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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks before the Spring Meeting of the Association of General Counsel


Giovanni P. Prezioso

General Counsel
U.S. Securities and Exchange Commission

Pebble Beach, CA
April 28, 2005

As a matter of policy, the Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the staff.


Good evening. Thank you for the kind introduction. As always, the views that I express this evening are my own, and do not necessarily represent those of the Commission or my colleagues on the staff.

My topic tonight is attorney conduct. In particular, I would like to discuss some recent Commission enforcement actions involving lawyers, including in-house counsel at public companies. Then, I would like to describe generally the kinds of investigations involving lawyers that are on the horizon, and how those fit together with the Commission's mandate under the Sarbanes-Oxley Act of 2002. Finally, I would like to close with a few thoughts about the particular implications of Section 307 of that legislation for general counsel at public companies.

Consider a scenario:

Your company's CEO is a strong believer in new technologies and wants to replace some expensive bank loans with debt securities sold on the internet, but does not want to take the time and incur the cost of registering the securities. This practice, he believes, has become quite popular among your competitors, none of whom apparently has registered their debt securities with the Commission. You're out of the office at a conference, so the CEO calls his favorite outside counsel and asks for advice. After careful consideration, outside counsel advises that she sees little financial exposure to the company in private litigation - since the only remedy is likely to be rescission of the debt offering, which effectively will mean merely repaying the debt that is already owed, given that interest rates are rising. Nevertheless, she says that the overwhelming weight of the case law and SEC interpretations requires compliance with the registration provisions of the Securities Act of 1933. The CEO hangs up the phone and says to himself, "Great, if we don't have any exposure to the plaintiff's bar, I'll take my chances with the SEC." He then carries out the transactions, without informing outside counsel.

What happens when the SEC's Enforcement Division learns about this? Ordinarily, the staff would seek sanctions against the company and the CEO, and would not accept an advice-of-counsel defense on these facts. Your company's SEC enforcement counsel would tell you that the company should settle, and the company probably would, as would the now-chastened CEO. Outside counsel gave accurate advice and had no reason to know it was being ignored - so she's off the hook.

Now, let's change the facts. Instead of being at a conference, you're in the office and the CEO calls you. He asks the same question. When you tell him you need to talk to outside counsel, he says, "Great, but I've got to go to a conference - so just take care of it while I'm away." You call outside counsel, get the same advice and make the same judgment as the CEO to proceed with the transaction. When the Enforcement Division shows up, should you be treated any differently than the CEO?

You can probably guess how I would answer that question. Just because you are a lawyer does not mean you get a pass to engage in conduct that would constitute a violation for anyone else at the company. At the same time, there is a sensitive issue here: not every case will present facts as clear as those in my scenario. Sometimes, a lawyer must make difficult legal judgments, and may well feel justified in taking a position with which the Commission or its staff might not agree.

The Commission has had to deal with these issues on several occasions in the past year. Of particular note, the Commission has brought and settled significant enforcement cases against lawyers serving as general counsel at public companies for causing their corporate client's violation of the securities laws. These cases have provoked consternation among some lawyers, who have claimed that the SEC has changed direction in its enforcement policy toward the bar.

In my view, much of this consternation is misplaced. In fact, the principles underlying the enforcement proceedings resolved in the past year have been broadly consistent with the approach to lawyer liability that the Commission, and the courts, have taken for many years. I would like to review some of those principles, in a way that may be helpful in framing your obligations in day-to-day practice.

What are the guiding principles for sanctioning lawyers who violate the securities laws?

For over thirty years now, there has been an ongoing debate about whether and when the Commission should use its powers to sanction lawyers. The debate has generally been framed in terms of lawyers' role as "gatekeepers," since at least the Carter & Johnson case of the early 1980s,1 although the issues tend to go beyond lawyers acting purely in a "gatekeeping" capacity.

Two competing policy considerations have driven this debate. On one hand, the Commission has long recognized that many securities law violations could not occur without the participation of lawyers - who have professional responsibilities and knowledge that can often prevent misconduct harmful to investors. On the other hand, many lawyers - and the Commission itself - have identified the importance of zealous advocacy in securities law matters, and have thus resisted policies that might chill lawyers' capacity to advance that objective.

The debate has many facets, including not only how the Commission should approach lawyer discipline as a substantive matter, but also regarding the Commission's authority and choice of forum for sanctioning lawyers. We don't have time tonight to review all of that history, but I would encourage you to read some of the literature in the area, including an important speech given by Ed Greene when he served as General Counsel of the Commission and a law review article written by Sy Lorne when he served in that capacity.2 There are also some more recent speeches by Commissioners and staff on this general topic that you can find on our website.

One central and recurring point, however, and one that I would like to focus on, is that the debate about lawyers as "gatekeepers" needs to be disentangled from consideration of the potential liability of lawyers as "principals." Put another way, while the two problems sometimes overlap in important ways, the Commission's approach to sanctioning lawyers who violate professional standards of conduct raises questions quite distinct from its approach to sanctioning lawyers for participating in securities law violations.

How has the Commission approached this latter question of securities law violations in the past? At the extremes, two propositions have become clear. At one end of the spectrum, to preserve an appropriate level of advocacy, the Commission ordinarily will not sanction lawyers under the securities laws merely for giving bad advice, even if that advice is negligent and perhaps worse.3 At the other end, the Commission will sanction a lawyer for conduct that - if carried out by any other person - would have given rise to an enforcement proceeding. This distinction has sometimes been characterized as a question of "when is a lawyer acting as a lawyer?"

To use the clearest example of the proposition, there is no serious doubt that when a lawyer engages in insider trading, the Commission should not have any reservations about instituting an enforcement action against that lawyer, simply because of his or her status as a member of the bar.4 A similar outcome can be expected for other securities law violations as well.5 These sanctions for violating the securities laws are separate from any professional disciplinary action, under the Commission's Rule 102(e)6 or otherwise, that might flow from the conduct or from an injunction imposed on the lawyer.

The principle that lawyers must conform their conduct to the same norms as others, I should underscore, is by no means limited to the securities laws. The Restatement of the Law Governing Lawyers makes the point quite explicitly:

Lawyers are subject to the general law. If activities of a nonlawyer in the same circumstances would render the nonlawyer civilly liable or afford the nonlawyer a defense to liability, the same activities by a lawyer in the same circumstances generally render the lawyer liable or afford the lawyer a defense.7

Courts have embraced the Restatement position in several states, including here in California.8

In considering this point, keep in mind that there are situations in which a lawyer - even in the course of practicing as a lawyer - can engage in conduct that constitutes a violation of the securities laws. For example, when a lawyer knowingly provides an opinion letter9 or drafts a disclosure document10 that contains a misstatement of fact or law that will be relied upon in the purchase or sale of securities, then that lawyer may be held liable for securities fraud. This, too, is consistent with the law more generally applicable to lawyers.11

Factual difficulties often present themselves, of course. In some cases, a lawyer's actions may involve a mixture of conduct and advice. And those cases will often involve inside counsel - so they will have a special relevance to this audience. They will be further complicated by the fact that the securities laws, like many other types of law, assign liability not only to primary violators, but also to secondary violators - those who aid and abet or cause violations by a company or other third party.12

In cases involving a mixture of conduct and advice, what factors may be relevant? First, a critical issue will be the extent to which the decision-making process depended on the lawyer. Lawyers who serve in senior management roles, including in some cases as directors, often assume significant decision-making responsibility, even on matters that are not purely legal. If you are given responsibility for negotiating a contract, for example, you may find yourself making business decisions, not just legal ones.13 As a general counsel, you may find yourself particularly integrated into the management structure - and occasions for crossing the line from providing management with legal advice to making management decisions are likely to be more frequent. Further, especially difficult issues can arise in the disclosure context, given the often heavy reliance on lawyers to assist in the drafting process.

In thinking about whether a lawyer has crossed the line - becoming more of a decision-maker or counseling a course of conduct, rather acting as a legal adviser - a key indicator, not surprisingly, will be the extent to which the lawyer in fact gave anyone else at the company legal "advice" on the relevant issue. If the lawyer provides the CEO with a balanced legal view and the CEO then disregards the implications of that view, there may be legitimate questions about the lawyer's obligations as a professional. In such a case, though, rarely will the lawyer be viewed as primarily, or even secondarily, liable under the securities laws absent further participation in the misconduct. On the other hand, if a lawyer makes a legal judgment about an issue that cannot fairly be viewed as immaterial and fails to inform anyone else at the company of the potential legal risks - in other words, if the lawyer doesn't advise anybody about anything - it will be much more difficult to argue that the lawyer played a purely advisory role. Rather, the lawyer's continuing participation in the activity without providing advice to others may, in some cases, constitute part of a course of conduct that effectively makes the ultimate business decision for the company.14

A second significant factor in assessing the lawyer's responsibility for securities law violations will be the nature of the legal judgments made by the lawyer. In matters involving close or difficult judgment calls, I do not believe that the Commission has - or should - second guess those calls, even when the lawyer is close to the center of the decision-making process. The securities laws often are too complex - and involve too many questions on which reasonable lawyers legitimately can disagree - to permit 20/20 hindsight to be the Commission standard. Having said that, there are many cases where every securities lawyer ought to know the answer, or where a non-securities lawyer cannot in good faith fail to seek advice - and in those cases, the lawyer may properly be held responsible for corporate conduct in which he or she participated.15

A third, and related factor, will also often come into play. Did the lawyer's activities occur in the context of an investigation or enforcement proceeding, or otherwise in direct representation of the client before the Commission or its staff? Absent misrepresentations to the Commission or other unethical conduct, there is a strong countervailing policy consideration against sanctioning lawyers in these contexts - for this is where the adversarial nature of the lawyer's role most needs protection.16

In the past year, there have been a few settled enforcement actions in which these principles were applied to hold lawyers responsible for causing their corporate client's violation.17 While some among the bar have expressed surprise at these cases, I think they represent continuity, not change and are wholly consistent with prior Commission statements and cases on substantially similar facts over a long period of years.18 They do not impose sanctions on lawyers for the advice that they gave - but for their actions in situations where they in fact failed to advise their clients and became participants in the prohibited conduct.

What has changed?

Having spent a fair amount of your time trying to explain some of the elements that have not changed in the Commission's approach to sanctioning lawyers for securities law violations, let me turn to what I think has changed - and what those changes mean for you as the chief legal officers at your companies.

What has changed - and this may seem obvious - is the law. The Sarbanes-Oxley Act, as you all know, significantly expanded the Commission's authority to adopt professional standards governing lawyers - and specifically required the Commission to adopt regulations mandating "up-the-ladder" reporting of evidence of certain material violations of law. There has been a great deal of attention devoted to the question of when to "report up," and the related but more difficult question of when and whether a lawyer may, or must, "report out." Much less attention has been devoted, however, to other aspects of the legislation that I think, over time, are likely to have an equally significant impact on lawyers.

First, Section 307 of the Sarbanes-Oxley Act went beyond mandating "up-the-ladder" reporting. It provided that the Commission should adopt "minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation" of public companies.19 To date, the Commission has principally focused on reporting issues, but its authority plainly goes beyond those issues. Further, the Sarbanes-Oxley Act included a little noted provision, Section 602, adding new Section 4C to the Exchange Act - a provision that explicitly confirms the Commission's authority to sanction all professionals appearing and practicing before it.20

What are the implications of these legislative provisions? Most importantly, I think, they alter one of the key underpinnings of the Commission's traditional approach to oversight of lawyers - the lack of an explicit mandate from Congress to regulate the profession. Traditionally, the Commission and its staff regularly cited this lack of an express mandate as an important rationale for exercising restraint.21 As a legal matter, the absence of an express mandate counseled for care in determining which cases against lawyers - as professionals, rather than as principals - should be litigated, and where they should be litigated. As a policy matter, moreover, the Commission had long indicated its sensitivity to regulating professional conduct, an area where it claimed no special expertise.

With the enactment of the Sarbanes-Oxley Act, any lingering questions about the Commission's authority disappeared. And while the Commission cannot be expected miraculously to become expert overnight in the regulation of lawyers as professionals, there is no doubt that it can - indeed, given the mandate of Congress, really must - devote more time and resources to developing its expertise in this area.

We are doing that. The Office of the General Counsel traditionally has played a central role in matters of professional discipline involving lawyers. In significant part, this has reflected a justifiable awareness on the part of the Commission that entrusting lawyers' professional discipline to the staff of the Enforcement Division might lead lawyers to fear, whether reasonably or not, potential retribution for zealous advocacy on behalf of their clients. Another, less noted component of this policy has been the potential for the Commission to benefit from the knowledge and experience of the General Counsel's office in matters of lawyer discipline, just as it does from the Office of the Chief Accountant in disciplining accountants.

Since enactment of the Sarbanes-Oxley Act, we have strengthened the capacity and expertise of the Office of the General Counsel in matters involving the professional obligations of lawyers. In addition to the previous expertise resident in the Office, including in the Ethics Office, we have begun, through the efforts of several lawyers in the course of the Section 307 rulemaking and in a variety of pending matters, to deepen our understanding and to expand our capabilities to regulate effectively in this area. As we strengthen our investigative resources, we are not searching for cases at the fringes - we are focusing on evidence of potentially serious misconduct: subornation of perjury, alteration of documents and potential violations of the regulations adopted under Section 307 itself. This is not, I might add, an especially pleasant task for me or others in our Office - we are all too human to relish questioning the conduct of fellow professionals. At the same time, I think it is a task that we must undertake, and must undertake seriously, in light of our Congressional mandate.

Of course, we cannot lose sight of the critical need to preserve attorneys' ability to serve as zealous advocates for their clients when they appear and practice before the Commission. What are we doing to assure that objective is met? Most importantly, the Commission itself serves as an independent overseer of the agency's enforcement processes - it has been, and I believe it will continue to be, extremely rigorous in assuring that those processes are not used to visit any retribution or exert inappropriate pressure on lawyers, even when their advocacy approaches the outer bounds of appropriate but aggressive representation.

Further, the Commission has long institutionalized several internal practices to help ensure this result. As is widely known, the "Wells process" allows parties to make written submissions arguing their cases directly to the Commission, unfiltered by the Commission staff. In addition, the Office of the General Counsel - which reviews all enforcement matters and makes its own recommendations to the Commission - plays a heightened role in cases involving lawyers. In particular, investigations of professional misconduct by attorneys are not handled by lawyers in the Enforcement Division who may have dealt with those attorneys in pending cases, but instead are referred to the Office of the General Counsel for investigation and, if appropriate, enforcement proceedings. The Commission's continuing support for these safeguards reflects, I believe, the strength of its commitment to protecting zealous advocacy.

What do the new provisions of the Sarbanes-Oxley Act regarding attorneys mean for the General Counsel of a public company?

There is a second aspect of the changes growing out of the Sarbanes-Oxley Act that I think merits an additional moment of discussion in this forum: the heightened role now assigned to the chief legal officer (CLO) of public companies.

As you know, the "up-the-ladder" reporting provisions of Section 307 of the Act specify that the Commission's rules must require the reporting of evidence of material violations, in the first instance, to the CEO or to the CLO of a public company.22 The standards adopted by the Commission clarify and amplify this obligation. Subject to certain limitations, they provide that the report must be brought to the attention of the CLO in every case or to the CLO as well as to the CEO.23 Further, the Commission's rules impose an affirmative duty on the CLO to "cause such inquiry" into the evidence of a material violation as he or she "reasonably believes is appropriate."24 The rules also create an obligation, except where the CLO reasonably determines that there is no material violation, to "take all reasonable steps to cause the issuer to adopt an appropriate response" and to advise the reporting attorney thereof.25

Before enactment of Section 307, no Commission rule or policy statement expressly imposed distinct responsibilities on a company's general counsel or other chief legal officer. The Commission had, of course, made clear in the Gutfreund matter that the general counsel at a regulated entity sometimes might serve in a supervisory role - and would be expected to discharge the same supervisory responsibilities as others26 - but in a sense this policy can be seen as nothing more than a variation on the proposition that an attorney must comply with the law just like anyone else.

The heightened responsibilities imposed under the Commission's Section 307 rules reflect, like the statute, the unique institutional role of a CLO. A system of reporting "up-the-ladder" cannot work well without a central clearinghouse through which the reports must flow. More importantly, from an accountability perspective - and strengthened accountability must be viewed as one of the primary goals of the Sarbanes-Oxley Act - it is essential for key corporate officials to know that they are personally expected to assume responsibility for doing the right thing.

More broadly, the responsibility of the CLO under the new rules flows from the primary point that Congress was making in Section 307: that a lawyer's client, in a corporate context, is not senior management, but the entity itself.27 The one lawyer who is responsible for all of the company's legal affairs - and whose only client is the company - is the CLO. Put another way, the CLO can and must place the company's interests first.

In doing this, the CLO can play an essential leadership role in assuring an appropriate "tone" and corporate culture that support rigorous compliance with all laws. The CLO generally can "push back" on senior management more forcefully than other employees when difficult legal issues arise, especially in light of the greatly heightened awareness among officers and directors today of the price of corporate malfeasance. Further, the CLO can serve as a bridge to the board on difficult legal matters. The CLO also can best assure an appropriate level of protection for whistleblowers and others who identify potential legal problems at the company, especially given the sometimes difficult task of sorting out potential cases of whistleblower retaliation from ordinary personnel disputes. Consider whether your company has given you the authority to perform these functions effectively.

Moreover, the responsibility under the Commission's Section 307 rules to conduct an inquiry, and to "cause" the company "to adopt an appropriate response" in cases where a violation has occurred, is a serious one. And I believe it has received insufficient attention in the public debate on our new rules. Congress gave us limited guidance in the statute, but it plainly expected some appropriate action to take place. Further, the basic mandate was, in many ways, already enshrined in prior professional responsibility requirements.28

In my view, additional dialogue between the Commission and the bar on this issue could be quite constructive. CLOs must work within a delicate framework in assuring an appropriate corporate response. After all, this response may entail significant expenditures of company resources or have other important business implications that require input from managers and others. Moreover, the specific requirements of the rules often will lead CLOs, when in doubt, to bring particular matters and responses to the attention of their boards of directors, who will be seeking guidance as to the factual and legal considerations that should guide their decision. We all could benefit, I believe, from efforts by public company CLOs, who ultimately should have the greatest direct interest in the topic, to work with each other and the Commission in outlining the procedural and substantive elements that would typically characterize an appropriate response.

And while there are challenges presented in defining an appropriate response, I am confident that attorneys will rarely go wrong if they revert back to the central premise of Section 307 that I alluded to a moment ago: putting the interests of the company, and its shareholders, ahead of the interest of its management or other interested parties. Actions that are taken in good faith and in the company's best interests, I believe, will rarely raise any significant questions at the Commission, or in any other forum.

Thank you for giving me your time this evening.



Modified: 06/20/2005