North Carolina Bar Association
PO Box 3688 - Cary, NC 27519-3688
January 21, 2003
Jonathan G. Katz, Secretary,
Securities and Exchange Commission,
450 Fifth Street, N.W.
Washington, D.C. 20549-0609.
Re: Sarbanes-Oxley Act § 307 - Implementation of Standards of Professional Conduct for Attorneys - Part 205 (File No. 33-8150.wp)
Dear Mr. Katz:
On behalf of the North Carolina Bar Association, we submit this letter in response to the Securities and Exchange Commission's proposed rules to implement Section 307 of the Sarbanes-Oxley Act of 2002 (the "Act") as published in Release Nos. 33-8150, 34-26868 and IC-25829 dated November 21, 2002.
The undersigned are the President of the North Carolina Bar Association, a voluntary bar organization representing over 12,000 lawyers and judges in North Carolina, and the Chair of the Task Force that was appointed by the Association's Professionalism Committee to consider the proposed rules and our response to it (the "Task Force").
We are mindful that the specified comment period on the proposed rules has expired and that a decision by the Commission on a final rule is imminent. We are also aware of the volume of comments from others in the legal profession, on both the larger issues and the smaller technical issues presented by the proposed rules, and so we understand that we add additional voice but not necessarily additional points to the mix of opinions and information before the Commission.
But our own process of studying the proposed rules, soliciting the views of our members, and educating each other on the significance of the proposed rules, leads us to one inescapable conclusion that we feel compelled to assert in this rulemaking proceeding:
The scope of the rules as proposed is so broad - affecting not only lawyers who view themselves as securities lawyers but many who do not and who have yet to digest its full measure - and the impact of the rules as proposed on the relationships between lawyers and their clients is such a radical departure from the time-honored role of lawyers as trusted counsel and the "conscience of the enterprise," that we must urge the Commission to slow down, adopt only what is necessary to implement the specific mandates of Section 307 by the statutory deadline, and allow time for broader discussion and debate within the legal profession and in the public as to the proper role of lawyers who serve public companies and the proper scope of regulation of the legal profession by the Commission.
Accordingly, we present to you the particular comments of the Task Force of our Professionalism Committee, which support our more general view on behalf of the North Carolina Bar Association as a whole that there has not been adequate time or public discussion, and there exists no legislative mandate, for the Commission to adopt (a) an expansive definition of what constitutes "appearing and practicing before the "Commission" or (b) a rule requiring "noisy withdrawal," or other actions involving disclosure of client confidences outside the organizational client. We also include the Task Force's comments on other matters that it has addressed.
Comments of Professionalism Committee Task Force
The Commission has proposed adding Part 205 to its rules and regulations to require attorneys appearing and practicing before the Commission to report evidence of material violations of securities laws to designated individuals and bodies within an organization and, in some circumstances, to require them to publicly withdraw from representation of the issuer. The Commission has also proposed a rule to apply to lawyers the negligence standards for improper professional conduct now applicable to accountants under Section 4C of the Securities Exchange Act of 1934 added by Section 602 of the Act and Rule 102(e) of the Commission's Rules of Practice, with the same penalties and remedies.
While our Task Force commends the Commission's efforts to enhance ethical standards of lawyers representing public companies, it has several serious concerns about the proposed rules it would like to share with you. It agrees that lawyers should be responsible for actively leading clients to comply with the law and meeting high standards of ethical and responsible conduct, including, in some cases, reporting inappropriate actions to appropriate authorities within an issuer. However, it believes that some of the proposals set forth by the Commission go beyond what is required by the Act and some proposals will have a practical effect contrary to what it believes the Act was intended to accomplish. The remainder of this letter sets out some of our Task Force's specific areas of concern with the proposed rules.
Comments on Provisions Not Required by the Act
In light of the short time frame mandated by the Act for promulgating rules, the Task Force urges the Commission to limit the scope of new rules to those required by the Act. The proposed range of the individuals to whom the rules would apply goes beyond what is required. Additionally, requiring attorneys to report material violations to the Commission is outside the requirements of the Act.
Appearing and Practicing before the Commission
"Appearing and practicing" before the Commission in the "representation of an issuer" would include any attorney involved with any document filed with the Commission or in any decision relating to the filing of a document with the Commission. Licensed attorneys who are not practicing law but are acting in another capacity for an issuer would be swept up by this definition, as would lawyers who are representing issuers on matters in other areas of law. The breadth of this rule requires any attorney whose client or employer is covered by the Act to be responsible for complying with all Commission rules and regulations. For example, intellectual property lawyers are often called on to advise on a particular section of a document that will be filed with the Commission. It is inappropriate for these attorneys to be subject to the same obligations as attorneys who are primarily responsible for the preparation and review of disclosure documents. Similarly, it is inappropriate for attorneys employed by companies in non-legal capacities to be subject to the same obligations as attorneys who are primarily responsible for the preparation and review of disclosure documents.
Because the rule applies a "reasonable lawyer" standard, effectively, individuals who may not know that they are covered by the rules may not grasp the significance of information they receive regarding an issuer and may not be able to assess such information in the context of this rule will be held to the standard of a reasonable securities lawyer. The Task Force believes only attorneys with significant responsibility for an issuer's compliance with federal securities law or overall compliance with government regulation should be subject to this rule.
Noisy Withdrawal and Disaffirmation
The Commission is not mandated to create a mechanism for attorneys to report outside the corporation under the Act and the Task Force urges the Commission to defer implementation of this rule until it has more time to consider a rule that preserves the nature of the attorney-client relationship and encourages issuers to fully involve their inside and outside legal counsel as ethical and legal advisors. The current proposal raises issues of conflict with state law, undermines lawyers' ability to counsel their clients, limits the confidentiality of information clients provide to their counsel, and inappropriately penalizes issuers that rely on one firm for multiple representations.
Senator John Edwards who proposed Section 307 and his colleagues in the United States Senate made abundantly clear that they contemplated only a rule that would require an attorney to go "up the ladder" within a corporate client if in the representation an attorney is confronted with evidence of, for example, a material violation of securities law and if the issuer does not respond appropriately. Senator Edwards said the Commission was to make a "simple rule with two parts. No. 1, a lawyer with evidence of a material violation has to report that evidence either to the chief legal officer or to the chief executive officer of the company. No. 2, if the person to whom the lawyer reports doesn't respond appropriately..., that lawyer has an obligation to go to the audit committee or to the board. It is that simple." 148 Cong. Rec. S6553 (July 10, 2002). Senator Enzi and Senator Corzine made statements to exactly the same effect. None of these senators suggested that the Commission under Section 307 was to require noisy withdrawal. Indeed, Senator Enzi expressly stated in the floor debates over Section 307 that the amendment "would not require the attorneys to report violations to the SEC, only to corporate legal counsel or the CEO, and ultimately to the board of directors." 148 Cong. Rec. S6555 (July 10, 2002).
State law already requires a lawyer to cease representation of a client to avoid participation or endorsement of illegal activity. For example, the American Bar Association Model Rule 1.13 requires a lawyer to use his or her best judgment as to whether reporting a matter to the highest authority in the organization will be in the best interest of the client. Model Rule 1.16(a)(1) requires a lawyer to terminate representation if it will result in a violation of the rules of professional conduct. The proposed rules also create a potential conflict with obligations imposed by state law for counsel to maintain the confidentiality of client information. The Task Force urges the Commission to consider carefully whether Congress intended to create conflicts with the state statutes and rules by creating a new standard for when a lawyer must withdraw from representation of an issuer.
The Task Force believes that lawyers will not be able to fully represent their clients if they are required to act as a conscripted police force for the Commission. Professional independence and preservation of the attorney-client privilege and client confidentiality are important values to be protected. Every issuer is entitled to representation by counsel that will act in its best interests. For representation to be effective, clients must feel free to confide in counsel without undue concern that counsel will be required to disclose those confidences to others, particularly a governmental agency. In the vast majority of cases counsel enjoy the confidence of their clients and, given access to the facts by their clients, succeed in persuading their clients to refrain from actions that harm the investing public.
The proposed rule will make senior management of issuers more reluctant to confer with both inside and outside counsel for fear that disagreement with counsel might result in a noisy withdrawal. Issuers will be motivated to avoid cautious and prudent attorneys, and tend more to take a less conservative approach to compliance with securities laws. Particularly when it is most needed, in the case of suspected misconduct, issuers may be reluctant to conduct an appropriate investigation with the involvement of counsel if the files of the internal investigation may ultimately be provided to the Commission. Criminal lawyers are not required to withdraw from representation of a client that has indicated it has committed an offense. Similarly, securities counsel should be able to represent issuers who may not have complied with securities laws if they can do so without violating their professional responsibility.
The fear that the lawyer's responsibility as whistleblower will reduce his or her ability to represent the client fully is likely to diminish counsel's ability to prevent problems and proactively encourage legal and ethical actions. If issuers are afraid to confide candidly in their counsel and instead proceed without the advice of counsel, issuers are more likely to proceed in ways that are not in the best interest of the public. The Task Force urges the Commission to encourage issuers to be open with counsel to involve them fully, particularly in difficult questions, and to strengthen attorneys' ability to investigate potential areas of concern fully without an inappropriate threat of harming their client through the act of creating a file on a difficult issue.
The Task Force also urges the Commission to consider how the rules requiring withdrawal would apply to a law firm, as opposed to an individual lawyer. The Task Force believes the proposed requirement that lawyers and, as a result, law firms in certain circumstances withdraw from representing the issuer is contrary to the legislative history of the Act and, from the perspective of both the issuer and the lawyers forced to withdraw, punitive in nature. To the extent the withdrawal requirement is intended to force a law firm to withdraw from unrelated representations, it is unreasonable, disruptive and unworkable. Withdrawal from litigation without court approval could violate court rules, not only ethical rules. Since, under the Commission's proposal, an issuer would be required to tell successor counsel the reason for the withdrawal of previous counsel, the issuer could have significant difficulty finding new representation, even on matters unrelated to the identified violation of securities law. The threat of withdrawal may effectively force a client to acquiesce in following the lawyer's advice even when in good faith it strongly disagrees with the advice. If the lawyer has reported to the board of directors of an issuer, the Commission should not require the board of directors to replace their judgment with that of their counsel.
Comments on Provisions to Implement Mandatory Statutory Requirements
The Task Force would also like to advise the Commission of concerns it has with some of the proposed rules that implement the portions Section 307 of the Act that are mandated. The Task Force believes further effort need to be made to ensure that rules promulgated by the Commission provide appropriate guidance to enhance compliance with legal and ethical standards but do not adversely affect issuers' ability to obtain sound legal advice.
The "material violation" language also creates a new standard of what is material which will be difficult for practitioners to apply. "Material violation" covers, in addition to violations of federal and state securities laws, breaches of common law fiduciary duty, including malfeasance, nonfeasance, abdication of duty, abuse of trust and approval of unlawful transactions. The language any "similar material violation," is too vague to be complied with. The term "material" should be defined in the same way the Supreme Court has defined it, in TSC Industries v. Northways, 426 U.S. 438 (1976). A violation which seems immaterial, when compounded with unforeseen future events could easily seem material in hindsight. The Task Force urges the Commission to restrict the meaning of "material violation" to only include facts for which there is a substantial likelihood that a reasonable shareholder would consider it important and that the reasonable investor would have altered his or her investment decision had the information been known.
Reasonably Believes Standard
An attorney should only be responsible for reporting evidence of a material violation based on his or her actual knowledge of events or circumstances. The Task Force encourages the Commission not to promote a standard which would require an attorney to predict future actions or to assess information based on expertise that the attorney would not otherwise be expected to have. If the reasonable attorney standard is retained, it should only be applied to attorneys who have primary responsibility for compliance with federal securities laws.
Using a standard based on awareness of evidence that would lead an attorney reasonably to believe that a material violation by the company or any officer, director, employee or agent of the company has occurred, is occurring, or is about to occur, imposes a difficult obligation on attorneys. It requires an attorney to predict the results of circumstances they are aware of or to conduct an investigation that might ultimately be required to be submitted to the Commission. If a lawyer becomes aware of circumstances that might lead to a violation and the lawyer is not obligated to investigate, the question that will be determined in hindsight is what the lawyer concluded about that information. That conclusion should be considered in the context of the lawyer's knowledge and belief, as opposed an objective lawyer standard. The objective standard shifts the effect of the Sarbanes-Oxley Act to weighing competence rather than ethics. To implement rules regulating lawyer ethics, the Commission should present a standard based on whether the lawyer in question was aware that the issuer was taking actions that would constitute a material violation of law.
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We appreciate your consideration of these views and comments.
J. Norfleet Pruden, III
/s/ Lynn F. Chandler
Lynn F. Chandler
Chair, Sarbanes-Oxley Task Force
of the Professionalism Committee