America's Community Bankers
December 18, 2002
Jonathan G. Katz
Re: Implementation of Standards of Professional Conduct for Attorneys
Dear Mr. Katz:
America's Community Bankers (ACB)1 is pleased to comment on the proposed rule issued by the Securities and Exchange Commission (SEC) to implement standards of professional conduct for attorneys,2 as required by section 307 of the Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley).3 The proposal would require attorneys to report evidence of a material violation of securities laws, material breach of fiduciary duty, or similar material violation, first to the chief legal officer and chief executive officer of the company and, if no appropriate response is received, to the audit committee, another committee of independent directors, or the full board. If there is still no appropriate response, the attorney must, for certain ongoing violations or violations about to occur, and may, for certain past violations, send notice to the SEC withdrawing from representation (a "noisy withdrawal") and disaffirming certain documents or filings that the attorney has prepared or assisted in preparing. The responsibilities of attorneys under the proposal will be different for in-house and retained counsel. The proposal also distinguishes between supervising and subordinate attorneys.
The proposal offers an alternative reporting scheme that allows the attorney to report a material violation to a "qualified legal compliance committee" (QLCC), which then would have the responsibility to review the evidence, conduct an investigation, and ensure that responsive action is taken, when necessary. The QLCC would have to be composed of directors who are not employed by the issuer and include a member of the company's audit committee.
ACB agrees with the main principle underlying section 307 of Sarbanes-Oxley and the proposed rule that an attorney appearing and practicing before the SEC in the representation of an issuer represents the company as an organization, rather than the officers, directors or employees, and must act in the best interest of the company and its shareholders. We also agree that when an attorney discovers evidence of potential violations of the securities laws, the attorney should bring those concerns to the attention of officials at the company who are responsible for reviewing the facts and taking corrective action. If those officials do not act appropriately, then the attorney should bring the concerns "up the ladder" to the audit committee or, if there is no audit committee, to a committee of independent directors or, if there is no such committee, to the full board. We are pleased that the SEC is allowing subordinate attorneys to report to supervising attorneys so that those attorneys more experienced and knowledgeable will be the ones to ultimately make the decision of whether the "up the ladder" reporting requirements are triggered.
We do have some concerns with aspects of the proposal. We do not believe that attorneys who are not acting in a legal capacity at a company should be covered by the rule even if they are admitted, licensed or otherwise qualified to practice law. While these individuals may desire to maintain their licenses to practice law, they have chosen to serve in a business, rather than a legal capacity, and should not be exposed to a requirement or standard higher than any other employee at the company serving in a similar capacity. This exception should be clearly noted in the regulation.
The objective standard used to determine whether evidence would lead an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur, should be clarified so that the rule holds the attorney only to the standard of someone with comparable knowledge and expertise on similar legal matters.
The SEC should clarify the definition of "material violation." Specifically, the SEC should limit the scope of a "material breach of fiduciary duty" and a "similar material violation" to breaches or violations over which the SEC would have jurisdiction.
The SEC should withhold adopting the "noisy withdrawal" aspects of the proposal. This provision is not a requirement of Sarbanes-Oxley and raises issues that require sufficient review, analysis and discussion that cannot be adequately undertaken in the tight time frame that the SEC has to implement the other specific requirements of section 307. The "noisy withdrawal" provision would impose on attorneys requirements of an unprecedented nature and appears to conflict with the language and intent of section 307. The conflict attorneys will confront between being an advocate for the client and facing the possibility of having to report to the SEC will adversely affect the ability of the client's officers and employees to have a candid relationship with the attorney, depriving the client of the right to obtain the best possible advice and advocacy from the attorney.
We question whether the QLCC would be a viable option for community banks because the members cannot be employed by the issuer. Aside from the difficulty of finding individuals willing to serve as directors, independent directors, and particularly audit committee members, will have greater responsibilities as a result of Sarbanes-Oxley and it would be difficult to add additional responsibilities that are not otherwise required by law or regulation. If a company does establish a QLCC, the rule should require retained counsel to report to the QLCC.
Definition of Attorney
The proposal would define an attorney as any person who is admitted, licensed, or otherwise qualified to practice law in any jurisdiction, domestic or foreign, or who holds himself or herself out as admitted, licensed, or otherwise qualified to practice law. ACB believes that the definition of attorney should be limited to those individuals who are serving the issuer in an advisory capacity. There are individuals who may want to maintain their license to practice law, but do not actively practice as they have chosen to apply their skills and talents in other professional endeavors. These individuals should not be treated any differently than other employees serving in a business capacity. They would not necessarily have any background or exposure to the securities laws and would not be in a position to make a judgment as to whether a response from management to a report of evidence of a material violation was appropriate. In treating supervising attorneys and subordinate attorneys differently, the SEC seems to recognize that it takes a certain amount of experience and knowledge to be able to make the judgments necessary to meet the requirements of the rule. Individuals not serving a company in a legal capacity will not have that experience and knowledge. Individuals who do not choose to practice law should not be held to the same standards as those who do.
It also would not make sense, from a practical standpoint, to apply the specific requirements to executive officers or directors who may be licensed attorneys, but are not serving in a legal capacity. If a chief executive officer or director happens to be a licensed attorney and becomes aware of evidence of a material violation by another officer or employee, the chief executive officer or director should be free to confront the individual or discuss the matter with the board or outside counsel without going through the steps required by the rule. It would be more beneficial to the company and its shareholders, and more expedient, for a problem to be handled in this manner. Otherwise, the question would arise as to whether the executive officer or director who reports the problem "up the ladder" would then have to recuse himself or herself from any review or investigation of the problem.
Use of Objective Standard
The rule holds attorneys to an objective standard in determining whether evidence would lead an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur. This standard should be clarified so that attorneys are compared to other attorneys with comparable knowledge and expertise and that the standard addresses only legal matters and not accounting issues. The definition of "appearing and practicing before the Commission" is very broad. It will cover individuals who assist in preparing the actual disclosure document, as well as any exhibit to the disclosure document including, for example, employment agreements and employee benefit- and tax-related documents. Therefore, attorneys with many different types of expertise, including tax attorneys, employee benefits attorneys, and regulatory attorneys, will be covered by the rule. Attorneys practicing in specialized areas should not be held to the same standards as attorneys with securities law expertise. Furthermore, the objective standard should be applied only as it relates to evidence of a legal nature. Attorneys should not be expected to make judgments about accounting issues.
Definition of Material Violations
The rule would define material violation as a material violation of the securities laws, a material breach of fiduciary duty, or a similar material violation. ACB believes that the SEC should clarify the definition of "material violation." In particular, the SEC should limit material breaches of fiduciary duty or a similar material violation to actions that affect laws and regulations under the jurisdiction of the SEC. We are particularly concerned that the definition could encompass violations of banking laws and breaches of fiduciary duty as they apply to the fiduciary relationship that banking institutions have with their customers. Corporate and securities lawyers do not necessarily know banking law, so while they might think that they see an issue, they would not know the effect that a particular problem could have on a company nor would the attorney be able to make a reasonable judgment as to whether management has presented an appropriate response. Furthermore, because the SEC does not have jurisdiction over violations of banking laws, it is unclear what actions the SEC could take if the agency gets a "noisy withdrawal" resulting from a matter involving laws outside its jurisdiction.
The intent of section 307 was to impose minimum standards of professional conduct for attorneys "appearing and practicing" before the SEC. Therefore, the reporting of evidence of material violations should encompass only violations of those laws, regulations and fiduciary duties that fall within the SEC's jurisdiction.
The proposed rule would require retained attorneys who do not get an appropriate response to their report of evidence of a material violation that is occurring or about to occur, and who reasonably believe that the violation is likely to result in substantial injury to the financial interest or property of the issuer or its investors, to file a notice with the SEC withdrawing from representation and disaffirming certain documents. If the attorney's report is with regard to a past material violation, the withdrawal and disaffirming of documents is permissive rather than mandatory. In-house counsel would not be required to withdraw, but would have to file a notice with the SEC disaffirming documents.
We agree with the SEC that instances where a "noisy withdrawal" would be required should be rare. However, the "noisy withdrawal" requirement is not required by the statute and appears to conflict with the express intent of Congress. Senator Edwards, who proposed section 307, said that the SEC was to make a "simple rule with two parts. No. 1, a lawyer with evidence of a material violation has to report that evidence either to the chief legal counsel or the chief executive officer of the company. No. 2, if the person to whom the lawyer reports doesn't respond appropriately . . . , that lawyer has an obligation to go to the audit committee or to the board. It is that simple."4 Furthermore, Senator Enzi, a key sponsor of section 307, made it clear that the provision "would not require the attorneys to report violations to the SEC, only to corporate legal counsel or the CEO, and ultimately, to the board of directors."5
Aside from going beyond what is required by the language and intent of the statute, the "noisy withdrawal" will have an adverse impact on the relationship that directors, officers and employees will have with the company's attorneys. While it is true that the attorney's responsibility is to the company and its shareholders, the practical reality is that the attorney must deal on a regular basis with the company's representatives in meeting the requirements of the securities laws. There is no requirement that legal counsel be involved in the preparation of periodic reports and other documents that are filed with the SEC. This provision may result in the exclusion of the attorney from participation in the reporting process, resulting in less, rather than better, compliance with the securities laws and regulations. Even if attorneys are involved in the process, the rule will discourage frank and open discussion among the company's representatives and the attorneys if there is a constant fear that an attorney may report to the SEC if disagreements are not resolved in what the attorney views as an appropriate manner. These same adverse results would be avoided if officers and employees knew that any disagreements or issues would be settled internally.
The "noisy withdrawal" requirement also raises serious issues under state professional codes of attorney conduct and the attorney-client privilege. We believe that those issues will be comprehensively addressed by the organized Bar. We do believe, however, that in order to fully review and analyze objections or suggestions regarding the "noisy withdrawal" provisions of the proposal, the SEC should not rush to adopt this aspect of the rule since it is not a Sarbanes-Oxley requirement. There is no reason why the SEC cannot adopt the remainder of the rule by the January 26th deadline, and leave this aspect of the proposal to further review and study.
Qualified Legal Compliance Committee
The SEC is proposing a procedure for reporting evidence of a material violation as an alternative to the "up the ladder" reporting. Under the alternative, an attorney could report evidence of a material violation to a QLCC. By using the QLCC, the attorney could avoid having to determine whether a response to evidence is appropriate and the "noisy withdrawal" requirement.
ACB appreciates the efforts of the SEC to come up with an alternative mechanism to reporting that would alleviate some of the concerns with the proposal. However, we are not sure that the QLCC will be a viable alternative for community banks. The QLCC must be composed of directors who are not employed by the issuer and must include at least one member of the audit committee. Independent directors, and particularly audit committee members, already will have extensive responsibilities. Not only do bank and savings association directors have responsibilities under state corporate law and Sarbanes-Oxley, they also must understand and enforce a full range of banking laws and regulations. These individuals may not be willing or able to accept the additional responsibilities required of a QLCC member. We request the SEC to reconsider the required composition of the committee. If membership were more flexible, we could see this as a more viable option for smaller companies. After all, as long as there is more than one member of the QLCC and the QLCC is authorized to retain outside experts, it is doubtful that a QLCC with more flexible membership requirements would be any less likely to fulfill its obligations than a committee made up of independent directors.
ACB believes that if a company establishes a QLCC, retained counsel should be required to report any evidence of a material violation to the committee. Any company that goes to the trouble of setting up the QLCC to coordinate the review and investigation of attorney reports should then receive the benefit of knowing that retained counsel will use the procedure and that all reports will come through the committee.
ACB appreciates the opportunity to comment on this important matter. If you have any questions, please contact the undersigned at (202) 857-3121 or via e-mail at firstname.lastname@example.org, or Diane Koonjy at (202) 857-3144 or via e-mail at email@example.com.