New York County Lawyer's Association
14 Vesey Street
New York, NY 10007-2992
(212) 267-6646 ∙ Fax (212) 406-9252
Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549
Attn: Jonathan G. Katz, Secretary
cc: File No. S7-45-02 Release Nos. 33-816; 34-47282; IC-25920
Dear Mr. Katz:
The Task Force on Corporate Responsibility (the "Task Force") of the New York County Lawyers' Association ("NYCLA") submits this letter in response to the request of the Securities and Exchange Commission (the "Commission") for comments on proposed rules (the "Proposal") under Section 307 of the Sarbanes-Oxley Act of 2002 (the "Act") relating to the Implementation of Standards of Professional Conduct. The Proposal is for amending Rule 205.3 of Title 17, Chapter II of the Code of Federal Regulations, establishing standards for professional conduct for attorneys who appear and practice before the Commission in the representation of issuers under the Securities Act of 1933, the Securities Exchange Act of 1934, Investment Company Act of 1940, the Investment Advisers Act of 1940, and the Sarbanes-Oxley Act of 2002. On December 18, 2000, the Task Force submitted its comments to the Commission regarding the initial proposal of new Part 205 of Title 17, Chapter II of the Code of Federal Regulations, establishing standards for professional conduct for attorneys who appear and practice before the Commission in the representation of issuers. Those comments are not repeated here.
The comments expressed in this letter represent the views of the Task Force and its members who have attempted to gather the various views of other NYCLA committees within the time permitted for public comment on the Proposal. These comments have not been approved by the Board or Executive Committee of NYCLA; ; however, the Board and Executive Committee have approved certain positions described herein relating to topics raised in the July 16, 2002, Preliminary Report of the American Bar Association Task Force on Corporate Responsibility (to which the Section II of the Proposal refers as the "Cheek Report"). On October 25, 2002, the Task Force presented its prepared testimony to the ABA at a hearing concerning the Cheek Report.
As a threshold matter, the Task Force supports the concept underlying Part 205's implementation of the principle that an attorney who performs services for an entity (in this case, a corporation that files with the Commission various reports, registration statements, and forms), represents that entity rather than any of its officers, directors, business units, or agents.1 The fact of that relationship renders the duty imposed by a lawyer's professional responsibility as a responsibility owed to the entity rather than to any individual or third party.
In addition, the lawyer's duty to render independent professional advice in the client's best interest is one owed to the client. A major component of a lawyer's professional responsibility is "independence" untainted by the influence of third parties whose interests or views would compromise or subvert the lawyer's exercise of professional judgement in rendering advice to the client. Naturally, a lawyer must be careful to render advice that is unaffected by the lawyer's own self interest.
In representing a client that is an organization, the lawyer's discharge of the duty to the client must necessarily be conducted through interaction with agents of that organization. Generally, that interaction is an unremarkable process involving communication with the entity's in-house counsel, executives, or others who act on behalf of the entity. Although, an entity's agents (with whom the lawyer must interact) may be unfaithful or self-interested stewards of the entity's assets, unfaithful agents and disloyal stewards are the exception rather than the rule in the American capitalist system and our financial markets. The Proposal seeks to address problems that arise in the context of an entity's aberrational management.
As a general matter, the development of corporate governance in this country rests on the notion that corporate decision makers who are both disinterested and informed provide an appropriate degree of protection against wrongful exploitation of an entity's assets. The SEC's and the Exchanges' regulation of the securities markets operates on the principle that the best assurance of the efficiency and integrity of those markets is premised on the transparency of both the process and the substance of true disinterestedness and truthful information. In that context, the Exchanges, state and Federal regulators, and courts have developed a system of corporate governance that functions to protect investors from the risks of factual misrepresentations and managerial machinations.
Against that background we offer the following comments on the Proposal. These comments reflect our concerns about two issues:
- The Proposal presents a number of definitional issues that require clarification whether it and Part 205 apply to individual lawyers or to law firms. Until those issues are clarified, no lawyer or law firm can conform its conduct to comply with the Proposal or Rules.
- The Proposal's "noisy withdrawal" provision is inappropriate.
Lawyers or Law Firms?
The Proposal and Rule 205 are unclear in regards to whether their requirements are imposed on individual lawyers or on law firms.2 That lack of clarity imposes an unfair risk of misinterpretation upon all who "practice and appear" before the Commission within the definition of Rule 205.2(a). As a starting point, we note a problem with how the Rules define an "attorney." Rule 205.2(c) defines an attorney as a "person who is admitted, licensed or otherwise qualified to practice law . . . ."3
Rule 205.2(c)'s use of the word "person" stands in distinction to the word "individual"4 or the term "attorney at law."5 On its face, Rule 205.2(c)'s definition of "attorney" appears limited to individual lawyers. If that definition were so limited, then Part 205 would not directly apply to such organizations that engage in the collective practice of law as limited liability companies, limited liability partnerships, partnerships, professional corporations, or professional associations. Yet, Rule 205(c)'s use of the disjunctive conjunction "or" could imply that the Rule's definition encompasses multi-lawyer groups that are authorized to practice law.6
The lawyers in a law firm are not collectively "admitted" or "licensed" to "practice law" as a "law firm"; however, by operation of New York law, the "law firm" itself is "qualified to practice" law in as much as it is statutorily "authorized" to practice law and, in fact, does engage in the practice of law. Consequently, a "law firm" may be within Rule 205.2(c)'s definition of "attorney" unless (1) the Rule's use of the term "person" really is limited to "natural persons" or "individuals" or (2) the Rule's use of the word "qualified" means something other than "authorized."7
In certain contexts, Part 205 uses the word "attorney" in a way that makes sense only if it refers to individuals, but in other contexts the Rule makes sense only if the word "attorney" applies to law firms. For example, Rule 205.7 uses both terms ("law firm" and "attorney"), suggesting a distinction between the two.8 Rule 205.4 distinguishes between "supervisory attorneys" and "subordinate attorneys," which usage has little meaning if the term "attorney" means anything other than an "individual lawyer." In contrast, however, the Proposal itself poses definitional problems flowing from questions raised by the Proposal's use of the word "retain."
Part 205 itself makes distinctions between attorneys who are "retained" or "employed" by an issuer. 9 The phrase "attorney employed by an issuer" makes contextual sense in Part 205 if it is interpreted to mean "an individual lawyer who is an employee" of an issuer. Yet, limiting the term "attorney retained by an issuer" to refer only to an individual lawyer is unworkable because issuers generally "retain" law firms (as opposed to individual lawyers) to provide legal services to them.10
As a practical matter, the definitions in Rule 205 and the Proposal create some anomalies when read literally. For example, lawyers who are partners or associates of a law firm are not "retained" by an issuer; rather, an issuer usually retains a "law firm" to represent it. To the extent such lawyers' activities are within the scope of Rule 205.2(a)'s definition, then those lawyers are "appearing and practicing before the commission." When one of those individual lawyers discovers evidence of a material violation meeting the Rule's threshold of reportability, then he or she must report it under Rule 205.3(b).11 If the issuer's response is unsatisfactory, then inconsistent consequences follow under proposed Rule 205.3(d)(1)(A) and (B).
First, Rule 205.3(d)(1)(A) and (B) literally apply only to attorneys who are "retained" or "employed" by an issuer. If a law firm's partners or associates are not individually "retained" by the issuer, then is one to conclude that the Proposal is inapplicable to them? Similarly, only lawyers who are "retained" or "employed" by an issuer are the subject of Proposed Rule 205.3(d)(3) when they believe they are the victims of a whistle-blowing discharge. It seems clear that this literal reading of the Proposal is not consistent with the Commission's intended scope of the Rules to make them applicable to counsel retained by issuers.
The existence of these anomalies invites an easy solution: interpreting the definition of "attorney" in Rule 205.2(c) to encompass a law firm retained by an issuer. That expansive interpretation, although possible for the reasons noted above, is syntactically awkward in the context of other provisions in Part 205 that are written in language suggesting that an "attorney" is an individual rather than a law firm.12
Interpreting "attorney" to mean "law firm" in the context of the Proposal raises questions concerning how applicable law attributes "knowledge" and "notice" to a law firm and to people working in law firms. For example, New York Partnership Law, Section 23 provides that the "knowledge of" and "notice to" any partner is the "knowledge of" and "notice to" the partnership.13 Consequently, information known to one partner concerning evidence of a "material violation" as defined by Rule 205.2(e) would be attributed to the law firm, but not to other partners. Presumably, pieces of evidence known to different partners - though not individually probative of a material violation - could amount to the requisite quantum of evidence to trigger Rule 205's reporting obligation where that information is (a) attributed to the law firm and (b) collectively evaluated in determining whether it satisfies the Rule's reporting threshold. Interestingly, a law firm organized as an LLC in New York would not be subject to the same attribution rule imposed by Section 23 of our Partnership Law.14
New York's D.R. 1-104 imposes managerial and supervisory responsibilities on lawyers in a law firm and upon the law firm itself.15 For example, D.R. 1-104(a) requires a law firm to "make reasonable efforts" to ensure that all lawyers in the firm conform to the disciplinary rules. Lawyers with "management responsibility" or "direct supervisory authority" also must make "reasonable effort" to ensure that other lawyers within the firm conform to the disciplinary rules. A law firm must also "adequately supervise" the work of its partners, associates, and non-lawyers. The required degree of supervision must take into account various factors enumerated in that disciplinary rule.16 In addition, supervisory lawyers are responsible for the ethical lapses of the others in the firm, if they (1) directed or ratified the offending conduct or (2) "in the exercise of reasonable management or supervisory authority . . . should have known" of the conduct so that "reasonable remedial action could be taken" to avoid or mitigate the consequences.17
If the word "attorney" means "law firm," then issues arise about the extent of a mandatory withdrawal under Proposed Rule 205.3(d)(1)(A). First, if (a) the Rules impose the withdrawal obligation upon a law firm and (b) the scope of the withdrawal encompasses all legal work being conducted for an issuer, then the disruption to both the firm and to the issuer would be considerable. If the extent of the required withdrawal is less encompassing, then the Proposal offers no meaningful guidance for action in terms of defining from which engagements the law firm must withdraw. This concern also highlights the problematic definition of "attorney." If (1) the definition of `attorney" is limited to an individual lawyer and (2) the requisite action required by the Proposal is therefore imposed only on that lawyer, then the Proposed Rule's withdrawal obligation would be limited to only those lawyers in a law firm who were troubled by the issuer's response under Rule 205. In that event, (a) the law firm would continue to represent the issuer, and (b) there would be only a change in the law firm's personnel working for the issuer. It is unclear whether that scenario would trigger any reporting obligations or a mandatory withdrawal because the individual lawyer was not retained by the issuer - only the law firm was so retained.
For the reasons described above, we submit that the definition of "attorney" in Part 205 should clearly state that it is limited to an "attorney" who is an "individual." Furthermore, we submit that the term "retain" and "retained" as used in Part 205 should be clarified to refer to (a) individual lawyers who are "retained" by an issuer as well as (b) individual lawyers who are partners or employees of law firms that are retained by an issuer. Furthermore, the Commission should clarify through a final rule or FAQ that (1) the obligations of Part 205 are imposed only on individual attorneys rather than on their co-workers and (2) the knowledge or state of mind of any individual lawyer will not be imputed or attributed to any other person merely because such lawyers happen to work in the same firm. In the event that the Commission decides to promulgate any rules that directly seek to regulate the law firms that render service to public companies, then we believe that such rules should be exposed to the opportunity for comment in the same way that the current revised version of the Proposal has been reissued for comment.18
We have read the various comments posted on the Commission's internet site in late December 2002, concerning the initial version of the Proposal's noisy withdrawal provisions. We concur with those comments that question the wisdom or authority of the Commission's imposing a "noisy withdrawal" requirement on lawyers representing any client.
As a practical matter, we do not perceive any meaningful distinction between (1) the Commission's current proposal that an issuer "report out" the fact of an attorney's withdrawal from a retainer agreement and (2) the attorney's own notice to the Commission of the fact of withdrawal. Section 205.3(e) of the Proposal does not solve any of the problems that have been amply identified by the numerous comments that analyzed the shortcomings inherent in the initial proposal issued in November 2002. Whether the reporting obligation is placed on the lawyer or on the client is immaterial to the fact that it is the reporting obligation itself that threatens to erode the candor required for meaningful attorney-client communications to transpire. We also believe that the Commission's definition of "reasonably likely" (described in the comments to the final rule) will multiply the new Rules' inherent problems because that definition should have been included in the proposed Rules and thereby rendered subject to public comment and scrutiny.19
We do not believe that the Proposal's "noisy withdrawal" provisions are within the scope of the language of Section 307 of the Act. The plain language of the statute requires the Commission to issue rules about reporting "up-the-ladder," ultimately to the full board or to a group of independent directors - it does not intimate any requirement for an "over-the-ladder" or "reporting-out" obligation to the Commission in the guise of a "noisy withdrawal." That lack of such statutory authority poses the substantial risk that some court will ultimately invalidate the Proposal's "noisy withdrawal" provisions -- but only after protracted litigation in the courts or before state disciplinary authorities. During that period of uncertainty, both issuers and members of the Bar will be subject to the risks of inconsistent determinations in different jurisdictions, the excessive costs of such proceedings, and the uncertainties accompanying such proceedings. These problems will inevitably create differences in the expectations of lawyers and clients regarding their rights and responsibilities under the Act and the Proposal. The cleavage in such expectations is very likely to cause misunderstandings and dysfunction that are not in the public interest.
Proposed Section 205.3(d)(1)(A) phrases the mandatory withdrawal requirement imposed upon an "attorney retained by an issuer" in terms that encompass ceasing all legal services for an issuer regardless of whether such services are within the Proposal's definition of "appearing and practicing" before the Commission.20 We submit that there are no words within Section 307 of the Act that evidence any Congressional authority to impose that sort of sweeping requirement upon lawyers who are "retained by an issuer" or work at law firms that are "retained by an issuer."
We believe there is no basis for the Commission to promulgate any rule that requires a lawyer or law firm to cease representing a client in matters that are unrelated to anything within the Commission's bailiwick. We surmise that the Commission's rationale for such a rule is based on the premise that the withdrawal of a lawyer's or law firm's services to an issuer will be so disruptive to the issuer that the threat of potential harm to the issuer will coerce it to follow the lawyer's or law firm's advice. We submit that (1) such reasoning does not comport with the Commission's authority under Section 307 of the Act and (2) it is not consistent with the standards of normative conduct that govern the relations between lawyers and clients in all jurisdictions of this country.
The operation of any rule like that proposed by Section 205.3(d)(1)(A) will probably be unworkable. First, if the word "attorney" does not include "law firm," then the result of the proposal will trigger only a change of personnel working on the matter within a law firm. Second, if the word "attorney" does not include "law firm," then the proposal threatens to transform any disagreement among lawyers in a law firm into an event that could trigger the draconian consequences of proposed Section 205.3(d). Third, the imposition of the Proposal's burdens upon individual attorneys (as opposed to a law firm) may have the effect of deterring other lawyers within a law firm from rendering assistance to any lawyer involved in making the professional judgments required by the proposal. Indeed, the Proposal provides incentives for a law firm to compartmentalize all of its work for an issuer so that lawyers in the firm are insulated from any contact with a matter that could potentially trigger the reporting and withdrawal burdens of the Proposal.21
Many of these same problems (on a different scale) are posed in scenarios where the word "attorney" includes an entire law firm. In those scenarios, an issuer would seek to minimize the disruptive consequences of any disagreement with outside counsel that might trigger a reporting obligation under the proposal. Clearly, interpreting "attorney" to include a "law firm" would provide significant incentives for an issuer to retain numerous outside law firms and lawyers whose engagements are limited to discrete projects. By diversifying its outside legal service providers, issuers could thereby better insulate themselves from any disruptive impact occasioned by the forced withdrawal of a law firm that was rendering a variety of services to the issuer. Alternatively, issuers may decide to minimize the risk of disruptive withdrawals by performing that legal work in-house.22
Proposed Rule 205.3(d)(2)'s withdrawal burden is particularly onerous. It requires a lawyer to seek permission from a court to withdraw from pending litigation whenever the Rule's mandate is triggered.23 If this part of the Proposal is applicable to an entire law firm, then it would require a number of withdrawal motions in various cases involving matters that are unrelated to the events and circumstances that triggered the withdrawal motion. In each of those motions, a court might require sworn disclosure of some details about the problem occasioning the need to withdraw. Those necessary disclosures - made in the public forum of pending judicial proceedings - could, in turn, (1) compromise the confidentiality of any communications regarding the "material violation" that triggered the need to withdraw from the litigation and (2) provide considerable tactical advantages to the issuer's litigation opponent. Neither result is in the best interests of an issuer or its investors.24
It seems likely that many prudent lawyers and firms will decline to represent public companies that lack a Qualified Legal Compliance Committee ("QLCC").25 An issuer with a QLCC provides a lawyer with a method to avoid the consequences of considering (a) whether the issuer's response to the lawyer's report is appropriate or timely and (b) whether an honest disagreement over legal advice may thrust that lawyer into the midst of deciding whether the only safe course is some noisy withdrawal.26 Yet, not all public companies will have a QLCC because of the costs involved.27 This could lead many lawyers and law firms to decline representing smaller public companies because the risk-reward ratio for such representation may not justify the risk that a mistake or an error of judgment could lead to censure or other penalty to the firm as a whole.
It may be unworkable and unfair to impose the Proposal's obligations upon any single lawyer who is retained by an issuer. The burden of resolving the many issues and pressures in that context would not encourage conduct that is likely to promote the policies underlying Section 307 of the Act. As a practical matter, lawyers and law firms retained by issuers "practice" as a team, render advice as a team, and allocate tasks among themselves as a team. Those tasks necessarily include gathering information, evaluating that information, researching applicable authorities, and formulating legal advice to render to the client.28 Any rule that tries to single out some specific attorney on that team or in a law firm would subvert the purpose of the Rule by creating incentives for law firms and individual lawyers within a law firm to deliberately divorce themselves from those parts of the process that could invoke an obligation to report, to evaluate the appropriateness of a response, or to withdraw from the representation.29
We believe that the balanced view of whether the withdrawal obligation should be mandatory is best expressed by the testimony30 of Professor Stephen Gillers of New York University's School of Law on October 25, 2002, before the ABA's Task Force on Corporate Responsibility:
I would not make this exception to confidentiality mandatory. Having the power will often be sufficient to cause the client to cease the misconduct and correct the harm. Further, having the power opens the lawyer to civil liability if he or she does nothing and the injury occurs. This is because the lawyer will not then be able to defend against a claim by citing confidentiality duties. That prospect will encourage use of the power when appropriate. Third, in some cases, making the duty mandatory can have the unfortunate result of causing lawyers to breach confidentiality when the facts are not entirely clear, just to be safe from a disciplinary charge.
Currently, lawyers practicing in New York have both the discretion to report a client's intention to commit a crime and the discretion to withdraw from representing the client who persists in its intention to commit a crime.31 In addition, a lawyer in New York may disclose information necessary to prevent further reliance on that lawyer's past work product after learning that such work product is being used as part of an ongoing fraud.32 In those instances, a lawyer may withdraw from representing the client.33 We do not perceive any need for the Commission to intrude into this area of regulating lawyers' professional responsibilities because existing state regulation of the Bar provides adequate protection of the public interest.34 Any announcement that a lawyer has withdrawn for "professional considerations" is nothing more than an invitation to investigate the reasons for the lawyer's withdrawal. That will cause harm to an issuer and its investors. It will inevitably draw the lawyer into litigation involving the scope of the attorney-client privilege, the work product immunities of the Federal Rules of Civil Procedure, and the scope of a lawyer's duty to maintain client confidences under local disciplinary rules.
The Commission's "noisy withdrawal" proposals appear to be modeled on the statute governing the conduct of accountants who discover illegal acts and fail to obtain a professionally satisfactory solution in accordance with Section 10A of the Securities Exchange Act of 1934 and amended by the Private Securities Litigation Reform Act of 1995 and the Commission's Rule 10A-1 under the 1934 Act. We believe that any analogy between lawyers and accountants on this score is inappropriate because their duties of independence are quite different.
Public accounting firms exist for the purpose of providing opinions, certifications, or attestations to third parties who can rely on those opinions, certifications, or attestations. As a practical matter, our free market system encourages many different classes of third parties (banks, stockholders, bond holders, and governmental agencies) to rely on the work of public accounting firms because it would be prohibitively expensive for each third party to conduct its own independent investigation to gather and assess the facts that are certified or attested by a public accountant. In effect, the third parties "share" the work product of a public accountant, even though the client, on whom the accountant issues an opinion, is usually the party who compensates the accountant for its work. All the rules of accountant independence focus on eliminating the mischief that can flow from the natural tension between (1) a client's selecting and paying for an auditor's services and (2) a client's simultaneously being the subject of that auditor's scrutiny and opinion.
Accountants who practice before the Commission or opine on the financial statements that are filed with the Commission are in no way analogous to lawyers who render securities advice to public companies.35 Accountants' duties are owed to the public and to those who rely on their opinions.36 Lawyers who advise public companies do not render opinions to the public at large and do not "certify" or "attest" to a public company's filings with the Commission.37 The distinction between lawyers and accountants is best summarized by the following proposition: Attorneys must be independent of the influence of third parties when they give opinions to their clients, accountants must be independent from their clients when they give opinions to third parties.38 Accountants are the public's watchdogs, attorneys are their client's counselors.
One of our legal system's oldest evidentiary rules is the attorney-client privilege, which is calculated to promote candid, open communications between a lawyer and his or her client. Only communication shared in confidence can effectively provide a lawyer with the requisite degree of information necessary to render appropriate and complete advice to a client. Where some regulation erodes the candor necessary for those communications to flourish, then that rule threatens to undermine the vitality and integrity of a lawyer's advice. The social and economic costs of that erosion are not in the best interests of issuers and investors.
A likely consequence of any mandatory withdrawal proposal is that corporate officers or employees may not turn to lawyers for advice in situations where legal advice may, if obtained, have benefited the corporation and its shareholders. Another likely consequence is that, when a corporation turns to a lawyer for advice, it may, in light of the Proposal's new obligations, limit the information it provides to its counsel upon which to formulate such advice. This chilling of communications between attorneys and clients, causing issuers to act without legal advice or to act upon legal advice rendered upon selectively filtered information, will likely undermine the attorney's ability to gather the relevant facts and advise the issuer as to appropriate conduct with respect to disclosures that should be made to the public or actions that should be taken to remedy material misconduct by an agent of an issuer. Thus as a consequence, the proposed Rules, although part of an effort to foster public companies' compliance with the law, may have precisely the opposite effect.
Accordingly, we pointedly ask: Why should an attorney be forced to abandon the issuer as a client when that attorney's services are not being misused and the attorney took no role in the wrongdoing giving rise to the problem? Where a client has wrongfully failed to disclose some material information in a filing, the attorney should, in good faith, be allowed to decide to stay with the client and to continuously urge compliance with the law. The Commission's rules should encourage that behavior.
Our Task Force respectfully requests that the Commission revise its Proposal in accordance with the comments set forth above. Members of the Task Force are prepared to meet and discuss these matters with the Commission and the staff and to respond to any questions.
/s/ Edwin David Robertson
Edwin David Robertson
Chair, Task Force on Corporate Responsibility
Members of the Task Force:
Ernest E. Badway
Kevin P. Conway
Michael A. Perino
Marc D. Powers
cc: The Hon. William Donaldson, Chairman
Hon. Paul S. Atkins, Commissioner
Hon. Roel C. Campos, Commissioner
Hon. Cynthia A. Glassman, Commissioner
Hon. Harvey J. Goldschmid, Commissioner
|1|| This concept is embodied in New York State's Disciplinary Rules of the Code of Professional Responsibility (22 N.Y.C.R.R. § 1200.29, D.R. 5-109) and the ABA's Model Rules of Professional Responsibility (Model Rule1.13(b)). Those disciplinary rules place an undue emphasis upon preventing "disruption" to an organization and could discourage the provision of necessary information to an entity's legitimate decision makers who need such information to discharge their responsibilities as effective corporate managers. Accordingly, we joined in the recommendation of the Cheek Report to remove any impediment to a lawyer's reporting legal problems to responsible, independent decision makers within the entity to which the lawyer is rendering legal services.
|2|| This letter uses the term "law firm" to refer to groups of lawyers in private practice who are organized in some legally recognized business combination, such as a partnership, professional corporation, or limited liability company. New York State's Disciplinary Rule 22 N.Y.C.R.R. § 1200.1(b) defines a "law firm" as a professional legal corporation, limited liability company, or partnership that is "engaged in the practice of law." Furthermore, it defines a "law firm" to include "the legal department of a corporation." We are not using the term "law firm" here to refer to a corporation's "legal department" or other group of lawyers directly employed by an "issuer."
|3|| The Commission's Rules of Practice do not directly define an "attorney" in Rule 102. Rather, Rule 102(a) and (b) specify the status or qualifications of who may appear before the Commission. Under those provisions, only an lawyer who is admitted to practice before the U.S. Supreme Court or the highest court of a state may represent somebody who is not representing himself, his employer, or a firm of which he is a partner or officer.
|4|| The definition's use of the word "person" is sufficiently broad to include both an "individual" (the most common term that refers to a single human being) and a group of individuals conducting the practice of law in the corporate form. Whether a partnership is a "person" distinct from its partners is perhaps more debatable than whether a professional corporation, limited liability company, or professional association is a "person." The lack of any meaningful functional distinction between a partnership and a limited liability company or professional association in this context reinforces the notion that the Rule's use of the term "person" indeed encompasses more than an "individual" because the Commission could have easily used the words "individual" or "lawyer" if it intended to limit the Rule's definition to a single lawyer. Other statutory definitions of the word "person" include partnerships, associations, and corporations. For example, Section 2(a)(2) of the Securities Act of 1933 defines "person" to mean "an individual, a corporation, a partnership, an association, a joint-stock company, a trust, any unincorporated organization, or a government or political subdivision thereof." The Commission's own Rule 102(a) uses the word "individual" to refer unmistakably to a natural person and Rule 102(b) uses the word "person" to refer to corporations, individuals, partnerships, associations, and trusts.
|5|| The term "attorney at law" appears in Rule 102(b) and unmistakably refers to an individual lawyer because of the additional phrase "admitted to practice before the Supreme Court ...."
|6|| For example, New York's Professional Service Limited Liability Company Law § 1204(f) refers to a PSLLC as "practicing law." Similarly, New York's Business Corporation Law § 1505(f) refers to a "professional corporation" as "practicing law," and § 1504(e) notes that a professional corporation may be "authorized to practice law," even though it is not required to take an "oath of office" or be "registered" to practice law.
|7|| We do not believe that the term "qualified" in this context could mean anything other than "authorized" because, if it did, then any person subject to discipline under the Rule could argue that the use of the word "qualified" to mean only "professionally competent" would excuse an incompetent person from the Rule's applicability.
|8|| §205.7 (a) provides, "Nothing in this part is intended to, or does, create a private right of action against any attorney, law firm, or issuer based upon compliance or noncompliance with its provisions."
|9|| See, e.g., Rules 205.2(b)(3), 205.2(g), 205.2(h), 205.3(b)(5), 205.3(b)(6)(i) and (ii), 205.3(b)(7). 205.3(b)(10), and 205.3(c) using the word "retained" and Rules 205.3(b)(10), 205.3(c), 205.2(g), 205.2(h) using the word "employed." We assume that an individual lawyer "employed" by an issuer would be (1) a common law employee, probably working in the legal department of an issuer as a lawyer or (2) a lawyer who is not functioning as a lawyer and who worked in a business unit of an issuer. The language of the Proposal makes significant distinctions between attorneys who are "employed" or "retained" by an issuer. See Proposed Rules 205.3(d)(1)(A) and 205.3(d)(1)(B), 205.3(d)(3), 205.3(d)(4), and 205.3(f).
|10|| Our review of (a) the comments to the initial proposal of Part 205 and (b) the summary and discussion accompanying the final rule in SEC Release Nos. 33-8185, 34-47276, and IC-25929 did not reveal any definitive answer to this question. Most of the Commission's discussion of this issue and many of the comments submitted in December 2002 were in the context of the meaning of "appearing and practicing in the representation of an issuer" rather than the definition of "attorney." Many of those comment letters vigorously insisted that the Rules should apply only to individual lawyers, but they suggested that the definitional issues should be resolved by limiting the conceptual scope of the term "appearing and practicing." See, for example, page 38 of the December 18, 2002, comment letter of the President of the American Bar Association, which observed, "It is unclear to us how an attorney employed by a law firm is required to act under the proposed rules where a law firm, rather than an individual, is retained by an issuer. If withdrawal is required, is it by the individual attorney or by the law firm, particularly where the law firm was engaged? If the entire firm were required to withdraw from all matters, the consequence could be severe and may well result in significant prejudice not only to the issuer but also to its shareholders." The December 18, 2002, comment letter of "77 Law Firms" observed, "While the `up-the-ladder' and `noisy withdrawal' obligations appear to be obligations of the individual lawyer, in a law firm context the clients are clients of the firm rather than any individual lawyer, and often several lawyers of varying seniority work on any given matter. In addition, the proposed rules attempt to deal with subordinate/superior relationships, but their operation within a law firm is far from clear. This creates uncertainty with respect to up-the-ladder obligations in the law firm context and becomes extremely problematic if withdrawal is required. We urge the Commission to provide the flexibility under the proposed rules for a law firm to design and implement procedures for the administration of reporting with respect to firm clients."
|11|| Rule 205.3(b) literally imposes that reporting obligation on an individual lawyer.
|12|| Although Rules 205.4 and 205.5 attempt to allocate responsibilities for compliance and to promote the communication of relevant information between "supervisory attorneys" and "subordinate attorneys," those measures are textually meaningful only in the context of individual lawyers.
|13|| This attribution rule does not attribute knowledge or notice to any individual partner.
|14|| A number of comments to the Commission's initial proposal for Part 205 discussed the thorny issues of attribution of knowledge and notice to lawyers and law firms. Many comments from the organized Bar urged that the rules clearly state that the regulations applied only in instances where knowledge of and notice to individual lawyers were involved. In contrast, the December 17, 2002, comment letter of Professor Susan P. Koniak and others said, "Namely, an entity, here a law firm, is responsible for acts of its agents performed within the scope of their employment, and the mental state of an entity is that of the agents within it. On the mens rea of entities, federal law holds that the knowledge of individual agents is combined to determine the knowledge, negligence, intent or recklessness of the entity itself." Noting that the proposed rules were ambiguous in delineating the attribution of knowledge and notice between lawyers and law firms, that comment letter called for a clearer pronouncement on this question, "It would be costly and confusing for the Commission to devise novel theories of imputation. Instead, the Commission should adopt imputation principles already found in federal law."
|15|| 22 N.Y.C.R.R. § 1200.5.
|16|| E.g., the experience of the lawyer being supervised and the amount of work involved.
|17|| NYCLA's Task Force is troubled by the Commission's attempt to impose some additional "theory of imputation" upon the existing principles by which those who practice law are charged with responsibility or accountability for some other person's behavior. Our objections to these proposals do not arise from the desire or motive to shield lawyers from accountability for professional misconduct. Instead, we believe that whatever behavior is deemed to constitute attorney misconduct should be clearly defined and distinctly delineated. Currently, lawyers and law firms are accountable for their misconduct under those principles of managerial and supervisory responsibilities described in 22 N.Y.C.R.R. § 1200.5 [D.R. 1-104]. The contours of an individual lawyer's responsibility for the malpractice of another lawyer turn on whether that liability flows (a) from the partner's unlimited liability for a general partnership's debts arising from a legal malpractice claim against the law firm or (b) from the partner's unlimited liability for a limited liability partnership's "negligent or wrongful act or misconduct committed by him or her or by any person under his or her direct supervision and control while rendering professional services on behalf of" such partnership (italics added). See N.Y. Partnership Law Section 26(c). We believe that the different formulations used in the Commission's Rule 205, D.R. 1-104, and Section 26(c) of the N.Y. Partnership Law do not serve the best interests of the general public, issuers, investors, or practicing lawyers. We submit that standards of professional behavior are most appropriately elevated by rules of normative behavior that are both congruent and consistent.
|18|| The December 17, 2002, comment letter of Professor Susan P. Koniak and others urged the Commission to adopt rules that include a specific provision dealing with the discipline of law firms. That letter presented the Commission with the following proposition: "Section 205.2(a) should include a subsection making it plain that law firms, not just individual lawyers, practice before the Commission. When a lawyer within a firm advises a corporation or individual on the securities laws, the law firm, not some individual lawyer, represents the client, and in matters of any size or complexity multiple lawyers in the firm, not just one partner and a few subordinates, are likely to be involved. Making it clear that law firms, not just individual lawyers, are legal persons (entities) subject to these rules is essential to an effective regulatory regime. The Commission's rules on accountants and other groups acknowledge that fact, and it should be recognized and applied here as well. The duty to regulate lawyers imposed by § 307 implies effective and efficient regulation. To achieve either goal, the rules must include law firms and specify sanctions that will be visited on firms when they are found in violation of the rules." That comment letter then notes that the roles of lawyers in law firms may make it more difficult to identify any single lawyer as "responsible" for a particular decision regarding disclosure issues. As the letter puts it, "The Commission's rules should address the need for discipline of law firms. Specialized corporate and securities practice involves the participation of a team of lawyers who bring differing skills and knowledge. Responsibility for decisions is often divided up or shared in ways that are uncertain or shifting. The diffusion of responsibility and knowledge leads to the argument that no one attorney can be held responsible for what was done. The Commission should add a rule permitting the censure or reprimand of a law firm and the assessment of monetary fines when the firm, which is clearly responsible for the representation, has failed to conform to responsibilities required by the Commission."
|19|| Final Rule 205.2(e) defines "Evidence of a material violation" to mean "credible evidence, based upon which it would be unreasonable, under the circumstances, for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is ongoing, or is about to occur." The language of the commentary in the final release goes on to say, "To be `reasonably likely' a material violation must be more than a mere possibility, but it need not be `more likely than not.'" (italics added). We are troubled by this definition because it clearly states that a reporting obligation is triggered even when an attorney does not believe that the underlying "violation" probably happened. If an attorney believes that the available evidence shows that there is, for example, a 54% probability that an event (i.e., a "material violation") has not occurred, then it logically follows that there is a 46% probability that the event did occur. From our understanding of the plain meaning of the Commission's comments, we believe that the "46%" probability would come within the ambit of what the Commission says it means by the term "reasonably likely." This use of the term "likely" in the Commission's commentary also conflicts with the use of the word "likely" in Paragraph 3 of Statement of Financial Accounting Standards No. 5. In F.A.S. No. 5, the word "likely" means "probable" and the term "reasonably possible" means "more than remote but less than likely." NYCLA's Task Force believes that the terminology of probability theory is not a fruitful starting point for Rule 205.3(e)'s definition of "evidence of a material a violation." While the language of probability theory may have some utility with respect to predicting the occurrence of future events, it has less utility in regards to determining whether some event has happened in the past under the circumstances posed by the Commission's mandate under Section 307 of the Act.
|20|| In contrast, Section 205.3(d)(1) (B) phrases the mandatory withdrawal requirement imposed upon an "attorney employed by an issuer" in terms that encompass ceasing only "participation or assistance in any matter concerning the violation."
|21|| The December 17, 2002, comment letter of Professor Susan P. Koniak and others noted that, "...law firms would have an even greater incentive to prevent any one lawyer from knowing too much about the client's affairs, again threatening the quality of legal services and the goal of compliance with the securities laws."
|22|| The possible consequences were noted in Part IV B of Release No. 33-8185, where the Commission substantially discounted consideration of these as "costs" because they were not quantifiable and because they were attributed to the noisy withdrawal feature which, though initially proposed in November 2002, was not a part of the final Rule issued pursuant to Release No. 33-8185. The Commission used the following language to describe the issues involved: "Part 205 may also encourage some issuers to handle more legal matters in-house and may cause other issuers to limit the use of in-house counsel and rely more heavily on outside counsel, possibly increasing the cost of legal services. The Commission received one comment indicating that issuers would refer more matters to in-house counsel and four comments indicating that the rule would result in more matters referred to outside counsel. None of the commenters attempted to quantify the costs associated with these shifts. To the extent that the rule, as originally proposed, provided some perceived incentives to transfer functions to or from outside counsel, principally because of the `noisy withdrawal' requirements, we believe that those perceived incentives are not present in the rule as adopted."
|23|| New York's Civil Practice Law & Rules Section 321(b)(1) permits substitution of counsel in a civil action upon written consent of the attorney and client. New York's Civil Practice Law & Rules Section 321(b)(2) permits the attorney's withdrawal on order of the court if the client does not consent or if there is no immediate substitution of successor counsel. In Federal Courts in New York, leave of court is always required for withdrawal or substitution of attorneys in a pending civil matter. Local Civil Rule 1.4 of the United States District Courts for the Eastern and Southern Districts of New York permit withdrawal or substitution of counsel of record "only by order of the court." The rule further provides, "Such order may be granted only upon a showing by affidavit or otherwise of satisfactory reasons for the order or displacement ...."
|24|| The only conduct that is likely to be deterred by Proposed Rule 205.3(d)(2) is a prudent issuer's retention of a lawyer to perform legal services that encompass different types of legal services, i.e., litigation and securities advice. See footnote 22 above.
|25|| Rule 205.2(k) defines a QLCC in terms of both the qualifications of its members as well as its required responsibilities. Under Rule 205.3(c)(1) and Rule 205.3(c)(2) reports of "evidence of a material violation" may be directed to the QLCC for evaluation and response.
|26|| The last sentence of Rule 205.3(c)(1) provides, "An attorney who reports evidence of a material violation to such a qualified legal compliance committee has satisfied his or her obligation to report such evidence and is not required to assess the issuer's response to the reported evidence of a material violation." Curiously, where the attorney makes a report to the issuer's Chief Legal Officer ("CLO") and the CLO, in turn, forwards the report to the QLCC pursuant to Rule 205.3(a)(2) and Rule 205.3(c)(2), the attorney who initiated the report may not be able to avail himself or herself of the "safe harbor" afforded by the last sentence of Rule 205.3(c)(1), unless the CLO's report (pursuant to the second sentence of Rule 205.3(c)(2))to the initiating attorney constitutes an "appropriate" response. The last sentence of Rule 205.3(c)(2), however, implies that the QLCC will also send a "response" to the initiating attorney.
|27|| Part III of the release explaining the Final Rule estimated that only 3,640 public companies would form a QLCC. Consequently, it appears that the Commission believes that more than 14,000 other public companies will not form a QLCC. Based on language in the Paperwork Reduction Act section of the final release, it appears that the Commission actually believes that the noisy withdrawal provision will cause an increase in the creation of QLCCs. "The Commission estimated in the proposing release that one quarter of issuers would form QLCCs and received comments suggesting both that it would be difficult to find people to serve on QLCCs and, on the other hand, many companies would use QLCCs. Moreover, the Commission is not adopting at this time the "noisy withdrawal" proposal, which may tend to cause fewer companies to form QLCCs. Accordingly, the Commission estimates that under the rule, as adopted, 20% of issuers will form QLCCs."
|28|| The December 17, 2002, comment letter of Professor Susan P. Koniak and others acknowledges this aspect of securities law practice in the following passage, "Specialized corporate and securities practice involves the participation of a team of lawyers who bring differing skills and knowledge. Responsibility for decisions is often divided up or shared in ways that are uncertain or shifting. The diffusion of responsibility and knowledge leads to the argument that no one attorney can be held responsible for what was done."
|29|| See footnote 21 above.
|30|| Professor Gillers made his remarks in the context of the question whether professional disciplinary rules should require lawyers to disclose a client's past misconduct or its intention to commit future wrongful conduct. We believe that the same policies underlying Professor Gillers's views also militate against any "noisy withdrawal" requirement. In the end analysis, we believe that a "noisy withdrawal" rule is nothing but a mandatory disclosure rule without particularizing the underlying basis for the disclosure or withdrawal. To the extent that the Commission intends the word "circumstances" in Proposed Rule 205.3(e) to mean anything more substantive than the dates, senders, and addressees of the various notices, then the Proposed Rule will probably require disclosure of privileged information and thereby eviscerate the issuer's rights to assert the attorney-client privilege in any litigation involving the alleged underlying violation.
|31|| 22 N.Y.C.C.R. § 1200.19 [D. R. 4-101] provides in pertinent part "Preservation of confidences and secrets of a client ... (c) A lawyer may reveal: ... (3) The intention of a client to commit a crime and the information necessary to prevent the crime."
|32|| 22 N.Y.C.C.R. § 1200.19 provides "Preservation of confidences and secrets of a client ... (c) A lawyer may reveal: ... (5) Confidences or secrets to the extent implicit in withdrawing a written or oral opinion or representation previously given by the lawyer and believed by the lawyer still to be relied upon by a third person where the lawyer has discovered that the opinion or representation was based on materially inaccurate information or is being used to further a crime or fraud."
|33|| 22 N.Y.C.C.R. § 1200.15 [D. R. 2-110].
|34|| See the December 13, 2002, comment letter to the Commission from Hon. Judith S. Kaye, Chief Judge of the State of New York and President of the Conference of Chief Justices.
|35|| Whenever a lawyer issues an opinion to a third party, then he or she is subject to liabilities similar to those that are imposed upon accountants on whose opinions a third party may rely. If a lawyer, in those circumstances, commits malpractice or knowingly misrepresents facts, then our legal system affixes liability in the same way as it imposes liability on accountants for malpractice or fraud.
|36|| Chief Justice Burger's opinion in United States v. Arthur Young & Co., 465 U.S. 805 (1984), said, "By certifying the public reports that collectively depict a corporation's financial status, the independent auditor assumes a public responsibility transcending any employment relationship with the client. The independent public accountant performing this special function owes ultimate allegiance to the corporation's creditors and stockholders, as well as to the investing public. This `public watchdog' function demands that the accountant maintain total independence from the client at all times and requires complete fidelity and public trust."
|37|| In many financing transactions and public offerings, lawyers do issue opinions on whether a company is incorporated in a particular state, whether shares of stock are validly issued under the laws of the corporation's domicile, or whether corporate action has validly occurred to authorize some transaction. Those types of limited opinions are irrelevant to § 307 of the Act, the operation of Part 205, or the stated reasons for the Proposal. There is no indication of any increase in the number of bogus legal opinions concerning the valid issuance of any corporate securities.
|38|| Statement of Auditing Standards No.1 states that the second "general standard" of the auditing profession is independence. It goes on to say, "To be independent, the auditor must be intellectually honest; to be recognized as independent, he must be free from any obligation to or interest in the client, its management, or its owners." In contrast, the professional obligations of lawyers require them to avoid "influence by others than the client." 22 N.Y.C.R.R. § 1200.26 (D.R. 5-107).