PHILIP ANISMAN
Barrister and Solicitor
80 Richmond Street West, Suite 1905
Toronto, Ontario M5H 2A4 |
Telephone: (416) 363-4200
Telecopier: (416) 363-6200 |
|
March 10, 2003
Mr. Jonathan G. Katz
Secretary, Securities and Exchange Commission
450 5th Street, N.W.
Washington, D.C. 20549-0609
Dear Mr. Katz,
Re: Standards of Professional Conduct for Attorneys
Your File No. S7-45-02
As the Commission is aware, the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") and the rules proposed and adopted under it have resulted in consideration of similar issues by securities regulatory authorities and others in Canada. This is the case, as well, with respect to section 307 of Sarbanes-Oxley and the rules proposed and adopted under it by the Commission.
I am sending you with this letter for the Commission's consideration a policy paper that I prepared for the University of Toronto, Capital Markets Institute, entitled "Regulation of Lawyers by Securities Commissions: Sarbanes-Oxley in Canada". The paper is based on a presentation made at a roundtable held by the Capital Markets Institute on January 29, 2003.
The roundtable discussion and the policy paper were prompted by the rules proposed in the Commission's Release No. 33-8150. Although the policy paper is based on requirements applicable in Canada to lawyers practising before Canadian securities commissions and reflects laws, obligations and a cultural context that may differ from those in the United States, the discussion in the policy paper may be of assistance to the Commission, on an analogical basis, in its current deliberations on implementing standards of professional conduct for lawyers practising before it.
The policy paper emphasizes the different roles performed by lawyers representing issuers and others before securities commissions in an advisory capacity and by lawyers acting in an adversarial context. The distinction is reflected in the difference between solicitors and barristers in countries in the British Commonwealth in which there is a divided bar with different rules applicable to solicitors who provide advice to clients and to barristers who appear on their behalf in courts and other tribunals.
Lawyers in Canada, like those in the United States, are entitled to practise as both barristers and solicitors. Although the policy paper uses these terms, the discussion in it is not based on a formal distinction between barristers and solicitors, but on the functional differences that flowfrom the different roles performed by lawyers acting for clients in advisory and adversarial capacities. The policy paper views these different functions as having significance for the obligations that are and should be imposed on lawyers performing them when practising or appearing before a securities commission.
The discussion accompanying the Commission's proposed and final rules under section 307 of Sarbanes-Oxley recognizes this distinction, but the rules for the most part fail to reflect it. Rather, they attempt to treat all lawyers acting on behalf of a registered issuer, other than in-house counsel, in the same manner and, subject to Rules 205.3(b)(6) and (7), impose identical obligations on all of them. This is clear from the definition of "appearing and practicing before the Commission" in Rule 205.2(a)(1), which expressly includes lawyers representing an issuer in a Commission proceeding or in connection with a Commission investigation, as well as lawyers providing advice regarding the filing or disclosure obligations of an issuer under federal securities laws. It is also reflected in the authorization for a lawyer appearing and practising before the Commission to reveal confidential information to the extent that the lawyer believes it necessary "to prevent the issuer, in a Commission investigation or administrative proceeding from committing perjury ... or committing any act ... that is likely to perpetrate a fraud upon the Commission" (Rule 205.3(d)(2)(ii)). These provisions appear to be directed at the integrity of the Commission's processes, rather than designed to address the types of issues that arose in Enron at which section 307 of Sarbanes-Oxley is aimed. Similarly, the questions in Release No. 33-8186 relating to proposed Rule 205.3(d)(2) appear to be aimed at adversarial proceedings in which a lawyer will require the permission of a court or administrative tribunal before withdrawing.
Rule 205.3(b)(6) exempts a lawyer who is retained to investigate a material violation previously reported by another lawyer or to defend the issuer (or others) in a proceeding based on the reported violation from the obligation to report "up the ladder." It does not exempt lawyers retained for the same purposes with respect to a violation that has not been reported by another lawyer under Rule 205.3(b). Moreover, lawyers who are exempted would, in order to retain the exemption, in effect be obligated to monitor the conduct of an issuer - client's chief legal officer and to report to the issuer's board of directors if its chief legal officer does not. For the reasons stated in the accompanying policy paper, it is questionable whether this monitoring function is necessary, especially as it would only apply after a report has been made under Rule 205.3(b).
The accompanying policy paper distinguishes between advisory and litigation contexts with respect to the obligations to which lawyers practising before a securities commission in Canada are subject. It also addresses a number of issues raised by Release No. 33-8186 with respect to the Commission's alternative proposal, particularly in its discussion of a lawyer's obligations to withdraw from representation of a client, to inform a securities commission of the withdrawal and to withdraw an opinion or representation previously made by the lawyer. These obligations do not go as far as the Commission's proposed "noisy withdrawal" in that they would not permit disclosure of the fact that a withdrawal is based on "professional considerations" or the specific types of disaffirmation contemplated in the Commission's proposed rules. They thus provide an additional alternative for the Commission's consideration.
The alternative proposed in Release No. 33-8186, which would impose on issuers anobligation to report a withdrawal by a lawyer, is said to be intended to address commenters' concerns relating to attorney-client privilege and the possibility that a "noisy withdrawal" obligation will interfere with the relationship of trust between issuers and their lawyers and result in withholding of information from lawyers that is necessary for proper legal advice to be given to issuers. It is difficult to see how imposing the reporting obligation on the issuer addresses these concerns. As the proposed rules would require a lawyer to withdraw from representation of an issuer, which would then trigger the reporting obligation, the incentives for issuers (or their officers) to withhold information from their lawyers would continue to exist, regardless of who bears the obligation to report a withdrawal.
In Canada lawyers are currently obligated to withdraw from representation in similar circumstances and to withdraw any prior representations made by them, if a failure to do so would assist an issuer in continuing on an illegal course of conduct. It is arguable that such obligations are themselves sufficient, along with "up the ladder" reporting, to accomplish the goals intended by Sarbanes-Oxley.
Reporting a withdrawal from representation by a lawyer, although arguably "material" because this information would be likely to influence investors' investment decisions, is a means of achieving the broader goal of preventing fraud by ensuring proper disclosure to investors of the information on which the withdrawal was based. Disclosure of the withdrawal can lead to disclosure of such underlying information, and the requirement to report may deter misleading or inadequate disclosure of an issuer's business and affairs for fear of the occurrence of such withdrawal. In short, the ultimate goal of this reporting obligation is to deter misleading disclosure by issuers or, failing this, cause its correction.
In the event of a withdrawal, the information most beneficial to investors is the information on which the withdrawal was based, that is, the true facts relating to the apprehended material violation of the issuer's disclosure or other obligations. While disclosure of this information may be required by proposed Rule 205(3)(e), it is not clearly required, as the proposed rule obligates an issuer to report only the notice of withdrawal "and the circumstances related thereto." In any event, if an issuer, at the board level, differs with a withdrawing lawyer on an issue of materiality or the appropriateness of its response, disclosure of the withdrawal may result in harm to the issuer and its investors, especially if the issuer is correct.
If the disclosure obligation of an issuer is intended as a flag to the Commission, there is no need for public disclosure in all cases. It may be preferable to require public disclosure of a lawyer's withdrawal only where the withdrawal itself is a material fact, while requiring that all withdrawals be reported to the Commission. This more limited reporting obligation would signal the Commission that there is a need to investigate, unless the issuer concludes that the withdrawal itself is material and should be disclosed, presumably because it is accurately based. In the latter case, the rule should expressly require disclosure of the underlying violation and related facts rather than merely "the circumstances relating to" the withdrawal.
I hope that the accompanying policy paper and this letter are of some assistance to
the Commission in its consideration of the rules adopted and proposed under section 307 of Sarbanes-Oxley.
Yours respectfully,
Philip Anisman
PA/dfc
Encls.
REGULATION OF LAWYERS BY SECURITIES COMMISSIONS:
SARBANES-OXLEY IN CANADA
A Policy Paper
prepared for the
University of Toronto Capital Markets Institute
by
Philip Anisman
TABLE OF CONTENTS
- Introduction
- Lawyers' Responsibilities
- "Up the Ladder" Reporting and Withdrawal
- Lawyers' Honesty and Disclosure Obligations
- Fraud and "Noisy Withdrawal"
- Other Issues
- Internal Investigations
- Law Firms
- In-House Counsel
- Jurisdiction to Regulate Lawyers' Conduct
- Securities Commission Jurisdiction
- Withdrawal and Disclosure
- Regulatory Actions by Securities Commissions
- Summary of Conclusions
- Lawyers' Current Responsibilities
- "Up the Ladder" Reporting and Withdrawal
- Lawyers' Honesty and Disclosure Obligations
- Whistle Blowing
- Recommendations on Lawyers' Responsibilities and Their Regulation
- Whistle Blowing
- Regulation of Lawyers by Securities Commissions
- Practising before a Commission
- "Up the Ladder" Reporting and Withdrawal>
- Regulation of Issuers
Regulation of Lawyers by Securities Commissions:
Sarbanes-Oxley In Canada
Philip Anisman
I. Introduction
The Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") required the Securities and Exchange Commission ("SEC") to adopt rules specifying minimum standards of professional conduct for lawyers appearing and practising before it in representing issuers, including a rule requiring "up the ladder" reporting of material violations of securities laws, breaches of fiduciary duties and similar violations. The SEC took the bit in its teeth and, going further than mandated in Sarbanes-Oxley, proposed rules broadly defining lawyers who practise before it on behalf of issuers, whether or not licensed to practise in the United States. The proposed rules would have required such lawyers to report evidence of a material violation by the issuer or any of its officers, directors or employees "up the ladder" to the issuer's chief legal officer and then, if a satisfactory response has not been received within a reasonable time, to a committee of the issuer's board of directors or to the board itself. In addition, if a lawyer did not receive a response reasonably demonstrating that there was no material violation or that the issuer had adopted defined remedial measures to address it, including disclosure (an "appropriate response"), the lawyer would have been obligated to withdraw from representing the issuer, to notify the SEC that the withdrawal was based on "professional considerations" and to disaffirm any opinion or document filed with or submitted to the SEC or any statement in such a document that "is or may be" materially false or misleading (called "noisy withdrawal" in the SEC's releases).
The proposed rules received vigorous support and opposition from academic and practising lawyers, respectively, in the United States. As the proposed rules would have affected Canadian lawyers acting for issuers registered with the SEC, the Law Society of Upper Canada ("LSUC"), the Federation of Canadian Law Societies and the Canadian Bar Association also made submissions to the SEC concerning them. In addition, the Chair of the Ontario Securities Commission ("OSC") wrote the LSUC and invited it to address the issues raised by Sarbanes-Oxley for the accountability of lawyers, and OSC staff have met with the LSUC committee created specifically to consider these issues.
On January 23, 2003 the SEC announced the adoption of rules that withdraw, at least temporarily, from the most contentious elements of the proposed rule. The SEC's final rule narrows the definition of lawyers practising before the SEC. Only lawyers acting for a registered issuer who provide advice on United States securities laws with respect to a document that the lawyer "has notice" will be filed with or submitted to the SEC are included. Non-U.S. lawyers are expressly excluded, if they do not give advice on United States laws or if they do so only incidentally to their ordinary practice in their home jurisdiction or in consultation with a U.S. lawyer.
The final rule requires "up the ladder" reporting by lawyers representing issuers and permits, but does not require, such lawyers to withdraw from their representation if they do not receive an appropriate response and to disclose confidential information related to the representation to the SEC. The SEC extended the comment period on its "noisy withdrawal" requirement for a further sixty days and requested comments on possible alternatives to it, suggesting mandatory"quiet" withdrawal by a lawyer with an obligation on the issuer to report it.
Although the SEC's rules regulating lawyers' conduct will not apply to Canadian lawyers who do not practise United States securities law, Sarbanes-Oxley and the rules proposed under it have raised issues that must be and are being considered in Canada. This paper addresses the merits of these issues and the appropriate Canadian authority to resolve them. In particular, the paper focuses on lawyers' obligations and whether their conduct in the course of practising law on behalf of issuers and others subject to securities laws should be regulated by securities commissions or left to law society Rules of Professional Conduct and disciplinary proceedings. The analysis and recommendations contained in the paper are intended to assist in the current consideration of these issues by the LSUC and the OSC in Ontario and by law societies and securities commissions elsewhere in Canada.
II. Lawyers' Responsibilities
A. "Up the Ladder" Reporting and Withdrawal
It is motherhood to say that a lawyer retained by or on behalf of a corporation is responsible to the corporation as an organization and not to the individual officers who retain and instruct him. The corporation is the client. If facts relating to the lawyer's retainer indicate a likelihood that the corporation is about to commit, is committing or has committed a serious violation of law, it is the lawyer's obligation to draw that matter to the attention of the officerinstructing him and if the matter is not adequately addressed, to take it over the officer's head, initially to a senior officer and then, if necessary, to a committee of the board of directors or to the full board to ensure that it is addressed properly by the corporate client. This obligation flows from the fact that a material violation committed by a corporation or its officers is likely to be harmful to the corporation and its shareholders.
Going "up the ladder" also reflects professional principles. The LSUC's Rules of Professional Conduct, for example, prohibit a lawyer from assisting a client in dishonesty or a violation of law. In addition, the LSUC's commentary to these Rules states that a lawyer should go "up the ladder" if he becomes aware of proposed illegal conduct by a corporate client and may have to withdraw from the retainer, if the matter is not appropriately remedied. Although the LSUC's commentary deals only with proposed conduct, the principle also applies to conduct that is ongoing and may, in some circumstances, apply to past illegal acts on which current corporate conduct is based.
A lawyer's obligations are less clear with respect to past illegal conduct that has been completed and with respect to conduct that while not illegal, is likely to contravene a policy of a securities commission or could lead to disciplinary proceedings by a securities commission under its so-called "public interest jurisdiction." In the former case, completed conduct, a lawyer's work on a specific retainer may not assist in the illegality; in the latter, conduct that a securities commission may find to be contrary to the public interest need not be illegal. A lawyer's duty to take steps in such circumstances will turn on the effect of the conduct on the corporation, that is, on itsmateriality. Past illegalities, when discovered, may cause significant harm to a corporation and its shareholders. Conduct contrary to the public interest may have the same effect and may also involve dishonesty or unfairness to the corporation's shareholders. In result, the principle precluding assistance in illegality or dishonesty may not be invoked in the same degree. A judgment call by the lawyer is required.
In any of the circumstances just described the lawyer may find it necessary to withdraw from representation of the client. If illegal conduct relating to the lawyer's representation is not addressed to his satisfaction, the lawyer cannot assist in its pursuit and must withdraw. If the lawyer's advice concerning the "public interest" is not accepted, the lawyer is not obligated to withdraw, but may choose to do so because of a lack of confidence in his relationship with the client, especially if the conduct smacks of dishonesty or gross unfairness. But withdrawal in this case is a matter of judgment and the judgment may be a difficult one. (It goes without saying that reporting "up the ladder" may also result in dismissal of the lawyer by the client.)
The LSUC's Rules of Professional Conduct and commentary do not expressly address any steps beyond withdrawal from representation. Yet if a lawyer is obligated to withdraw because of the client's persistence in its pursuit of its illegal activities, withdrawal alone may not be sufficient. It may be necessary to go further and withdraw an opinion previously given on behalf of the client that facilitates a transaction or other conduct; a failure to do so would allow the opinion to continue in effect, thus assisting the client in the illegal conduct that led to withdrawal. It may also be necessary for the lawyer to withdraw representations short of an opinion on whichcontinuation of the corporation's objectives depend.
B. Lawyers' Honesty and Disclosure Obligations
A second motherhood principle is that a lawyer cannot mislead a securities commission or allow a client to do so. This obligation applies whether a lawyer is advising a client (acting as a solicitor) or acting as an advocate (a "barrister"). But depending on the nature of the retainer, there are differences in a lawyer's responsibilities to provide information. The nature of the representation undertaken by a lawyer will determine how forthcoming the lawyer is required to be.
If advising or otherwise acting on an exemption application, a filing relating to a transaction or an issuer's continuous disclosure obligations, a lawyer must be fully forthcoming and take all reasonable steps to ensure that the client discloses to the securities commission all material relevant information concerning the matter in question. A failure on the part of a client to make full disclosure may constitute an offence under securities legislation and may involve a lawyer in knowingly assisting the client contrary to the Rules of Professional Conduct. Indeed, if a lawyer discovers a material error in information previously provided to a commission, he must take steps to have it corrected. And if a client refuses to make full disclosure or to correct such an error, the lawyer will have no choice but to withdraw his services and, possibly, representations previously made by him to the commission. This obligation, which derives from the Rules of Professional Conduct, is reinforced by securities legislation which prohibits any person, including a lawyer, fromfiling a document or making any statement that is material and misleading to the commission or its staff. A failure to comply with this legislation is an offence.
A lawyer who is acting as an advocate, whether on an investigation by commission staff or in a proceeding before a commission, also cannot mislead the commission. But a lawyer acting in this capacity has no obligation to be forthcoming or to insist that his client disclose information, except as required by law, for example, in a formal commission investigation. An advocate in an adversarial proceeding is "openly and necessarily partisan" and has no obligation "to assist an adversary or advance matters derogatory to the client's case," as stated in the commentary to the LSUC's Rules of Professional Conduct.
The SEC's initial proposed rules concerning mandatory "noisy withdrawal" did not distinguish between the litigation and advisory contexts and would have required withdrawal by a lawyer acting for an issuer regardless of whether the lawyer is acting as a solicitor or as a barrister. In this respect they went too far. The final rule attempts a middle ground with respect to lawyers retained in response to a report of a violation under the rule, but would still in some circumstances impose such obligations on a lawyer acting as a barrister. As the LSUC's Rules of Professional Conduct recognize, the adversarial function is inconsistent with withdrawal based on a client's failure to correct illegal conduct, provided that the lawyer does not knowingly assist in the conduct or mislead the commission.
C. Fraud and "Noisy Withdrawal"
The most difficult issues presented by the SEC's rules relate to its proposal to adopt a mandatory "noisy withdrawal" obligation that would require a lawyer to withdraw from a representation, inform the SEC that the withdrawal was based on "professional considerations" and promptly disaffirm to the SEC any opinion, document or representation in a document in the preparation of which the lawyer assisted that he reasonably believes "is or may be materially false or misleading". (The SEC's new alternative proposal would require the lawyer to report to the chief legal officer and would obligate the issuer to publicly disclose a withdrawal and the circumstances relating to it, while still permitting the lawyer to inform the SEC of the withdrawal, if the issuer fails to make the required disclosure.) The lawyer would be obligated to take these steps when he has reported "up the ladder", does not receive an appropriate response and reasonably believes that a material violation is ongoing or about to occur and is likely to result in substantial harm to the financial interest or property of the issuer or investors. The stringency of these proposed requirements reflects their genesis.
Sarbanes-Oxley's mandate to the SEC was a response to corporate scandals like those involving Enron and Worldcom. Its requirements are intended to address ongoing dramatic fraudulent conduct involving intentional misrepresentation of the results of corporate operations to investors and others. The focus on fraud by issuers explains why Sarbanes-Oxley's mandate to the SEC is limited to lawyers representing issuers. As the rules are based on an assumption of fraud or breach of fiduciary duty, strong measures are not surprising.
The LSUC's Rules of Professional Conduct would preclude a lawyer from acting for a client in such circumstances. A lawyer who knowingly assists a client in fraudulent conduct or a breach of fiduciary duty would be subject to discipline by the LSUC and could also be civilly liable for his knowing assistance. But the LSUC's Rules of Professional Conduct would not permit a lawyer to disclose that the withdrawal is based on "professional considerations" or to reveal that the client is engaging in illegal conduct. Disclosure of a client's ongoing or proposed illegal conduct is permitted under the LSUC's Rules only where the lawyer believes on reasonable grounds "that there is an imminent risk to an identifiable person or group of persons of death or serious bodily" or psychological harm. Even then, the rule is not mandatory and allows disclosure only if the lawyer obtains a court order permitting it, where practicable.
The LSUC's position is the dominant one in the British Commonwealth. It is worth noting, however, that in the United States a majority of states (approximately forty) permit disclosure in circumstances which are likely to result in serious financial harm, and in New South Wales, Australia a solicitor (but not a barrister) is required to disclose to the authorities that a client will "probably" commit an indictable offence or has committed one and is concealing it. Consideration of any similar change to the LSUC's current rules with respect to fraud or financial harm must take into account a lawyer's duty to his clients and broader social responsibilities.
Disclosure of information obtained in the course of representing a client raises issues concerning a lawyer's loyalty to his client, client privilege and confidentiality. Issuers, like other clients, require legal advice based on full information of relevant facts that must be provided by theissuer, itself. Protection of such information encourages a client to be candid in light of the understanding that the information is confidential and may not be disclosed by the lawyer. Requiring, or even permitting, lawyers to divulge such information may undermine the relationship of trust between the client and its lawyer and may lead some clients to hold back relevant information or allocate various tasks among different lawyers in different firms to ensure that the lawyer will not be in a position to take steps unilaterally.
These arguments against erosion of privilege and confidentiality are strongest in an adversarial context. In a regulatory context, where disclosure of material information is required on a "continuous" basis as a matter of law, confidentiality is arguably necessary only to protect those who wish to avoid compliance. As Canadian businessmen generally express a preference to comply with regulatory requirements applicable to their corporations, the likelihood that clients will be less than candid with their lawyers is reduced. In fact, disclosure of a regulatory violation is frequently in the client's interests, especially if the client is a registered dealer or adviser. For all these reasons, concerns relating to privilege and confidentiality may warrant less weight in an advisory context, where lawyers' ongoing relationships with their clients may themselves engender confidence.
The existing responsibilities of lawyers also raise these issues. In some circumstances, withdrawal alone may be "loud". A lawyer acting on a filing with a securities commission would ordinarily be obligated to advise the commission of a withdrawal of legal services, although no more. Withdrawal would be enough to send a signal to a regulator that might invite further investigation. If an opinion has been given and is withdrawn, the signal would bestronger, without the declarations required by the SEC's proposed rules. These obligations exist now, and they include circumstances where serious financial harm is likely.
Moreover, there is a respectable body of opinion in Canada that a lawyer should disclose perjury committed by a client, even during a criminal trial, rather than merely requesting court permission to withdraw. Perjury raises issues relating to the integrity of court processes and the administration of justice that are not applicable in the securities regulatory advisory context. But it is difficult to accept the permissibility of disclosure of a client's perjury to protect these conceptual values and, at the same time, to reject the possibility of disclosure to prevent the substantial financial harm that may result to investors, corporate employees and others from securities fraud in a case like Enron.
The Enron experience, however, does not provide an appropriate model on which to base rules governing lawyers' disclosure obligations in connection with their representation of issuers and other securities market participants. Hypothesizing fraud as the trigger for such disclosure is too easy. Fraud suggests intentional misrepresentation from misleading statements or from a failure to disclose material information. But decisions about disclosure, which are commonly faced by securities lawyers advising corporate issuers, are frequently not clear.
A determination of the materiality of a specific piece of information and the obligation to disclose it commonly involves a difficult judgment call based on information provided by corporate officers in a context in which lawyers lack expertise. Whether the information ismaterial, that is, whether it is likely to have a significant effect on the market price or value of the issuer's securities or whether it would be substantially likely to have a significant influence on investor decisionmaking, involves a judgment based on the likelihood of its occurrence and the potential impact it will have on the issuer's business or affairs. On matters such as these corporate officers and directors, businessmen, may justifiably conclude that information is not material, even when the corporation's lawyer thinks it may be. On occasion, they, rather than the lawyer, may be right.
In circumstances like these, which appear to be more common than outright fraud, a decision concerning withdrawal from representation and disclosure by the lawyer to regulatory authorities is inherently problematic. A lawyer who believes that information is material, when corporate officers determine not to disclose it, should report his views "up the ladder" to ensure that the issue is addressed at the highest corporate levels. If the board of directors also differs with him, the lawyer may have to withdraw, and sometimes notify a securities commission of the withdrawal. But in such circumstances a lawyer should not ordinarily be obligated to disclose to regulatory authorities the issuer's failure to make timely or other disclosure in compliance with the requirements of securities legislation, simply because in the lawyer's view that failure is a violation. Violations of this nature are not the same as the fraudulent conduct of Enron, Worldcom or Xerox, even though they may have a similar effect, if the lawyer is right.
A mandatory "noisy withdrawal" obligation appears not to be warranted in light of the restrictive approach traditionally taken in Canada to disclosure of client violations. Such arequirement would interfere with lawyer-client relationships by increasing a lawyer's influence over client decisionmaking on matters involving business judgment and, arguably, give lawyers the ability to make such business decisions in place of their client's board of directors.
Nevertheless, on balance, serious consideration should be given to extending the existing rule to allow a lawyer to disclose a client's illegal conduct to a regulatory authority in limited circumstances where it is necessary to prevent, not only death or bodily or psychological harm, but also substantial financial harm. This extension would not significantly undermine a lawyer's duty of loyalty or client relationship. A lawyer would invariably be hesitant to challenge a client and withdraw from representation, except in circumstances in which a serious violation is apparent and the harm to the issuer or investors is clear. Carefree use of this power would be inconsistent both with a lawyer's responsibilities and with his economic self-interest in view of the fact that withdrawal, even without disclosure, necessarily results in loss of the client.
Disclosure should be permitted only where a lawyer knows or has sufficient information to believe with substantial certainty that an issuer or its officers are engaging in a serious, ongoing fraudulent scheme, which relates to the lawyer's retainer by the issuer and is intended to mislead investors, so that the lawyer's continuing to provide services would have the effect of furthering the scheme. Even in these circumstances, disclosure should be permitted only with respect to advisory (solicitors') services to a client. It should not be permissible for a barrister. In an adversarial context a lawyer should be entitled, as now, to do no more than withdraw from representation where continuing to act would constitute assistance to the client in dishonest ordishonourable conduct.
D. Other Issues
1. Internal Investigations
The SEC's rules do not adequately distinguish between lawyers acting as advocates and solicitors acting for a corporation on an ongoing basis or in connection with a transaction. As a result they treat a lawyer retained to conduct an internal investigation of possible corporate misconduct as being subject to their "up the ladder" and other obligations, except a lawyer retained in response to an "up the ladder" report and then only in specified circumstances. A lawyer retained for this purpose is in a different position than regular corporate counsel. The lawyer's responsibilities to report will be defined by the retainer, and his report would be expected to reach the corporation's board of directors if the matter is material.
Lawyers performing such services should be treated like those acting as advocates. They should not be permitted to disclose to an outside authority information they learn in the course of their retainer. Their obligation not to assist an issuer in dishonest or illegal conduct always exists and can be met by a refusal to allow their report to be quoted or included in a disclosure document in a misleading way.
2. Law Firms
The obligations imposed and proposed by the SEC can readily be applied to individual lawyers. Law firms are more difficult. In a law firm a partner will usually have responsibility to coordinate all services provided in connection with a specific transaction. The same or another partner in the firm may be responsible for the client in question. Such lawyers (the "client partners") receive information from others in the firm who provide legal services to the issuer-client and may find themselves in a position requiring "up the ladder" reporting. As a client partner's relationship with the client may be a significant one for the lawyer, law firms may wish to have a defined procedure to address questions of "up the ladder" reporting and, if permitted, disclosure of illegal activity to regulatory authorities.
This may raise questions about whether only individual lawyers or law firms, as well, should be subject to discipline for a failure to comply with professional obligations. In some circumstances the LSUC requires a law firm to report improper conduct by one of its partners. A law firm that does not is itself subject to discipline. Law firms representing issuers engaging in illegal conduct, particularly if it is fraudulent, could be subject to the same obligations as individual lawyers.
If a lawyer's responsibilities differ depending on whether the lawyer is acting as a solicitor or an advocate, it may be difficult for the same firm to fulfil all disclosure obligations where a corporate client becomes subject to an investigation or discipline by a securities commission. Inthese circumstances the client partner would have an obligation to ensure full disclosure of information reported to him by a lawyer acting in the adversarial proceeding. If a client admits wrongdoing to a litigation partner, there may be questions about the firm's responsibility to have the corporation disclose the information under securities regulatory requirements. These issues require fuller consideration, including whether such matters should be handled like situations in which a law firm finds itself in a conflict of interest and refers the matter to another firm.
3. In-House Counsel
Lawyers employed by a corporation are generally subject to the same rules of professional conduct as other lawyers, treating their employer as their client. The SEC's rules impose similar reporting obligations on in-house counsel who become aware of evidence of a material violation by their employer or its officers.
It is questionable whether in-house counsel should be treated differently than other officers of a corporation with respect to "up the ladder" reporting obligations. Although it is likely that a lawyer will be quicker to appreciate that a given set of circumstances may involve a material violation, all employees of a corporation owe their obligations to the corporation. A requirement concerning "up the ladder" reporting should apply to every officer of a corporation and not be restricted to lawyers.
III. Jurisdiction to Regulate Lawyers' Conduct
A. Securities Commission Jurisdiction
Securities commissions in Canada currently have jurisdiction to consider the conduct of lawyers acting on behalf of corporations and other market participants. They may do so under their authority to discipline any person if, after a hearing, they conclude that it is in the public interest to do so. The OSC, for example, has taken proceedings and imposed sanctions on lawyers for their conduct in representing issuers on at least three occasions. Although some argue that securities commissions should not be attempting to discipline the conduct of lawyers in representing their clients, jurisdiction to do so has been unequivocally confirmed by the courts.
Even though the commissions have jurisdiction to impose disciplinary sanctions on lawyers on the basis of their "public interest jurisdiction", this is not the optimum approach to such matters. Although the content of the "public interest" standard is undefined, the commissions' disciplinary "public interest" jurisdiction is directed at protection of securities markets and not at the conduct of lawyers providing legal services. Sanctions designed to protect the marketplace, like cease trading orders and denials of exemptions, are not appropriate measures for lawyers acting in a professional capacity, unless the lawyer is also a party to or principal in an improper transaction.
If securities commissions wish to address the professional conduct of lawyers acting for market participants on securities regulatory matters, they should do so from the perspective ofcontrolling the integrity of their own processes. This is best done through a proceeding to determine whether a lawyer will be permitted to engage in practice before the commission.
Securities commissions arguably now have jurisdiction to conduct such hearings. The Ontario Securities Act ( s. 61(2)(i)), for example, requires the Director of the OSC to refuse a receipt for a prospectus where a person who prepared it or prepared a report contained in it is not acceptable to the Director. Although the relevant section does not expressly address lawyers, it clearly encompasses them, as they are generally responsible for drafting prospectuses. This authority provides a basis for independent proceedings to determine whether a lawyer is entitled to practise before the commission with respect to prospectus filings and, inferentially, at all as a solicitor. It would be unfair to an issuer to refuse to accept a prospectus after it has been filed on the basis of the lawyer who prepared it; and if such a proceeding were convened, it would be necessary to give the lawyer notice and an opportunity to be heard. A hearing held in advance with respect to the lawyer would be fairer to issuers, as well as to the lawyer. The OSC, however, has not adopted this interpretation, but has taken the position that it lacks authority to prohibit a lawyer from appearing before it in any capacity.
If a commission wishes to address the conduct of lawyers in providing legal services, it should seek an amendment to its securities act to permit it to initiate proceedings to determine whether a lawyer is entitled to represent issuers and other market participants on applications and filings with it. The standard of culpability should be knowledge or recklessness, or at least a high degree of negligence, on the part of the lawyer.
If this approach is adopted, the legislative authority conferred on the commission should be limited to lawyers performing solicitors' work. A commission should not be entitled to prohibit a lawyer from acting on an enforcement matter or in a hearing, as is recognized in Ontario's Statutory Powers Procedure Act which provides that a tribunal cannot exclude from a hearing a lawyer representing a party. If lawyers are to be disciplined for excessive or untoward conduct in the course of adversarial representations, responsibility should remain with the LSUC.
B. Withdrawal and Disclosure
Rules concerning withdrawal from representation and disclosure of a client's violation should also be left to the LSUC. Sarbanes-Oxley is limited to representation of securities issuers registered with the SEC and is aimed at ensuring compliance by issuers with their disclosure obligations under securities laws, rather than at lawyers' responsibilities. A lawyer's responsibilities to his clients, the courts and the public are best determined by law societies, as the principles on which they are based cannot be limited to securities laws and representation of corporate issuers. Obligations to withdraw and disclose client violations may arise in a substantial number of contexts, including financial regulatory regimes. Such issues are better addressed in the context of lawyers' obligations, with the law societies and the securities commissions acting cooperatively, as is occurring now in Ontario largely as a result of Sarbanes-Oxley.
The same analysis applies to a requirement that a lawyer report "up the ladder" within a corporation. The strongest argument against leaving this process to law societies is that not all lawsocieties in Canada have adopted an obligation to report "up the ladder", while an obligation imposed under securities laws would be national in impact. A nationwide rule, however, does not require the participation of securities commissions. A lawyer's obligation to a corporate client exists whether or not a law society has specifically confirmed it. There is no current compulsion for securities commissions to address this issue in view of this fact (and the fact that the SEC's final rules do not apply to Canadian lawyers who do not practise U.S. law). These matters, too, can be dealt with by law societies with cooperation from securities commissions.
C. Regulatory Actions by Securities Commissions
If the commissions wish to address issues relating to "up the ladder" reporting, there are ways in which they can do so currently. A commission might adopt rules requiring reporting issuers to have policies providing internal processes to facilitate "up the ladder" reporting, not only by lawyers, but by all corporate officers and employees. Such processes could include a corporation's audit committee or a committee similar to the "qualified legal compliance committee" encouraged by the SEC's rules. In Ontario, the OSC has arguably been granted such authority by amendments to the Securities Act in December 2002.
In addition, securities regulators could require issuers whose lawyer has withdrawn to inform subsequent lawyers retained to deal with the same matters of the withdrawal and the reasons for it, as would be required under the most recently proposed rules of the SEC. They might also require an issuer to permit the lawyer who has withdrawn to explain his position to allsubsequent lawyers retained by it. As this might lead a new lawyer to withdraw, as well, the SEC's proposed requirement appears designed to ensure compliance by issuers who might otherwise be unable to obtain legal representation.
Finally, securities commissions might treat withdrawal by a lawyer as a material change or material fact that must be publicly disclosed. This is the alternative to "noisy withdrawal" proposed by the SEC, which would require the issuer to disclose that a lawyer has withdrawn and the circumstances leading to the withdrawal. It is questionable whether a disclosure obligation should apply in all cases of withdrawal, as not every withdrawal, even if based on "professional considerations", will be material. This is an issue that might be addressed on a case by case basis in light of existing timely disclosure obligations under securities laws and policy guidelines published by the commissions.
IV. Summary of Conclusions
A. Lawyers' Current Responsibilities
In summary the following principles currently apply to lawyers representing issuers and others before securities commissions:
1. "Up the Ladder" Reporting and Withdrawal
A lawyer cannot assist a client in pursuing illegal or dishonest activities. If a lawyer discovers that a corporate client is engaged in such activities, the lawyer must report the matter to the highest authority within the corporation, if necessary to do so in order to have it properly addressed. This includes going "up the ladder" over the head of an instructing officer to more senior officers and to the corporation's board of directors.
If a matter so reported is not adequately addressed within the corporation, the lawyer must withdraw from representation of the client and must also withdraw opinions and other representations previously made on the client's behalf, if not doing so would have the effect of assisting the corporation in the pursuit of an illegal or dishonest objective.
2. Lawyers' Honesty and Disclosure Obligations
A lawyer cannot mislead a securities commission or allow a client to do so, but the lawyer's disclosure obligations to a securities commission differ depending on whether he is acting in an advisory or adversarial capacity.
A lawyer representing a corporation in connection with an application to orfiling with a securities commission, must ensure that all relevant information is disclosed to the commission. If a client refuses to make full disclosure, or to correct an error previously made, the lawyer must withdraw his services and, possibly, representations previously made by the lawyer to the commission.
A lawyer who is acting as an advocate, representing a client in a proceeding before a commission or on an investigation of the client by staff of a commission, also cannot mislead the commission, but has no obligation to disclose information or to insist that his client do so, other than as required by law.
3. Whistle Blowing
Under current rules, a lawyer may disclose illegal conduct by a client only where there is an imminent risk to an identifiable person or group of persons of death or serious bodily or psychological harm and then only if the lawyer first obtains a court order permitting such disclosure, where practicable to do so. A lawyer may not disclose a client's illegal conduct if the only harm that will result is financial, however serious it may be.
B. Recommendations on Lawyers' Responsibilities and Their Regulation
1. Whistle Blowing
Consideration should be given to extending the current rule to permit, but not require, a lawyer to disclose illegal conduct by a client where the lawyer is representing the client in an advisory capacity, as a solicitor, but only where the lawyer knows or has sufficient information to believe with substantial certainty that the corporate client or its officers are engaging in a serious, ongoing fraudulent scheme that is intended to mislead investors and that is related to the lawyer's retainer so that continuing to provide services would have the effect of furthering the scheme, and where such disclosure is necessary to prevent a substantial risk of serious financial harm to an identifiable person or class of persons.
In these circumstances, a lawyer acting in an adversarial capacity, as a barrister, should not be entitled to do more than withdraw from representation where continuing to act would constitute assistance to the client in dishonest or dishonourable conduct.
2. Regulation of Lawyers by Securities Commissions
a. Practising before a Commission
Securities commissions should not attempt to discipline lawyers under their "public interest" jurisdiction for conduct relating only to a lawyer's professional activities as an adviser. Commission disciplinary action against a lawyer in these circumstances should relate to protection of the integrity of the commission's processes. Securities acts should be amended, if thought necessary, to authorize commissions to initiate proceedings to prohibit a lawyer from acting in an advisory capacity on matters that come before a securities commission on the basis of knowing or reckless conduct, or at least conduct exhibiting a high degree of negligence, in his representation of corporate or other clients. The purpose of such proceedings should be limited to determining whether a lawyer is entitled to represent issuers and other market participants on applications and filings with the commission.
Securities commissions should not have similar authority to preclude lawyers from acting as barristers on hearings or investigations before them. Discipline of lawyers for excessive or untoward conduct in the course of a hearing or other adversarial representation should remain the responsibility of law societies.
b. "Up the Ladder" Reporting and Withdrawal
Rules concerning "up the ladder" reporting and withdrawal from representation should also be left to law societies, rather than securities commissions. A lawyer's responsibility to clients, the courts and the public are best determined by law societies, as the principles on which they are based cannot be limited to securities laws and representation of corporate issuers. The purpose of the rules adopted in the United States under Sarbanes-Oxley is to ensure that corporate issuers comply with their disclosure obligations under securities laws. Lawyers' responsibilities are best addressed by law societies acting cooperatively with the securities commissions, as is now occurring in Ontario.
c. Regulation of Issuers
Securities commissions may address issues relating to "up the ladder" reporting by requiring public issuers of securities to adopt policies and internal processes that facilitate such reporting by all corporate officers and employees, including in-house lawyers. They may also require issuers whose external lawyer has withdrawn to inform subsequent lawyers retained to deal with the same matters of the withdrawal and the reasons for it. And they may require issuers to disclose a withdrawal publicly, if the withdrawal is itself amaterial fact as defined under securities legislation.
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