Munger, Tolles & Olson LLP
Simon M. Lorne
writer's direct dial:
writer's direct dial:
January 6, 2003
Via e-mail: firstname.lastname@example.org
Re: File No. S7-45-02
Ladies and Gentlemen:
This letter is submitted in partial response to the Commission's request for comments contained in Securities Act Release No. 8,150, "Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys" (Nov. 21, 2002) (the "Release") and the Proposed Rules (the "Proposed Rules") described in and attached to the Release. In a separate letter (December 18, 2002) I (like many others) have addressed the question whether the so-called "reporting out" or "noisy withdrawal" provisions-i.e., provisions requiring counsel, under certain circumstances, to withdraw from the representation and to notify the Commission-should be adopted at all or at this time. This letter addresses some of the more technical issues embodied in this complex set of proposals.
In writing this letter, I do so individually, and not on behalf of my law firm (whose letterhead I use for purposes of identification only), any of my or our clients, or any other organizations with which I am or may be associated.
In studying the Release closely, as well as a number of the comment letters provided to date, I believe there are six relatively technical points that are particularly worthy of much more careful consideration by the Commission. I would note, however, that there are a large number of lesser points, most of them addressed in other comment letters, that could also raise issues of significance over time.
Among other things, I believe that the extent and nature of the concerns that exist with respect to the Proposed Rules, as well as the very significant other demands on the time and attention of the Commission and the Staff at present, argue very strongly for the Commission's doing no more in the immediate time frame than is minimally necessary to satisfy the obligations imposed on it under Sarbanes-Oxley §307. I would therefore urge the Commission to adopt provisional rules at present and to continue to re-examine the entire package, including such provisional rules, at a more measured pace, when they can be given the care and attention they properly deserve.
The relatively technical issues that I raise below are the following:
1. The definitions of an "attorney" "appearing and practicing before the Commission" "in the representation of an issuer."
The definitions of these three terms in the Proposed Rules, fundamental to the operation of the rules in there entirety (and only examined appropriately in relation to each other), are as follows:
It is understandable, and largely appropriate, that the Commission would seek the broadest possible definition of terms such as these in the context of disciplinary proceedings and the like, such as in Rule 102, 17 C.F.R. §200.102. In the context of Part 205, however, when one takes into consideration the fundamental purpose of Sarbanes-Oxley §307 and of §205, it becomes readily apparent that such an approach does not work effectively.
The goal of the Proposed Rules, as of Sarbanes-Oxley §307 generally, is to affect the way in which lawyers practice their profession-reporting "up the ladder," etc. It seeks to impose affirmative duties on a lawyer in that lawyer's relationship with the client-to determine whether there exists evidence of a material violation, to notify the client appropriately, etc. A definition of an "attorney" "appearing before the Commission" "in the representation of an issuer"-when the definitions are intended to serve this ultimate purpose-should be limited in application to those who are actually acting in an attorney's role with respect to the client issuer in connection with the matters in question. It is only those lawyers whose behavior is susceptible to being guided in the manner sought.
The happenstance that some other person involved in the transaction in some way may be licensed somewhere to practice law does not provide a basis for assigning these duties to him or her. The fact that a lawyer, representing a party other than the issuer, happens to be involved in the transaction is not a basis for trying to create duties of that lawyer toward the issuer.
Assume, for example, that a Chief Executive Officer hires her own personal counsel at the issuer's expense (with the approval of the Board) to provide her with personal advice on matters such as signing a certification as now required through Sarbanes-Oxley §§302 and 906. It is quite easily within the definitions that the CEO's lawyer is advising "a party" "for the benefit of the issuer." Yet it is equally clear that if the issuer has conflicting advice of its regular corporate counsel, and chooses to follow the advice of its regular counsel, imposing the proposed §205.3 requirements on the CEO's personal counsel makes no sense at all. Such a process, unnecessarily invited by the interaction of the definitions, should be avoided, and the way to avoid it is to make clear that the rules are, in fact, aimed at the lawyer or firm that is in fact representing the issuer with respect to the relevant matters.
Unless, in fact, the lawyer is acting as a lawyer, representing the issuer as his or her client, with respect to the matters under inquiry, i.e., unless the lawyer is giving legal advice to the issuer and making legal judgments concerning the activities of the issuer, the Commission cannot hope-and should not attempt-to affect his or her performance through these Rules. The excessive jurisdictional reach, in this context, is ineffective and ill advised.
The language in the "appearing and practicing" definition regarding "[p]reparing . . . any . . . writing which the attorney has reason to believe will be filed with or incorporated into any registration statement . . . ." is also unduly broad and deserves more careful attention given the relatively limited purpose of the Proposed Rules. Large numbers of documents are filed with a registration statement or other filings as exhibits. Quite often, the drafters of those documents are not the corporation's regular securities counsel and may not focus at all on the documents' being so filed. (And, again, those documents may be prepared by one who is not acting as an attorney, or whose services may not be rendered to the issuer but might well be deemed to be "on its behalf" within the meaning of the Proposed Rule.) To provide such lawyers with the reporting (whether "up" or "out") of the Proposed Rules serves no useful purpose and is unfair to them.
Finally, I would note that the excessive jurisdictional reach of the Proposed Rule, coupled with other legal uncertainties as to the scope and dimensions of the Proposed Rules generally (as has been detailed in other comment letters), not only undermines the practical working of the Proposed Rules themselves, but also operates to increase the risk that the Proposed Rules would be found by a court to be substantially invalid or even invalid in their entirety.
In view of the foregoing, I would revise the foregoing rules to read as follows (suggested revisions in bold face):
2. Conduct to be reported.
Sarbanes-Oxley §307 provides, in relevant part, that "requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof . . . ." [Emphasis added.] Thus, the conduct to which the statute refers is limited to securities law violations and fiduciary breaches by (1) the company itself, or (2) by an agent of the company, presumably acting in an agency capacity.
By contrast, Proposed Rules embrace a very much broader application. The relevant provisions of the Proposed Rules are in §§205.2 and 205.3:
Thus, as written, the reporting requirements of the lawyer would become applicable if the lawyer learns of violations "by any officer, director, employee, or agent of the issuer" whether or not the violation was related to the issuer in any way. If, in the course of representing the issuer, the lawyer became aware that a corporate officer breached his or her duties as trustee of a family trust, a literal reading of the rule would require that the lawyer seek to have the issuer involved in correcting the breach, or, ultimately, make a "noisy withdrawal."
Obviously, the example posited is not one with which the Proposed Rules are concerned, and the Commission would not seek to enforce them in that manner. Other activities of officers and directors in their individual capacities, however, might generate a different enforcement response. For example, questions may arise as to whether an individual's trading in an issuer's securities did or did not transgress Rule 10b-5. Historically, counsel have advised officers as to the relevant law, and have left officers to decide whether the non-public information they possess is or is not "material." Is it the intention of the Proposed Rules that counsel should now seek to reach his or her independent conclusion on that issue and, if the conclusion is that there is "evidence" of a violation, report and require an investigation? That may or may not be an appropriate response from a policy perspective, but trading in securities is not something an officer or director does in his or her capacity as an agent of the corporation, and thus is not within the statutory provisions.
These concerns reach a particularly significant level in the context of fiduciary duties. It is important to recognize that Sarbanes-Oxley §307, as interpreted through the Proposed Rules, raises potentially difficult questions of interaction between federal securities law obligations and fiduciary duties, typically imposed by state law. The Proposed Rules, relating to breaches of fiduciary duty by officers or directors whether or not they are acting in a representational capacity unnecessarily exacerbate those difficulties.
Directors' fiduciary duties are typically implicated not when they are acting as agents of the corporation, but rather when they are acting in their own, individual capacities as directors. That is, the typical director's duty to shareholders is not the duty of the corporation, for which a director is an agent, but is a direct duty of the director as such.
Given the role played by fiduciary duty concepts in the securities law generally [(see, e.g., Chiarella v. U.S., 445 U.S. 222, 100 S. Ct. 1108, 63 L. Ed. 2d 348 (1980)], pursuant to which (for example) violations of Exchange Act §10(b) and Rule 10b-5 require a breach of a duty (although not necessarily a "fiduciary duty" as such) in order to sustain a finding of a violation, it would appear rational for the Proposed Rules to focus on fiduciary violations in this context, and not to go beyond the strict terms of the statute.
Additionally, the notion in the Proposed Rules of a "breach of fiduciary duty recognized at common law" must be seen as a phrase of particularly ambiguous legal content, particularly here. Justice Frankfurter noted the ambiguities and uncertainties surrounding the notion of fiduciary duty generally in SEC v. Chenery Corp., 318 U.S. 80 (1943)at 85-86: "to say that a man is a fiduciary only begins analysis; it gives direction to further inquiry. To whom is he a fiduciary? What obligations does he owe as a fiduciary?" Here, though, the Commission's Proposed Rule suggests an impossible task: identifying breaches of fiduciary duty by reference to some "common law" that is not a single body of discernible law. In different jurisdictions and in different contexts, so-called "fiduciary duties" have or have not been recognized. Under a given set of facts, a duty that is called "fiduciary" may exist in one jurisdiction and not in another.
For all of these reasons, at least in a provisional rule, I would recommend defining "breach of fiduciary duty" for purposes of Sarbanes-Oxley §307 rules as follows:
While this clearly does not eliminate ambiguities in the definition-the cases suggest that resolving such ambiguities is not a feasible task-it has the benefit of providing that the same concept is consistently used throughout the securities laws, so that each relevant interpretive case helps to clarify other aspects of the securities laws.
I would propose that the Commission modify the reporting duty in §205.3(b) of the Proposed Rules to clarify that their reach is limited to the statutory reach as follows (additional language in bold):
3. "Appropriate response"
The Proposed Rules [§205.2(b)] define "appropriate response" as
" . . . a response to evidence of a material violation reported to appropriate officers or directors of an issuer that provides a basis for an attorney reasonably to believe:
"(1) That no material violation, as defined in paragraph (i) of this section, is occurring, has occurred, or is about to occur; or
"(2) That the issuer has, as necessary, adopted remedial measures, including appropriate disclosures, and/or imposed sanctions that can be expected to stop any material violation that is occurring, prevent any material violation that has yet to occur, and/or rectify any material violation that has already occurred."
This proposed definition of the term is too limited. In this definition, and throughout the Proposed Rules, greater accommodation should be made for the possibility-increasingly prevalent in the modern corporate world-that more than one lawyer (or firm) will be involved in the client representation. In many of the matters that may be under consideration in this area, reasonable minds may differ as to whether there is, or has been, a "material violation." A lawyer who is one of the lawyers, or firms, representing an issuer should not be subject to a "reporting up" or-even more extreme-"reporting out" obligation if the issuer is acting in good faith in reliance on the views of other lawyers, reputable and appropriately informed, that the proposed (or continuing) behavior is within legally permissible bounds.
To respond to this concern in this context, I believe that it should be sufficient for the lawyer in question to conclude that the issuer has received advice of informed counsel knowledgeable in the relevant areas of the law and is acting in accordance with that advice. The requirement that the issuer be acting in good faith should be sufficient to minimize concerns with "forum shopping," and the adopting release might well specify that the issuer who has been advised of a material violation by one lawyer has an obligation to advise any other lawyers considering the same matter of that fact.
In the rule itself, I would add "or" in lieu of the period at the end of clause (2) and then add the following provision:
The important point is that so long as the issuer is receiving, and acting in a manner consistent with, advice from counsel that is knowledgeable in the area, and informed as to the specific facts, there should be no requirement that any other counsel either come to the same conclusion as that counsel or withdraw and follow the other procedures of Section 205.
4. Qualified Legal Compliance Committees
It has elsewhere been noted that this is the QLCC is an innovative, and potentially useful construct. I concur with that evaluation.
As currently used in Section 205, however, I find it difficult, unnecessarily suggestive of questions that do not admit of any easy answer, and ultimately unsuccessful.
Effectively, it appears that the Commission is proposing, through the mechanism of rules ostensibly relating to the practice of law before the Commission, to establish new and unprecedented reporting obligations of individual directors. If a QLCC is formed, with specifically detailed requirements as to the obligations of QLCC members, the duties of counsel are substantially alleviated.
It is unclear, however, how those duties of QLCC members could or would be enforced. Assuming that a QLCC is established, meeting the specified requirements, that a material violation is referred to it and that the issuer does not take the remedial actions directed. How is the "responsibility . . . to notify the Commission . . . and to disaffirm in writing any document . . . ." to be enforced? The Commission has no direct authority over such individuals. Surely, the regulatory response should not be that suggested by the source of the proposed obligation-i.e., the debarring of the lawyer.
In general, it is a faulty regulatory process to use one source of authority to achieve other, substantially unrelated, goals. These rules are supposed to be concerned with the practice of law. They should not be used to reform the operating processes of corporate boards.
It should also be noted that in suggesting the creation of the QLCC, the Commission, presumably by design, pits the goals of the corporation's independent directors in direct conflict with those of counsel. Ceteris paribus, lawyers should prefer that a QLCC exist in order to shift the onus of reporting away from themselves, while the independent directors should prefer that such a burden not be shifted to them, with unknown consequences.
Of course, if the Commission were to abandon the notion or "reporting out"-as I believe it should-then the role of the QLCC would be of considerably reduced significance.
5. "Issuer as client" and shareholders
§205.3(a) of the Proposed Rules provides that "An attorney appearing and practicing before the Commission in the representation of an issuer represents the issuer as an organization and shall act in the best interest of the issuer and its shareholders. That the attorney may work with and advise the issuer's officers, directors, or employees in the course of representing the issuer does not make such individuals the attorney's clients."
The reference to "shareholders" at the end of the first sentence is unnecessary, and in at least some cases is clearly erroneous. In the standard ethical constructs the concept of representing an organization means just that: representing the entity (e.g., ABA, Model Rule 1.13(a): "A lawyer . . . represents the organization acting through its duly authorized constituents"). See, for example, the recent and thoughtful analysis of one of the experts in the area, Larry P. Scriggins: "Model Rule 1.13 makes it clear that the lawyer for an organization represents the organization, not its employees, officers, directors or stockholders as such." (Emphasis added.) ["Legal Ethics, Confidentiality and the Organizational Client," 58 Business Lawyer 123, 124 (November 2002)].2
The Proposed Rule's suggestion of broadening the notion of the organization to include one particular group of constituents-particularly, in the context of Commission registrant's, a diverse and, for the most part, unknown group of constituents-threatens to do real harm to representational concepts.
For example, in the case of a majority-owned registrant, it might arguably be true that if the "shareholders" can speak for the organization, the lawyer's duties are satisfied by informing a majority shareholder of the relevant facts and following that shareholder's advice, yet clearly that is not what the Commission does or should envision.
It should also be noted that in some situations, shareholders should specifically not be viewed as those for whose benefit the corporation exists. Namely, in the case of entities in or approaching insolvency, it has been recognized that the director's duties may shift from the protection of stockholders to the protection of creditors. See, e.g., Credit Lyonnais Bank Nederland, N.V. v. Pathe Commun. Corp., Civil No. 12150 (Del. Ch. Dec. 30, 1991). Those cases are a legitimate attempt by the courts to recognize the sensitive balance between economic owners and titular owners in extreme cases, but those may well be the cases in which the Proposed Rules are most likely to become important. Surely it should not be the case that the directors' duties are shifted to creditors while the lawyers' remain attached to stockholders.
The better-informed view of corporate structure recognizes shareholders as owners, but not as those entitled generally to speak for the entity.3 The role of the director is not purely to represent shareholders. It is also, and importantly, a duty to make decisions about matters that affect shareholder interests. Thus, mergers must in most states be approved by shareholders, but they must also be approved by directors independently. And while a shareholder may vote on such a proposal in whatever fashion he or she chooses, without generally being answerable to any third parties, directors have obligations of loyalty and due care that must govern their voting. If there is a body that should be routinely recognized as entitled to give voice to the corporation's goals it is the board of directors, not the shareholders. It is inappropriate for the Commission, through the Proposed Rules, to affect those relationships.
For all of these reasons, I would revise the Proposed Rule to read as follows (new language in bold):
"§205.3 Issuer as client.
"(a) Representing an issuer. An attorney appearing and practicing before the Commission in the representation of an issuer represents the issuer as an organization and shall act in the best interest of the issuer. That the attorney may work with and advise the issuer's officers, directors, employees or shareholders in the course of representing the issuer does not make such individuals the attorney's clients."
6. Exposure to criminal liability and to private damage actions.
The Release recognized that the Proposed Rules should not be the basis for criminal proceedings (at least in the contexts described in the Release generally) or for private litigation.
As to criminal exposure, however, the Proposed Rules [§205.6] only provide that "(a) A violation of this part by any attorney appearing and practicing before the Commission in the representation of an issuer shall be treated for all purposes in the same manner as a violation of the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.), and any such attorney shall be subject to the same penalties and remedies, and to the same extent, as for a violation of that Act."
Not only does this language not support the language of the Release, by its terms it makes clear that a violation is a criminal offense. While the Release suggested, vaguely, that higher standards would apply to a criminal proceeding ("The Commission does not believe, however, that violations of the Proposed Rule would, without more, meet the standard prescribed in Section 32(a) of the Exchange Act (15 U.S.C. 78ff), which provides for the imposition of criminal penalties.") the Commission was not specific or clear in the Release, but was silent in the Proposed Rule.
While it may be conceivable that there would be some limited circumstances in which a violation of the Commission's new rules of practice should have criminal consequences, I believe that there would be no cases in which (1) the attorney's behavior warranted criminal sanctions, and (2) the attorney did not also violate other provisions of law that have criminal consequences. I would therefore be willing to eliminate practitioners' concerns with exposure to criminal liability from this source.
I also believe that the Commission should make clear in the rule, as it indicates in the Release, that these rules do not give rise to any private right of action. ["The Commission notes that nothing in Section 307 creates a private right of action against an attorney. Indeed, statements by the sponsors of the provision unequivocally demonstrate that there was never an intention to create a right of action by third parties for violation of the rule. Similarly, the Commission does not intend that the provisions of Part 205 create any private right of action against an attorney based on his or her compliance or non-compliance with its provisions." (Citation to Senator Edwards' floor statement omitted.)] While such a provision may be unnecessary, it is already clear that some number of commentators are concerned with this issue, and given the clarity of the Commission's position in the Release, there is no reason not to allay practitioners' concerns explicitly within the rule itself.
For these reasons, I would revise the rule to read as follows:
"(a) A violation of this part by any attorney appearing and practicing before the Commission in the representation of an issuer shall be treated for all purposes in the same manner as a violation of the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.), and any such attorney shall be subject to the same penalties and remedies, and to the same extent, as for a violation of that Act, provided, however, that (i) Section 32 of that Act (15 U.S.C. §78ff) shall not apply to any such violation and (ii)this part shall be enforceable only by the Commission and no private right of action shall lie for violation of this part."
* * *
I appreciate the opportunity to provide these suggestions, and would urge the Commission to consider this issue with the extraordinary care and caution that it deserves.
cc: Hon. Harvey L. Pitt
Hon. Paul Atkins
Hon. Roel Campos
Hon. Cynthia A. Glassman
Hon. Harvey Goldschmid
Alan L. Beller
Senior Counsel to the Commission and
Giovanni P. Prezioso