Foley & Lardner
March 20, 2003
Via E-mail - email@example.com
Securities and Exchange Commission
Re: File No. S7-45-02
Ladies and Gentlemen:
I am a partner at the Washington, D.C. office of Foley & Lardner. My practice consists largely of representing public companies and officers of public companies in connection with SEC investigations and/or internal investigations. I submit these comments on my own behalf, and not on behalf of any specific client(s).
I compliment the Commission and the staff for the substantial improvements that they made between the issuance of the proposing release and the adoption of the final Part 205. I devoted substantial time to studying the proposed rules as co-chair of the D.C. Bar task force that commented on the proposed rules and to studying the final rules in connection with speaking, writing and advising about the Part. In my opinion, the final Part 205 largely achieves the mandate set out in Part 205 and is much more clear, and much more workable, than the proposed rules.
I have strong concerns regarding both the original noisy withdrawal proposal and the proposed alternative. I recognize, however, that many other commenters will address these proposals. Accordingly, with one exception, I do not intend to address those concerns in this comment letter. The one exception is that if the Commission does adopt some form of reporting out, the Commission must clarify its definition of what it means to become aware of evidence in appearing and practicing before the Commission in the representation of an issuer (e.g., what does it mean to say that an attorney acts on behalf of, for the benefit of, or at the behest of an issuer?). It is one thing to make the internal reporting requirement ambiguous' an attorney can respond to the ambiguity by erring on the side of reporting the matter internally. It is a very different matter to make a reporting out provision dependent on such ambiguous terms.
The primary purpose of this letter is to suggest some minor adjustments in the rules that the Commission has already adopted. In general, my comments are directed at the need for greater clarity in the rules. I also address some instances in which minor adjustments would otherwise be in the public interest.
1. Commenting on SEC Filings
Section 205.2(a) defines "appearing and practicing before the Commission" to include "[p]roviding advice in respect to the United States securities laws or the Commission's rules and regulations thereunder regarding any document . . . ." In discussing this provision with colleagues, I have encountered a divergence of views as to whether this rule would include, for example, a regulatory attorney commenting on whether the risk disclosures in a proposed SEC filing fairly presented the regulatory risks confronting the company. Some believe that the rule does not include this activity at least as long as the request and the comments are not phrased in terms of "materiality." Others believe that the rules do cover this activity. No public interest is served by leaving this important question unresolved. I urge that the Commission clarify that this service is not covered. Absent such clarification, I fear that attorneys will hesitate to provide this important service.
2. Attorney-Client Relationship
Section 205.2(a)(i) provides that an attorney is not "appearing and practicing before the Commission" if the attorney is not acting "in the context of providing legal services to an issuer with whom the attorney had an attorney-client relationship." The promulgating release states:
These statements are confusing. When will an attorney be deemed to have an attorney-client relationship with an issuer even though the attorney-client privilege does not apply? What are the criteria by which legal services are distinguished from other services? What are the criteria by which "the expectations and understandings between the attorney and the issuer" control the relevant determination? For example, does this phrase include an attorney who, as a compliance officer, assists an issuer in preparing a Form BD or in gathering documents in response to an SEC subpoena?
3. Expanded Definition of Issuer
Section 205.3(a) provides that an attorney who appears and practices before the Commission in the representation of an issuer owes his or her professional and ethical duties to the issuer as an organization. This provision appears on its face to be unobjectionable. Section 205.2(h), however, states that for the purpose of defining "appearing and practicing before the Commission" and "in the representation of an issuer," the term, "issuer" includes "any person controlled by an issuer, where an attorney provides legal services to such person on behalf of, or at the behest of, or for the benefit of the issuer, regardless of whether the attorney is employed or retained by the issuer." Read in the context of this definition, Section 205.3(a) provides that an attorney owes his or her ethical duties to the issuer if the attorney represents a person controlled by an issuer for the benefit of, at the behest of, or for the benefit of the issuer. This result is deeply troubling.
I recognize the need to address the problems posed by the examples in the promulgating release (e.g., issuers of a subsidiary, especially when the legal affairs of the subsidiary are handled by the issuer's legal department or outside counsel acting under the direction and supervision of the issuer's legal department). This definition, however, sweeps too far, especially since the key terms in the extended definition are undefined and susceptible to a range of interpretations. The concept of "controlled persons" can include a number of persons other than an issuer's wholly owned subsidiaries. It can include employees, partially owned-subsidiaries and debtors. Moreover, the terms "for the benefit of," "at the behest of," and "on behalf of" are remarkably vague. I was recently at a meeting of approximately twenty securities attorneys who formed the tentative consensus (in which I did not concur) that an attorney for a controlled person acts for the benefit of the issuer if the goal of the representation would be of benefit to the issuer.
This extended definition is also troubling in the context of Section 205.3(b). Say an attorney represents the CFO of an issuer in an SEC investigation into the issuer's accounting and financial reporting. As an employee of the issuer, the CFO is arguably a person controlled by the issuer. If the attorney assists the CFO in persuasively defending his/her decisions regarding the disclosures and accounting, the issuer will likely benefit. The attorney might use this reality, among others, to persuade the issuer to advance the cost of the representation. The attorney's client, however, is the CFO (not the issuer). While I do not believe that the attorney acts in the representation of the issuer for the purpose of the part, others might differ. If I am wrong then I require more direct guidance from the Commission before I can interpret the rule as negating the duties that I owe to my clients, and denying clients of their right to effective assistance of counsel. If the others are wrong, the Commission should clarify that the attorneys still owe their duties to their clients. An attorney's ethical and professional duties should run to his client and the CFO should not be deterred from confiding in his or her attorney by the prospect that Part 205 might require the attorney to report those confidences and secrets to the issuer. Any other result would raise serious constitutional questions by potentially denying the CFO effective assistance of counsel.
4. Hearsay as Evidence of Material Violation
In discussing the definition of "evidence of a material violation" in the promulgating release, the Commission states that "an attorney is not required (or expected) to report "gossip, hearsay, [or] innuendo." Most out-of-court statements are technically hearsay. I question whether the Commission intended this statement to be taken literally and suggest that the Commission clarify its position regarding credible hearsay.
5. Definition of Material
The promulgating release states that the term, "material" should have the meaning given by the case law. The general rule that has judicially evolved for determining the materiality of particular information is whether there is a substantial likelihood that a reasonable investor would have considered the information important in making his or her investment decision and whether there is a substantial likelihood that the misstated or omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information available. Consistent with the purpose of the Section 307 of protecting investors, this suggests that a violation would not be "material" for the purpose of the rule if it has already been disclosed to investors. The Commission should clarify that the reporting requirement is not triggered if the violation was material at the time it occurred, but is no longer material by the time that the attorney becomes aware of the violation.
6. Application of Section 205.3(b)
Section 205.3(b) applies when in appearing and practicing before the Commission, an attorney becomes aware of evidence of a material violation. The Commission should clarify this requirement. This clarification should, at a minimum, provide guidance regarding the following hypotheticals:
7. Application of Section 205.3(b) to CLO's
Section 205.3(b) does not work in the context of a CLO who, in appearing and practicing before the Commission in the representation of an issuer, becomes aware of evidence of a material violation. Does the CLO have to report the evidence to himself/herself? Section 205.3(b)(1). After making an inquiry and forming the reasonable belief that there is no material violation, does the CLO have to advise himself or herself of that belief? Section 205.3(b)(2). The Commission should address the responsibilities of the CLO as the reporting attorney.
8. Protection from Liability
Section 205.6(c) attempts to provide protection against liability to attorneys for liability that might otherwise arise from an attorney attempting to comply with the Part. Many provisions of the Part are vague or require the exercise of judgment with which others might disagree (e.g., whether an attorney was appearing and practicing before the Commission in the representation of an issuer, whether evidence constitutes evidence of a material violation, whether an issuer response was timely and appropriate). At a minimum, the Section should be amended to protect attorneys from discipline and other liability if the attorney acted reasonably and in good faith; an attorney who took action in response to the requirements of the Part should be protected from liability at least as long as the attorney's conduct was reasonable and in good faith. Otherwise, attorneys will be deterred from taking action in response to the Part's requirements and unfairly exposed to liability.
In promulgating Section 205.6(c), the Commission relied on the supremacy clause and the principle that federal law trumps state law. I am a member of the Bar of the District of Columbia, which is not a state. Has the Commission considered whether it can trump the laws of the District of Columbia? If not, then to the extent that Part 205 imposes duties that conflict with D.C. law (including the D.C. Rules of Professional Conduct) then the Part unfairly subjects me and thousands of other attorneys to exposure under the laws of the District of Columbia. The Commission should consider this issue in drafting the rules, especially noisy withdrawal provisions that clearly are not mandated by Congress.
9. Supervisory Obligations of CLO
Section 205.4(b) requires supervisory attorney to "make reasonable efforts to ensure that a subordinate attorney, as defined in §205.5(a), that he or she supervises or directs conforms to" Part 205. Section 205.e(a) defines "subordinate attorney" to mean "[a]n attorney who appears and practices before the Commission in the representation of an issuer on a matter under the supervision or direction of another attorney (other than under the direct supervision or direction of the issuer's chief legal officer (or the equivalent thereof)) is a subordinate attorney." Thus, Section 205.4(b) does not impose a "reasonable efforts" obligation on a CLO with respect to her direct reports.
The Commission also needs to clarify the significance of the effective date of Part 205. It appears clear that no reporting obligation is triggered merely because an attorney in appearing and practicing before the Commission in the representation of an issuer became aware of evidence of a material violation before the effective date. What if that attorney again becomes aware of evidence of which the attorney was previously aware? What if the information previously possessed by the attorney indicated the possibility of a material violation but did not meet the definition of evidence of a material violation until the attorney became aware of additional evidence after the effective date?
Part 205 is designed to help restore confidence in the integrity of issuer disclosures. The foregoing suggestions are intended to assist the Commission in achieving that goal.
Thank you again for the opportunity to comment on the SEC standards and to suggest improvements.