Munger, Tolles & Olson LLP
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Simon M. Lorne
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December 18, 2002
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Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-45-02
Ladies and Gentlemen:
This letter is submitted in partial response to the Commission's request for comments contained in Securities Act Release No. 8,150, "Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys" (Nov. 21, 2002) (the "Release") and the proposed rules (the "Proposed Rules") described in and attached to the Release. This letter is devoted to the question whether the so-called "noisy withdrawal" provisions-i.e., provisions requiring counsel, under certain circumstances, to withdraw from the representation and to notify the Commission-should be adopted at this time.
In writing this letter, I do so individually, and not on behalf of my law firm (whose letterhead I use for purposes of identification only), any of my or our clients, or any other organizations with which I am or may be associated.
The issue of a lawyer's obligation to withdraw from a representation, and to report-essentially what the Commission proposes through the "noisy withdrawal" mechanism of §205.3(d)-under circumstances such as those described in the Proposed Rules has been debated since at least the National Student Marketing cases in the early 1970's, through the Kutak Commission revisions to the ABA's Code of Professional Conduct in the latter part of that decade, through Carter and Johnson, through Kern and Kaye Scholer to Ethics 2000 and the Cheek Committee Report [the American Bar Association Task Force on Corporate Responsibility, Preliminary Report, (July 2002)]. Whatever else may be true, it can probably be safely said that a consensus on these issues cannot be reached.
However, the entry of the federal government, through the Commission, on the stage increases, rather than decreases, the divisions of opinion. Even some outspoken advocates of a lawyer's duty to report publicly in the case of client fraud, such as Delaware Supreme Court Chief Justice Norman Veasey (who was also Chairman of the ABA's Ethics 2000 Commission), do not believe that the obligation should be imposed by a federal authority. Such an entry also introduces elements of Constitutional uncertainty. Is the regulation of lawyers peculiarly a matter for state law-and court-oversight and therefore subject to Reservation of Powers/Separation of Powers arguments? Possibly. May a federal agency, acting pursuant to a general, and apparent (but certainly not explicit), grant of Congressional authority pre-empt conflicting state laws under the Supremacy clause? Possibly. The answers to these questions cannot be predicted with any certainty. But it is clear that they add uncertainty and sources for disagreement and debate to a field that is already overcrowded with comparable landmines.
As we know, the Sarbanes-Oxley Act of 2002 does not mandate the Commission's entry into this field. Section 307 clearly provides that the Commission is not limited in its action to the "up the ladder" reporting provisions that the statute mandates. The statute does, not, however, in any way suggest that the Commission should adopt a requirement that lawyers withdraw from representations, much less that they withdraw and notify federal regulatory authorities, and the legislative history, such as it is, is clearly to the contrary effect.
I. The Lesser Public Harm
Having participated in this debate for at least 25 years-my first published piece in the area being Lorne, "The Corporate and Securities Adviser, the Public Interest, and Professional Ethics," 76 Mich.L.Rev. 423 (1978)-I have concluded that mandatory withdrawal and reporting ultimately accomplishes more harm than good for investors. The competing concerns can be simply stated, even if they are ultimately in irreconcilable conflict. On the one hand, we all prefer that harm be avoided. If lawyers have information as to client fraud, which may cause harm to investors, disclosure by them may avoid that harm.
On the other hand, if clients know that they cannot rely on their lawyers to retain confidences, will they as readily, or as often, entrust information to their lawyers? Presumably not. If one believes, as I do, that lawyers tend invariably to counsel clients in a risk-averse manner, then the concern that clients will not entrust important information to the lawyers means that consistent harm will result simply because the lawyers will not be in a position to provide clients with advice.
And, of course, if the result of such a requirement is impaired sharing of information with lawyers, not only will the benefit of investor-oriented legal advice be lost, but ultimately the very benefit sought to be obtained-the disclosure in cases of real fraud-will be lost as well, simply because lawyers will not have the information, and will not be in a position to disclose.
How do we know which course of action would cause less harm in the long-run? We don't. Any answer is speculative. Even in those states that today authorize (or mandate) disclosure of client fraud, we have no measure of whether access to information by lawyers has been impaired, or of whether any such impairment has affected the quality of legal advice. I, for one, am not willing to risk the loss in the absence of any evidence of beneficial effect.
II. The Economic Argument
Perhaps the principle reason for the success of market economies relative to that of centrally planned economies-widely recognized over the past several years-is the identification of economic risks and rewards with decision making and, ultimately, customer satisfaction. The company that makes the right market decisions receives the customers' money and thrives. The company that does not fails. When success and failure are divorced from decision-making, the system responds less well.
This is precisely what the proposed rules would do.
I do not concern myself here with the extreme case. In extreme cases, lawyers when they recognize that their clients are engaging in fraudulent conduct will do everything in their power to stop it, and will withdraw from the representation-quite possibly with some degree of noise-if needs be. The present system of litigation ensures that result and no more is necessary. To the extent that any of the recent corporate frauds were accomplished with the assistance of lawyers-itself an uncertain conclusion-the lawyers' continued involvement was almost certainly attributable to their failure to recognize the fraud. No Commission rule is useful, or will be effective, in making lawyers more sensitive to the existence of fraudulent conduct by their clients.
But it is in the marginal case, where reasonable minds might differ as to whether a "material" "violation" of securities law or fiduciary duty-very difficult tests-is occurring, that the proposed rules will ultimately have their effect. And that effect will be to transfer ultimate decision-making authority from the duly elected representatives of the shareholders to the lawyers. In most, if not all, instances, issuers will not allow themselves to be the object of a "noisy withdrawal," particularly in a marginal case. If the lawyer decides that would be required, the client will alter its behavior to satisfy the lawyer's needs. But the cost-benefit constraints affecting the lawyer are substantially different from those affecting the issuer or its shareholders. The lawyer receives none of the potential rewards associated with a correct decision. And the lawyer's risks from an incorrect conclusion-discipline from the Commission and possible criminal prosecution for an Exchange Act violation1--are greater than those facing the issuer and its shareholders.
This separation of decision-making from decision consequences is inappropriate, and results solely from the proposed "noisy withdrawal" provisions of §205.3(d).
III. The Complexity of the Rules
The Proposed Rules, as proposed, are quite complex and are counter-intuitive. Persons who are not acting in a matter as lawyers are nonetheless defined as "attorneys." Advice that an issuer need not appear before the Commission-by, for example, registering securities-is "appearing before the Commission." One is acting "in the representation of an issuer" if he or she is taking action that is "in any way . . . for the benefit of" that issuer, "whether or not [he or she is] employed or retained by the issuer." Nonetheless, under the proposed rules, this person not acting in a legal capacity, whose hired lawyer tells the issuer that it need not register a security, is supposed (under appropriate circumstances) to resign from the issuer who does not employ him or her and to notify the Commission of that resignation.
The point here is not that the Proposed Rules are poorly drafted. It is that they are very difficult to draft appropriately, and that anything as complex as this is very dangerous when the consequences are very significant. The consequences of a "reporting out" obligation are not to be underestimated. The consequences of a "reporting up" obligation are largely unobjectionable. I would urge the Commission not to adopt a complex, and not easily workable, set of rules while attaching extreme consequences to those rules.
IV The Benefits of Delay
The Proposed Rules were announced on November 6, but were not available until November 21 (a delay that, in itself, shows the complexity and importance of the issues involved). They were subject to a short comment period and, under the statute, there is only a short period before some final rules are required to be adopted. All of this during a generally busy time of year, with that problem exacerbated by the other demands of Sarbanes-Oxley.
This is not an environment in which to adopt far-reaching, complex, controversial proposals such as these. The rules actually mandated by Sarbanes-Oxley are not fundamentally controversial, and they are the subject of a Congressional mandate. Adopt them (with appropriate changes to respond to comments and concerns). But do not do more than is required on this topic at this time. If the Commission believes that the "reporting out" obligation is important, by all means it should consider adoption of such a requirement. But the issues involved are substantial, and the differing views of well-intentioned persons should not be ignored. Such an obligation, fundamentally affecting the relationship of lawyers with their clients, should be subjected to thoughtful and extensive scrutiny. It should not be adopted under the temporal pressures imposed by Sarbanes-Oxley §307.
* * *
I appreciate the opportunity to provide these suggestions, and would urge the Commission to consider this issue with the extraordinary care and caution that it deserves.
Simon M. Lorne
cc: Hon. Harvey L. Pitt
Hon. Paul Atkins
Hon. Roel Campos
Hon. Cynthia A. Glassman
Hon. Harvey Goldschmid
Alan L. Beller
Senior Counsel to the Commission and
Director, Division of Corporation Finance
Giovanni P. Prezioso
|1 ||I recognize that the Commission, in its proposing release-but not in the proposed rules themselves-suggests a higher standard would be required for criminal prosecution. However, that is not necessarily the law, and there have been previous occasions on which one Commission has taken action that an earlier Commission, in an earlier release, stated it would not take.