Weil, Gotshal & Manges llp

December 18, 2002


U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Attention: Jonathan G. Katz, Secretary

Re: Proposed Part 205 of the Commission's Rules of Practice, Standards of Professional Conduct for Attorneys; Implementation of Section 307 of the Sarbanes-Oxley Act of 2002
(Commission File No. S7-45-02)

Ladies and Gentlemen:

We submit this letter in response to the request of the Securities and Exchange Commission (the "Commission") in its Release No. 34-46868 (the "Proposing Release") for comments on its proposal to adopt Part 205 of the Commission's Rules of Practice to implement Section 307 of the Sarbanes-Oxley Act of 2002 (the "Act").

Section 307 directs the Commission to promulgate rules setting forth minimum standards of professional conduct for attorneys representing issuers before the Commission, including a rule requiring such attorneys to report evidence of a material violation of the securities laws or breach of fiduciary duty or similar violation by an issuer or its agents to senior officials of the issuer. Section 307 does not mandate or contemplate that the Commission promulgate rules regulating withdrawal by attorneys from issuer engagements.

Proposed Part 205 would supplement, in two principal respects, the Commission's existing rules of practice applicable to attorneys, which apply state law standards of professional conduct, to regulate the activities of attorneys who represent issuers (as defined in the Act). First, consistent with Section 307, the proposed rule would require an attorney to report evidence of wrongdoing internally "up the ladder" within the issuer's organization. Second, in some instances, the proposed rule would require the attorney to withdraw (with notice to the Commission) from representing the issuer before the Commission if the issuer does not appropriately respond to the attorney's report of evidence of possible wrongdoing.

We believe a well-crafted "upward reporting" obligation for attorneys advising issuers on their disclosure and other securities law obligations will be a useful complement to the corporate governance and disclosure reforms which the Act mandates. Although we have concerns regarding specific aspects of the Commission's "up the ladder" reporting proposal, we support the Commission's initiative in this respect. However, in seeking to establish a professional responsibility for attorneys to withdraw from a client representation, the Commission would undertake to regulate attorney conduct in an area fraught with complexity and the risk of unintended consequences. For the Commission to impose on attorneys practicing before the Commission further "noisy withdrawal" requirements, as proposed, would both involve contentious issues of fundamental significance regarding the role of legal counsel in our system of securities regulation, and risk lessening the protections afforded investors by this system contrary to the principal goals of the Act. Mandating "noisy withdrawal" also raises substantial issues concerning the scope of the authority granted to the Commission under the Act to regulate attorney conduct. This is particularly the case given the long-established policy of the Congress to favor state regulation of professional conduct, and the notable absence from the Act of any specific provision making an exception to this policy. We urge the Commission to defer action on the "noisy withdrawal" aspects of its proposal at this time in order to provide a sufficient opportunity for analysis and debate on the matter.

In addressing these matters, we urge the Commission to keep in mind that significantly different policy and practical issues are raised, on the one hand, by a requirement that legal counsel reveal to the Commission information obtained (or a conclusion reached) in the course of its representation and, on the other hand, by a requirement that legal counsel report that same information or conclusion within the issuer's organization. Still different issues are raised where these requirements would be applied in the context of counsel representing an issuer in defending an adversary proceeding or in responding to an inquiry or investigation that may lead to an adversary proceeding. The standards and definitions that are appropriate for the one purpose or context differ significantly from those applicable to the other. Any attempt, as in the proposed rule, to use the same standards and definitions for both purposes or in all contexts will produce many difficulties and significant harm.

We are mindful of the fact that the purpose of the Commission's initiative in proposing the rule is the protection of the investing public as contemplated by the Congress. We are also aware that there have been situations, some of sensational aspect, which suggest a need to emphasize the importance of an unwavering commitment to ethical conduct on the part of attorneys (as well as corporate officials and other outside professionals). Implicit in this objective is the preservation of the benefits of the current system of private and confidential communications between lawyers and their clients, and the facilitation of advice from lawyers to clients. This system largely goes unnoticed and unpublicized, but it constitutes a principal mechanism for compliance with our securities, corporate and related laws. Any attorney professional responsibility rule adopted by the Commission should preserve and enhance those aspects of the attorney-client relationship which are generally effective.

The adoption of appropriate (intra-corporate) "up the ladder" reporting obligations will enhance the ability of counsel to advise clients effectively on these matters and improve the securities regulatory system. In contrast, the proposed "noisy withdrawal" provisions will impair the attorney-client relationship and lessen the effectiveness of the system. It would be a serious mistake, in an effort to address a problem revealed by sensational misdeeds in some instances, to adopt rules that by their overbreadth impair the effectiveness of a system which in the vast preponderance of instances (over the relevant universe of about 11,000 issuers) provides issuers the "right" legal advice, and usually constitutes an effective deterrent to legal violations and results in significant compliance. The investing public will be the loser. We urge the Commission to consider its initiative from this perspective.

General Comments

"Upward Reporting" Provisions

We consider obligatory internal reporting by legal counsel of wrongdoing an appropriate standard of conduct for attorneys who advise issuers in matters involving compliance under the securities laws. This standard, in the context of issuer representations regarding securities law matters, is consistent with professional responsibility standards generally applicable when an attorney represents a publicly-traded company and in other similar contexts. It also accords with prevailing practices generally followed by reputable attorneys experienced in representing issuers on securities law matters.

Notwithstanding our support for appropriate "up the ladder" reporting obligations for attorneys, we have three principal objections to that aspect of the rule as proposed:

  • the definition of "appearing and practicing" before the Commission is overly broad - it should not reach attorneys retained to investigate potential violations, or attorneys who do not have principal responsibility for advising on securities law matters;

  • the proposed definition of "material" departs, without justification or explanation, from the governing standard, as set by the U.S. Supreme Court in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438 (1976), and other cases, and affects the concepts "evidence of a material violation" and "material violation" which are key to the operation of the rule; and

  • attorneys should only be liable for "knowing" violations of the rule: liability should not be premised on conduct adjudged after the fact to have been "negligent" or "reckless" based on what a hypothetical reasonable attorney should have known about an issuer's affairs; and attorneys who act in good faith should not be subject to sanction under the rule.

"Noisy Withdrawal" Provisions

The provisions of the proposed rule that seek to regulate attorney conduct beyond the "upward reporting" requirements mandated by Section 307 would, in our view, neither complement those requirements nor enhance the effectiveness of the other provisions of the Act. To the contrary, we believe adoption of the proposed "noisy withdrawal" requirement would risk doing more to harm investor interests than to further investor protection. This harm would come by discouraging issuers from consulting counsel, substituting attorney judgments about risk for business judgment and hampering the ability of issuers to defend themselves against claims that they have committed violations of the securities law or other relevant laws.

Chilling Attorney-Client Communications. The "noisy withdrawal" provisions of the proposed rule, as they interact with the proposed upward reporting provisions, dangerously jeopardize the advisory relationship fostered by the attorney-client privilege. Specifically, the proposed rule mandates (in certain circumstances) and permits (in other circumstances) counsel to withdraw from representing an issuer in a way that reveals that counsel believes the issuer has committed a material violation and, where pertinent to a disclosure document or other report submitted to the Commission, identifies the document that is involved, presumably prompting a Commission inquiry. This will inevitably lead issuers and their directors, officers, employees and other agents to perceive that they cannot communicate with their counsel freely on a matter that may involve a potential material violation because of a risk of bringing upon themselves a Commission inquiry. The likely result will be less consultation with counsel. This is contrary to one of the major goals of the Act (and also of the U.S. Sentencing Guidelines) of encouraging issuers to implement policies and procedures to prevent and mitigate violations of the securities laws.

This risk is exacerbated by the increased uncertainty under the proposed rule that attorney-client confidences will not be protected by attorney-client privilege. Included among these confidences may be information included in the records which the proposed rule mandates attorneys to create and keep as part of their upward reporting obligation. The potential for such disclosure of what otherwise would be confidential attorney-client communications, whether made in connection with an action by the Commission against an attorney to enforce the proposed rule or in a Commission inquiry, investigation or administrative proceeding prompted by a "noisy withdrawal" or otherwise commenced, cannot but discourage open communication between issuers and counsel. While the proposed rule purports to override state law in this area and to establish only a "limited waiver" to the attorney-client privilege for disclosures so made, there is substantial doubt that these provisions will be effective. There also appears to have been no consideration in the Proposing Release of the impact of the proposed rule on work-product privilege.

Until these issues can be resolved, mandating "noisy withdrawal" as contemplated by the proposed rule would risk lessening the effectiveness of counsel in advising issuers on compliance with the securities laws in the vast majority of instances in the hope, not of deterring issuer misconduct - which the upward reporting obligations alone sufficiently address - but of making prosecution of egregious instances easier.

Substituting Attorney Judgments for Business Judgments. The proposed "noisy withdrawal" requirement would also impose on attorneys representing issuers (both foreign and domestic) standards that are significantly different from the prevailing professional responsibility standards in numerous jurisdictions for withdrawal from a client representation. In the United States, these standards have been addressed notably by the American Bar Association's Model Rules of Professional Conduct (specifically, Model Rules 1.6, 1.13 and 1.16) and the operative state law attorney responsibility provisions based on these model rules. We note that the American Bar Association and other groups currently have under consideration whether a change is warranted in the existing standards which establish when it is permissible or required that an attorney withdraw from a representation because of client wrongdoing, and how a withdrawal should be effectuated. The proposed rule requires particular actions to be taken by an attorney at the time when "an attorney reasonably" would believe there to be a material violation - that is whenever a hypothetical reasonable attorney might have such a belief. It is critical to remember, however, that experienced attorneys in good faith can differ on what is reasonable, just as corporate officials in good faith may differ, when making materiality determinations. There may often be more than one reasonable answer to the same inquiry. Attorneys should not be subject to sanction under the proposed rule where they act in good faith simply because someone comes to a different view of what was reasonable after the fact.

A comparison of the provisions of the proposed rule and the provisions of Model Rule 1.13 demonstrates the importance of setting an appropriate standard by which an attorney can assess his or her obligations and by which the attorney may be judged fairly after the fact. Model Rule 1.13 establishes a standard for when counsel may withdraw from representation of an organization as a result of the persistence by the client, after contrary advice from counsel, to maintain a course of action or inaction that is "clearly a violation of law and that is likely to result in substantial injury" to the client (and, by reference to Model Rule 1.16, that involves the attorney's services in a course of action or inaction by the client which the attorney "reasonably believes is criminal or fraudulent conduct"). In contrast, proposed Section 205.3(d) jettisons the "clear violation" standard for a one-step standard of "reasonable belief" by an attorney "that a material violation is ongoing or is about to occur and is likely to result in substantial injury to the financial interest or property of the issuer or of investors." In a context where an attorney has already satisfied his or her "up the ladder" reporting obligations, this suggests that the attorney should substitute his or her "reasonable belief" for the fully informed judgment of the issuer's highest decisionmakers in instances where there is no clear violation of law. Similarly, as we discuss further below, in addressing what constitutes an "appropriate response" to an "up the ladder" report of an attorney of a possible material violation, the proposed rule and the Proposing Release imply that the attorney will be in a position to do more in evaluating the issuer's response than to make an assessment of the issuer's good faith in its response. This assumes that the attorney would have all of the information needed to make - and was permitted to make - his or her own judgment on the merits. The Commission should recognize that this often will not be the case and that satisfaction of the attorney's professional responsibilities will be measured by what the attorney in good faith knows about its client's situation. The text of the rule should reflect this.1

Impairing Issuer's Ability to Defend Against Claims of Wrongdoing. In addition, the proposed rule risks seriously impairing the ability of issuers to defend themselves in Commission administrative proceedings and to protect their interests in responding to a inquiry or formal investigation by the Commission. As we discuss further below, this is part of a broader problem of the application of the rule, as drafted, to attorneys engaged to respond to third party (including Commission) claims of wrongdoing or inquiries or investigations into possible wrongdoing. The definitions of "appearing and practicing before the Commission," "in the representation of an issuer" and "appropriate response," together with the substantive upward reporting, "withdrawal" and "disaffirmance" obligations, would make it impossible for an attorney (without violating Part 205) from responding on behalf of an issuer to a Commission inquiry or defending an issuer against a claim asserted in a Commission administrative proceeding (on either procedural or substantive grounds) where the attorney believes the client has committed a material violation of continuing effect that is likely to result in substantial injury to the financial interests of the issuer or investors in the issuer.2 This inability, in turn, may also prevent the issuer from having the same counsel represent it in responding to a claim asserted by an investor or other private party once a Commission investigation or claim is under way.3

We doubt that these outcomes are what the Commission intends, given its stated intent not "to impair zealous advocacy, which is essential to the Commission's processes." Proposing Release, at Section IV.A. These key points, however, cannot be subject to any ambiguity: if a third-party asserts that an issuer or any of its directors, officers or other agents have violated the securities laws, the issuer and its agents must, in all cases, be permitted to retain counsel to investigate the claim and respond to it, including defense in litigation, without being at risk of violating the rule. This must be the case even where counsel believes a material violation has occurred. We note, in particular, that the proposed rule defines "appropriate response" to require "a basis for an attorney reasonably to believe . . . that no material violation . . . is occurring, has occurred, or is about to occur; or . . . that the issuer has, as necessary, adopted remedial measures." In instances where counsel, after investigation, determines that the assertion is, or probably will be found to be, meritorious, it seemingly will be impossible for the issuer to provide an "appropriate response" to counsel unless the issuer, in effect, admits the wrongdoing, giving up its defenses (substantive and procedural). It cannot be that counsel in such circumstances must leave its client to fend on its own. Nor can it be that an attorney will be at risk of sanction under Part 205 simply because he defends a client who ultimately is adjudged to have committed a material violation.

Insofar as a material violation in the context of a third-party claim or investigation may involve the risk of future damage to the substantial financial interests of investors or other third parties, an attorney is subject to generally applicable professional responsibility rules apart from the proposed rule. The Commission should consider a rule specifically applicable in such situations only to "issuers" and "practice before the Commission" only if a need has clearly been shown that such situations cannot otherwise be adequately addressed.

Overall, the proposed rule adopts an overly broad, one-size-fits-all approach to deal with the relatively infrequent instances when egregious conduct is aided and abetted, or knowingly furthered, by attorneys. Such instances can be addressed more appropriately by other, more narrowly focused means and, indeed, may already be largely addressed by the existing provisions that bar attorneys (and anyone else) from participating in an issuer's violation of the securities laws or aiding or abetting in such a violation.

We do not believe it is necessary in the context of the current rule proposal to address the circumstances in which attorney withdrawal from the representation of an issuer with regard to its compliance with the securities laws is appropriate. It is evident that much more careful consideration is required to prevent untoward and unwarranted consequences from the significant departure from existing standards that the proposed rule would effectuate. The comment period on the proposed rule is too short to permit the investor, issuer and legal communities or the Commission to analyze these problems properly. Given the statutory mandate that the Commission adopt a rule addressing minimum "up the ladder" professional responsibility standards by January 26, 2003, we urge the Commission to undertake rulemaking to supplement its existing professional responsibility standards on that subject alone and to defer for further consideration action on any other standards, including any "noisy withdrawal" requirement.

In the Proposing Release, the Commission indicates that it is considering whether it should promulgate rules that "occupy the field" on the subject of attorney responsibility for reporting issuer wrongdoing. In our view, this is not the time for the Commission to do so. The Commission should instead allow the pending review of these issues to continue and not impede the development of standards in this area by premature action.

Application to Foreign Issuers and Foreign Attorneys

As proposed, the rule would generally apply to non-U.S. issuers and attorneys on the same terms as applicable to domestic U.S. issuers and attorneys, which raises a significant number of practical and legal concerns. These concerns extend from questions of competence of non-U.S. lawyers to make the judgments under the U.S. securities laws required by the proposed rule, to issues of conflict between the proposed standards of attorney conduct and those in effect in non-U.S. jurisdictions, to issues of how the disclosure obligations applicable to foreign issuers interact with their disclosure obligations under the Commission's rules and beyond to more general concerns about the functioning of the international capital markets and comity among regulatory bodies when addressing transnational matters. For example, significant issues exist as to the potential for non-U.S. lawyers to be subjected by the proposed rule to obligations that conflict with their existing obligations under foreign laws and whether the proposed rule will adversely affect the level of participation of non-U.S. companies in the U.S. capital markets. We urge the Commission to investigate further these concerns before extending its regulation in this area to foreign issuers or attorneys.

Specific Comments

The Definition of "Appearing and Practicing Before the Commission" and Related Provisions Impede the Defense of Issuers in Ways Irreconcilable with the Adversarial System. The proposed rule is overbroad in failing to distinguish between, on the one hand, representing an issuer or its agents in investigating, responding to and defending a third-party claim or investigation of a material violation (whether asserted or instigated by the Commission or a private party) and, on the other hand, advising an issuer on satisfying its disclosure or other obligations under the securities laws. The considerations which support upward reporting and attorney withdrawal where an attorney is assisting an issuer in preparing disclosure documents or otherwise satisfying an issuer's obligations under the securities laws do not apply where an attorney is retained to respond to a third-party claim or an investigation into the possibility of a violation. The asserted violation or need to investigate a possible violation has already been made known to the issuer by the third-party. Moreover, the issuer has already responded to it by retaining counsel to investigate, respond to and defend against the assertion. There is no need at this stage for an "upward report" to the issuer's chief executive by the attorney conducting the investigation, as the rule, as currently drafted, provides, even if the attorney has concluded from the information available to him that there is evidence of a material violation. Only where the counsel so retained is frustrated in its investigation or has provided its advice to the issuer for dealing with the circumstances involved and determined that the issuer has not appropriately dealt with the circumstance might further internal "up the ladder" reporting, as provided by the proposed rule, be appropriate.

Accordingly, we urge the Commission to add provisions to proposed Part 205 to clarify that counsel engaged to represent a client in investigating, responding to or defending an assertion of a material violation made by a third-party (including the Commission) or an inquiry or investigation to determine if there was a material violation will not have an "up the ladder" reporting obligation unless and until it has concluded that the issuer's treatment of the matter, or response to the conclusions of its investigation, would not constitute an appropriate response to a report it had made of "evidence of material violation."

The Definition of "Appearing and Practicing Before the Commission" Extends to Attorneys Without a Sufficient Nexus to Matters Involving Compliance with the Securities Laws. We urge the Commission to clarify that the proposed rule would only apply to those attorneys who actually advise an issuer with respect to its disclosure or other securities laws obligations. This clarification is warranted given the reality of how most issuers use counsel. Many attorneys, with expertise in various areas, may represent an issuer in connection with transactions or litigation or other matters that are described in an issuer's disclosures, and may provide input into the preparation of disclosure documents. However, these attorneys often do not have responsibility for the issuer's disclosures concerning the matter or are not aware of how those disclosures relate to other information the issuer publicly discloses, all of which is part of the "total mix" of information relevant to investors. These attorneys usually are in no position to make the kind of materiality judgments that are frequently called for the preparation of reports to the Commission. Indeed, relatively few attorneys will likely have knowledge of all the factors that may go into an issuer's disclosure decision-making. It is neither necessary nor efficient - and will only create confusion - for attorneys who are not in fact advising on such matters to be subject to the upward reporting obligations of the proposed rule.

Take, for instance, an issuer that has entered into a credit agreement and an employment agreement. It would be appropriate for the proposed rule to govern the conduct of the securities law practitioner who advises the issuer on whether or not to file those agreements as exhibits to an upcoming filing. Extension of the proposed rule to the attorneys who originally prepared the agreements would neither enhance the effectiveness of the proposed rule nor advance the Act's goals to protect investors and improve corporate disclosure. Instead, it would jeopardize those lawyers based on acts or failures to act on matters beyond the scope of their engagement or even knowledge.

To be sure, in many situations, a lawyer advising on the preparation of an issuer's disclosure may face issues that require (or simply prudently call for) input and judgment from other attorneys. However, so long as the lawyer is ultimately responsible for making the judgment under the securities laws with respect to the appropriate advice to be given is subject to the proposed rule, the other attorneys who provide input should not fall within the scope of the proposed rule. The proposed rule should not apply to attorneys who are consulted by a securities lawyer only to provide substantive advice (e.g., an environmental lawyer who assesses the potential liabilities associated with a property or an intellectual property lawyer who prepares an opinion in a patent infringement matter, in either example, to assist the securities lawyer's assessment of materiality or appropriate disclosure). Similarly, when a securities lawyer confers with another experienced attorney (such as a litigator) not involved in the disclosure or other engagement to discuss general issues of materiality or questions of adequate disclosure in relation to an unnamed client following a recitation of limited facts, the consulted attorney should not be brought within the scope of the proposed rule, even though the advice the securities lawyer ultimately offers to his or her client may be informed by the discussions with the litigator. In these scenarios, the effectiveness of the proposed rule should depend upon its application to the attorneys responsible for advising the issuer on the disclosure required under the securities laws, and not to attorneys whose substantive work may form a building block for those disclosure judgments. The latter attorneys should not be at risk (indeed, without even knowing they are at risk) for giving their judgments, suggestions and insights to a colleague. A rule that discourages such consultations will adversely affect the quality of legal advice.

A nexus requirement would also clarify provisions of the proposed rule relating to supervisory and subordinate attorneys. Following again the rationale that the rule's application should be directed at (and its effectiveness will depend upon) the conduct of lawyers with the responsibility for advising an issuer on its obligations under the securities laws, we urge the Commission to limit the definition of "supervisory attorney" to those with a significant nexus to the disclosure of the information, event or circumstance at issue based on the standard we articulated in the previous paragraph. An attorney should not be subject to liability for violation of the rule based on informal consultations, or imputed or vicarious responsibility solely by reason of his or her position, where that attorney did not in fact exercise professional judgment in the representation of the issuer. For example, a lawyer with management responsibility within a law firm (or a corporate legal department) should not be construed to be a "supervisory attorney" unless the managing attorney acted (with a subordinate attorney) to advise the issuer on the action to be taken in relation to, or was specifically consulted on, the matter at issue (even if an attorney preparing an issuer disclosure document is within the group of attorneys he or she manages). In particular, Section 205.4(b) of the proposed rule would impose obligations on attorneys in a manner inconsistent with the nexus that should be required for this purpose. The type of procedures and practices referred to therein should be dealt with separately in determining whether an attorney who in fact is involved in the issuer's disclosure procedures has fulfilled his supervisory responsibility.

A narrowing of the proposed rule to apply only to attorneys with a clearly defined nexus with, and responsibility for, an issuer's compliance with its disclosure or other obligations under the securities laws would not create a loophole in the rule's operation. It is necessary only to ensure that at some point in the compliance process, there will be a responsible attorney whose conduct would be subject to the requirements of the rule.

The Definition of "Material" Should Conform to the Usage Customarily Applicable Under the Securities Laws. We believe that the definition of "material" should take into account the intent of the Act and the proposed rule: the protection of investors. The standard for determining if information or an event or circumstance is "material" to investors for purposes of the securities laws is well established. Accordingly, this conventional definition, as most notably articulated by the U.S. Supreme Court in TSC Industries, Inc. v. Northway, Inc., and confirmed in Basic, Inc. v. Levinson, 485 U.S. 224 (1988), would be a more appropriate standard for purposes of Part 205. The pertinent standard, as customarily stated, is that there is "a substantial likelihood that the disclosure . . . would have been viewed by a reasonable investor as having significantly altered the `total mix' of information available." The combination of clarity and investor focus provided under the TSC standard is critical to counsel having an ability to determine what information should be subject to the upward reporting obligation, as discussed below, and would be even more crucial in determining whether an "appropriate response" has been provided to an "up the ladder" report.

The definition for "material" proposed in Section 205.2(h) differs significantly and is far more speculative in nature. The information described thereby (i.e., that about which "a reasonable investor would want to be informed before making an investment decision") is not the standard that governs issuers' disclosure obligations under any securities law provision. Notably, it is not the test that is applied under the general antifraud provisions of the securities laws. This difference is not merely technical. The materiality standard as proposed would permit the anomalous circumstance where an attorney could be sanctioned under Part 205 for failure to "report up" a misstatement or omission that would not (under TSC) be material and thus would not constitute a securities law violation for which a client could be sanctioned. We urge the Commission to conform the definition of "materiality" in Part 205 to the existing articulation under the securities laws and to clarify that an attorney determining his or her obligations under Part 205 should apply to client conduct the same materiality standard applicable to determining a client's obligations.

The Definition of "Evidence of a Material Violation" Should Focus on Investor Interests. We also urge the Commission to modify the definition of "material violation" to tailor the application of the proposed rule more closely to the stated intent of the Act to protect investors. A "material violation" should include only those violations that are "material" to investors. The materiality of a violation cannot be determined in a vacuum: many sanctionable violations are not material to investors. Materiality to investors should be a threshold requirement that must be present in the case of each type of violation identified in the definition of "material violation." Moreover, materiality to investors should be assessed as of the time an attorney becomes aware of the possible violation. If an attorney becomes aware of evidence of a violation at a point in time when it is no longer material to investors (e.g., when a misstatement or omission has become stale due to the passage of time or the occurrence of an intervening event), the duty to report that misstatement or omission under the proposed rule should not be triggered. There may, nevertheless, be circumstances where the conduct or officers, employees or agents of the issuer relating to such event would warrant upward reporting or such reporting would be warranted because of what the event indicates regarding deficiencies in the issuer's disclosure or internal controls that themselves may constitute material violations, so it should be recognized that this would be only a limited qualification of the requirement.

Finally, whether or not information constitutes "evidence of a material violation" should also be judged in the context of a particular attorney's representation of the issuer. An appropriate standard would take into account the total mix of information known to the attorney at the time he or she makes the required determination under the rule, taking into account the attorney's perception of the credibility of the information. This standard should also reflect the level of involvement of the particular attorney in the representation of the issuer, as discussed above.

Lack of Good Faith Should Be the Standard for Imposing Sanctions. Many obligations under the securities laws and, by extension, under the proposed rule involve judgments about issues about which reasonable men and women can differ. In recognition of this, we believe that sanctions for conduct that, after the fact, is determined to be negligent or "reckless" are inappropriate, and that the risk of sanction for "unreasonable" conduct as defined under Section 205.6(b)(2)(ii) would be particularly onerous. An attorney acting in good faith should not be subject to Commission sanction simply on account of an after-the-fact review of the attorney's conduct (when the reality of wrongdoing is clear) whereby someone determines that the attorney acted "unreasonably."

The proposed rule generally applies an "objective" test (e.g., whether an attorney "reasonably" believed that there was "evidence of a material violation," or whether there was an "appropriate response" to the attorney's report of such evidence). The "reasonable belief" standard creates a "should have known" trigger - compliance or non-compliance with which will generally be assessed with 20/20 hindsight only after a problem in fact has arisen. As it is in this context that an attorney's conduct will be scrutinized under the rule, an attorney should not be subject to sanction for failing to report "up the ladder" unless he or she was aware of circumstances which, in the context of all the credible information available to the attorney, he or she considered in good faith to be evidence of a material violation. That is, an attorney's conduct should be judged on the basis of what, in good faith, the attorney knows and understands - not what a hypothetical reasonable attorney should know about the circumstances - and based on his or her good faith legal judgment about what constitutes a violation of law that would be material (as determined for purposes of the rule).

No Private Right of Action Should Arise Under the Rule. As proposed, Section 205.6(a) provides that "a violation of this part by any attorney . . . shall be treated for all purposes in the same manner as a violation of the Securities Exchange Act of 1934." At the same time, the Commission notes in the Proposing Release that "nothing in Section 307 creates a private right of action against an attorney," and that the Commission "does not intend that the provisions of Part 205 create any private right of action against an attorney." Proposing Release, at Section IV.B. (Section 205.6 Sanctions). We strongly urge the Commission to state its intention in the rule explicitly, inasmuch as the absence of provisions creating a private right of action has never been dispositive as to whether such a right exists, as the jurisprudence under Section 10(b) of the Securities Exchange Act of 1934 demonstrates. The coercive effect of threats of civil liability under the proposed rules on the ability of counsel to advise their clients objectively and provide zealous representation should not be discounted.

Other Matters. We also note the following areas in which we believe the text of the proposed rule needs clarification.

  • In Section 205.3(a), the proposed rule states that an attorney representing an issuer should act in the best interests of the issuer "and its shareholders." This reference to shareholders is subject to misinterpretation in two respects. First, it is contrary to the well established principle that counsel to a corporation or similar entity represents the entity and not any of its constituents. It should be clarified that the reference to shareholder interests in the rule is to the interests of "shareholders in general, as such" to denote that the interests relevant in determining an attorney's responsibility are those interests of the owners of the entity which are derived from their ownership in the entity, and not any other collective or individual interests of those owners. Second, it should be clarified that the reference to shareholder interests does not apply where the proposed rule concerns an "issuer" that qualifies as such only because it has issued, or is in the process of issuing, debt securities. In those cases, counsel should act in the best interests of the issuer as an entity and not its shareholders (whose interests may be adverse to those of its debt holders). (In such instances, the issuer's responsibility to make proper disclosure to holders of its debt securities, and liability for failure to do so, creates sufficient parallelism of the issuer's interests and those of the holders of its debt securities, as such, that no separate reference to the interests of such holders is needed.)

  • With respect to the recordkeeping requirement of Section 205.3(b)(2) of the proposed rule, the collection and assessment by counsel of information in the course of customary due diligence should not trigger a requirement for recordkeeping even though the diligence process necessarily involves the collection of information that may be considered during the process to be evidence of a material violation. A principal aspect of due diligence is to look behind information that suggests a problem. The upward reporting and recordkeeping process should be triggered only when an attorney, after a completed inquiry, has been unable to conclude from the information gathered that an appropriate explanation has been provided to dispel a reasonable belief that information encountered constitutes evidence of a material violation. Otherwise, needless administrative burden and cost to attorneys and their clients will result (such as the upward delivery of routine due diligence inquiries to the general counsel and chief executive of an issuer). The Commission should accordingly clarify the operation of the rule in this context.

We appreciate the opportunity to submit these comments. Members of our firm are available to meet with the Commission or the Staff to respond to any questions and otherwise to be of assistance.

Respectfully submitted,

Weil, Gotshal & Manges llp

cc: Hon. Harvey L. Pitt

Hon. Paul Atkins

Hon. Roel Campos

Hon. Cynthia A. Glassman

Hon. Harvey Goldschmid

Giovanni P. Prezioso
General Counsel

Alan L. Beller
Director, Division of Corporation Finance
and Senior Counselor to the Commission

1 We recognize that the Commission has indicated in the Proposing Release that counsel may not have an obligation to report "up the ladder" even though counsel has evidence of issuer conduct that, under applicable law, might constitute a "material violation," reasonable arguments may be advanced that such conduct is not a violation of law. Proposing Release, at Section IV.B. (Reporting within the Issuer Evidence of a Material Violation). It is critical, however, to the proper application of the rule (in determining what obligations an attorney has under the rule, how he or she should act toward his or her client and how the client should respond to the attorney's actions) that this be clearly established, and this point should not be just a "gloss" on the rule.
2 We acknowledge that the Commission attempts to distinguish between past and ongoing or imminent violations in relation to the "noisy withdrawal" requirements under Section 205.3(d). We note, however, that the proposed rule does not address in any meaningful way so-called "continuing disclosure violations" or how the proposed rule is impacted by the doctrine of "fraud on the market." In these circumstances - which may be the most common circumstances - there will be continuing effects from past disclosures that may be questionable, which may trigger the mandatory withdrawal provisions of Section 205.3(d) and thereby render the proposed distinction between past and ongoing or imminent violations meaningless.
3 In the Proposing Release, the Commission indicated that counsel representing an issuer in a civil enforcement action brought by the Commission would not be considered to be "representing an issuer before the Commission," but that counsel representing an issuer in responding to a Commission inquiry or investigation would be. This is an impractical distinction, as in most instances civil enforcement actions by the Commission follow - as they should - informal inquiries and/or formal investigations by the Commission. There is no discernable reason why an issuer should be prevented from having the same counsel who represented it in responding to a Commission inquiry defend it in a civil enforcement action by the Commission. This illustrates why issuer representations involving response to Commission inquiries should be treated differently from representations involving the preparation of issuer disclosures, as discussed below.