibited by Rule 1.6.")
The so-called "noisy withdrawal" exception has existed in New York since 1990. See NY DR 4-101(C)(5). It is based on a comment to the MR 1.6 of the 1983 ABA Model Rules, and allows a lawyer to reveal client confidences or secrets to the extent "implicit in withdrawing a written or oral opinion or representation previously given by the lawyer and believed by the lawyer still to be relied upon by a third person where the lawyer has discovered that the opinion or representation was based on materially inaccurate information or is being used to further a crime or fraud." (emphasis added). See also current MR 1.6, comment 14, which states that a lawyer who withdraws from representation to avoid his or her services being used in furthering criminal or fraudulent conduct may give notice of the fact of withdrawal and may disaffirm any opinion, document, affirmation or the like.
The purpose of the "noisy withdrawal" provision is not to allow the lawyer to "signal" a problem at the client that the lawyer is prohibited from disclosing directly. It is to allow a lawyer whose services have been misused by the client to perpetrate a crime or fraud to disassociate himself or herself from the crime or fraud when a quiet withdrawal from the representation is insufficient because third parties are relying on a statement or opinion given by the lawyer. See, e.g. New York State Bar Association, Report of the Special Committee to Consider Adoption of ABA Model Rules of Professional Conduct (December 14, 1984) at 22 (explanation of change to Rule 1.6(b)(3).
Consequently, we believe that any requirement for disaffirmance should be limited to opinions and representations of the lawyer and documents that are so clearly associated with the lawyer, that readers will assume that the lawyer has assured their accuracy, e.g. opinions or filings signed by the lawyer.
d.The over-the-ladder reporting responsibility will deter corporate officers from discussing difficult issues with their lawyers.
The Commission staff indicated in the "Costs" section of the Preamble that, there is no data to suggest that the rule would create such an incentive. In the absence of data, which we believe would be extremely difficult if not impossible to gather, we urge the Commission to give weight to the judgment of practitioners that the proposed change would in fact have a deterrent effect.
Lawyers are most effective when they are perceived to be working for the good of the corporation. If Rule 205 is adopted as proposed, and lawyers are viewed as having a personal interest in reporting evidence that a violation of securities law or fiduciary duty has occurred or is continuing, even when the lawyer does not have enough evidence to be reasonably certain of a violation, it is likely that lawyers will only be consulted as to proposed future conduct, and then only when the law is clear. As the Commission stated in In re Carter and Johnson, "Lawyers who are seen by their clients as being motivated by fears for their personal liability will not be consulted in difficult issues."
If the Commission determines to retain the requirements to disaffirm certain documents, we believe the standard should be the same for all lawyers, including the CLO, and that the standard should be that the lawyer reasonably believes that the document is materially false or misleading. The Proposed Rule currently requires a reporting lawyer other than the CLO to disaffirm a document if he or she reasonably believes the document is or may be materially false or misleading. Disaffirming a document filed on behalf of an issuer is a step with serious consequences for the issuer. The reasonable belief standard gives the lawyer sufficient latitude to take action without being absolutely certain of a problem. A lawyer should not be entitled to disaffirm a document if he or she merely believes that the document may be materially false or misleading.
Finally, there are minor word changes in the disclosure and disaffirmation provisions as applied to the CLO and reporting lawyers that we believe should be conformed to avoid unintended differences in meaning. For example, the definition of "appropriate response" in Rule 205.2(b) and the obligations of the CLO who believes that a material violation has occurred contain similar lists of remedies. However, there are small differences in the language of these sections that have no apparent justification. Similarly, if the issuer fails to respond appropriately to a report of a material violation, the CLO must disaffirm documents that the CLO reasonably believes are "false or materially misleading". However, a reporting lawyer other than the CLO must disaffirm any document the attorney reasonably believes is or may be "materially false or misleading". There does not seem to be a good reason to have the adjective "materially" apply differently. Compare Rules 205.3(b)(3)(are false or materially misleading), 205.2(j)(5) (is false or materially misleading) and 205.3(b)(3) (are false or materially misleading) with Sections 205.3(d)(1)(i)(C), 205.3(D)(1)(ii)(A), 205.3(d)(2)(i)(C), 205.3(d)(2)(ii)(A), and 205.3(d)(4)(all of which use "is or may be materially false or misleading").
We believe the Commission's definitions of "appearing and practicing before the Commission" and "in the representation of an issuer" are far too broad, and should be limited to lawyers who are retained or employed to give legal advice to the issuer and who participate in the drafting of documents that will be filed with the Commission as part of disclosure documents.
a. The definition should not include persons admitted to practice law but who are not retained or employed to give legal advice to the issuer. The Commission's proposed definition includes anyone who is admitted to practice law, even if they not retained or employed to give legal advice to the issuer, including business persons who happen to be admitted to practice. This broad definition presents a serious problem for chief legal officers of large corporations which may employ as business people many persons who were trained as lawyers. Many such firms (our among them) have adopted a policy that only lawyers who report to the General Counsel are authorized to practice law on behalf of the corporation. This includes lawyers in the Legal Department and outside counsel hired by the Legal Department. We believe this is the only way to ensure that legal decisions are made in accordance with corporate legal policy, as set by the General Counsel. We believe that any decision by the Commission to consider anyone admitted to a bar as a lawyer "appearing and practicing before the Commission in the representation of an issuer" would not only be factually incorrect and contrary to the common understanding of the terms "practicing" and "representation", but would also undermine the proper organization of legal affairs within a Corporation. In addition, since those persons do not have an attorney-client relationship with the issuer, any reports they make to the CLO and the records of such reports that they keep would not be subject to the attorney-client privilege under state law or the ethical privilege. The attorney client privilege generally requires that legal advice be sought from a legal adviser in his or her capacity as such. See 8 Wigmore, Evidence Section 2292 (McNaughton rev. 1961); the ethical privilege applies to information gained in or relating to a professional relationship. See NY DR 4-101(A), MR 1.6.
b. The definition should not include lawyers who represent the issuer in negotiating contracts that must be filed as material contracts. The Commission should only apply Section 205 to lawyers who have reason to know that they are subject to them. A lawyer who represents the issuer or one of its subsidiaries in drafting contracts may have no reason to know that any particular contract will be deemed a material contract that is required under Regulation S-K to be filed as an exhibit to a registration statement or an Exchange Act report. Given that the Proposed Rule's "over-the-ladder" requirements go significantly beyond ethical requirements regarding the reporting of misconduct, and the serious ramifications of failure to comply with the Proposed Rules, we believe the application of the Proposed Rules should be limited to persons who have no reason to question whether they are covered.
c. "Transacting business with the Commission" should not include lawyers who comment on proposed rules of the Commission. The definition of transacting business with the Commission includes anyone who communicates with the Commission. We believe that communications that involve only commenting on proposed rules of the Commission should be excluded. The right to petition the government is guaranteed by the First Amendment to the Constitution. We believe that lawyers should have the same rights as all other citizens to petition their government, without fear of incurring special responsibilities as "attorneys appearing and practicing before the Commission".
d. The definition of "representation of issuers" should apply only to lawyers with an attorney-client relationship with the issuer. An attorney-client relationship is formed when a person manifests the intent that the lawyer provide legal services and the lawyer manifests his or her consent to do so. See Restatement of the Law (Third), The Law Governing Lawyers, Section 14 (American Law Institute 1998). In contrast, the Proposed Rule defines "in the representation of an "issuer" as "acting in any way on behalf, at the behest, or for the benefit of an issuer, whether or not employed or retained by the issuer." This language is far too broad to the extent that it reaches representation "at the behest" of an issuer or "in any way for the benefit" of the issuer where there is no attorney client relationship with the issuer.
The Commission appears to be concerned with ensuring that lawyers who are paid by a third party to provide legal services to an issuer be included within the ambit of the rule. Such relationships, however, are already included within the common understanding of an attorney-client relationship. See, e.g. MR 1.8(f), NY DR 5-107(A) and (B). The relationship is well described by comment 11 to MR 1.8: "Lawyers are frequently asked to represent a client under circumstances in which a third person will compensate the lawyer, in whole or in part. . . . Because third-party payers frequently have interests that differ from those of the client . . . lawyers are prohibited from accepting or continuing such representations unless the lawyer determines that there will be no interference with the lawyer's independent professional judgment and there is informed consent from the client."
Underwriters' counsel in an underwriting for an investment-grade issuer is often designated by the issuer and paid from the proceeds of the securities sold by the issuer. However, such counsel has an attorney-client relationship only with the underwriters and should not be deemed to be representing the issuer, despite the fact that they may be acting "at the behest" of the issuer.
Similarly, there are many circumstances in which counsel for one party to a transaction, in performing services for his or her own client, may also confer a benefit on another party to the transaction. For example, counsel to an underwriter may confer benefits on the issuer. However, these services are not rendered for the benefit of the other party, but rather for the benefit of the lawyer's own client. Moreover, in-house counsel are legally prohibited by the laws of most states from providing legal services to persons other than their corporate employers because a corporation (other than a professional corporation of lawyers) is prohibited from practicing law. See, e.g. New York Judiciary Law Section 495 (Although a corporation may employ an attorney "in and about its own immediate affairs", no corporation may "render legal services or advice, nor . . . furnish attorneys or counsel"). Consequently, no lawyer should be deemed to be appearing and practicing before the Commission in the representation of an issuer other than his or her own client.
Section 307 requires the Commission to adopt a rule requiring an attorney 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". We believe that (i) violations of securities law should be limited to Federal securities law, (ii) "breach of fiduciary duty" should be interpreted as breaches by corporate officers and agents of common law fiduciary duties to the issuer, and (iii) "similar violations" should be interpreted as violations of state law that impose on corporate officers, directors and agents duties to the corporation that are similar to common law fiduciary duties.
Limiting the definition of securities law to violation of Federal securities law would be consistent with the legislative history. Senator Enzi stated: "This amendment is designed to assure that attorneys are responsible for fully informing their corporate clients of evidence of material violations of Federal securities law." See 148 Cong. Record at S6554.
The proposed definition of "breach of fiduciary duty" includes any breach of fiduciary duty recognized at common law, including misfeasance, nonfeasance, abdication of duty, abuse of trust and approval of unlawful transactions." We believe the legislative history indicates that Congress intended the reporting obligation to apply to breaches of fiduciary duty where the duty was owed to the issuer. The Congressional hearings on Sarbanes-Oxley were a direct result of corporate scandals in which corporate officers and directors engaged in self-dealing that adversely affected the corporations to which they owed their loyalty. These scandals included corporate officers purchasing and dealing with corporate assets or receiving large corporate loans for personal purposes. See, e.g. Statement of Senator Enzi ("Over the past few months, Congress and the public have concentrated on the role of accountants and auditors involved in Enron, WorldCom, Global Crossing, and others. We have held hearings and drafted legislation intended to restore a high level of ethical behavior to corporate America.") 148 Cong. Record at S6554.
Rule 205.3(b) triggers the reporting obligation when an attorney who "appears and practices" becomes aware of "evidence of a material violation." The definition of "evidence of a material violation" in Rule 205.2(e) is "information that would lead an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur". The Preamble notes that the reporting obligation is objective rather than subjective, and exists even where the reporting attorney "does not personally believe that a material violation has occurred, is occurring, or is about to occur." We believe an attorney should not have a reporting obligation unless he or she believes the evidence is both credible and sufficient to establish a prima facie case of violation, i.e. evidence, which, if not explained, rebutted or contradicted, would support the conclusion that a violation has occurred, is occurring or will occur. This is particularly important if the reporting lawyer will make a record of the report. The reporting lawyer should be able to reach a legal conclusion of a violation, so that the report will constitute legal advice, and not merely facts or allegations.
If a reporting attorney reasonably believes that the CLO or CEO has not provided an "appropriate response", the reporting attorney is required by Rule 205.3(b)(4) to report the evidence to the audit committee of the Board of Directors. Rule 205.2(b) defines "appropriate response" as a response that provides a basis for the reporting attorney to believe either that no material violation is occurring, has occurred or is about to occur, or that the issuer has, as necessary, adopted remedial measures, including appropriate disclosures, "and/or" imposed sanctions that can be expected to stop any material violation "and/or" rectified any material violation that has already occurred. The use of the term "and/or" indicates that, if the CLO agrees that a material violation exists, then any one of the proposed actions would suffice.
Because the term "and/or" is inherently confusing, we believe that "and/or" should be clarified. In addition, the term "rectification" should be explained. It is not clear whether the term should be read to contemplate restitution to injured parties. We do not believe that Congress intended to impose on attorneys an obligation to require their corporate clients to make monetary restitution to third parties or to determine whether the amount of any such restitution is appropriate. The question of disclosure of client confidential information for the purpose of rectification has been extremely controversial. Although the Preamble states that nearly forty states have adopted the recommendation of the Kutak Commission to permit disclosure of confidential information to the extent necessary to rectify the consequences of a criminal or fraudulent act in which the attorney's services were used2, according to a leading ethics textbook, only six states have adopted such a provision.3
In addition, since it is possible that two reasonable lawyers could reach different conclusions about the adequacy of the corporation's response to a report of a material violation, we believe the Rule should include a provision similar to MR 5.2 and NY DR 1-104(F) that the reporting lawyer, whether an outside attorney or in-house counsel does not violate Rule 205 if he or she accepts the CLO's reasonable resolution of an arguable question of fact or law. Reasonable lawyers may disagree about many aspects of securities law or fiduciary duty, and a reporting lawyer should not be obligated to take an issue to the Board of Directors where there is a genuine disagreement over an arguable question.
As noted above in Section 3, we do not believe that persons who happen to have licenses to practice law, but who do not report to the CLO should be deemed to be "appearing and practicing" before the Commission in the representation of a client. If the Commission determines that the rule should cover such persons, we believe it should clarify whether lawyers in the Legal Department, including the CLO, are supervisory lawyers with respect to such persons. It appears from the language of Rule 205.4 that the Commission does not consider the CLO to be the "supervisory attorney" for persons who happen to be lawyers but who do not report to the Legal Department. This is entirely appropriate since the CLO neither supervises nor directs such persons. However, confirmation of this conclusion in the Preamble to the final rule would be useful. Thus, the CLO is not required to "make reasonable efforts to ensure" that such persons confirm to Part 205 and comply with the statutes and other rules administered by the Commission. Although it is not clear how the Commission expects lawyers acting as business people to become familiar with the obligations the Commission has imposed on them, it would be quite burdensome for the CLO to (i) catalogue every person in a large corporation who holds a license to practice law, (ii) train such persons in their responsibilities under the Act, and (iii) make reasonable efforts to ensure that such persons conform to Rule 205 and comply with the statutes and other rules administered by the Commission.
The definition of "report" in Rule 205.2(m) is "to make known to directly". The Preamble makes clear that an attorney who is obligated to report evidence of a material violation must do so directly to the CLO or CEO rather than indirectly. We believe the Rule should allow a CLO to designate a person or persons whose responsibility would be to receive reports in the first instance, to investigate and to make a recommendation to the CLO as to whether a material violation exists or will occur and what remedial steps should be taken. We see no benefit in having the reports go directly to the CLO who then, in accordance with Rule 205.3(b)(3), may "cause such inquiry into the evidence . . . as he or she reasonably believes is necessary to determine whether the material violation described in the report has occurred, is occurring or is about to occur." This will be especially important for issuers who wish to encourage their lawyers to make a report wherever there is any colorable evidence of a violation.
We have serious concerns about whether the requirement in Rule 205.3(b)(2) that the reporting lawyer maintain a copy of a report will effect a waiver of the attorney-client privilege and the duty to maintain client confidences under the lawyer ethical codes. This will be particularly true if the information necessary to trigger a report by the reporting lawyer does not rise to the level of a legal conclusion that there has been a violation of law or fiduciary duty, but only constitutes a recitation of facts that constitute some evidence of such a violation. We do not believe the Commission should require the maintenance of any record that might not be subject to the attorney-client privilege or work product doctrines under applicable law. We understand, moreover, that there is some case law that indicates that, if a document is required by law to be maintained, it is not subject to the attorney-client privilege. We urge the Commission not to take any action that might undermine the attorney-client privilege.
In the Preamble discussion of Section 205.6, the Commission notes that it has not established a "safe harbor" provision within the rule similar to Section 10A(3)(c) of the Exchange Act, which proscribes private suits against auditors for statements or conclusions expressed in notices to the Commission mandated by Section 10A(b)(3). The Commission asks whether it should include a similar provision within the proposed rule prohibiting private actions challenging an attorney's decision to take, or not to take, action under the proposed rule, when taken in good faith. We believe such a provision would be consistent with the legislative history (as noted in footnote 81 to the Proposal), as well as the lawyer codes. See, e.g. NY EC 4-7.
* * * * *
We understand that the Commission has been directed by Congress to publish rules under Section 307 by January 26, 2003. We believe that, in recognition of the major changes that some of the Commission's proposals would have on the nature of the attorney-client relationship, the Commission should not promulgate by the statutory deadline of January 26, 2003 any requirement for corporate lawyers to make disclosures or implicit disclosures outside the corporation. We believe that continued comment by the bar will ultimately result in a rule that fulfills the goal of enabling lawyers to participate fully in corporate decision-making so that they are in a position to counsel compliance with law and fiduciary duty.
Very truly yours,
1 References to the ethical considerations (EC) and disciplinary rules (DR) of the New York Code of Professional Responsibility are to the Code as currently in effect. References to the Model Rules (MR) are to the ABA Model Rules of Professional Conduct, as amended through February 5, 2002, i.e. the final product of the ABA Ethics 2000 Commission.
2 Footnote 63 indicates that 18 states have adopted such a provision.
3 See Gillers & Simon, Regulation of Lawyers: Statutes and Standards (2001), which identifies Connecticut, Pennsylvania, Maryland, Michigan, New Jersey and Wisconsin as the only states that permit lawyers to reveal client confidential information "to rectify the consequences of a client's criminal or fraudulent act in the furtherance of which the lawyer's services were used" or words to that effect