March 3, 2003
Jonathan G. Katz,
RE: File No. S7-45-02
Dear Mr. Katz,
This letter is in response to the Securities and Exchange Commission's ("SEC") call for comments on proposed rules setting standards of professional conduct for attorneys who appear and practice before the SEC on behalf of issuers.
Section 307 of the Sarbanes-Oxley Act of 2002 requires the SEC to prescribe rules, in the public interest and for the protection of investors, providing minimum standards of professional conduct for attorneys appearing and practicing before the SEC in any way in the representation of issuers.1 These rules would require an up-the-ladder reporting mechanism where an attorney is to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof, to the chief legal counsel (CLC) or chief executive officer (CEO) of the company, and, if the attorney does not receive an appropriate response then he must report the evidence of the material violation to the board of directors or an independent committee of the board.2
II. Noisy Withdrawal
As part of the up-the-ladder reporting system, the SEC initially proposed section 205.3(d), a "noisy withdrawal" provision that permits or requires an attorney to withdraw from representing the company, state the withdrawal was for professional considerations, notify the SEC he withdrew, and disaffirm all documents filed or submitted to the SEC on behalf of the issuer.3 The events of the past year involving Enron and others have called the actions of some attorneys under scrutiny.4 Lawmakers feel "some lawyers have forgotten their responsibility."5 Additionally, other lawmakers doubt that current state ethics rules effectively deter attorney misconduct.6 Thus, the purpose for the noisy withdrawal proposals is to further the up-the-ladder requirement, enhance investor confidence in the financial reporting process, deter instances of attorney and issuer misconduct, and reduce the impact of misconduct on issuers and shareholders.7
After the receipt of several comment letters supporting or criticizing the noisy withdrawal provision, the SEC is now offering an alternative that would require the issuer, instead of the attorney, to report to the SEC instances where an attorney withdrew or the issuer received written notice of its failure to respond to a report of a material violation.8
A. Requiring the Attorney to Report
In the initial call for comment, Section 205.3(d) proposed a noisy withdrawal where attorneys who had followed the up-the-ladder reporting mechanism but did not receive a reasonable or appropriate response were required to notify the SEC of their withdrawal for professional considerations and disavow their affiliation with any documents filed with the SEC.9
The proposal leaves several open questions. First, an attorney is only required to report to the SEC via a noisy withdrawal if he does not receive an appropriate response from the corporation. It is not clear what an "appropriate response" is. What if the corporation tells the attorney they plan to investigate and then never do? Is an outside attorney expected to continuously monitor internal corporate practices until resolution occurs? How would an outside attorney gain access to the information as to a proper resolution within the corporation? What if the corporation investigates, but finds that they disagree with the attorney's opinion that there was evidence of a material violation? The proposed rule needs to more clearly define "appropriate response." Alternatively, the proposed rule should be revised, as attorneys are not the proper individuals to report violations to the SEC. The attorney should only be required to report up-the-ladder to his issuer-client via the Board of Directors.
Second, the requirement that an attorney is obligated to report to the SEC when there is not an appropriate response raises issues of loyalty to the client. The client in these instances is the corporation and not the investing public. An attorney generally owes no duty to the investing public. The attorney must maintain client confidentiality, a basic premise of the legal profession. The purpose of the duty of confidentiality is to promote trust between client and lawyer. However, an attorney's duty of confidentiality does not extend to his client's plans to engage in future criminal conduct.10 The SEC requires an attorney to report evidence of a material violation when the attorney has not received an appropriate response. Forcing an attorney to reveal confidences to the SEC without a clear determination of wrongdoing and only based on the attorney's reasonable belief that evidence exists as to a material violation on the corporation's part may chill the relationship between the attorney and client. Thus, issuers may, in turn, exclude attorneys from information based on fear of reporting. The standard for reporting is so low--one only needs "evidence of a material violation"--that clients may fear premature reporting by apprehensive attorneys.
Third, forcing attorneys to disclose client confidences will create evidentiary issues relating to the attorney-client privilege. The attorney-client privilege is intended to encourage full and frank communication between attorneys and their clients and thereby promote broader public interests in observance of law and administration of justice.11 The attorney-client privilege prohibits officials from compelling the revelation of confidential communications between an attorney and a client if the subject of the communication concerns the professional relationship between attorney and client.12 Generally, once information is disclosed to a third party, it is no longer protected.
With respect to both confidentiality and the attorney-client privilege, there may be inconsistency between state ethics rules and the reporting requirements of §205.3(d). However, ABA Model Rule 1.6 requires an attorney to withdraw if their services are used to further a crime, and they attorney may disaffirm any work the attorney produced based on fraudulent information.13 To the extent that states do not follow ABA Model Rule 1.6, attorneys may be subject to penalties for violating state ethics rules. To alleviate this problem, the SEC could preempt state ethics rules regarding confidentiality or attorney-client privilege. This would relieve the burden on the attorney from having to choose between a state ethics violation and a federal securities law violation.14
Another option, besides preemption, would be to refer attorneys who violate the SEC rules regarding professional responsibility to the appropriate state ethics board for adjudication. The problem with this option is that not all states impose the same penalties. Regardless, the SEC was not created to become a regulator of attorney conduct. It would detract from the SEC's mission if it were to become bogged down in resolving attorney ethics violations.
A third option would be to provide a safe-harbor for attorneys who do report violations. A safe-harbor provision would encourage good faith reporting by attorneys without fear of reprisal by their employer or the issuer.
Overall, attorneys should not be required to make a noisy withdrawal and report violations to the SEC. The attorney should only be required to follow the up-the-ladder reporting mechanism to the Board of Directors. If the corporation-issuer continues its course of noncompliance, the attorney can withdraw on his own. However, if the SEC chooses to implement the noisy withdrawal requirement for attorneys, then they should provide a safe harbor for conflicting state ethics violations or choose to preempt state ethics rules altogether. There is a need for a hard and fast rule so that the SEC does not become overwhelmed with professional responsibility actions.
B. Requiring the Issuer to Report
Requiring issuers to report is the better solution. Often times, attorneys do not have knowledge of the entire corporate scheme. In the case of Enron, the corporation had hundreds of auditors and attorneys working on multiple and varied projects.15 Thus, corporations are better objects of the blame for failing to report. The procedure is easier to implement as the SEC can require issuers to declare each time they make a filing or appear before the SEC in any manner that there have been no allegations, reports or evidence of material violations reported to the corporation or no attorney withdrawals.
The requirement that issuers must report also provides attorneys with an out if the corporation is acting unlawfully. Because the corporation is their client, attorneys should only be required to report up-the-ladder as high as the Board of Directors. If there is continued wrongdoing, the attorney can withdraw. Requiring an attorney to disclose only up to the Board of Directors eliminates any confidentiality or attorney-client issues because the corporation is the client. Requiring the corporation to make the disclosure to the SEC puts the decision and burden in the client's hand regarding self-disclosure.
III. Qualified Legal Compliance Committee
Currently, the proposed rule in section 205.3 provides that an attorney can report evidence of a material violation to a qualified legal compliance committee so that the issuer can resolve the matter internally.16 Reporting to this committee relieves counsel of his obligation, but it is unclear what the responsibility of this committee is after receiving the complaint. This proposal allows public companies to resolve matters internally via a committee without reporting the resolution, either positive or negative, to the public. This substantially defeats Sarbanes-Oxley's purpose of protecting investors. First, is the SEC ever apprised of the complaints received by these committees? How will the investing public ever know if the internal resolution is satisfactory or on the level? The SEC should require a confidential memorandum from the issuer regarding the resolution of the items dealt with by these committees. Additionally, the SEC should publish a list of corporations who are currently reviewing complaints within qualified legal compliance committees so that investors are alerted as to any potential risk in investing with that company.
IV. Constitutional Concerns
A. Separation of Powers
Does the SEC have the power to determine what conduct will or will not waive the attorney-client privilege? Attorney-client privilege is typically an evidentiary issue. It seems as though the SEC is stepping into the role of judiciary by stating in §205.3(d)(3) that notification to the SEC prescribed by §205.3(d) does not breach the attorney-client privilege.17
The proposed rules state that the attorney should report to the SEC when the attorney reasonably believes that a material violation has occurred. Reasonably believes is both objective and subjective. Does SEC have the authority to decide whether an attorney has the requisite mental state? It seems as though the SEC is again stepping into role of judiciary. Is an attorney culpable if, in his mind, no violation has occurred, but another attorney would disagree?
Last, is the SEC stepping into the role of legislature by creating criminal liability for violations of these proposed rules? The SEC is creating aiding & abetting liability for attorneys under these rules. In addition, the SEC treats violations of these rules the same as a violation of the securities laws.18 Thus, attorneys could be guilty of a felony. A long-standing principle of separation of powers is that so long as Congress provides administrative agencies with standards guiding their actions so that a court can determine "whether the will of Congress has been obeyed" then no delegation of legislative authority has occurred.19 The SEC is supposed to carry out the laws that Congress created; not create additional laws. Again, an administrative agency's rulemaking authority is not the power to make law, but to make rules that give effect to the will of Congress.20 The agency is not supposed to create new criminal sanctions. The SEC can avoid creating new criminal sanctions by implementing its alternative proposal that the issuer self-report. Further, the existing state ethics rules and malpractice laws provide enough punishment for errant attorneys.
The Tenth Amendment provides that "[t]he powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.21 States traditionally govern ethics rules. There is no federal body of ethics law to preempt state rules.
If the SEC requires the attorney to report violations, it might force the attorney to choose between a securities violation and/or state ethics rule violations. The SEC could institute a necessity defense (choice of evils) for attorneys who are faced with this choice. Alternatively, if the SEC requires the issuer, not the attorney, to report, the SEC avoids imposing conflicting state and federal penalties on attorneys.
Section 205.2 defines attorneys appearing or practicing before the commission. "Appearing and practicing before the [SEC] includes, but is not limited to, an attorney's:
This definition is vague and overbroad. The definition encompasses domestic and foreign corporate law professionals, but also snares a broader group of individuals who may have had minimal contact with an SEC filing such as non-corporate attorneys, associates acting at a supervising attorney's behest, law clerks, and unlicensed individuals.
"Vagueness is constitutionally problematic when a criminal statute either 'fail[s] to provide the kind of notice that will enable ordinary people to understand what conduct it prohibits[, or] may authorize and even encourage arbitrary and discriminatory enforcement.'"23 In order for a statute to not be vague, it needs to provide fair notice and limits on prosecutorial discretion.24 Here, the statute calls for criminal penalties and only provides `lawyer's notice' because typically only experienced corporate lawyers will be familiar with the statute. Law clerks and unlicensed professionals who complete projects at an attorney's request that ultimately become incorporated into a filing are deemed to have appeared before the SEC and will be subject to these guidelines. This statue does not provide adequate notice to those individuals. The SEC is unfairly casting a broad net and creating liability for individuals who do not have knowledge that they are violating a statute. The statute needs to incorporate a more clearly defined mental state or a narrower definition of practicing before the SEC to establish violations.
D. Inconsistent with Sarbanes-Oxley
The proposed rules exceed Congress' mission in creating the Securities and Exchange Commission.25 The purpose of SEC is not attorney professional responsibility. By adopting a rule requiring attorney reporting, the SEC risks becoming a watchdog for professional ethics and discipline instead of what the SEC was intended for. However, if the SEC requires issuers to report unlawful activity it would alleviate this concern.
Further, the Sarbanes-Oxley Act does not mandate section 205.3(d) and its proposed rules because an attorney's obligation extends only to his client and not the investing public. Section 205.3(d) expands an attorney's responsibility beyond that of his client by requiring an attorney to report violations to the SEC. The SEC can avoid this problem by implementing its alternative proposal that the issuer report any violations.
This letter opposes a requirement that attorneys must report evidence of a material violation to the SEC after a noisy withdrawal. Attorneys should only be required to follow the up-the-ladder mandate to the issuer's Board of Directors. The better method is to require issuers to report any reports of material violations or attorney withdrawals. Requiring issuers to self-report would alleviate many of the ethical and constitutional issues raised by the attorney-reporting requirement.
Thank you for your time and consideration of these comments.