Comments of on S7-45-02

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

File: No. 33-8150.wp

Re: Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys, 17 C.F.R. Part 205; Comments of Edward C, Brewer, III

Dear Mr. Katz:

This letter will provide comments on the proposed rules implementing section 307 of the Sarbanes-Oxley Act.

I am a signatory to the Painter and Koniak/Cramton/Cohen (“KCC”) letters and a teacher of Professional Responsibility, and these comments are in addition to those stated in the KCC letter. These comments arose from my recent efforts to explain and teach principles from the proposed regulations in a continuing legal education seminar, from my scholarly work on the ethics of internal investigations, and from my familiarity with securities enforcement from several years of securities compliance and litigation representation. Please accept my congratulations on the Commission’s efforts in the proposed rule, and permit me to offer my compliments to my colleagues who drafted the KCC letter.

I hope it is convenient that I proceed section by section. My references to the Disciplinary Rules, Ethical Considerations, and Model Rules are intended as references to those provisions as they may be in force in the several states.

Section 205.1, Purpose and Scope
1. Issue: Scope of State-Law Preemption
2. Discussion: This section contains a full conflicts waiver, which on its face would preempt even stricter and broader state confidentiality exceptions. The confidentiality exceptions have two dimensions: (I) their mandatory or permissive character; and (II) their scope of information subject to disclosure (e.g., securities fraud, financial fraud, civil fraud generally, crimes generally (including criminal fraud), and crimes involving imminent death or serious bodily injury). The preemption language should mention both dimensions for sake of clarity, and since any shorthand is likely to be unclear. The proposed solution below may solve part of the KCC letter’s concern over the meaning of a “permissive” disclosure as it relates to the negative pregnant of “not-permitted” disclosures.
3. Proposed Solution: Subject to the discussion under point 2 below, a limited-preemption provision such as the following:
  1. This part shall govern attorneys appearing and practicing before the Commission in any way in the representation of an issuer, provided, that where the standards of a state where an attorney is admitted or practices permit or require disclosure of information not subject to mandatory or permissive disclosure under this part, those state standards shall govern.
Section 205.1, Purpose and Scope
1. Issue: Preemption; Accounting for Horizontal Choice-of-Law Problems
2. Discussion: The language “where an attorney is admitted or practices” may be intended to account for horizontal choice-of-law problems for ethics in multi-state practice. The states use varying choice-of-law principles: (I) ABA Model Rule 8.5(b), which applies the standards of the forum in litigation matters, and in other matters, the standards of the state of admission (if multiple states, the state where the conduct has its predominant effect); (II) several common-law methods (primarily geographic jurisdiction, but also both traditional and modern conflicts principles), and (III) perhaps someday, Ethics 2000 Rule 8.5(b), which applies the ethics rules of the jurisdiction in which the conduct occurred or its predominant effect was felt, with a safe harbor for the lawyer’s reasonable belief about the governing law. See, e.g., Geoffrey J. Ritts, Professional Responsibility and the Conflict of Laws, 18 J. Legal Prof. 17 (1993). The word “practices” is likely to be too narrow under general choice-of-law principles, so at the very least a “conduct” and/or “predominant effect” rule should be stated. Better yet, you might use a flexible provision that simply refers to the final result. The Commission can expect significant problems of theory and application if it refers to the ethics rules of the jurisdiction of admission or practice if those rules were not applicable in the first place.
  You appear to use the word “standards” to refer to principles of ethics from whatever source derived, in preference to the narrower term “ethics rules.” The point is well taken, since some ethics principles come from caselaw, and there may be a statute or two out there. This creates a further problem of terminology, in that “Standards” is a near-term of art in legal ethics that refers to ethics rules applicable to a particular area of practice, such as the ABA Standards Relating to the Administration of Criminal Justice (3d ed. 1992), or function, such as the ABA Standards for Imposing Lawyer Sanctions (1986), adopted in a few states. I am not sure that the problem is worth a solution, but you may wish to be aware of it.
3. Proposed Solution: A limited-preemption provision, see point 1 above, that makes reference to the final result of the horizontal choice-of-law process:
  1. This part shall govern attorneys appearing and practicing before the Commission in any way in the representation of an issuer, provided, that where state standards applicable to an attorney’s conduct permit or require disclosure of information not subject to mandatory or permissive disclosure under this part, those state standards shall govern.
Section 205.2(a)(4), Appearing and Practicing, Transactional Coverage
1. Issue: Breadth of Coverage and Possible Need for Safe Harbors
2. Discussion: The Commission has properly sought to cover attorneys representing public companies in transactions material for securities disclosure purposes, the Enron partnerships being a classic example. The proposed rule would go much further to include transactional counsel in a wide variety of transactions, not all of which will matter for securities disclosure purposes. In one sense, it would be only good practice to consider whether a lawyer’s work product may have potential securities ramifications.
  The “reason to believe” standard (even if modified per the KCC letter), however, may be too “fuzzy” for a coverage-defining provision, for two reasons. First, a transactional lawyer who makes the wrong call on coverage could find him- or herself confronted with a state disciplinary complaint for disclosing matter permitted by Part 205 but prohibited under state ethics rules, a situation in which the lawyer’s “reason to believe” may be rejected and federal preemption is not likely to be given adequate deference, and in which the Commission may have no jurisdiction to act. Second, the “reason to believe” standard is going to create uncertainty for malpractice insurers, which could subject non-securities transactional lawyers to increased premiums. This is not to say that a bright-line rule is possible here, but that there may be a need to consider whether one or more safe harbors should be provided for transactional lawyers.
  The two safe harbors described below may provide the transactional lawyer with a clear non-coverage rule, while maintaining the force of Part 205 in the run of cases and retaining the perhaps desirable uncertainty of the standard in a borderline case. If the second safe harbor were thought to eliminate the effect of Part 205 for Enron-type situations, then I would agree it should not be included. It does assume, however, that the issuer would have securities counsel in place who would have responsibility for Part 205 compliance.
3. Proposed Solution:
  1. (B)(4), provided, that this provision shall not apply to an attorney
Section 205.2(c), Definition of Attorney
1. Issue: Inclusion of Attorneys Acting in Non-Legal Capacities
2. Discussion: The confidentiality/disclosure provisions of Disciplinary Rule 4-101 (“gained in the professional relationship”) and Model Rule 1.6 (“relating to the representation of a client”) assume that the attorney has a professional relationship in his or her capacity as an attorney, not in some non-legal capacity. The inclusion in Part 205 of attorneys acting in non-attorney capacities thus may suggest that there is a confidentiality obligation where none exists. It may also create a confusion of roles and responsibilities within the issuer for the attorney-not-acting-as-such, who may feel compelled to jump into disclosure issues as to which the issuer is already being advised. That in turn will create unnecessary difficulties not only for the issuer but also for the CEO, CLO, QLCC, and others, including the attorneys who have responsibilities both to advise the issuer and to comply with Part 205. The ethics rules do regulate attorneys in their non-attorney capacities, as in Disciplinary Rule 1-102(A) and Model Rule 8.4, which regulate “serious misconduct,” but the Commission has not sought to replicate those rules in Part 205.
3. Proposed Solution: Add the phrase “and who is representing the issuer as an attorney” at the end of the existing definition.
Section 205.2(j), Qualified Legal Compliance Committee
1. Issue: Incentives for Creation
2. Discussion: I assume that the Commission has thought through the incentives that public companies will have to create QLCCs, but I cannot discern them, and I fear that the Commission’s and the KCC letter’s assumption that public companies will create QLCCs may be overly sanguine. The decentralization of reporting authority inherent in the QLCC structure, while probably an excellent idea from a regulatory perspective, may be so different from the customary practice of a board or a committee of the board that acts as a body and not as individuals, that issuers are reluctant to undertake the creation of a QLCC. The notion that “good” law firms will simply decline or resist representing public companies that do not have QLCCs seems more amusing than anything else, and even were it correct, there are going to be law firms willing to undertake such representations. Obviously the Commission can use the QLCC form as a remedial measure in its enforcement proceedings, but many (more) cows will be out of the barn before that begins to have a significant effect. Since I was a business litigator and have not later studied the dynamics of board representation, I do not profess to have expertise on the point, so I offer this comment for whatever value it may have in light of your greater experience and expertise.
  Proposed Solution: Address incentives as you see fit; consider making creation of a QLCC mandatory if such may be done within the Commission’s authority.
Section 205.3(a), Creation of Duties
1. Issue: Creation of Duty Under the Securities Laws to Shareholders
2. Discussion: The duty established by the language to act “in the best interest of the issuer and its shareholders” goes further than the ethics rules go or need to go, and beyond the scope of the securities laws into corporate-law regulation traditionally governed by state law. As to the former, Model Rule 1.13(a) provides that the attorney represents “the organization acting through its duly authorized constituents,” and Model Code Ethical Consideration 5-18 contradicts the proposed rule in stating that the lawyer “owes his allegiance to the entity and not to a stockholder, director, officer . . . or other person connected with the entity.” As to the latter, assuming that the Commission had the authority to regulate the company-shareholder relationship (and nothing in Sarbanes-Oxley seems to say that), the duty is not consistent with the goal of the securities laws, to protect both purchasers and sellers of securities and the securities markets, and not necessarily shareholders as a group. (In fact, shareholders’ interests may well not be consistent with securities purchasers’ interests.)
  The Commission’s goals in Part 205 do not require an additional and potentially conflicting obligation running from an attorney to a “shareholder,” on top of the attorney’s obligations to the “issuer” under state corporate law, the issuer’s obligations to the Commission and to the public under the securities laws, and the attorney’s obligations to the Commission under Part 205. It is not clear what the addition of the “shareholder” duty accomplishes, since that duty does not figure into any of the operative provisions of the proposed rule.
  Parenthetically, in the unhappy event that the term were to be retained, the Commission may wish to make clear in its comments that “shareholder” refers not only to corporate stockholders, but also to the holders of the “shares” of partnerships or limited liability companies. This may be so obvious as to be unnecessary to state, but the distinction between the terms “stockholder” and “shareholder” is sometimes misunderstood.
3. Proposed Solution: Delete the phrase “and its shareholders.”
Section 205.3(a), Relations with Issuer Constituents
1. Issue: Use of Word “Advise”
2. Discussion: The proposed rule makes reference to an attorney for the issuer who “may work with and advise the issuer’s [constituents].” This presents two problems. First, where the attorney is not representing the constituent, as the rule assumes, the word “advise” is colloquially permissible but professionally problematic, since an attorney does not “advise” a non-client. If the Commission retains this usage, it will have much company among the practicing bar, but the usage remains a bad one. Second, as reflected in Model Rule 1.13(e), an attorney in fact may represent both the issuer and a constituent. This may not be wise, but it is possible. More importantly for present purposes, this raises conflict of interest concerns, not confidentiality or disclosure concerns. The disclosure obligations of Part 205 will make it even less likely that securities counsel will find a multiple representation of an issuer and its constituents to be consistent with Disciplinary Rule 5-105 or Model Rule 1.7 under state law. When appropriate, the Commission may well have a useful message for the securities bar about the permissibility of multiple representations in securities practice. But the Commission should not speak to multiple representations until the Commission decides to broaden its professional regulation beyond the core concerns of Sarbanes-Oxley § 307.
3. Proposed Solution: First, replace “advise” with “communicate with.” Second, make clear in the comments that the Commission is not attempting at this time to regulate the ethics of multiple representations.
Section 205.3(b)(1) and (3), Chief Legal Officer’s Responsibilities
1. Issue: The “Equivalent Thereof”
2. Discussion: The proposed rules frequently use the term “chief legal officer (or the equivalent thereof).” The third paragraph in the section-by-section analysis under the heading “Chief Legal Officer’s Duty to Investigate (page 32 of the .html printout) explains that “[w]here an issuer has no general counsel or chief legal officer, the ‘equivalent’ would be the chief executive officer . . . .” This is not a self-evident proposition, since one might assume that in the absence of a General Counsel, outside general counsel might be the “equivalent.” Even grammatically, it is unclear whether the “equivalency” is in the person’s function, in which case the “chief legal” advisor might be outside general counsel, or in the person’s title, in which case an “officer” would not include outside counsel. And in the latter case, which officer it might refer to remains unclear (e.g., suppose the CFO functions more as an attorney than the CEO does). It seems undesirable to treat outside general counsel as the CLO, since that might well make the attorney-CLO reporting relationship under the proposed rule difficult or impossible to implement. Within the issuer, it seems undesirable to put the CLO functions in the hands of an in-house attorney who does not have the stature of a “General Counsel,” but since the office of “General Counsel” is not usually a corporate office in the state-law sense, I frankly am not certain how to express the concept and so have used the phrase “general responsibility for the issuer’s legal affairs.” So the choice of the CEO seems appropriate, but it may be desirable to include a definition in § 205.2 stating what the comment explains.
3. Proposed Solution: A definition substantially as follows:
  1. “Chief Legal Officer” shall mean the person employed by the issuer with the title “General Counsel” or with general responsibilities for the issuer’s legal affairs, and shall not include outside general counsel. In the absence of such a person, the term shall refer to the Chief Executive Officer of the issuer.
Section 205.3(b)(6), Investigating Attorney
1. Issue: Coverage of Investigating Attorney
2. Discussion: It is hard to quarrel with the coverage of an investigating attorney if the attorney is functioning in the classic role of counsel to what we originally called a special litigation committee of the board of directors. But if the attorney is retained and investigates in anticipation of potential litigation with the Commission, then to that extent, the attorney should not be deemed to be “appearing and practicing” before the Commission. This problem seems to be related to the problems that the Commission itself has noted of chilling legitimate advocacy in an administrative proceeding, and the Commission’s ability to regulate aspects of federal court proceedings. In this narrow situation, that complex of issues probably will require a clarifying proviso that subparagraph (b)(6) does not apply to an attorney retained in anticipation of litigation or administrative proceedings. I am not certain that my proposed solution is the best phraseology, but the concept would survive in any better provision.
3. Proposed Solution: Add the language “provided, that this subparagraph shall not apply to an attorney retained by the issuer in anticipation of litigation or administrative proceedings.”
Section 205.3(d)(4) Disclosure by Terminated Attorney
1. Issue: Report and Disaffirmance After Discharge of “Attorney formerly employed or retained by an issuer”
2. Discussion: There are two problems here. First, this provision does not clearly include an associate within a law firm retained by the issuer. It is arguable that where a law-firm associate works on an issuer’s matter, that associate is “retained,” but I think the better argument is that the law firm itself, or the partner in charge, is “retained,” and that the partner decided to “staff” the matter with, among others, the associate. Certainly, that is the way law-firm retainer letters are usually drafted. The Commission does not need to have junior attorneys wondering whether they were “retained.” Second, the word “employed” would refer only to an associate attorney, and for reasons stated in the next paragraph, would not refer to partners in a law firm. What is needed is a provision that protects not only the issuer’s in-house attorneys but also both partners and associates of a law firm representing the issuer. Finally, it would seem that this provision should include other forms of discrimination as described in § 806 of Sarbanes-Oxley. The Commission should not be deterred in action on this point by the limitations of § 806 of Sarbanes-Oxley, since as assumed by the proposed rule itself, § 602 provides ample support for including partners in a disclosure provision.
  This second problem is closely related to a more fundamental problem created by § 806 of Sarbanes-Oxley itself, which refers only to discrimination against an “employee” by an issuer or an “agent” of an issuer. Nominally, the term “agent” is amply broad enough to include an outside law firm representing the issuer, but the term “employee” cannot be read as including a partner in such a firm, see Hishon v. King & Spalding, 467 U.S. 69 (1984), absent relatively unusual circumstances, see Simpson v. Ernst & Young, 850 F. Supp. 648 (S.D. Ohio 1994), subsequent opinion, 879 F. Supp. 802 (S.D. Ohio 1994), aff’d, 100 F.3d 436 (6th Cir. 1996), cert. denied, 117 S. Ct. 1862 (1997). In most securities firms of any size, junior partners will be the attorneys who are most likely to be privy to information about the issuer and its affairs, and most likely to be knowledgeable and experienced enough to “know what is going on.” That may or may not be true of senior associates, and is less likely to be true of junior associates. I hope that the Commission will revisit this issue with Congress at an appropriate point, since it seems to be a gaping hole in the coverage of § 806.
3. Proposed Solution: Change (d)(4) to read as follows:
  1. An attorney presently or formerly employed or retained by an issuer or who is or was a member of or employed by an agent of an issuer who has reported evidence . . . discharged, demoted, suspended, threatened, harassed, or in any other manner discriminated against in the terms and conditions of employment for so doing . . . .
Section 205.3(e)(2), Permissive Disclosure to the Commission
1. Issue: Limitation to “Illegal Act”
2. Discussion: The proposed rule for permissive disclosure of an issuer’s “illegal act” is essentially no different from the existing Model Code provision, and is narrower than the rule in several states that permit or require disclosure of future civil fraud, or that permit or require disclosure of past civil fraud (these states are listed in the chart prepared by the Attorneys’ Liability Assurance Society, Inc., which is included in the Morgan & Rotunda and some other professional responsibility rules supplements). The Commission’s section-by-section analysis, however, makes reference to some of those states with civil-fraud disclosure provisions: New Jersey and Wisconsin, for example, provide for mandatory disclosure of future civil fraud, and Hawaii and Ohio provide for mandatory of past civil fraud during the representation. A total of 11 states provide for some form of disclosure of future civil fraud, and 16 states of past civil fraud. It is true that the Model Rules permit only disclosure of future, present, or past crimes involving imminent death or serious bodily injury, and to the extent that those provisions are in force in the states, the Commission will have changed the law. But most of the Commission’s work involves civil fraud, not criminal fraud, and the Commission will have accomplished less than it might have on external disclosure if the proposed rule remains limited to permissive disclosure of “illegal acts.”
  While the point can certainly be argued both ways, there would be much to commend a provision for permissive disclosure of future, ongoing, or past civil fraud, perhaps using either the term “material violation” or the language from § 205.2(i) about “a material violation of the securities laws, a material breach of fiduciary duty, or a similar material violation.” This comment may be subject to the KCC letter’s observations about a focus on “violations,” and it may be well for the Commission to clear up what “a similar material violation” means (even if only to say a similar violation of what?) But subject to those caveats, the Commission would appear to be authorized by § 602 of Sarbanes-Oxley, even read in conjunction with the internal-reporting provisions of § 307, to provide for permissive external disclosure of civil fraud-like conduct.
3. Proposed Solution: Most simply, replace “illegal act” with “material violation”, or with the definitional terms from § 205.2(i).
Section 205.3(e)(3), Non-Waiver of Attorney-Client Privilege
1. Issue: “Unsettled Question”
2. Discussion: I have never regarded the question of whether limited disclosure to the Commission vitiates the attorney-client privilege as to third parties to be an “unsettled question” as stated in the comments to this section at pages 49 of the .html printout under “Disclosure of Issuer Confidences.” There is the occasional contrary decision, see Diversified Industries, Inc v. Meredith, 572 F.2d 596 (8th Cir. 1978) (en banc); cf. McKesson HBOC, Inc. v. Adler, 254 Ga. App. 500, 562 S.E.2d 809 (2002) (state work product not necessarily waived by disclosure to Commission), but the significant majority of decisions hold that the privilege is waived by selective disclosure to an agency. If what the Commission means is that a position that the Commission would like to see generally enshrined in caselaw has not yet been approved by the ultimate authority of the Supreme Court, so be it, but then the Commission should just say that. It may be appropriate for the Commission to assert policymaking authority on this point, but to suggest that there is a competing general rule among the judicial decisions, which I think the notion of “unsettled question” does, is simply not accurate.
3. Proposed Solution: Clarify or correct section-by-section analysis.
Section 205.4(a), Definition of Supervisory Attorney
1. Issue: Scope of “Having Supervisory Authority”
2. Discussion: The managing partner and a section head in a law firm would have “supervisory authority” over an associate subject to the direct “supervision” of the securities partner in charge of the representation of an issuer. That seems to spread this responsibility much further than it needs to be spread, and probably to a non-productive point. That much could perhaps be corrected by deleting the phrase “having supervisory authority” from the rule. If you intend for the rule to have that effect, you might want to make that clear in the section-by-section analysis.
  If the goal is indeed to create greater responsibility within a firm whose attorneys represent an issuer, there are two alternatives. The first is to create “systems” responsibility like that in Model Rules 5.1 and 5.3, which is somewhat similar to the systems responsibility of principals within broker-dealers. The second would be to impose obligations on the firm itself, and not on attorneys “having supervisory authority,” which is the approach of Ethics 2000 Rules 5.1 and 5.3. The “firm” approach seems to be part of the Commission’s reasoning in In re Keating, Muething & Klekamp, Release No. 34-15982, 1979 WL 186370 (S.E.C. June 2, 1979). The imposition of firm responsibilities is nothing new in securities regulation, of course, and I believe that the KCC letter discusses this concept as well.
3. Proposed Solution: For the narrow solution, delete “having supervisory authority” from the rule. For the broader solution, the Commission should undertake further consideration of systems and firm-responsibility provisions.
Section 205.4(a), Definition of Supervisory Attorney
1. Issue: CLO’s Supervisory Duties
2. Discussion: It is unclear whether the Commission means to say that the CLO is a supervisory attorney over in-house attorneys, or over outside attorneys as well. It seems that the former is or should be the case, since the latter relationship is covered by the internal reporting provisions, and a “supervisory” relationship between the CLO and a reporting attorney could be read as relieving the reporting attorney from responsibility in the same manner as the QLCC provisions do. This needs to be clarified. The Commission should consider also whether there are some cases in which the General Counsel does not supervise some attorneys: this may depend on the structure of the internal legal representation in the issuer or its affiliated companies. These variant relationships would need to be fairly subsumed within a general provision or reflected in specific provisions of the rule.
3. Proposed Solution: As to the simple problem, add “of attorneys employed by the issuer” to the second sentence of this section. Time does not permit my attempting to craft a solution for the more complex problem.
Section 205.5, Responsibilities of a Subordinate Attorney
1. Issue: Condition of Subsection (d) Safe Harbor
2. Discussion: The subordinate attorney provisions are threefold: no “Calley” defense, a safe harbor for report to supervisor, and a safe harbor for permissive (b)-(c)-(d) steps. First, it is not completely clear how subparagraph (b) affects the subordinate attorney’s obligations, since those obligations are (relatively easily) satisfied under (c), raising the question whether (b) is needed or even desirable at all. Second, the second safe harbor has two problems. Primarily, the conditioning of the second safe harbor on the subordinate attorney’s “reasonable belief” that the supervising attorney has failed to comply with Part 205 makes the safe harbor too narrow. The subordinate attorney who has to make that call is the subordinate attorney who is not, or less, likely to act. As a practical matter, any subordinate attorney is going to assess his superior’s actions before deciding to put life and career on the line in “doing the right thing.” The second safe harbor should reflect that practical fact by being as broad as is reasonably practicable.
3. Proposed Solution: Eliminate all language in (d) after the references to “(b), (c) and (d).”
Section 205.6(b), Sanctions and Professional Standard
1. Issue: Negligence Standard for Attorneys
2. Discussion: The Commission is going to see the argument that a negligence standard for attorneys is precluded, under the expressio unius principle, by the reference to negligence standards for accountants in § 602(b) of Sarbanes-Oxley, and perhaps by the language of § 602(a). I do not propose to hold for that position here, partly because I am ambivalent on the matter and partly because I assume that the Commission has already thought about the problem and decided to litigate the position taken in the proposed rule in a federal court. I do, however, think that it would be appropriate and desirable for the Commission to explain the reasoning behind the view that the Commission is not precluded from adopting a negligence standard for attorneys. I may part company with the KCC letter on this point, since if the Commission is going to regulate attorneys under a negligence standard, the existing ethical practice bears more resemblance to the § 602(b) distinction between multiple instances of negligence and isolated instances of gross negligence than it does the unitary standard proposed by the KCC letter. Moreover, a bimodal set of negligence standards, one for each profession, is likely to lead both to substantive confusion and to lack of utility in the disciplinary decisions in the two classes of cases. It may well be that the treatment of negligence in the discipline of accountants under § 102(e) and of registered representatives under the broker-dealer regulations would provide additional analysis, but I am insufficiently knowledgeable about the former and too far from the latter to be of real assistance.
3. Proposed Solution: At least, explain the Commission’s rationale for its authority and the use of a negligence standard for attorneys, and if the same be adopted, explain the difference between a unitary standard for a attorneys and a specific standard for accountants.

I will be happy to respond to any questions the Commission or the Staff may have about the foregoing. My contact information is above.

Respectfully submitted, Edward C. Brewer, III
Professor of Law

ECBIII:ecbiii