Cravath, Swaine & Moore
New York, London, Hong Kong

December 18, 2002

Sarbanes-Oxley Act Section 307
Implementation of Standards of
Professional Conduct for Attorneys
File No. 33-8150.wp

Dear Mr. Katz:

This letter relates to the proposed adoption by the Securities and Exchange Commission of Part 205 under Section 307 of the Sarbanes-Oxley Act of 2002. In this letter, I will first make some preliminary observations regarding proposed Part 205 and then discuss some specific issues.

Preliminary Observations

I am aware of the comment letter with respect to Part 205 signed by a number of United States law firms, including Cravath, Swaine & Moore. I fully support the comments made in that letter, including:

• The recommendation that the Commission defer action on the "mandatory noisy withdrawal" contemplated in proposed Part 205. I support this recommendation because Section 307 does not require mandatory noisy withdrawal, and it is an issue of sufficient complexity that the Commission should not act without extensive input from bar associations throughout the world and full consideration of that input, which clearly is not possible by January 26, 2003.
   
• The recommendation that the Commission defer action with respect to the applicability of proposed Part 205 to non-U.S. lawyers. I support this recommendation because subjecting non-U.S. lawyers to proposed Part 205 is such a complex issue and raises such significant issues of international comity that the Commission should not rush to action on this point.
   
• The extensive drafting suggestions with respect to the key definitions in proposed Part 205. I support these suggestions because proposed Part 205, as written, is hopelessly ambiguous. I do not regard it as appropriate for the Commission to regulate attorneys without giving them the benefit of rules that are clear in their scope and applicability.

I recognize that Section 307 directs the Commission to implement "up the ladder" reporting by January 26, 2003. As a lawyer subject to the existing New York State ethical rules relating to representation of entities, I do not have any concerns with the concept of "up the ladder" reporting. As the Commission discharges its mandate in this area, however, the Commission should be sensitive to the long-term consequences of its regulatory responsibility over attorneys. Extensive substantive regulation of attorneys by the Commission would represent a significant and fundamental shift in the nature of the regulation of attorneys, with currently unknowable consequences. I urge the Commission to move very carefully in this area. In particular:

• It is clear that the Commission has drawn upon existing rules for ethical behavior by attorneys and recent proposals with respect to revisions to those rules for the purpose of developing proposed Part 205. The Commission should recognize, however, that there is a significant difference between the enforcement of an ethical rule by bar associations and courts, on the one hand, and the enforcement of the exact same rule by the Commission, on the other hand. Because the Commission is not neutral with respect to the enforcement of the securities laws against private citizens, the Commission cannot be neutral with respect to the enforcement of rules relating to the manner in which attorneys advise their clients on the application of the securities laws. There is grave danger that enforcement by the Commission of rules with respect to advice given by lawyers to clients regarding the application of the securities laws will inevitably deprive clients of the benefit of legal advice. Issuers and their counsel frequently challenge the Commission with respect to the application of the securitieslaws; sometimes issuers are successful and sometimes they are not. Ordinarily, counsel's good faith disagreement with a regulatory agency would not be viewed as raising an ethical issue for the attorney involved. Commission enforcement of the ethical responsibilities of lawyers raises a significant risk that otherwise perfectly appropriate behavior by attorneys—disagreeing with the Commission on a matter arising under the securities laws—will be converted into an ethical issue that impairs the ability of the lawyer to advise his or her own client.
   
• This issue is particularly acute in the area of defending issuers against Commission enforcement action or private litigation with respect to disclosure matters. It will be extremely difficult for lawyers to advise clients to resist Commission enforcement or private lawsuits in this area if a determination against the issuer could create an ethical issue for defense counsel. There is an interesting parallel with the standard for sanctions under Rule 11: even a sanctionable defense under Rule 11 is not viewed as an ethical issue for the sanctioned attorney if the defense was in good faith.
   
• Notwithstanding the recent spate of corporate governance failures, there is scant evidence that proposed Part 205 would have made any difference. Most attorneys in the United States are already subject to "up the ladder" reporting obligations, and existing Rule 102(e)(1) authorizes Commission action against attorneys who violate ethical obligations. In addition, the Commission currently has the ability to bring proceedings against attorneys for aiding and abetting securities law violations. While Congress has clearly decided that the Commission should implement rules in this area, I urge the Commission to act carefully in implementing, or going beyond, the Congressional mandate in the absence of evidence that the proposed rules will create any beneficial change in behavior.

Specific Comments

Proposed Rule 205.3(a). I recommend that the first sentence of Proposed Rule 205.3(a) be revised to delete the words "and its shareholders".

The reference to "and its shareholders" is unnecessary. The Commission clearly can implement "up the ladder" reporting and, if ultimately thought necessary, "mandatory noisy withdrawal" without the inclusion of the words "and its shareholders" in Rule 205.3(a).

The reference to "and its shareholders" is, in any event, overly simplistic and simply not correct in many circumstances. For example, counsel to an issuer that is in bankruptcy clearly does not have an obligation to act in the best interests of the shareholders of the issuer. Counsel retained to defend an issuer in a lawsuit brought by shareholders cannot have an obligation to act both in the best interests of the defendant issuer and in the best interests of the plaintiffs. In addition, the corporate laws of many States specifically authorize the boards of directors of issuers incorporated in those states to take account of the interests of stakeholders in addition to shareholders. It will place counsel for those issuers in an impossible position if counsel owes a duty to shareholders that differs from the duty of the board of directors of the issuer.

Finally, the reference to "and its shareholders" is fundamentally confused. Corporate finance theory distinguishes between those people who are shareholders of a company at a particular point in time and the concept of the shareholders as a group. That distinction has significant consequences for proposed Part 205. For example, a failure by an issuer to make adequate disclosures may lead to trading in the securities of that issuer on an uninformed basis and may result in a wealth transfer from one set of investors to another. That obviously has implications for the people who are shareholders at any particular point in time. Because it is simply a wealth transfer within the investor base, however, it does not have any effect on the shareholders as a group. On the other hand, a fiduciary duty claim that involves potential misbehavior by management at the expense of shareholders will adversely affect both the shareholders at any particular point in time and the shareholders as a group. If the focus of the words "and its shareholders" is the shareholders at a point in time, the Commission must recognize that those shareholders are not in fact benefitted by the prompt disclosure of negative information with respect to the issuer. The complexity ofthese issues shows how confusing the words "and its shareholders" would be in proposed Rule 205.3(a), and I recommend that they be deleted.

"Awareness of Evidence of a Material Violation". This is a key definition in proposed Part 205. As proposed, it is also extraordinarily ambiguous. The discussion of this definition in the proposing release simply adds confusion rather than enlightenment.

The concept of "awareness of evidence of a material violation" involves three components: knowledge of the facts, knowledge of the law, and knowledge of materiality. It seems from the proposing release that "knowledge of the facts" is to be subjective. According to the proposing release, the facts are to be judged by the reporting attorney on the basis of what he or she knows, not what he or she should have known or what he or she would have known had he or she conducted an investigation. The analysis of "knowledge of the law" is more confused. While the text of proposed Part 205 refers to the "reasonably competent" lawyer, the proposing release recognizes that different "reasonably competent" lawyers have different skill sets. It is impossible to tell from proposed Part 205 and the proposing release whether the "knowledge of the law" component is meant to be subjective or objective. This uncertainty is exacerbated by the breadth of the concept in proposed Part 205 of "fiduciary duty and similar material violation". There is substantial risk that this ambiguity will convert genuine good faith disagreements on unresolved legal questions into ethical issues for lawyers. Finally, there is absolutely no discussion or guidance as to how "knowledge of materiality" is to be determined.

"Appearing and Practicing before the Commission". Proposed Part 205 is also unclear as to the relationship between "appearing and practicing before the Commission" and the "awareness of evidence of a material violation". The proposed rules should be clarified to state that the reporting obligation is only triggered if the awareness by an attorney of evidence of a material violation arises out of and in the course of appearing and practicing before the Commission in the representation of an issuer.

"Appropriate Response". The proposed definition of "appropriate response" is also ambiguous and raises significant uncertainty. In the proposing release, the Commission has highlighted two ends of the spectrum: first, a legal opinion by a reputable law firm that fully addresses all issues (which clearly is an appropriate response), and, second, the bald assertion by the issuer that there has beenno material violation (which clearly is not). Of course, in most instances the actual response would fall somewhere in between those two extremes. The proposed rule may put the reporting attorney in the impossible position of having to pass judgment on the reasonableness of another lawyer's opinion or, even worse, may result in the ethical obligations of a reporting lawyer depending on the view of a hypothetical third party reasonable lawyer as to the reputation of that other opining lawyer. Of course, all this would arise in circumstances in which the actions of the reporting lawyer would be judged with the benefit of hindsight. This is yet another example of how proposed Part 205 has the potential of converting simple disagreements as to legal judgment into ethical issues for the attorneys involved.

I urge the Commission to revise the definition of "appropriate response" such that a reporting attorney can with confidence, and without speculation, determine whether he or she has received an appropriate response.

I am confident that the Commission will reflect on these comments, and on those in other letters from reputable members of the legal profession, and produce final rules under Section 307 that are consistent with Section 307 and the best interests of investors.

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

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