Federated Investors, Inc.
December 18, 2002
Mr. Jonathan G. Katz
Re: Implementation of Standards of Professional Conduct for Attorneys
Dear Mr. Katz:
This letter presents the comments of Federated Investors, Inc. ("Federated")1 regarding the proposals2 of the Securities and Exchange Commission ("Commission") to implement the requirements of § 307 of the Sarbanes-Oxley Act of 2002 (the "2002 Act"). Section 307 requires the Commission to "issue rules" by January 26, 2003, setting forth "minimum standards" of professional conduct for attorneys "appearing and practicing before the Commission" in any way "in the representation of issuers." Section 307 states that these standards must include a rule mandating so-called "up the ladder reporting" by attorneys of certain matters i.e., (1) 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, to the chief legal counsel or the chief executive officer of the company (or the equivalent thereof); and (2) if the counsel or officer does not appropriately respond to the evidence, requiring the attorney to report the evidence to the audit committee of the board of directors of the issuer or to another committee of the board of directors comprised solely of directors not employed directly or indirectly by the issuer, or to the board of directors.
However, the Commission's proposals go far beyond the concepts of both "minimum standards" and up the ladder reporting in many significant respects. For example, the proposals: also require "reporting out" of certain events to the Commission; adopt an "expansive view" of who is "appearing and practicing" before the Commission;3 and include a "broad definition" of what constitutes "in the representation of an issuer."4 As the Investment Company Institute (the "ICI," whose comments on these proposals Federated strongly supports) and others have commented, in those respects and others these ambitious proposals raise a host of significant issues, which are only beginning to come to light.
For example, one of the specific points made in the ICI's comment letter on these proposals focuses on the breadth of the proposed definition of the phrase "in the representation of an issuer" as applied to the unique circumstances of an investment company. The ICI identifies major issues with the Commission's intention to treat an attorney who is employed by the investment adviser to an investment company as "jointly representing" both the adviser and the investment company (referred to in the ICI's letter as the "Joint Representation Position").
Federated shares the ICI's concerns with the Joint Representation Position. In addition to the issues raised by the ICI, we must point out that implementation of the joint representation theory will inevitably put attorneys employed by investment advisers in the untenable position of having to choose between sanctions under state law (including possible disbarment) and compliance with Part 205. Notwithstanding the somewhat conclusory discussion of this point at pages 71678-71679 of the Release, we believe that traditional notions of client representation would hold that the "in-house" attorney's only client is his employer - the investment advisory firm. Given the comprehensive nature of the regulatory scheme to which investment companies are subject, it is likely that the facts giving rise to a material violation by the investment company issuer will also involve a violation of law on the part of the adviser. Requiring the adviser's attorney to report such violations to the investment company effectively requires that attorney to violate the duties he owes to, and the privileges of, his employer/client, which could trigger severe sanctions under applicable state law. While the adviser would be free to make such a report to the investment company (and the Commission would be able to require the adviser to do so), the adviser's attorney is not. The Commission could easily spare in-house attorneys from this perilous dilemma by requiring true up the ladder reporting by them within their employer's organization.
Moreover, we also have somewhat broader, and perhaps more fundamental, concerns over the proposal to define "in the representation of an issuer" so broadly as to encompass "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" (emphasis supplied). It appears to us that, under this sweeping proposed definition, even lawyers representing a party adverse to an issuer would nonetheless often be deemed to be "representing" that issuer. Take the example of a lawyer who represents Company A in negotiating a business deal with Issuer B. Under normal circumstances, it would appear ludicrous to suggest that the lawyer also somehow "represents" Issuer B. However, under the proposal, any number of activities the lawyer undertakes in representing Company A would result in the lawyer being deemed to "represent" Issuer B as well. Thus, if Company A's lawyer renders an opinion to Issuer B in connection with the closing of the transaction, it appears that he could be deemed to have acted "at the behest" or "for the benefit" of Issuer B, notwithstanding that the lawyer's real (and, we would submit, only) client is Company A.
In our view, such a result is not only counter-intuitive and contrary to state law, it is also deeply unfair not just to the lawyer but also to Issuer B. It is unfair to the lawyer because, unless he happens to be practicing in the securities area, he would have no reason to even suspect that there might be an obligation to report certain matters to the chief legal officer of an adverse party. It is unfair to Issuer B because it is an open invitation for opponent's counsel to use the mechanisms in Part 205 to, for example, gain an unfair advantage over an issuer or harm a competitor of the client.5
These are but two examples of how proposals as aggressive and sweeping as these might have unfortunate, and unintended, consequences. In recognition of the importance of identifying, analyzing, and resolving these types of issues in a thorough and reasoned manner, and given that the Commission has acknowledged that the proposals go beyond what is required by §3076 while nevertheless providing an unreasonably short notice and comment period7, Federated urges the Commission to take the following steps:
Federated believes that by proceeding in this manner, the Commission can fulfill the statute's requirement to "issue rules" by the specified deadline, while at the same time providing the Commission, its staff, and the public with the time that is necessary to review, analyze and comment on proposals of this magnitude. Given the fundamental nature of the issues that these proposals are addressing, and the significant, and sometimes subtle, issues the proposals raise, we believe this is the only responsible course of action.
* * * * *
In conclusion, as we have done in previous letters on certain of the Commission's proposed rules under the 2002 Act, Federated again urges the Commission to remain circumspect in expanding the regulatory burdens on reporting companies (and, in this case, on affected attorneys) beyond those specifically mandated by the 2002 Act. While we would not stint at any measure reasonably designed to enhance investor confidence in the markets, financial reporting or investment companies, we expect that some of the changes wrought in the 2002 Act will do little to further this laudable goal. We therefore ask the Commission to exercise a healthy skepticism as to whether additional "expansive" regulations will realistically further the objectives of the 2002 Act.
Federated very much appreciates having the opportunity to comment on these proposals. If you would like to discuss these comments with us, please contact the undersigned by phone at (412) 288-7496 or by e-mail at firstname.lastname@example.org. Thank you very much.
cc: Paul F. Roye, Director