April 6, 2003
Mr. Jonathan G. Katz
Re: File No. S7-45-02
Ladies and Gentlemen:
The Commission's recently adopted regulations regarding professional conduct of attorneys, and the current proposed extension of those rules, raise significant issues of law and policy. These issues are not confined to the administration of the securities laws, but have important implications for the evolution of our legal system and the way in which society shapes the role of lawyers within that system.
The Rulemaking Environment and the Need for New Rules
The Commission confronts those issues in a hothouse political environment, warmed by loss of confidence in corporate governance, fertilized by business scandals, and irrigated by a disastrous stock market. In the wake of any major scandal there is an inevitable tendency toward legislative and regulatory overreaction. This is no exception. While it may be that some changes in regulation are called for to reduce the likelihood of another Enron, or WorldCom, or Tyco, it is essential that the Commission not rush into adopting complex new rules when the enforcement of simple old ones is a perfectly satisfactory remedy. Most, if not all, of the misconduct in these cases violated at least one, and often several, existing legal proscriptions. And it should not be forgotten that the overwhelming majority of corporations in this country are, and remain, conscientious and scrupulous about complying with their legal and ethical obligations.
This is not to say that there is not room for changes in law and practice whose purpose is to alter institutional practices in order to discourage misconduct and encourage healthy behavior. Much of the Sarbanes-Oxley Act is directed at those ends. In attempting to use regulation to alter behavior, however, we must take care that we not impose new compliance burdens whose costs outweigh their benefits. I believe that the attorney conduct rules recently adopted by the Commission may already have gotten that balance wrong; and I am certain that adoption of the proposed additional rules would be a mistake.
"Hyperlexis" and Legal Rules in a Healthy Society
A quarter of a century ago, Bayless Manning, a distinguished scholar and corporate lawyer, published a prescient article, which he called "Hyperlexis: Our National Disease." (71 Nw. U.L. Rev. 767 (1977)). In that article, he argued persuasively that the nation is suffering from "the pathological condition" of an "exploding" volume of laws and regulations. A few years later, Dean Manning further developed that theme in an elegant and often-cited short piece, "Hyperlexis and the Law of Conservation of Ambiguity: Thoughts on Section 385," 36 Tax Law. 9 (1982). In it he observed that lawyers, like experts in any field, when confronted by ambiguity are typically "seized by an urge to elaborate" in an effort to reduce it. The result is a burgeoning complexity of laws and regulations that grow ever more difficult to navigate, ultimately posing grave threats to respect for and compliance with the law. And the tragedy of it all is that the elaboration of rules seldom results in truly reducing ambiguity, it merely transfers the ambiguity to some other place in the rules. It is worth contemplating the recently-adopted Part 205 in the light of this sage counsel.
The primary immediate purpose of Part 205 is to define "minimum standards of professional conduct" for securities lawyers faced with evidence that their client, or its officers, directors or employees, has violated, or is about to violate, the law or a fiduciary duty. For decades - at least - attorneys in the United States thought they could go about the ethical practice of the law in these situations guided by three or four short paragraphs in their relevant codes of professional responsibility. The American Bar Association Model Rules of Professional Conduct ("ABA Model Rules"), for example, includes only three rules relevant to the issue: Rule 1.4, "Communications," Rule 1.6, "Confidentiality," and Rule 1.13 "Organization as Client." Together, these were thought by generations of serious, thoughtful attorneys to provide sufficient standards of professional conduct, without further elaboration other than that which naturally grows out of a body of precedent and commentary interpreting and applying the simple rules. Even if one were to refer to one or two of the other rules that might help to determine an appropriate course of action in a particular situation, the entirety of the body of relevant rules is short, simple, and generally relatively easy to interpret.
Contrast the elegant simplicity of the ABA Model Rules and their state derivatives with the new Part 205, which goes on for over 3,500 words and, in the version I have before me, occupies nine pages of small print. Even conceding that some changes in the previous substantive rules regarding lawyers' duties when they learn their clients are engaged in a violation of the law, it can fairly be asked whether these changes could not have been accomplished with greater economy. The goal of this letter is not, however, to urge the repeal of rules that have already been adopted. The foregoing observations are intended only to suggest that the Commission should heed Dean Manning's caution in approaching the current proposal, lest in its efforts to reduce ambiguity the Commission add further complexity to a set of rules that neither require nor can easily support it.
Ultimately, the health of a society depends largely on voluntary adherence to private codes of ethics and morality. The principal role of the public codes of conduct we call law is to establish a floor, a minimum standard for violations so serious that they merit formal sanctions. In any healthy society, most of the citizenry is guided in most of its conduct by higher standards derived from private codes. Indeed, it has been observed that one could develop a measure of a society's health over time by plotting two lines, one representing the informal private standards of conduct required by ethics, morality and general norms of civilized behavior and the other representing the formal standards required by the law. The distance between these two metaphorical lines would serve as a fair gauge of how well the society is doing at governing itself. They would converge only if the society is experiencing one or the other of two adverse trends: either private standards of conduct are in decline; or adherence to private standards has so weakened that the society has been forced to rely more heavily on the law to enforce acceptable standards of behavior.
Interaction of the Proposed Rules with Private Standards of Conduct
Sadly, in the area of conduct to which Part 205 applies, these two metaphorical lines have now converged, and there is no longer much, if any, distance between them. The Commission's detailed rules have now effectively displaced the private standards embodied in the profession's codes of professional responsibility; and, if one accepts the proposition above, one must conclude that society is less healthy for it.
The Commission's proposed extension of these rules is subject to the same objections, but in amplified form. Were the proposed rules to be adopted, the two metaphorical lines would not only converge, but they would cross. For, as proposed, the rules would require attorneys in some jurisdictions to take actions that existing codes of professional responsibility would prohibit.
Rule 1.6 of the ABA Model Rules forbids lawyers to divulge client confidences with certain narrow exceptions, none of which would be applicable. Whatever one might think of Rule 1.6, it, and the analogous rules in all of the states, were drafted by serious, thoughtful, and presumably ethical people. In formulating the private standards of conduct embodied in these rules, they chose to strike the balance between conflicting interests in a way different from the balance proposed by the Commission. One might disagree with the balance struck by the various state bar associations (and there is considerable variety among them in how they deal with the issue), but one cannot dismiss the rules they formulated as clearly erroneous or ill-founded. The Commission should pause and ponder deeply the potential consequences of legalizing standards of conduct that have heretofore been left (largely successfully) to privately developed bodies of ethical rules.
The problems with the proposed extensions of Part 205 do not stop there, however. Because of the particular nature of the relevant private standards of conduct implicated in this discussion, their interaction with the proposed public rules is more complex than usual. In most cases, the standards of conduct required by legal rules underlie and support the standards required by private norms of behavior. Even if the two sets of standards do converge to the point that they are identical, they remain mutually reinforcing, and not in conflict with each other.
In some situations, however, the private norm is intended to serve a goal different from the public one, and there arises the potential of conflict between them. Such is the case with lawyers' duties when confronted with evidence of wrongdoing by their clients. Lawyers in such situations are subject to not one, but two, standards of behavior, one that may prohibit disclosure and another that may require it. The prohibition against disclosure (e.g., ABA Model Rule 1.6(a)) is intended to protect the nature of the attorney-client relationship. But lawyers may - and in some states must - disclose such confidences when necessary to protect the interests of victims or potential victims of wrongdoing (compare, ABA Model Rule 1.6(b)(1) with Virginia Rules of Professional Conduct, Rule 1.6(c)(1), and Texas Disciplinary Rules of Professional Conduct, Rule 1.05(e)).
While there is considerable variation from state to state as to the exceptions from the general duty to maintain client confidences, most codes of professional responsibility have been careful to leave a space between situations in which disclosure is prohibited and those in which it is required. Thus under ABA Rule 1.6(b)(1) a lawyer "may" disclose a confidence "to prevent reasonably certain death or substantial bodily harm." While informal private norms of conduct would generally incline a responsible lawyer towards disclosure in such circumstances, the formal rules leave the lawyer latitude to exercise judgment and to be wrong in that judgment.
The existence of some area of discretion between two otherwise conflicting requirements is essential to the health of any system of rules of behavior. The application of ethical rules, however clear, to the ambiguities and uncertainties of real life is often difficult enough. Where there is a potential conflict between two rules arising from the differing interests they serve, it is essential that those who are bound by the rules be allowed some latitude to exercise judgment - indeed even to err innocently. Otherwise those subject to the rules would be forced to walk a careful tightrope, knowing that a foot set down on either side of the line would put them in violation of one rule or the other.
The Operation of the Proposed Rules in the Real World
This is precisely the situation that would obtain if the Commission were to adopt the "noisy withdrawal" proposal. Consider the following situation: A securities attorney (who could be outside counsel or the chief legal officer) is advising the chief executive officer of a public company in a situation in which there is considerable time pressure. Both are responsible, ethical professionals. The company proposes to take a certain course of action and the CEO asks the attorney whether it would be lawful. The attorney researches the issue as thoroughly as time allows, concludes that the law is unclear on the point, and so advises the CEO, adding that, while the attorney does not believe the course of action would clearly be unlawful, there is a risk that a tribunal might find it so in the future. The attorney recommends, therefore, that the company not pursue the proposed course. The CEO thanks the attorney for the thoughtful advice and informs him or her that, balancing the legal risks against serious adverse business consequences of not taking the proposed action, he has decided to go ahead.
Until today, at that point most lawyers would have believed they had fully discharged their professional responsibilities, it being ultimately the client's right to decide whether to take the "legal risk" in such a situation. Most lawyers would also have believed that they were ethically and legally free to continue to represent the client in taking the action in question, indeed perhaps even under some obligation to continue with the engagement and, through sound advice, attempt to minimize or even eventually eliminate the legal risk.
If the Commission adopts the proposed rules, the attorney would be in an entirely different situation, faced with a new and harsh dilemma. If the course of action is in fact lawful (as the attorney believes it may well be), the private system of rules to which he or she is subject as a lawyer (not to mention his or her professional instincts and training) would flatly prohibit divulging client confidences through a "noisy withdrawal." On the other hand, the attorney must now worry that the situation might turn sour, and it might later be determined that the client's actions were in fact unlawful and taken in the face of counsel's advice that they may be unlawful. Were that to come to pass, the attorney would be exposed to a risk of an enforcement action by the Commission - which would, of course, be proceeding with the benefit of hindsight, extensive discovery, lengthy reflection and lots of time for legal research - charging him or her with having failed to withdraw from the representation and notify the Commission.
In short, the situation that would be created by the proposed rules would force the attorney to make the call whether the client's proposed course of action is lawful. And there would no latitude for error. From an erroneous call as to what the law requires would follow an erroneous conclusion as to the conduct required. If the attorney concludes, wrongly, that the client's proposed action is lawful, he or she must keep the client's confidence and risk being found to have violated a duty to "withdraw noisily." Conversely, if the attorney concludes, wrongly, that the client is about to violate the law, he or she will feel compelled to notify the Commission, and thus will violate a sworn duty to maintain client confidences.
If the Commission goes forward with this proposal, cases like the one described above, while perhaps uncommon, will occur. And their occurrence, as well as their potential to occur, will do great harm, both directly to lawyers who find themselves trapped in an unreasonable ethical bind, and indirectly to the relationship between attorney and client that is so essential to the health of our legal system.
It is enough that, in Part 205 as already adopted, the Commission has converged the line drawn by the requirements of the law with the line drawn by the well-developed system of private standards of conduct embodied in the rules of professional ethics. If the argument above is correct, the long-term consequences for the legal profession and the rule of law will not be beneficial. Whether or not that is so, it would certainly be a mistake for the Commission to extend the rules of Part 205 to set up a situation in which attorneys may be faced with walking a narrow line between their duty to their clients and their obligations under the securities laws. The Commission should not make this mistake.