Bar Association of San Francisco
Beverly Hills Bar Association
December 18, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. 33-8150.wp
Dear Mr. Chairman and Honorable Commissioners:
The Bar Association of San Francisco respectfully submits the following comments in response to your request for comments on the SEC's Proposed Rule 205 in connection with Section 307 of the Sarbanes-Oxley Act ("Section 307"). The Beverly Hills Bar Association joins with the Bar Association of San Francisco in presenting these comments. A statement concerning the Beverly Hills Bar Association appears at the conclusion of this letter.
The Bar Association of San Francisco (the "Association") is a not-for-profit membership organization of over 9,900 legal professionals in the San Francisco Bay Area. Our Association promotes high ethical standards of integrity, excellence, and respect in the practice of law. An important part of our mission is to provide assistance in the development of rules of professional conduct for lawyers which serve and protect the public, preserve the attorney-client relationship, and promote the administration of justice.
Members of our Association have substantial experience in representing businesses in IPOs, public offerings, and mergers and acquisitions. Many lawyers in our Association regularly practice before the SEC and advise businesses of varying size, including publicly held corporations with operations throughout the country and the world. Our Standing Committee on Legal Ethics has been heavily involved in the work of the ABA Ethics 2000 Commission and in the revision of the California Rules of Professional Conduct. The Association also recently submitted written comments in response to the draft report by the ABA Task Force on Corporate Responsibility and participated in public hearings held by the Task Force in Stanford, California on November 11, 2002.
The Association supports the efforts of Congress and the SEC to improve ". . . the accuracy and reliability of corporate disclosures made pursuant to the securities law. . ." However, this letter reflects our grave concerns with the features and basic assumptions of Proposed Rule 205 (the "Proposed Rule" or the "Rule"). The Proposed Rule is an overly broad reaction to Congress's directive under Section 307. We believe that implementation of Proposed Rule 205, as it is currently drafted, would cause unintended harm to the public interest by undermining the essential fiduciary relationship between an issuer and its attorney and rendering the attorney less effective in fulfilling his or her professional responsibilities to the entity-client.
A. Duty to Investors. The Proposed Rule is based on the fundamentally flawed concept that an issuer's attorney holds the same fiduciary duty to investors as the attorney owes to the entity-client. While the intention of Section 307 is to protect the public from corporate scams, imposing on a company's lawyers a fiduciary duty to the company's investors is contrary to the fundamental nature of the attorney-client relationship. Virtually every rule making authority that has considered the issue of the proper representation of the organization has determined that the lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents. Restatement Third, The Law Governing Lawyers, Section 96; ABA Model Rule 1.13(a); California Rule of Professional Conduct 3-600(A). It has long been decided that the lawyer employed or retained by a corporation owes his or her allegiance to the entity and not to the shareholders, officers, directors or other constituents connected with the entity. See ABA Model Code of Professional Responsibility, EC 5-18 (1969); Restatement Third, The Law Governing Lawyers, section 96, Reporter's Note.
An attorney owes a duty to his or her client first and foremost. Representing another person or entity with interests adverse to the client is in direct violation of the rules of ethics governing lawyers. For example, an issuer's attorney may be called upon to opine on the company's managerial decision whether to declare stock dividends. Obviously, what is in the company's best interest may not be in the investor's best interest. The attorney who holds a duty to both the company and the investor is obviously conflicted in this situation and thereby unable to perform his or her job. Therefore, while the regulation of attorneys under Proposed Rule 205 is intended to result in protection of the investor, the attorney's primary fiduciary obligation is to act in the best interests of the corporate entity and he or she does not have a duty to represent the interests of the investors and shareholders. Such an obligation would be contrary to the law - see, Restatement Third, The Law Governing Lawyers, Section 96, Comment b and Reporter's Note. It is well established that representing a corporation does not constitute representing its shareholders. Jacuzzi v. Jacuzzi (1963) 218 CA2d 24, 29, 32 CR 188, 191-192; California State Bar Formal Opinion 1989-113; ABA Model Rule, 1.13, Comment 7. The SEC's definition at 205.2(f) of what constitutes "representation of an issuer" is much too broad in that it includes representation of the issuer's subsidiaries, agents, and investors. This Association respectively submits that to promulgate regulations that impose duties on lawyers representing issuers to not only their organizational client but also to potential investors in that client will result in inevitable conflicts in attempting to serve competing interests that in the end will render lawyers less effective and will not serve the public interest.
B. Persons Subject to Rule. The Proposed Rule is overarching as to the persons and situations it intends to regulate. The intent of Section 307 is to regulate attorneys appearing and practicing before the SEC on behalf of issuers. The Proposed Rule has gone beyond the statutory directive and at §205.2(c) purports to regulate non-lawyers - those persons holding themselves out as practicing law. The issue of practicing without a license is not one to be addressed in this forum. The definition of attorney under the Proposed Act also includes attorneys practicing in foreign jurisdictions. The SEC should not attempt to widen its jurisdiction beyond the boundaries of the United States. In contrast to preemption claims against the states, extraterritorial jurisdiction claims which also constrict the right to counsel within an issuing entity have no valid claim of preemption against conflicting rules of other sovereign jurisdictions.
Section 205.2(a)(5)(iii) includes in the definition of "practicing and appearing" before the SEC, "advising any party that the party is not obligated to submit or file a registration statement . . . with the Commission . . ." The purpose of the SEC is to regulate the issuance of stock by certain companies, thereby lending integrity and legitimacy to those particular financial securities. The status of nonregistration should convey information to investors in and of itself. It would go well beyond the SEC's purview to regulate the business activities of companies who never intended to issue registered securities.
Section 205.2(f) defines an attorney as representing an issuer even if the attorney is not retained by the issuer. This definition is overly broad and will severely limit an attorney's ability to practice law and effectively represent his or her clients. Implementation of the Rule would create unavoidable conflicts of interest, placing the attorney at odds with his or her corporate client. Attorneys are often asked to give advice to a potential client before being retained by that person. See ABA Model Rule 1.18 (2002). Often, the person never retains the attorney. If an attorney is potentially liable for any information disclosed during that initial meeting, the attorney will be reluctant to take on issues or clients. The Proposed Rule, if implemented, would substantially interfere with the effective practice of securities law, which would not serve the public interest.
Section 205 attempts to regulate attorneys beyond just those that practice or appear before the SEC in connection with the issuer. The Rule's reporting obligation applies even to an attorney serving in the role as an advocate representing the interests of the corporation in a civil injunctive action who is also representing the issuer in an investigation before the SEC. The attorney would have an obligation to report "whether or not the evidence is related to the subject matter of the litigation." (Page 29 of Proposed Rules.) This goes far beyond the intention of Congress in regulating corporate attorneys in their practice before the SEC. The role of a lawyer as a litigator or advocate for his or her client is recognized as being substantially different than a lawyer serving as a counselor or advisor. "As a representative of clients, a lawyer performs various functions. As advisor, a lawyer provides a client with an informed understanding of the client's legal rights and obligations and explains their practical implications. As advocate, a lawyer zealously asserts the client's position under the rules of the adversary system..." (Preamble to the Model Rules of Professional Conduct, paragraph 2). The Proposed Rules are contrary to the judicially established professional duties of loyalty and confidentiality owed by all lawyers to every client. The Rule, if implemented, would cause confusion and result in inconsistency in the rules governing lawyer conduct in these areas of practice.
C. Beyond the Mandate of 307. - Section 307 requires an attorney to report evidence of a material violation by an issuer in the manner as provided in the statute. Section 307 does not require the attorney to act as an investigator or policeman if the company through it authorized decision makers do not respond appropriately to the evidence. The requirement for a "noisy withdrawal" is not contemplated by the statute and goes far beyond the mandate of Section 307. An attorney who has reported evidence of a material violation cannot be expected to always know whether a violation is actually occurring or is likely to occur. The lawyer's responsibility under Section 307 is to report evidence of wrongdoing so that those within the corporate governance, whose job it is to do so, can make the informed decisions necessary to prevent potential violations and remediate actual violations that have previously occurred.
Furthermore, if an attorney is required to make a noisy withdrawal, the attorney's function as counsel to the company will again have been undermined. An attorney for a publicly held company plays an essential role in counseling the entity-client with respect to compliance with the law. The law has become increasingly complex such that a competent lawyer must be able to maintain his or her professional independence in order to provide sound professional advice and counseling to his or her entity-client. If an attorney is forced to withdraw when he or she suspects that a violation may occur, the ability to properly counsel the client will have been lost. In addition, successor counsel will be burdened by the same obligation and will likely be forced to resign. The Rule is therefore self-defeating in that the issuer is likely to be left without effective legal counsel.
D. Duty of Confidentiality. In many places within the Proposed Rule, the SEC states that the reporting of confidential information by the attorney will not result in a violation of the attorney-client privilege or the duty of confidentiality. The SEC's fiat contravenes well established principles of the attorney-client privilege and the duty of confidentiality. The attorney-client privilege is recognized between attorneys and corporate clients. (Upjohn Co. v United States (1981) 449 US 383, 101 S. Ct. 677.) Confidentiality is the central feature of the unique relationship between an attorney and client. Confidentiality enables lawyers to function as lawyers, promotes client autonomy and dignity, and is essential to an effective and impartial system of justice.
Declaring in a rule that disclosure of otherwise confidential information does not violate the attorney-client privilege and, by implication, the attorney's fiduciary duty of confidentiality, does not make it so. The confidentiality of attorney-client communications is well recognized and essential to the attorney-client relationship. An attorney has an essential role in counseling the client with respect to the complex application of the law so that the informed client will be able to comply with the law and be better able to prevent constituents of the organization from committing an illegal act. Because a client or potential client can rely on the fact that discussions with an attorney about complex issues, including those issues involve illegal activities, will remain confidential, a lawyer has the ability to effectively counsel the client to take appropriate action before a violation occurs. The lawyer's duty of confidentiality is a cardinal principle of professional responsibility that has been empirically demonstrated through experience and dialogue in the profession to be both sound and essential to the fiduciary relationship between attorney and client and to the system of justice in this Country. The vast majority of issuers that consistently comply with the securities laws do so with the confidential advice and assistance of their lawyers. In many cases, these issuers have longstanding and valuable relationships with their counsel. The collapse of Enron and several other companies, while dramatic, do not warrant the significant departure from these principles as evidenced in proposed Rule 205. Nor has Congress mandated such a departure in Section 307 of the Act. If an attorney is obligated to report what is told to him or her in confidence, it will severely limit the attorney's ability to candidly and effectively counsel the client with respect to the client's compliance obligations to the SEC. It is not in the public interest to promulgate rules that will substantially impair a lawyer's ability to counsel clients in this manner.
The Proposed Rule is too expansive. The potential consequences of the Proposed Rules need to be more carefully considered and analyzed. The SEC appears to have relied heavily on the ABA Task Force's Report on Corporate Responsibility. It is important to note that the Report has not been adopted and has in fact been met with valid criticism in the legal community as a result of its many flaws. As a result, the Task Force's final report has been delayed and will not be finalized until next March. Therefore, in light of the short time frame given to the SEC (180 days) to promulgate the new Rule, and the all too brief comment period for Proposed Rule 205, the Association respectfully suggests that the SEC limit the Rule to Congress's directive under Section 307 and postpone for more thoughtful consideration any expansion of that mandate.
Past President - Bar Association of San Francisco
President - Bar Association of San Francisco
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The Beverly Hills Bar Association is one of the largest voluntary metropolitan bar associations in the nation. Its over 3,500 members are dedicated to serving the legal profession, raising and maintaining professional and ethical standards of the bar, providing leadership on major issues affecting the profession and the community, facilitating access to legal services, and supporting the justice system. The Association therefore has a keen interest in the development of sound principles of the core duties of the profession, including the fiduciary duty and duty of confidentiality a lawyer owes to a client. The Association is therefore very interested in finding the balance between proper corporate governance and the professional duties of counsel.
Christopher T. Bradford
President, Beverly Hills Bar Association