April 7, 2003
Securities and Exchange Commission
Re: File No. S7-45-02
Ladies and Gentlemen:
This letter is submitted in response to the request of the Securities and Exchange Commission for comments on its Release No. 33-8186; 34-47282; IC-25920; File No. S7-45-02 entitled "Proposed Rule: Implementation of Standards of Conduct for Attorneys" (the "Second Proposing Release"). The Second Proposing Release sets forth an alternative Section 3(d) of Rule 205 to that set forth in Release No. 33-8150 (the "Original Release").
We do not undertake in this letter a detailed technical commentary on various provisions of the proposals. Instead, we raise here, and we ask the Commission and its staff to consider, the fundamental issues these proposals have invoked. Notwithstanding the comments of one of the Commissioners at the January 23 Commission meeting that he did not want to read any further comments "from lawyers" (the persons whose conduct, we point out, is most directly affected by these proposals), we believe the bar, and especially the securities bar, has both the duty and the right to assert that
If the Commission adopts Section 3(d) of Rule 205, whether in the form proposed in the Second Proposing Release or in the form proposed in the Original Release, the Commission will have fundamentally changed the nature of the attorney client relationship1 without providing any evidence that such a fundamental change is necessary, appropriate or desirable to accomplish the Commission's goal of further strengthening corporate governance reform. As justification for the drastic measures the Commission has proposed, the Commission cites remarks by Senator Edwards and then Chairman Harvey Pitt about attorneys' alleged involvement in recent financial scandals and an "acknowledgement" in the July 16, 2002 Preliminary Report of the American Bar Association Task Force on Corporate Responsibility that "attorneys representing and advising corporate clients bear some share of the blame for this failure [of the corporate governance system]." However, neither these sources nor the Commission has provided any evidence that these vague and general statements are accurate. Without evidence, these remarks sound like simply another instance of politically motivated "lawyer bashing."
In fact, the Commission's own Study and Report on Violations by Securities Professionals, required by Section 703 of the Sarbanes-Oxley Act of 2002 (the "Act") states that in the four years from 1998 through 2001 only 48 attorneys (an average of 12 attorneys per year) were "found" to have violated the federal securities laws in actions brought by the Commission. Moreover, even that number may well be misleading in the context of the proposed rule. First, as the Commission itself points out in footnote 1 of the Study, "a majority" of the cases it brings are resolved by settlement in which the respondent neither admits nor denies the Commission's findings of violations and no court has found a violation (although such cases are included in the 48 cases set forth in the Commission's study because the Commission has "found" a violation in such cases). Second, even assuming each of the 48 attorney actions over four years constituted a violation, it is very difficult on the basis of the information in the Commission's study to determine how many of the 48 cases involved issuer conduct of the type that Section 307 of the Act and proposed Rule 205 are intended to address. It is worth noting, however, that Exhibit A to the Commission's study states that during the four-year period a total of only 23 actions classified as related to securities offerings and issuer financial disclosures were involved in the identification of counts brought against attorneys.
Further, the Commission has more recently released its Report Pursuant to Section 704 of the Sarbanes-Oxley Act of 2002, as directed by Congress in Section 704. That report purports to be a study of five years (ending July 30, 2002) of Commission enforcement actions "based on improper issuer financial reporting, fraud, audit failure, or auditor independence violations."2 The actions reviewed were characterized by the Commission as "Issuer Financial Disclosure Cases,"3 a category that appears in the Report to cover most, if not all, of the types of major corporate scandals that generated the Sarbanes-Oxley legislation (and clearly the type of corporate scandal referred to by Senator Edwards, then Chairman Pitt and the Preliminary Report of the American Bar Association Task Force on Corporate Responsibility). In that Report, the Commission states that during the five-year period it brought 515 actions involving 705 individuals. Of those 705 individuals, a total of 14 attorneys over a five-year period were charged with violations and 11 of those were General Counsel of the issuer, a group of lawyers not subject to the proposed mandatory withdrawal rules. That leaves three outside lawyers out of 705 individuals charged by the Commission over a five-year period with violating the antifraud provisions of the federal securities laws in the category the Commission identifies as "Issuer Financial Disclosures Cases."
None of this suggests an epidemic of lawyer misconduct under the securities laws. Certainly, this is hardly an indication that a fundamental change in the attorney client relationship is necessary, appropriate or desirable. Former Chairman Pitt has commented on his disappointment at the failure of the states to enforce attorney ethics rules in matters referred to them by the Commission, but has provided no evidence of the alleged inaction. How many cases has the Commission referred to the relevant state authorities? What were the circumstances? In which cases did the states act and in which cases did they not?
We believe it is incumbent on the Commission to show a compelling reason for so fundamentally and negatively affecting the attorney client relationship. General and unsupported statements, in many cases made by persons in the middle of a political and media firestorm, are not compelling reasons.
It is, of course, conceivable that the Commission, its staff, Senator Edwards, former Chairman Pitt or the ABA Task Force have some evidence of their otherwise unsupported allegations of lawyer misconduct in the corporate world. If they do, they have not revealed it. More importantly, the Commission apparently has not felt the need to even try to provide any such evidence as support for the stated rationale for the proposed rules. We reiterate our view that the Commission ought to provide evidence before adopting a rule as radical and far-reaching as either of those proposed.
We submit that the evidence is missing because the stated general rationale for the proposed rule is not, in fact, the basis for the proposals. Clearly, the effect (and, we believe, the intended and deliberate effect) of Section 3(d) of Rule 205 would be to conscript attorneys to become extensions of the Commission's enforcement arm, no matter what the negative impact to the attorney-client relationship. This is a radical departure from what Section 307 of the Act requires and, as we pointed out in our prior comment letter, directly contrary to the express and unequivocal intention, in the legislative history of Section 307, of the principal congressional proponents of Section 307.4 By, in essence, requiring attorneys to serve two masters -- their clients and the federal government -- Section 3(d) is a threat to attorney independence, to the ethical duties owed to clients by attorneys and to the best traditions of the legal profession. It seeks to dragoon attorneys, whose focus should be on serving as a trusted advisor to their clients, into becoming levers the Commission (and others) may use against the attorneys' clients.
An attorney's overriding duty is that of zealous advocacy on behalf of the client, which includes advising the client as to possible violations of the law (including advice to the effect that the law has not been violated). To do this effectively an attorney must be apprised of the entire universe of information that bears on a client's given situation. Our legal system has long recognized the need for full and frank discussions between clients and attorneys. In fact, we believe that attorney-client counseling is the best means to prevent client misconduct. By requiring an attorney to withdraw and by making that withdrawal "noisy" (whether because the attorney must inform the Commission or the issuer must file a Form 8-K),5 Section 3(d) would impede full and frank discussions between attorneys and their clients.
Moreover, by requiring mandatory withdrawal and making that withdrawal noisy, Section 3(d) would effectively make attorneys watchdogs or investigators required to second guess a client's decisions in order to protect their own interests, a role necessarily at odds both with the attorney's traditional role of trusted legal advisor and the attorney's ethical obligation of zealous representation. As a result, issuers would be less candid with their attorneys, would likely exclude their attorneys from sensitive discussions, and might withhold information from their attorneys in certain instances, knowing that in the end, if properly informed, their attorneys may be required to make a withdrawal and the attorney or the issuer would be required to make that withdrawal public. It is difficult to conceive of a device more calculated to undermine the professional relationship of a lawyer with the lawyer's client. The proposals, if adopted, will necessarily detract from an attorney's ability to fulfill his or her duty to zealously advocate in his or her client's best interest. Because this risk would impede full development of facts essential to rendering legal advice, it would also impede an attorney's ability to counsel a client as to appropriate action to protect the interests of the issuer and its stakeholders. In the end, the attainment of the underlying objectives of the Act, to improve corporate governance and accountability of boards of directors, would be less likely to be accomplished, because issuers either may refrain from seeking legal advice on the most difficult or sensitive issues facing those issuers or obtain legal advice while withholding important facts.
It is not sufficient in considering the effect of the proposals to ask the rhetorical question (posed by one of the Commissioners at the Commission's open meeting on January 23, 2003) why any lawyer would object to withdrawing and reporting an instance of client fraud. The mere posing of the question, unless done purely to encourage discussion, is shocking. The standards for reporting "evidence" of "material violations" up the ladder in the portion of Rule 205 already adopted by the Commission make it clear that the provisions of Section 3(d) would apply not only to fraud, clear violations of law or "corporate looting" but also to issues, like many disclosure issues, that are matters of judgment and where there is no clear right or wrong answer. In these instances, an attorney trying to comply with the proposed rule must consider withdrawing from representation if his or her client does not take the most conservative course of action. If the attorney does indeed withdraw in these sorts of cases, the effect of that withdrawal and the report of the withdrawal, whether by the attorney or the issuer, would almost certainly cause serious damage to the client and its stakeholders. Where it is later found that the withdrawing attorney has misjudged a situation or a less conservative course of action would have been appropriate, the client might also have a cause of action against the attorney. This highlights the conflict of interest in which attorneys will be placed if the provisions of Section 3(d) are adopted.
Furthermore, an issuer's board of directors, not its attorneys, must make these judgments on behalf of an issuer and must be the ultimate arbiter of the conduct of an issuer. A state's corporation statutes, which provide for the creation and governance of corporations, have bestowed the authority to direct the operation and management of corporations upon boards of directors. The state statutes, and the judicial decisions interpreting them, dictate the duties of directors to a corporation and its shareholders and provide for appropriate standards of behavior in carrying out those duties. It is not appropriate - it is in fact contrary to these statutes and judicial decisions - to substitute a lawyer's judgment for that of a corporation's board of directors in the operation or management of a corporation.
By requiring an attorney to go beyond reporting to an issuer's board of directors, Section 3(d) does just that. The ultimate decision with respect to whether the corporation has "appropriately" dealt with an attorney's report of "evidence" of a possible violation is shifted to the attorney and away from the governing body that has been charged by statute with managing the corporation. Moreover, that result is rather peculiar in a proposed rule under the Sarbanes-Oxley Act, the principal thrust of which is to unequivocally impose responsibility and accountability for corporate governance on the board of directors and director committees. The statutory mandate in Section 307 of the Act, by capping the up the ladder reporting obligation at the board level, recognizes that the board of directors, not the attorneys, should make the final judgment.
Accordingly, we believe that once an attorney appearing and practicing before the Commission has been given the opportunity to fully and candidly discuss an otherwise unresolved issue with the board of directors or a properly authorized committee of the board of directors, as required by the legislative mandate in Section 307 and Rule 205 as adopted by the Commission in January, his or her duty to the client has been fulfilled, and Rule 205 should go no further.6
We believe that the mandatory withdrawal provisions of Section 3(d) are so fundamentally unsound that they should be eliminated completely. The conjunction of mandatory attorney withdrawal with mandatory reporting to the Commission of that withdrawal by either the attorney or the issuer is an inappropriate exercise of regulatory power. It strikes directly at the heart of the attorney/client relationship because it substitutes for the profession's own ethics rules a rule imposed by the very agency regulating the attorney's client, with the purpose and effect, not of regulating the professional conduct of the attorney, but of strengthening that regulatory agency's policing power over the client. We submit that the Commission should not embark on a course which would permit a government regulatory agency to compel an attorney, under threat of sanctions and loss of livelihood, to act against the client's interest, as that interest is conceived by the attorney in good faith and in the exercise of his or her professional judgment. An attorney appearing and practicing before the Commission on behalf of issuers represents the issuer, not the Commission, not "the public" and not the federal government.
An attorney cannot guarantee the conduct of a client. We believe, however, clients are far more likely to comply with law when properly counseled by attorneys they trust and with whom they share all relevant information. Moreover, we believe that the public interest, the Commission's interest and the federal government's interest are best served when attorneys are able to achieve that trusted counseling relationship with clients. The proposed rules will impede that relationship and will be counterproductive to the goals of the Commission and Congress. Consequently, we urge the Commission to reject both its original noisy withdrawal provisions and its alternate proposal and rely instead on existing state ethics rules governing withdrawal by attorneys.
We would be happy to discuss any questions the Commission or its staff may have with respect to this letter. Any such questions may be directed to Robert L. Estep at (214) 969-3719.
cc: Hon. William H. Donaldson, Chairman