Schafer Law Firm
April 7, 2003
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-45-02 and Release No. 33-8186
Proposed Rule: Standards of Professional Conduct for Attorneys
Dear SEC Officials:
I comment on Release Nos. 33-8186 ("Reporting Alternatives Release"), 33-8150 ("Proposing Release"), and 33-8185 ("Adopting Release"), all relating to the new securities lawyer conduct rules at 17 CFR Part 205 ("SEC Lawyer Conduct Rules"). In the Commissioners' open meeting on January 23, 2003, Commissioner Harvey Goldschmid expressly invited comments from nonlawyers upon the reporting alternatives, and the Reporting Alternatives Release declared, "The Commission is interested especially in receiving comments from interested parties outside the legal profession." I do hope that the Commission will place the greatest weight upon the comments, though very few, from parties representing nonlawyer interests, such as those of investors and pension fund beneficiaries. I believe that all of them will support the "noisy withdrawal" proposal, as do I.
Though I have been a lawyer for 24 years, I sometimes perceive myself philosophically as "outside of the legal profession" to the extent that the recent (of the last 20 years) views of a majority of the roughly 500-member governing body of the American Bar Association ("ABA") on the role of lawyers in society (as mere mercenaries) now define their so-called "profession." Quite different views have been expressed over that period by most law professors and philosophers who have researched and written extensively about the moral decay and misdirection of the lawyer fraternity, including particularly law professors Deborah L. Rhode,1 William H. Simon,2 and co-authors Richard Zitrin and Carol M. Langford.3 But the ABA's policymakers continue to deny that lawyers have any responsibility to the public, as shown at their convention in August 2001 by their rejection of the ABA Ethics 2000 Commission's proposed public-interest exceptions to confidentiality in ABA Model Rules of Professional Conduct, Rule 1.6.
On January 9, 2003, Commissioner Paul Atkins, spoke about the proposed SEC Lawyer Conduct Rules to an audience at an Advanced ALI-ABA Course of Study. He said, "I rather doubt that additional technical rules will achieve their intended goal unless lawyers move from an overly technical approach to securities law compliance and instead adopt more of a principle-based approach that focuses on the fundamental spirit underlying the securities laws." I heartily agree with Commissioner Atkins.
I suggest that the way the Commission might achieve a principle-based approach is to change its regulatory approach from writing extraordinarily technical rules with hundreds of pages of mind-numbing commentary to instead writing, in simple and clear language, the principles to be followed and providing for strong regulatory or private enforcement and tough sanctions for noncompliance. An illustration of that principle-based approach to rulemaking is Rule 10b-5. The principle of full disclosure is stated clearly and simply, and the consequence for noncompliance is great. It's the "railroad crossing approach" to regulation - the safe course is well-marked and the cost of deviation is great, so appropriate caution is employed. That approach works better than attempting through technical regulations to address every imaginable circumstance and to define every word and phrase. The regulatory staff should not need to engage in absurd debates over the difference, if any, between "likely" and "reasonably likely."
That simple-rule approach was reflected in the ABA's early ethics rules concerning client crime and fraud. The ABA Canons of Professional Ethics as amended in 1928 included two simple rules:
Canon 37. Confidences of a Client. It is the duty of a lawyer to preserve his client's confidences. ... The announced intention of a client to commit a crime is not included within the confidences which he is bound to respect. He may properly make such disclosures as may be necessary to prevent the act or protect those against whom it is threatened.
Canon 41. Discovery of Imposition and Deception. When a lawyer discovers that some fraud or deception has been practiced, which has unjustly imposed upon the court or a party, he should endeavor to rectify it at first by advising his client, and if his client refuses to forego the advantage thus unjustly gained, he should promptly inform the injured person or his counsel, so that they may take appropriate steps.
And the ABA's 1969 Code of Professional Responsibility continued to express those two rules in clear and simple terms:
Disciplinary Rule 4-101(C). A lawyer may reveal: ...(3) The intention of his client to commit a crime and the information necessary to prevent the crime.
Disciplinary Rule 7-102(B). A lawyer who receives information clearly establishing that: (1) His client has, in the course of representation, perpetrated a fraud upon a person or tribunal shall promptly call upon the client to rectify the same, and if his client refuses or is unable to do so, he shall reveal the fraud to the affected person or tribunal.
Those simple ethics rules reflected the common law doctrine generally traced to the 1884 English case of Queen v. Cox4 that no confidentiality is due a client who uses a lawyer to further criminal or fraudulent conduct - the crime-fraud exception to confidentiality. The problem with the ABA's simple ethics rules addressing client crime and fraud was that there was no effective enforcement of them, so they were widely ignored in practice.
In 1972, the SEC changed that by suing prominent law firms and lawyer for aiding their clients' fraud in the National Student Marketing Corp. case.5 And during the 1970s, the SEC commissioners and staff publicly, though speeches and judicial and administrative proceedings, strongly took the position that, as reflected in the long-standing lawyer ethics rules, lawyers should prevent or report corporate client securities law violations or else incur liability for failing to do so. As is described in my comment letter dated December 16, 2002, on the Proposing Release, the ABA reacted by flip-flopping its ethics rules so as to shield lawyers from such liability.
Another major threat to lawyers that contributed to the ABA's flip-flop of its ethics rules concerning client crime and fraud was the 1976 Tarasoff case.6 In it, the California Supreme Court held that a professional's ethical duty of confidentiality to a client (in that case, a psychotherapist's duty to a client) did not shield him from liability for failing to reveal information to prevent the client from killing another person. Lawyers immediately recognized their personal exposure to "Tarasoff liability" for serious harm that their clients might cause to others, and so they fashioned ethics rules to counter that threat.
So the nearly absolute confidentiality provisions of the ABA's 1983 Model Rules of Professional Conduct are the result of lawyers, with a self-serving guild mentality, trying to shield themselves from liability both to agencies like the SEC and also to victims of their clients' lawlessness. While other principled defenses of "sacrosanct" confidentiality are expressed to outside interests, within the ABA's own House of Delegates the rationale that always carries the vote needed to defeat public-interest exceptions to confidentiality is the threat of liability if "the door is opened" to permit the revelations of client crime or fraud. Examples follow:
"If you begin to open the door ... then the lawyer who does not make disclosure is exposed to very serious sanctions and liability because of the charge ... that he could have made disclosure." Statement by 1983 ABA Delegate L.G. Davidson in floor debate over the Kutak Commission's proposed Model Rule 1.6.7
"[A]dopting the [rectify-fraud confidentiality exception] proposal will surely expose lawyers to liability if they fail to reveal a client confidence in circumstances a claimant contends should have prompted disclosure. Such lawyers are protected since they cannot reveal what they are prohibited from disclosing." Statement by 1991 ABA Delegate William Brennan in floor debate over the ABA Ethics Committee's re-submission of the Kutak Commission's proposed Model Rule 1.6(b)(2).8
"If this rule were adopted ... it would create significant liability exposure for counsel. In a world in which lawyers are sued with ever increasing frequency, the fact that a lawyer had the discretion to disclose confidential information, and did not, will be no defense to the claim that if the lawyer had disclosed confidential information some harm or other could have been prevented." ABA spokesman Lawrence J. Fox opposing a recommendation that Model Rule 1.6 be amended so lawyers for miscreant fiduciaries would have discretion to inform their harmed beneficiaries.9
"The liability creating effect will occur when lawyers, who no longer will have the shield of Rule 1.6's prohibition on disclosure of confidential information to explain a failure to disclose where client fraud was involved ..." By Lawrence J. Fox in his 2001 Minority Report opposing the ABA Ethics 2000 Commission Report's recommendation that lawyers be again permitted to disclose crime and fraud that a client had furthered using the lawyer's services.10
And contrary to the historical core values and traditions of the legal profession, and the very meaning of the word "profession,"11 the proponents of absolute confidentiality have been justifying it over the last 20 years by claiming that lawyers have no duty to society or the public:
"We have rejected one concept that the Kutak Commission apparently espouses, that lawyers have a general duty to do good for society that often overrides their specific duty to serve their clients." By Theodore I. Koskoff, President of the American Trial Lawyers Association, in the Preface to ATLA's alternative ethics code, The American Lawyer's Code of Conduct (1982).12
"Academics have this lofty notion that lawyers should do good for society. But I'm not buying it. I don't think we should put the lawyers in a position where they have duties to the public, except in the case of death or bodily harm." By Lawrence J. Fox, former Chair of the ABA Litigation Section and of the ABA Standing Committee on Ethics and Professional Responsibility.13
So even though in response to the Proposing Release and the Reporting Alternatives Release you have been deluged with arguments that a "noisy withdrawal" rule would go against centuries of tradition, recognize that the current "tradition" actually is only about two decades old. As I quoted in my comment letter dated December 16, 2002, on the Proposing Release, the ABA's own Statement of Policy adopted formally in August of 1975 recognized that ethical lawyers must make a "noisy withdrawal" upon their discovery of a client's clear acts of fraud in securities or other matters. To my genuine surprise, the ABA's comment letter of December 18, 2002, on the Proposing Release continues to recognize, as explained on its page 25 and footnote 15, that the interplay of its Model Rules 1.2, 1.6, and 4.1, requires a lawyer, in order to avoid assisting a client's criminal or fraudulent act upon a party (including the SEC), to withdraw and to disclose material facts to the extent their disclosureby the client was necessary to comply with law (including federal securities law).
It should be noted that, contrary to any arguments that a "noisy withdrawal" requirement would destroy the foundations of the legal system, the Tennessee State Supreme Court adopted only last August, after considerable study, its own customized version of the ABA Model Rules of Professional Conduct that includes a "noisy withdrawal" requirement in the body of its Rule 4.1.14
Other arguments against "noisy withdrawal" are easily countered. The claim is made that corporate employees, managers and officers will not be open and honest with an issuer's lawyers if they are not guaranteed absolute confidentiality. If true, then perhaps an issuer's lawyers should be forbidden to even report illegality up-the-ladder within an issuer's organization. But that argument, though made by the corporate bar in the 1970's, has been rejected and abandoned. Corporate employees, managers and officers may well have to choose between being open and honest, possibly salvaging their jobs and careers, or being secretive and dishonest, and certainly incurring job and career destroying consequences if and when the truth becomes known.
And the argument that a policy of permitting lawyers to maintain the cloak of secrecy over client crime and fraud actually enables them, through remonstrative counseling, to thwart an even greater degree of crime and fraud is pure speculation. Professor Kostant recently analyzed that argument, that he calls the "rhetoric of pervisity," saying:15
[S]ome courts ... have used the rhetoric of perversity to argue that a duty not to assist with client fraud would inevitably destroy attorney-client confidentiality and this duty would necessarily result in not less, but more client fraud. This "analysis" ignores the fact that the attorney-client privilege does not apply to communications in furtherance of a crime or fraud, that there are exceptions to an attorney's duty to protect client confidences ... and that a duty to rectify client fraud existed in most states until 1983 without dire consequences. ... Perversity rhetoric is simplistic because it makes sweeping claims without supporting empirical data. Where is the evidence that if lawyers are not required to keep client fraud confidential, clients will simply not confide in lawyers but continue to engage in fraud undeterred by their honest lawyers? By simply postulating that disclosure will result in more fraud, the perversity rhetoric ignores the possibility that clients may engage in more fraud because they could rely on strict confidentiality from lawyers who assist them with legal advice, and that clients might abandon fraudulent schemes when told that their lawyers would disclose their intended misconduct.
Law Professor William H. Simon publicly accuses the ABA of bad faith in persisting with its "preversity rhetoric" in defending its nearly absolute rule of confidentiality, saying:16
[T]he indications of bad faith in the bar's claims for confidentiality are too salient to pass over. The bar has always defended confidentiality in sloppy, cavalier, and dogmatic ways. The arguments are rarely articulated in any systematic manner (and then, usually, by their critics). These arguments depend on assumptions about behavioral trends, but the bar has never adduced any evidence for them and never shown any interest in investigating them. Although the American Bar Association supports an excellent research institution-the American Bar Foundation-to the tune of several million dollars a year, this institution has never done any work on the factual premises of the bar's most important normative pronouncement.
Notwithstanding the organized bar's unsupported arguments that absolute confidentiality is more likely than not to produce the greatest degree of compliance with the law, courts have been consistent in holding that government officials are not entitled to confidentiality when they confide in government lawyers about their lawless activities. The courts recognize that responsible public policy requires lawyers to expose governmental lawlessness.17
Claims by foreign lawyers and some U.S. lawyers that the proposed "noisy withdrawal" rule would expose them to liability or sanctions under laws or rules protecting their clients' secrets could be obviated by simply requiring that all issuers seeking to use U.S. capital markets must waive their rights under such laws or rules, and must consent in advance to their lawyers making such disclosures as might be required, under future circumstances, to comply with the SEC's rules. I note that securities lawyer Mike Liles, Jr., on behalf of Karr Tuttle Campbell, in his comment letter of March 6, 2003, on the Reporting Alternatives Release asserts that most major law firms likely will refuse to represent public companies unless they establish qualified legal compliance committees. Law firms also could refuse to represent issuers that fail in advance to consent irrevocably to the firm and its lawyers making a noisy withdrawal if future circumstances later should call for it.
In the Paperwork Reduction Act parts of the releases, you estimate that about 18,200 issuers (primarily based on the count of 2001 annual reports filed) will be affected by the SEC Lawyer Conduct Rules. I urge you to recognize that hundreds if not thousands of them (including issuers not in that count because they failed to file an annual report in 2001) may be seriously noncompliant with even the existing periodic disclosure rules, so relying upon their officers and directors to file a Form 8-K announcing their former lawyer's withdrawal is most unwise. Please consider the comment letter on the Proposing Release by lawyer Joe Drain, dated December 17, 2002. Mr. Dear's cynicism about your proposed technical rules appears based upon his real world experience in noncompliant corporate middle America. He wrote:
What does this do for one case I know of--a very small public company with equity securities registered under section 12(g) of the Securities Exchange Act of 1934, which hasn't filed a Form 10-Q since 2000, hasn't filed a proxy or information statement at least since EDGAR became operational in 1994, filed its Form 10-K for 2000 18 months late, its Form 10-K for 2001 six months late, hasn't asked shareholders to elect a board for at least eight years and possibly longer, and prepares financial statements in accordance with accounting principles the likes of which I've never seen before, but nevertheless has been unmolested by the SEC for all of these years (which, by the way, was tipped off about this at least as far back as 1994 and has done nothing about it)? A lot of good disclosure controls and procedures and 302 certifications are doing there. The company doesn't use lawyers. Or another case of a large company I know of, whose CEO and Chairman are systematically plundering the company with rapacious compensation programs for themselves, which naturally they have chosen not to disclose, among other important things their investing public and probably their accountants too have been deliberately kept in the dark about? Reporting up the chain of command would have been pointless. One of the things they've avoided disclosing is that the Chairman controls vastly more stock than he is willing to admit to, enough to ensure that he gets his way no matter what.
My point is that you will be taking a reckless regulatory approach if, with issuers such as those about which Mr. Dear writes (and I also have seen such noncompliance), you rely upon issuers to self-disclose on Form 8-K the facts and circumstances of withdrawals by their lawyers for professional considerations.
My last suggestion is that you strongly consider requiring that issuers publicly disclose in their periodic reports the identities of the law firms and attorneys who they have retained to appear and practice before the Commission on their behalf, and to disclose, much like executive compensation is disclosed, the compensation paid to those firms. With such information, investors and analysts will probe for the truth upon learning of an issuer's separation from a law firm (even if no Form 8-K if filed) just as they would upon learning of the sudden unexplained separation of a key executive.
Thank you for considering these comments.
Very truly yours,
Douglas A. Schafer
|1|| Deborah L. Rhode, In the Interests of Justice: Reforming the Legal Profession (Oxford U. Press, 2000).
|2|| William H. Simon, The Practice of Justice: A Theory of Lawyers’ Ethics, (Harvard U. Press 1998).
|3|| Richard Zitrin and Carol M. Langford, The Moral Compass of the American Lawyer: Truth, Justice, Power, and Greed, (Ballantine Books 1999).
|4|| Queen v. Cox, 14 Q.B. 153 (1884), also reported at 5 Am. Crim. Rep. 140.
|5|| SEC v. National Student Mktg. Corp., 457 F. Supp. 682 (D.D.C. 1978).
|6|| Tarasoff v. Regents of the University of California, 17 Cal. 3d 425, 551 P.2d 334, 131 Cal. Rptr. 14 (1976).
|7|| As quoted in Susan P. Koniak, The Law Between the Bar and the State, 70 N.C.L. Rev. 1389, 1444 n.234 (1992).
|8|| As quoted in Geoffrey C. Hazard, Jr., Lawyers and Client Fraud: They Still Don’t Get It, 6 Geo.
J. Legal Ethics 701, 722 (1993).
|9|| 1993 Fordham U. Law School Conference on Ethical Issues in Representing Older Clients. 62 Fordham L. Rev. 961, 998, 1448 (1994).
|10|| http://www.abanet.org/cpr/e2k-dissent.html (visited April 7, 2003).
|11|| R.W. Nahstoll, The Lawyer’s Allegiance: Priorities Regarding Confidentiality, 41 Wash. & Lee L. Rev. 421, 424 n.7 (1984).
|12|| TRIAL, Vol. 17, No. 7, Pg. 55, 56 (July 1982).
|13|| Quoted by Sarah Boxer in “Lawyers Are Asking, How Secret Is a Secret?,” The New York Times, Aug. 11, 2001, Arts Section.
|14|| http://www.tba.org/ethics2002.html (visited April 7, 2003).
|15|| Peter C. Kostant, Sacred Cows or Cash Cows: The Abuse of Rhetoric in Justifying Some Current Norms of Transactional Lawyering, 36 Wake Forest L. Rev. 49, 83 (2001).
|16|| Simon, note 2 above, at 56.
|17|| In re Lindsey, 332 U.S. App. D.C. 357, 158 F.3d 1263, 1273 (D.C. Cir. 1998) (“If there is wrongdoing in government, it must be exposed.”); In re a Witness, 288 F.3d 289 (7th Cir. 2002) (“the government lawyer [is] duty-bound to report internal criminal violations, not to shield them from public exposure.”).