Richard W. Painter
Visiting Professor of Law
  335 Hutchins Hall
625 South State Street

Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, NW
Washington, D.C. 20549-0609

December 12, 2002

Re: Proposed Rules pursuant to Section 307 of the Sarbanes-Oxley Act of 2002
under File Number 33-8150.wp

Dear Mr. Katz:

I write in response to the Commission's request for public comment on its Proposed Rule for Implementation of Standards of Professional Conduct for Attorneys, 17 CFR Part 205 (the "Proposed Rules"). The Commission has issued the Proposed Rules pursuant to the mandate of Congress in Section 307 of the Sarbanes-Oxley Act which was signed into law by the President on July 30, 2002.

I congratulate the Commission for an impressive job of drafting the Proposed Rules in a very short period of time. Although I and other commentators will suggest changes to some language in the Proposed Rules, only a few of these changes are of critical import (such as clarification that the applicable standards throughout the rules are objective rather than subjective, discussed further in response to Question 4 below). I do not believe that any of these changes warrant reconsideration of the basic principles behind the Proposed Rules or delay in their promulgation as final rules of the Commission.

The Commission, in carrying out the Congressional mandate in Section 307 and proposing these rules, has done much to restore public confidence in the legal profession. The role of lawyers in preserving our democratic form of government, described by De Tocqueville and others, as well as lawyers' role in maintaining the integrity of our economic system, can be carried out only if lawyers conduct themselves in a manner that instills public confidence in our profession. For a lawyer to stand by and do nothing while a client defrauds investors is contrary to everything our profession stands for. Most lawyers thus already do the right thing when faced with client securities law violations and breaches of fiduciary duty, but a few lawyers do not. The Commission's continued efforts in this area, through the Proposed Rules and any future rules that the Commission decides to promulgate under Section 307, will allow honest lawyers and clients to thrive in a legal and economic system that values disclosure - including disclosure by lawyers to their own clients - over deceit.

I discuss below some general questions concerning the Proposed Rules, along with my own response to those questions. Other specific questions are discussed in bullet point paragraphs in the next section of this letter. Finally, I wish to direct the Commission's attention to the Comment Letter of Susan Koniak, Professor at Boston University Law School, Roger Cramton, Professor and former Dean of Cornell Law School, George Cohen, Professor of Law, University of Virginia School of Law and other signatories. I have reviewed that letter and agree with the recommendations made therein. I only address the subject matter of a few of its recommendations below, but I believe that the others are also worthy of your serious attention.

General Questions

1. Should the Commission go beyond the up-the-ladder reporting requirement in Section 307 to address other questions of professional responsibility such as what a lawyer should do if up-the-ladder reporting fails?


The Commission furthers the intent of Section 307, and faithfully carries out the statute's mandate, by addressing questions beyond the up-the-ladder reporting language that is in part of the text of Section 307. Section 307 requires the Commission to:

"issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers, including a rule - [setting forth the up-the-ladder reporting requirement]" (emphasis added)

The word "rules" is plural not singular. The reference to "minimum standards" is again plural and, in conjunction with the rest of the sentence, implies that the Commission is being directed to make a general assessment of what standards of attorney conduct are consistent with the public interest and the protection of investors. The statute furthermore directs the Commission to issue rules for attorneys appearing and practicing before the Commission "in any way" in the representation of issuers. Finally, the word "including" drives the point home: Congress does not expect the up-the-ladder reporting requirement to be the only rule issued by the Commission under Section 307.

This approach is entirely consistent with the rest of the federal securities laws. Congress in many instances directs the Commission to decide what specific rules are appropriate in the public interest and for the protection of investors. Congress, when it directs the Commission to determine what rules are in the public interest and appropriate for the protection of investors, does not intend that the Commission should only do the absolute minimum required in the statute. Indeed, for the Commission to limit itself to the absolute minimum, when faced with a statutory mandate as broad as Section 307, would frustrate the intent of Congress.

One obvious question that needs to be addressed by Commission rules under Section 307 is what a lawyer must do if up-the-ladder reporting fails because an issuer's directors will not take appropriate remedial action. This question is closely related to, and logically follows from, the specific rule set forth in the statute. Congress also must have foreseen that the Commission would address this question, even if Congress did not instruct the Commission how specifically to do so. Indeed, Congress knew that the Commission had previously addressed the responsibilities of securities lawyers who face recalcitrant clients. See Letter, dated March 28, 2002, from SEC General Counsel David Becker to Richard W. Painter, citing In Re Carter and Johnson (1981). This question is directly relevant to protection of investors and the public interest, which are the underlying purposes of Section 307. Finally, this question is not just theoretical but real - some issuers (particularly immediately after IPOs) have few independent directors, and even independent directors sometimes refuse to act. Lawyers thus should know what to do if up-the-ladder reporting fails. The Proposed Rules provide a good answer to this question, but even if the Commission were to decide that a different answer is more appropriate, the Commission should not respond to criticism of the Proposed Rules by leaving this question unanswered.

2. Has the Commission appropriately answered the question of what a lawyer is required to do if up-the-ladder reporting fails?

Yes, but other answers are appropriate as well.

In previous correspondence with the Commission, I urged the Commission to require that a lawyer confronted with such a dilemma either (i) resign or (ii) disclose to the Commission information necessary to prevent the violation from occurring. The lawyer would be permitted to choose between these options or to choose both. Under this approach, the lawyer who chose to resign rather than disclose would not have to make a "noisy" withdrawal, although the lawyer might choose to do so.

I still believe that this approach, which is somewhat more flexible than the Commission's Proposed Rules, would be workable, and that an inflexible requirement of a noisy withdrawal is not necessary. I would, however, add two caveats. First, if the lawyer has recently communicated directly with the Commission on behalf of the issuer (perhaps in the last six months), the noisy withdrawal should be required, including appropriate notice to the Commission. The Commission should not be misled into believing that the issuer is currently represented by the lawyer when in fact the issuer is not. Second, the issuer should be required to disclose to the Commission and to investors the fact that the lawyer has resigned (by filing a Form 8-K), although the issuer should not be required to disclose the reasons the lawyer resigned, as it would if its auditor had resigned. This approach avoids requiring the issuer to waive the attorney-client privilege, but still puts the burden on the issuer to disclose the attorney's resignation. This approach also avoids imposing on attorneys the burden of "noisy withdrawal" and would alleviate the concerns of commentators who find this burden to be unreasonable.

I do not mean to imply, however, that the Commission's proposal to require a noisy withdrawal is inappropriate. Noisy withdrawal is allowed under the rules of just about every jurisdiction, and (unless specific client information is disclosed) does not endanger the attorney-client privilege. For the Commission to require it is not unreasonable. I only recognize that this noisy withdrawal requirement in the Proposed Rules will be the subject of substantial criticism and that alternative approaches would likely yield equally desirable results.

I should emphasize also that concerns about the "noisy withdrawal" provision in the Proposed Rules are perhaps overblown in view of the fact that the Commission has made this a default rule. As pointed out in my answer to Question 3 below, the noisy withdrawal requirement is only imposed on those issuers and lawyers that do not choose to operate within the rubric of a QLCC. Noisy withdrawal thus is a "penalty default rule" that many issuers and their lawyers will choose to opt out of by establishing a QLCC. See R. Painter and J. Duggan, Lawyer Disclosure of Corporate Fraud, 50 SMU Law Review 267 (1996) (suggesting that stringent "penalty default rules" requiring notification to the Commission be imposed to encourage issuers and lawyers to agree in advance to their own alternative procedures for reporting violations), citing Ian Ayres & Robert Gertner, Filling Gaps in Incomplete Contracts: An Economic Theory of Default Rules, 99 Yale L. J. 87-130 (1989) (discussing use of penalty default rules in other areas of the law).

However the Commission decides to address the noisy withdrawal question, one thing is clear: withdrawal should be required if the lawyer is unable or unwilling to prevent the conduct in question (for example by disclosure to the Commission). A lawyer cannot represent a client whom the lawyer knows is using the lawyer's services to violate securities laws. See ABA Model Rules 1.2(d) and 1.16. Lawyers who continue to represent clients in these circumstances expose themselves and their firms to significant legal liability, even under the law that preceded Section 307 and the Commission's Proposed Rules. For all of these reasons, it is in the interests of corporate clients, investors, and lawyers themselves that the Commission require a lawyer to resign if the client will not desist from known securities law violations and the lawyer is unable or unwilling to disclose information necessary to prevent the violation from occurring. This aspect of the Proposed Rules - the requirement of resignation - should not be changed in the final rules.

Finally, discussion in the final rules of what the lawyer is required to do should remain distinct from the question of whether the lawyer is permitted to disclose client confidences to the Commission, a topic discussed in my response to Question 5 below.

3. Should issuers be allowed to opt ex-ante into a rule that would allow lawyer reporting to be done through a Qualified Legal Compliance Committee (QLCC)?

Yes, provided the QLCC remains independent of the issuer's senior management in substance as well as form, and provided complete disclosure about the QLCC is made to investors.

I have argued before that federal securities laws and Commission regulations should allow issuers in advance to redirect up-the-ladder reporting by their lawyers to an independent compliance committee instead of to the full board of directors. Painter and Duggan, supra. at 267-68 (1996). I have also suggested allowing issuers to opt out of a rule that would impose a "noisy withdrawal" requirement on issuer's counsel. Id at 268. The issuer, however, should be required to opt out of default rules in Commission regulations and into such alternative reporting procedures ex-ante, and not be allowed to do so after an incident arises that must be reported. Id. at 266. Furthermore, full disclosure of such opt-out/opt-in arrangements should be made to shareholders, or better yet, shareholder approval should be required. Id. at 269. See also R. Painter, Rules Lawyers Play By, 76 N.Y.U. Law Review 716-722 (2001).

With the exception of shareholder approval, these principles are incorporated into the QLCC that is contemplated by the Commission's Proposed Rules. The Commission's final rules should make it clear, however, that the issuer has to opt into the QLCC arrangement in advance and cannot simply establish a QLCC in response to an incident that must be reported. Furthermore, although I would prefer that shareholders approve of QLCC arrangements, full and accurate disclosure by the issuer about a QLCC, including biographical information on its members, should assure that shareholders are at least informally involved in establishing and monitoring the QLCC. Other Commission rules, perhaps in Regulation S-K, should require issuers to make this disclosure to their shareholders.

It is likely that many issuers will establish QLCCs (particularly because, under the Proposed Rules, an issuer using this procedure thereby opts out of the mandatory noisy withdrawal). Lawyers may even insist that their corporate clients establish QLCCs. Because so much reporting under the Proposed Rules is thus likely to be done through QLCCs, instead of through the default terms of the Proposed Rules, including mandatory noisy withdrawal, it is critical that the Commission take steps to ascertain that QLCCs established by issuers are truly independent of issuers' senior management. Shareholder monitors should also be encouraged to participate in assuring the integrity of this opt-in reporting procedure.

4. Do the Proposed Rules use appropriate evidentiary thresholds to trigger the various reporting requirements?

Probably, but on two questions - the amount of evidence required to trigger each reporting requirement and whether the lawyer's assessment of this evidence is held to an objective or subjective standard - the Proposed Rules are unclear.

Congress, when it enacted Section 307, was well aware of the evidentiary threshold that was proposed in my letter to Chairman Pitt of March 7, 2002 (signed by 40 law professors and introduced into the Congressional Record by Senator Edwards). That letter had proposed that up-the-ladder reporting be required "if the lawyer knows that the client is violating the securities laws." Congress, however, enacted a different rule. Congress chose broader language that required "an attorney to report evidence of a material violation of securities law or fiduciary breach or other similar violation." The probability of a violation that creates a duty to report is lower, because the word "evidence" implies something less than certainty or even a high degree of probability. Furthermore, by using the word "evidence," without any reference to the lawyer's own knowledge, Congress implied that the standard used to judge the lawyer's assessment of the evidence should be objective rather than subjective.

Standard professional usage of the term "reasonable" in this context often denotes an objective standard of knowledge. Nonetheless, nowhere does Section 307 itself use the word "reasonable," and because of that word's varying interpretations, I find its use, even as defined in the Proposed Rules, potentially confusing. The fact that many commentators will no doubt urge the Commission to interpret "reasonableness" from a subjective rather than an objective vantage point, contrary to Congressional intent, could lead to yet more confusion in the final rules.

The definitions at the beginning of the final rules should make clear that the applicable standard for evaluating lawyer conduct under the rules is objective rather than subjective. It is also important that the final rules specify how much evidence of a violation is required to trigger specific duties at each stage of the reporting process. For example, evidence that a violation is "possible" could trigger the duty to report to the Chief Legal Officer, whereas evidence that a violation is "likely" could trigger the duty to report to the full board or to the QLCC. Evidence that a violation was "highly likely" or a "near certainty" could trigger the requirement of a noisy withdrawal. In order to avoid reintroduction of subjective criteria, reference should be made throughout the final rules to evidence of which the lawyer is or should be aware, not to the lawyer's own assessment of whether there is or is not a violation. Under this scheme, it should thus be the lawyer's responsibility to report the evidence to the client, going up the ladder if need be, so the client can determine whether there has been a violation and decide what to do about it. At the noisy withdrawal stage, the requisite level of evidence of which the lawyer is or should be aware once again should trigger the requirement that the lawyer act in accordance with the rules.

Professors Cramton, Cohen and Koniak have made more specific suggestions for addressing these problems in their own comment letter, and I will not restate their comments here other than to say that I believe their observations would be useful to the Commission in drafting the final rules.

5. Is the Commission right to allow an attorney to disclose client information to the Commission in some circumstances?


The vast majority of states allow, and some states require, a lawyer to disclose client information in the circumstances described in Paragraph 205.3(e) of the Proposed Rules. A very few states forbid disclosure. This minority rule narrows the lawyer's options for responding to client conduct that could defraud investors and expose the lawyer to liability for legal work that the lawyer has already done. No lawyer representing a client before the Commission should be put in such a situation where the lawyer cannot use a full range of options, including disclosure and the threat of disclosure, to protect investors and the lawyer from financial injury at the hands of a client that has used the lawyer's services to perpetrate a fraud.

State ethics rules that forbid disclosure in client crime/fraud situations are not only contrary to public policy, but contrary to common law articulations of both the duty to keep client confidences and the attorney-client privilege, contrary to the longstanding position of the ABA in the Model Code prior to adoption of the Model Rules, contrary to the current position of the ALI, and contrary to the views of most commentators who have written on this issue. The ABA's own Ethics 2000 Commission has recommended that the ABA's endorsement of the minority view in Model Rule 1.6 be brought into line with the approach in the majority of jurisdictions, and the ABA's Corporate Responsibility Task Force has echoed this recommendation.

It is no secret that the most pervasive argument in favor of the minority rule is that a lawyer who is forbidden to disclose can, if sued for assisting a client in fraudulent conduct, defend the case by claiming that the lawyer had relatively few options in responding to the situation and thus relatively little leverage over the client. Such arguments, however, usually fail to protect lawyers from liability even in jurisdictions with the minority rule, because even that rule allows the lawyer to resign and, in most cases, to make a noisy withdrawal. More important, professional responsibility rules should not be designed with defense of malpractice claims as their primary objective, but with a view toward minimizing lawyer complicity in fraud that gives rise to malpractice claims to begin with. The majority rule, which is adopted by the Commission in the Proposed Rules, furthers this objective.

Furthermore, failure of the Commission to address this question, and to preempt state ethics rules that conflict with both the majority rule and the investor protection objectives of the securities laws, exposes lawyers to conflicting rules in different jurisdictions. Information that must not be disclosed in the District of Columbia may be required to be disclosed in New Jersey or Florida, and a lawyer who represents a client in the District of Columbia and one of these other states may be forced to choose between disobeying the District of Columbia rule and exposing himself to liability elsewhere. A large number of law firms with offices in states with different rules are particularly vulnerable to this dilemma. Such, however, is a dilemma that no client should be allowed through fraudulent conduct to impose on a lawyer or law firm. When the client is an issuer of securities subject to federal securities laws, there should be a nationwide standard allowing the lawyer to disclose.

The Commission should, on the other hand, abstain from preempting ethics rules in the relatively few states that go further and require disclosure in order to prevent a client crime. Powerful public policy arguments can be made in favor of such a rule, which places the lawyer's responsibility to the legal system on a par with the lawyer's responsibility to the client. The ABA Model Rules and ethics rules in many jurisdictions indeed require a lawyer to disclose some client crimes such as perjury, even in circumstances where the actual harm inflicted by the crime is arguably small. States that wish to adopt ethics rules that place financial fraud and other crimes on a par with perjury should be allowed to do so. The argument that mandatory disclosure destroys the attorney-client relationship and leads to the demise of the legal profession is bellied by the fact that lawyers practice in these jurisdictions that require disclosure, and clients hire these lawyers to zealously represent them, every day. Finally, Section 307 directs the Commission to define "minimum standards of professional conduct" for lawyers representing issuers, and such language clearly implies that more exacting state rules on disclosure of client fraud should not be disturbed.

6. Should the Commission address the issue of attorney-client privilege in the Release accompanying the Final Rules?

The Release should only restate the law of privilege in areas where it is clear, and should avoid discussing the Commission's preferred resolution of arguable questions of privilege and waiver.

It is important that the Release clarify basic evidentiary principles concerning the attorney-client privilege, particularly after opponents of Section 307 and critics of the Proposed Rules have raised privilege concerns that simply do not exist. Reporting information to a corporate client's board of directors, for example, does not waive the privilege. Neither does a noisy withdrawal in which the lawyer simply informs the Commission that the lawyer is resigning for professional reasons without disclosing further information about the client. The Commission should use the Release accompanying the final rules to clear up any possible misunderstanding concerning these elementary principles of evidence.

Questions of privilege and waiver are more ambiguous, however, if an attorney chooses to report client information to the Commission, as the Proposed Rules permit even without client consent in some circumstances. In this situation, a selective waiver theory could bar third parties from discovery of the information disclosed to the Commission, although many courts reject selective waiver. An argument can also be made that there is no waiver to begin with, because only the client can waive the privilege. On the other hand, a court might find that the attorney waived the privilege as an agent of the client, even without client authorization, or that the client implicitly authorized the waiver by hiring an attorney subject to the Proposed Rules, providing the attorney with information and then acting in a manner that gave the attorney the option to disclose the information to the Commission. Finally, an argument can be made that the privilege never existed to begin with because of the client crime/fraud exception, but here also the law is unclear because there may be situations where disclosure would be allowed under the Proposed Rules, yet the crime/fraud exception would not apply. The resolution of each of these questions depends on the specific facts of each case and the law in each jurisdiction where the privilege is being asserted. The situation is complicated by the fact that clients could face future litigation in a multitude of jurisdictions and that privilege and waiver questions often turn on fact-specific inquiry.

As I point out in my answer to the immediately preceding Question 5, the final rules should allow a lawyer to disclose client information in the circumstances set forth in the Proposed Rules. However, a lawyer who chooses to disclose specific client information to the Commission should not be misled into believing that the evidentiary privilege is preserved when it may not be. Possible loss of the attorney-client privilege is a factor that the lawyer should consider, and weigh along with other relevant factors, such as the need to protect investors from the client's fraudulent conduct, when deciding whether to disclose specific client information to the Commission. The Release accompanying the final rules should not seek to sway the lawyer's evaluation of these evidentiary questions over which the Commission has little or no control.

Finally, if the Commission seeks to resolve these evidentiary questions definitively in order to assure lawyers that the attorney-client privilege is not waived by disclosure to the Commission, the only effective method of doing so is to seek an act of Congress establishing selective waiver and preempting inconsistent state law. Commission rules, or a release accompanying such rules, cannot alone accomplish this objective.

7. Is the Commission correct to impose different standards of professional responsibility on in-house attorneys than on outside attorneys?

Perhaps, although such an approach has little precedent in the ABA Model Rules or in state ethics rules. There is, by contrast, ample precedent for distinguishing between subordinate and supervisory lawyers, and that approach might be a better way of dealing with the dilemmas confronted by inside counsel.

Last summer, when Section 307 was in House-Senate conference, I was asked by a Senate staff member whether an exception to the up-the-ladder reporting requirement should be made for inside counsel. My response to this question was that neither ABA ethics rules nor state ethics rules impose differing obligations on inside and outside counsel. Such a distinction would be unprecedented and, at least in the context of the up-the-ladder reporting requirement, would be unjustified.

The Commission's Proposed Rules, however, seek to make such a distinction in a very different context - that in which a lawyer who has already pursued up-the-ladder reporting to no avail, must resign if the violation is sufficiently serious. The Proposed Rules answer this question in the affirmative for outside counsel but in the negative for inside counsel. The Proposed Rules then go on, however, to require that inside counsel disaffirm his own work product in a manner that will probably lead to his being fired. The end result in many cases thus will be the same as for outside counsel, except that inside counsel is allowed, as an alternative to resigning, to incur the risk of being fired for complying with the Proposed Rules.

The Commission's Proposed Rules articulate what is perhaps the best possible resolution of this very difficult question. This is certainly not an unconscionable resolution, given the hardships inflicted on inside counsel, for whom resigning from a representation means loss of a job. On the other hand, the additional options available to inside counsel under the Proposed Rules are, for the reasons mentioned above, more apparent than real.

A better alternative might be to require withdrawal of the senior legal officer of the issuer in the exact same manner as withdrawal is required of outside counsel. The responsibilities of subordinate legal officers employed by the issuer would stop with the internal reporting obligations set forth in the Proposed Rules, and these subordinate legal officers thus would not be required to resign or disaffirm work product. Although the issuer's senior legal officer, under this approach, would have to resign if the issuer's directors refused to correct a violation serious enough to require withdrawal, the additional responsibilities, and usually compensation, that come along with the senior legal officer's position justify this heightened duty. The senior legal officer of the issuer is also usually in a position to persuade the issuer to establish a QLCC, which effectively allows the issuer and all its lawyers to opt out of the withdrawal requirements in the Proposed Rules. Furthermore, a senior legal officer who does not resign or put a stop to a violation serious enough to require withdrawal under the Proposed Rules is very likely to suffer professional and financial consequences (including liability exposure) more serious than those that would be suffered through loss of employment. Finally, the Commission, if still concerned about the hardships imposed on inside counsel in these circumstances, could require issuers to undertake to indemnify senior legal officers who resign in accordance with Section 307 for a specified amount of lost salary (perhaps one year).

In summary, while I fully understand the purpose of distinguishing between inside and outside counsel, such an approach is unprecedented in professional responsibility rules and may be inadvisable here. The final rules could instead rely here, as they do elsewhere, on a distinction which does have precedent in professional responsibility rules, that between subordinate and supervisory attorneys. The final rules thus could impose the obligation to resign and/or disaffirm work product only on supervisory attorneys, whether they are retained or employed by the issuer.

Specific Recommendations

1. The definition of "breach of fiduciary duty" should include breaches of fiduciary duty "recognized by state or federal law, including but not limited to fiduciary duty recognized at common law. . . " Breaches of fiduciary duty to pension funds under federal law such as ERISA, and other similar violations would thus clearly be covered, whereas arguably they are not under the current definition in the Proposed Rules. See Dana Muir, Sarbanes-Oxley Section 307: No Mandated Disclosure of ERISA Fiduciary Breaches?. 2 Pensions and Benefits 233 (BNA, December 5, 2002). The reference in Section 307 to "the public interest" as well as to the "protection of investors" clearly indicates that Congress intended the definition of "breach of fiduciary duty" in the Commission's rules to be wide reaching, and to encompass such things as breach of duty to employee pension plans and their beneficiaries.

2. The definition of "material", when qualifying a violation of securities laws, should refer to "information that a reasonable investor would consider important in making an investment or voting decision." The definition of "material", when qualifying a violation of fiduciary duty or other similar violation, however, for reasons explained in paragraph 1 above, should refer to "information that a reasonable person protected by the law or legal duty in question would consider important either in making an investment decision or in taking other steps to protect that person's legal or economic interest." Section 307's reference to fiduciary breaches and other similar violations, and reference to the public interest as well as protection of investors, requires that the word "material", when used outside the context of securities law violations, incorporate interests other than those of investors.

3. The definition of "evidence of a material violation" should read something like "information that would lead a prudent and competent attorney representing clients before the Commission, acting reasonably, to conclude that there is probable cause to believe that a violation has occurred or is occurring." First, for reasons explained in my answer to Question 4 in the General Questions above, it needs to be clear that the attorney's evaluation of evidence is to be judged objectively rather than subjectively. Second, with respect to the amount of evidence, Congress used the word "evidence" without limitation in Section 307. It is thus difficult to believe that Congress intended none of Section 307's provisions to apply when there is evidence constituting probable cause, which is one of the most widely used evidentiary standards applied to the investigative stage of legal proceedings. Higher probability of a violation should not be required for the initial step of reporting to the Chief Legal Officer, and the definitions section of the final rules thus should incorporate an evidentiary threshold of probable cause. Higher evidentiary thresholds should be required to trigger subsequent additional requirements such as up-the-ladder reporting to the directors or withdrawal. These higher evidentiary thresholds could be referred to specifically in the text of the relevant subsections of the final rules.

4. Anywhere the word "reasonable" or "reasonably" is used, whether in the definitions or in the text of the rules, there should be a statement that the applicable standard is objective (what a prudent and competent attorney, acting reasonably, would do or know under the circumstances), not subjective. This is consistent with the text of Section 307, which is devoid of subjective criteria even though subjective tests were incorporated in various proposals known to Congress at the time. The definition also should clarify that the relevant standard is that of a "prudent and competent attorney representing clients before the Commission." Lawyers who choose to practice securities law thus should be held to the standards expected of securities lawyers generally, not to standards expected of lawyers who may not be familiar with securities law.

5. The final rules should address imputation of knowledge within law firms. Lawyers in the same law firm that represents an issuer in connection with both securities matters and other matters (for example environmental or labor matters) should communicate with each other to the extent necessary for the securities lawyers to know whether descriptions of the issuer's business, legal affairs and other disclosures to which the securities laws apply are accurate. The Commission should clarify in the Release accompanying the final rules, if not in the text of the rules themselves, that the Commission would ordinarily expect a lawyer, and a law firm, to take steps to assure that securities lawyers are aware of information about the issuer that is available to other lawyers in the same law firm.

6. Many of the requirements under the Proposed Rules are best directed at law firms in addition to individual lawyers. In some instances a law firm will not have acted reasonably under the circumstances, even if no specific lawyer at the firm can be shown to have fallen below the requisite standard of care. In these circumstances, the firm should be held responsible, even if only sanctioned with a letter of reprimand. Ethics rules in several states, including New York, now allow for discipline of law firms as well as individual lawyers, and the Commission should seriously consider following suit.

7. I have suggested in my prior correspondence with the Commission that rules under Section 307 should address issues that are not addressed in the Proposed Rules, such as contingent fees and equity-in-lieu-of-legal-fees arrangements for corporate transactions. Because of the short time deadline imposed by Congress under Section 307, it would be unreasonable to expect the Commission to address all such issues at this time. The Commission should, however, give these issues serious future consideration under the broad Congressional mandate in Section 307.

I again compliment the Commission on its diligent and detailed effort to address the pressing problems that are the subject of the Congressional mandate in Section 307. Your continued attention to these problems will not only protect investors from those relatively few issuers that choose to violate securities laws and breach fiduciary duties, but will also restore public confidence in securities lawyers. Our economic system and the legal profession will be better for it.

Very truly yours,

Richard W. Painter
Visiting Professor of Law
Professor of Law
University of Illinois College of Law
(217) 333-0712

cc: The Hon. Harvey Goldschmid
The Hon. John Edwards
The Hon. Michael Enzi
The Hon. John Corzine