Erik N. Frias
43709 Clemens Terrace
Ashburn, VA 20147
April 7, 2003
Securities and Exchange Commission
450 5th Street, NW
Washington, DC 20549
Attn: Jonathan G. Katz, Secretary
Via email: email@example.com
Re: File No. S7-45-02
Release Nos. 33-8186, 34-47282, IC-25920
Implementation of Standards of Professional Conduct for Attorneys
Dear Mr. Katz:
I am pleased to submit this letter in response to the Commission's request for comment on its proposals to implement new standards for attorney conduct when practicing before the Commission. The main proposal, one that was originally included with the "up-the-ladder" reporting proposals required under section 307 of the Sarbanes-Oxley Act but not implemented at that time, seeks, inter alia, a requirement that a retained attorney1 who, in the course of his2 representation of a company subject to the federal securities laws,3 "reasonably believes that a material violation is ongoing or is about to occur" and receives no appropriate response from the client after following the "up-the-ladder" reporting procedures, withdraw from that representation and immediately notify the Commission of his withdrawal. Furthermore, the attorney shall be required to include in its notifications to his client and to the Commission that the withdrawal was mandated by "professional considerations."
In light of the voluminous commentary in opposition to the original plan, the Commission has also suggested two alternatives that purport to lessen the disclosure burden to the withdrawing attorney, thereby shifting those burdens back to the client. The first alternative seeks to require the attorney only to notify the client of his withdrawal and that the withdrawal was mandated by "professional considerations." The client would then be required to disclose to subsequent counsel that previous counsel withdrew for those considerations. The second alternative seeks to place a duty of public disclosure upon the company, requiring that the client disclose to the Commission the withdrawal of its counsel and that such withdrawal was mandated by "professional considerations."
I applaud the Commission for extending the comment period for these provisions. Because the original proposal included matter that was beyond the immediate scope of section 307 along with matter that was appropriate under that section, it is important that those separate issues be considered discretely. Furthermore, I feel that there were a number of excellent comments that were received in response to that proposal which were deserving of the Commission's attention.
As a preliminary matter, I feel that attorney complicity with any illegal conduct of his client, be it a violation of the federal securities laws or any other law, should be punished appropriately. Any position taken to the contrary would be ludicrous and irresponsible.4 Appropriate punishment in the case of complicity with a securities violation may include disbarment, civil enforcement actions by the SEC or state regulatory agencies, and perhaps even criminal prosecution. My criticism of this proposal is not, therefore, an argument against attorney liability in all cases, but instead a reflection of my opinion that there are serious flaws with the proposed rule.
I cannot give my unconditional support to any of the so-called "noisy withdrawal" proposals. I believe that there are fundamental flaws with each alternative as well as a serious question about the competence of the Commission to administer such rules. For these reasons, I feel that the Commission should resist the temptation to become an active watchdog of attorneys' professional responsibility and should not implement the proposed rules.
I. The Proposed Rules are Inconsistent with Existing Standards of Professional Responsibility
One of the principal reasons behind the implementation of section 307 of the Sarbanes-Oxley Act, as well as one of the stated reasons for the original proposed rule, is the lack of standards currently in place that prevent an attorney from playing an active role in the fraud of his client.5 This is plainly untrue.
The Model Rules of Professional Responsibility (Model Rules), which form the basis for state regulation of attorney conduct in the vast majority of jurisdictions in this nation, directly address the proper role of an attorney facing criminal or fraudulent conduct by his client. In many cases, the Model Rules prescribe conduct in substantially the same manner as does the proposed rule. However, there are important differences between the two, and some of those differences create situations where compliance of both the federal and state rules becomes impossible. These situations arise with regard to an attorney's existing duty of candor to the tribunal and his ability to withdraw from representing a client.
A. Duty of Candor to the Tribunal
The Model Rules place a duty of candor upon an attorney practicing before a tribunal, preventing him from knowingly offering any evidence or testimony or from making any false statements to that tribunal.6 Therefore, in situations where the attorney knows the conduct of his client to be a violation of the securities laws, the Model Rules prevent the attorney from participating with his client in the fraud.7 Furthermore, in cases where the attorney has already offered material information to the Commission that he later discovers to be false, he is bound to take remedial measures.
The proposed rule seeks to place a similar duty upon the attorney, but does so under different circumstances. Under the proposal, an attorney is bound to make remedial measures in any case where he "reasonably believes that a material violation is ongoing or is about to occur." This requirement does violence to the existing ethical requirement in two ways.
First, it lowers the standard of knowledge on the part of the attorney. Because there are conceivable instances where an attorney may have suspicions, even reasonable suspicions, about the conduct of his client without being able to ascertain the veracity of his suspicions, the attorney is placed in an ethical dilemma. Because the state rules only permit remedial measures where he "knows" of a violation, he is prohibited from taking any actions that may impair his ability to zealously represent his client in cases where his awareness does not rise to actual knowledge.
Second, the proposal seeks to mandate remedial measures in advance of a violation. While it is always the duty of an attorney to act to prevent the criminal or fraudulent conduct of his client,8 a vague duty to take specific action in prevention of conduct that may or may not take place in the future is one that is entirely foreign to any notion known in common practice. To place such a duty upon an attorney is likely to place him in untenable situations in which he has no real options.
B. Withdrawing from Representation of a Client
The Model Rules include scenarios where it may be necessary for an attorney to withdraw from his representation of the client, and even contemplate "noisy withdrawal" under certain limited circumstances. An attorney is required to decline or withdraw from representation of a client if that client demands that the attorney violate any law or any of the Model Rules,9 and is permitted from withdrawing when his client pursues an illegal or immoral course of conduct with or without aid from the attorney.10 Therefore, an attorney already has a duty to withdraw from representing a client that seeks his services in furtherance of a crime or fraud. Furthermore, the Model Rules contemplate a disclosure to the tribunal that "professional considerations" mandated the withdrawal when the tribunal demands an explanation for the withdrawal.11 The Model Rules also require that, even upon discharge or withdrawal, the attorney take all reasonable steps to mitigate the adverse consequences of that discharge or withdrawal to the client.12 An attorney may disaffirm any opinion or document filed on behalf of the client.13
The Commission's proposed rule seeks to require an attorney to withdraw from representation under less restrictive circumstances and to do so in such a manner that can cause grave consequences to his client. This requirement places the attorney again in an untenable situation where he is forced to choose between competing and contradictory ethical requirements.
Because the proposal merely seeks to require a withdrawal where the Model Rules already requires it in some circumstances and permits it in others, there is no actual conflict between the two with regard to the withdrawal provisions. The conflict occurs where the proposal seeks to require that the attorney make certain disclosures to the Commission. An attorney who has made no filings and has submitted no opinions with the Commission with regard to a specific client is completely forbidden by the Model Rules from making any notice to the Commission of the nature of his withdrawal. Because he would have no documents or opinions to disaffirm, any notice of his withdrawal to the Commission "for professional considerations" would violate his duty to mitigate the consequences of his (even mandatory) withdrawal.14 The fact that, under the Commission's proposal, an attorney shall be required to make this sort of "noisy withdrawal" in circumstances where the attorney's assistance was never given or requested in furtherance of the fraud, therefore places the attorney in a situation where compliance with both his duties to the Commission and those under state law becomes impossible.
C. The Purpose Served by Noisy Withdrawal
As already noted, the Model Rules already contemplate a need for an attorney to notify a tribunal that his withdrawal was mandated by "professional considerations" under certain limited circumstances. The purpose for this "noisy withdrawal" is not intended to be a weapon to be wielded by the attorney to force the client into compliance, but instead a method of withdrawing from an unethical situation while mitigating the adverse consequences to the client, to whom he still owes fiduciary duties. It is therefore a prophylactic tool to be used in situations where the tribunal demands an explanation for the withdrawal before granting leave of the attorney.
In the case at hand, the Commission wishes to use what has been always more of a prophylaxis instead as an offensive weapon that an attorney must use to blow the whistle on his own client. In so doing, the Commission intends to deputize the entire securities bar15 to identify violations of the securities laws and to violate their existing ethical duties to their clients.
II. Attention Focused upon the Attorney-Client Privilege is Misplaced
Presumably in response to the vast commentary in opposition to the original proposal, the Commission states that the "noisy withdrawal" procedures mandated in the proposal do not breach the attorney-client privilege, claiming this to be "settled law." The commentators and the Commission each make statements that are inaccurate because they confuse the attorney-client privilege, a rule of evidence,16 with the duty of confidentiality, an ethical duty to the client identified in Model Rule 1.6. Because the attorney-client privilege is nothing more than a rule of evidence, to discuss a "breach" of the privilege is a bit of a misnomer and focuses attention in the wrong place.
The duty of confidentiality, although somewhat related to the privilege, has some significant differences. The primary difference is with the exceptions to the rule. While the privilege permits an attorney to provide testimony of his clients' crimes or frauds when the client sought the services of the attorney in furtherance of the conduct (crime/fraud exception), the Model Rules only recognize a single exception to the duty of confidentiality, where the attorney can notify authorities of his client's intention to cause serious bodily harm or death to another person. The Model Rules recognize no exception to the duty of confidentiality where the client engages in financial fraud.17 Therefore, any disclosure of confidential information concerning the fraudulent behavior of an attorney's client, unless compelled by a court of law, would violate the Model Rules and therefore subject the attorney to discipline by his state bar.
The assertion by the Commission that this kind of disclosure does not violate the attorney-client privilege is also similarly misplaced. Because the proposal does not seek to alter any of the rules of evidence, this assertion is axiomatic. However, because the proposal implicates state ethical obligations that may be in conflict with the requirements of the proposal, any assertion that the requirements do not breach the attorney's duty of confidentiality would be inaccurate.
III. The Scope of the Proposed Rule is Too Broad
Apart from the conflicts between the proposed rule and existing standards of ethical conduct, there are serious ambiguities in the proposal that makes the rule very impractical to administer and even more difficult for practitioners to follow. Although the text of the rule borrows from existing Rules of Practice with regard to the target of the regulation, the definition of an attorney "practicing before the Commission" is too broad, as it is likely to apply to persons who would have no expectation of regulation by the Commission. Also, the proposed rule is unclear if the attorney is required to withdraw his services with regard to every aspect of his representation, or if he is merely required to discontinue his representation of that client before the Commission.
A. Practicing Before the Commission
The Commission defines "practicing before the Commission" to include any attorney who prepares any document to be filed with the Commission.18 Although this appropriately includes all attorneys who would expect to be included, such as attorneys who specialize in advising their clients on securities issues, it also includes many attorneys who may have no specialized knowledge or experience with the securities laws and therefore would have no expectation of inclusion as the subject of SEC regulation. Attorneys that may fall into this category may include an attorney who specializes in negotiating employment agreements. Because some of those agreements that such an attorney has drafted may have to be included with SEC filings, his participation in the drafting of that agreement brings him within the scope of the regulation and subject to all of the consequences of the proposed rule.
The proposed rule may require this attorney to expand his expertise beyond his own specialty, and require that he become able to identify violations of the securities laws. Because the proposal includes a standard of knowledge of a violation below that of actual knowledge, it is conceivable that an attorney who lacks the training and expertise to identify a securities law violation may be subject to discipline by the Commission when he fails to comply with this proposed rule.
B. Extent of Mandated Withdrawal
The proposed rule is unclear about the scope of withdrawal that shall be required, leaving the reasonable attorney to assume that complete withdrawal from all representation is mandated. Because the requirement that the attorney withdraw from representing the client on unrelated matters serves no purpose to the Commission other than to harass and inconvenience the attorney and client, this requirement is absurd. Furthermore, it is a well-settled principle that a substantial relationship must exist between matters at issue in order to require disqualification of an attorney.19 Therefore, this requirement is not only contrary to the stated purpose of the regulation, but it is also contrary to law.
IV. The Alternatives Proposed do Little to Alleviate the Flaws of the Original Proposal
In light of the mountainous commentary to the original proposal, the Commission has offered three alternatives. The first alternative20 is, instead of mandatory noisy withdrawal, a permissive noisy withdrawal where the attorney may notify the Commission of his withdrawal from representing a client and that such withdrawal was mandated by professional considerations. The second alternative places the notification burden onto the client when his attorney withdraws. The third alternative places no duty of public disclosure, instead merely requiring the client to inform subsequent counsel that the previous counsel withdrew for professional considerations.
A. Permissive Noisy Withdrawal
The idea of allowing noisy withdrawal as an alternative to requiring it diverges from the original proposal in an insignificant, and absurd, way. Not only does a permissive noisy withdrawal fail to serve the stated purposes of the regulation,21 this alternative does nothing to alleviate the problems inherent in the original proposal. Because noisy withdrawal under the circumstances identified in the proposal would be inconsistent with an attorney's ethical obligations under state law,22 rendering this kind of withdrawal permissive instead of mandatory accomplishes nothing.
B. Corporate Notification to the Commission
The proposed alternative to noisy withdrawal that requires the client to notify the Commission in the event of a withdrawal by the attorney leaves something to be desired as well. While it avoids a technical violation of the attorney's duty of confidentiality by allowing the attorney to maintain his client's confidences, this alternative instead violates the spirit of the ethical rule. By making an end-run around the duty of confidentiality, this alternative seeks to give the Commission a peek into what has traditionally been considered sacrosanct, the confidences between an attorney and his client.
C. Corporate Notification to Successor Counsel
The final alternative appears to be the least objectionable. This option requires the withdrawing attorney to provide written notice to the client of his withdrawal and the client to inform successor counsel that the withdrawal was mandated by professional considerations. It is perfectly reasonable to expect that a withdrawing attorney should provide written notice to his client, and equally reasonable for successor counsel to be fully informed of the nature of the termination of previous counsel. For these reasons, I feel that this is the best of all of the stated alternatives.
V. The Commission is Poorly Suited to Regulate the Legal Profession
The legal profession has traditionally been a self-regulating industry. This has been necessarily true because lawyers are in the best place to decide what is best for the legal profession. For that reason, state legislatures have delegated the authority to regulate the legal profession to the highest court in each state. This delegation has been appropriate because the courts have traditionally been viewed as the most neutral party in the legal process. The courts are mostly interested in the equity of justice.
The Commission is seeking to tip the scales in favor of law enforcement with its proposed Implementation of Standards of Professional Conduct for Attorneys. It is attempting to create new ethical obligations for attorneys by interfering with the most elementary aspect of the attorney-client relationship, the duty of the attorney to maintain his clients' confidences and to represent them zealously with no contradictory agendae.
Current ethical standards may not be perfect. The American Bar Association, drafters of the Model Rules of Professional Conduct, is in constant discussions on how to improve those rules.23 Recent debate has resulted in several updates to the Model Rules, and more are likely in the future as this area of law continues to develop.
The Securities and Exchange Commission is poorly suited to administer rules of attorney conduct. The Commission has already demonstrated a certain level of incompetence in the administration of ethical rules much simpler than those under consideration today.24 The Commission's history with its own Rule 102(e) is illustrative of this precise problem. In one case, In re George C. Kern Jr.,25 the Commission discontinued 102(e) proceedings against Mr. Kern after pursuing them for almost four years. Mr. Kern was forced to wait almost three years after an initial proceeding had found that he had acted in violation of the rule before he was finally able to work without the specter of the case looming before him. The final decision to discontinue the proceedings was anticlimactic, considering the publicity surrounding the initial findings. In the other case, arguably the Commission's lowest hour with regard to administration of ethical standards, In re Carter,26 the Commission dropped proceedings against two attorneys almost six years after the conduct, mostly because of its own lack of objective standards by which they could proceed. These cases highlight the fact that the regulation of attorney conduct is best left in the hands of ethics experts, not law enforcement agencies.
The Commission would be wise to not adopt any of the proposed rules discussed herein. Ethical rules are best left to the people who have been drafting them for decades. Competing ethical standards are likely to leave practicing attorneys in situations where there ethical duties may come into conflict, leaving them open to discipline or liability regardless of which duty with which they decide to comply.
The most reasonable recommendations for improvement are those espoused by the ABA Task Force on Corporate Responsibility. In its recommendations for amendment to the Model Rules, the Task Force recommends that in cases where a retained attorney has reason to believe that his client is violating the law, he should notify the client's General Counsel, shifting the responsibility of compliance to the General Counsel.27 This recommendation is far superior because the General Counsel is in a much greater position to investigate the practices of the company and to oversee compliance.
Once again, I appreciate the opportunity to provide my thoughts on your proposed rules. I hope that the Commission seriously considers my commentary.
Erik N. Frias
|1|| In the interest of economy, I am offering commentary solely on the provisions that are directly applicable to retained attorneys. Although many of the same critiques may be equally applicable to the provisions applicable to employed attorneys, I reserve those criticisms for other commentators. Therefore, in any instance where I refer to an attorney, it is only intended that those references are to be applied as they pertain to retained attorneys.
|2|| With apologies to all female members of the bar, any reference herein to the masculine shall include the feminine. I choose to use the masculine form solely in the interest of economy, without any malice or gender bias.
|3|| Although the text of the proposal refers to such companies as "issuers", I feel that this term is imprecise for this purpose. As I understand it, the proposed rule shall act as a rule under the Securities Act, the Exchange Act and the Investment Company Act. Because an "issuer" is more of a subject of the Securities Act and Investment Company Act than of the Exchange Act, a different term would be preferable.
|4|| Even the harshest criticisms of the role of the SEC in overseeing the conduct of professionals practicing before it concede this axiomatic point. See e.g., Harvey L. Pitt & Dixie L. Johnson, Justice Delayed, Justice Denied: Observations on the SEC's `Kern' Decision, N.Y.L.J., July 21, 1991, at 1.
|5|| Proposed Rule at Pt. II.A; remarks by Sen. Michael Enzi, 148 Cong. Rec. at S6555 ("[The states] have provided no specific ethical rule of conduct to remedy this kind of situation."). The text of the proposed rule even purports to draw from the conclusions drawn by the ABA Task Force on Corporate Responsibility. This inference, however, is disingenuine, because, although the task force did concede some flaws in the Model Rules of Professional Responsibility and suggested that the ABA update those rules, it never concluded that regulation of attorney conduct should lie anywhere other than with the states.
|6|| Model Rule 3.3 reads, in pertinent part:
(a) A lawyer shall not knowingly:
(1) make a false statement of material fact or law to a tribunal;
(2) fail to disclose a material fact to a tribunal when disclosure is necessary to avoid assisting a criminal or fraudulent act by the client; . . .
(4) offer evidence that the lawyer knows to be false. If a lawyer has offered material evidence and comes to know of its falsity, the lawyer shall take reasonable remedial measures.
|7|| Note the requirement of actual knowledge with this rule. It has always been considered elementary that actual knowledge should be required as the basis for attorney complicity liability. See, e.g., In re Carter, Exchange Act Rel. No. 17,597 (Feb. 28, 1981); SEC v. Coffey, 493 F.2d 1304 (6th Cir. 1974); see also Lisa H. Nicholson, A Hobson's Choice for Securities Lawyers in the Post-Enron Environment: Striking a Balance Between the Obligation of Client Loyalty and Market Gatekeeper, 16 Geo. J. Legal Ethics 91, 109-10 ("It is black letter law that professional defendants must have acted fraudulently in their own right to be held liable as primary violators . . . .").
|8|| The preamble to the Model Rules includes a description of the attorney's duties, including those of a public citizen and an officer of the court. Such duties are entirely consistent with a duty to prevent criminal and fraudulent conduct where an attorney is capable of doing so.
|9|| Paragraph 2 in the comments to Model Rule 1.16 reads:
A lawyer ordinarily must decline or withdraw from representation if the client demands that the lawyer engage in conduct that is illegal or violates the Rules of Professional Conduct or other law. The lawyer is not obliged to decline or withdraw simply because the client suggests such a course of conduct; a client may make such a suggestion in the hope that a lawyer will not be constrained by a professional obligation.
|10|| Model Rule 1.16, cmt. 7.
|11|| Model Rule 1.16, cmt. 3.
|12|| Model Rule 1.16, cmt. 9.
|13|| Model Rule 1.6, cmt. 16.
|14|| Although this is an excellent example of such a conflict, there are endless scenarios where the Model Rules would forbid any kind of notice, even upon a mandatory withdrawal.
|15|| Actually, the reach of this proposal goes much further than just the securities bar. See infra Part III.A.
|16|| The attorney-client privilege, like all privileges, is a creature of state common law. In Federal Courts, the privilege is administered as it would be in the relevant state jurisdiction. Fed. R. Evid. 501.
|17|| The ABA Task Force on Corporate Responsibility did note that many states, in their own rules of professional conduct, diverge from the Model Rules in this respect. A growing number of states recognize a fraud exception to the duty of confidentiality, causing the task force to recommend an amendment to Rule 1.6. James H. Cheek et al, Preliminary Report of the American Bar Association Task Force on Corporate Responsibility 32 (2002).
|18|| SEC Rules of Practice, Rule 102(f).
|19|| Trone v. Smith, 621 F.2d 994 (9th Cir. 1980).
|20|| Although these alternatives are not presented in the order in which they were proposed, I choose to comment on them in this order for logical reasons.
|21|| It appears highly unlikely that many attorneys will actually go through the noisy withdrawal process if it is not required.
|22|| See supra Part I.
|23|| The ABA's Task Force on Corporate Responsibility suggested many reforms to the Model Rules, including some that may place significant ethical burdens upon a securities lawyer faced with securities violations by his client. See Cheek, supra note 17.
|24|| Pitt & Johnson, supra note 4. Even members of the SEC staff have had similar reservations. See, e.g., Edward F. Greene, Lawyer Disciplinary Proceedings Before the SEC, Remarks to the New York County Lawyer's Association, Jan. 18, 1982, Fed. Sec. L. Rep. ¶ 83,089 ("I believe that the Commission should use existing state law standards."). Mr. Greene was the General Counsel at the time he delivered this address.
|25|| Exchange Act Rel. No. 29,356 (June 21, 1991).
|26|| Exchange Act Rel. No. 17,597 (Feb. 28, 1981).
|27|| Cheek, supra note 17, at 39-42.