Jonathan G. Katz, Secretary
RE: Proposed Rule: Implementation of Standards
Dear Mr. Katz:
We are pleased to submit this letter to the Securities and Exchange Commission (the "Commission") in response to the Commission's request, contained in Release Nos. 33-8186; 34-47282; IC-25920 (the "Proposing Release"), for comments on (i) the Commission's proposed rules prescribing attorney withdrawal and issuer reporting to the Commission of such withdrawal (the "Alternative Proposal"); (ii) the Commission's proposed rules prescribing attorney withdrawal and the attorney's notification to the Commission of such withdrawal (the "Noisy Withdrawal Proposal"); and (iii) the Commission's final rules, contained in Part 205 of Title 17 of the Code of Federal Regulations, implementing standards of professional conduct for attorneys (the "Final Rules").
As a preliminary matter, we note the Commission's statement in the Proposing Release that all relevant comment letters previously submitted on proposed Part 205 will continue to be considered by the Commission in its deliberations. To that end, we call your attention to our comments relating to the Noisy Withdrawal Proposal contained in our December 16, 2002 letter to the Commission and reemphasize our strongly held view that the Noisy Withdrawal Proposal is inconsistent with the public interest, is unnecessary and should not be adopted (or, if adopted, should be significantly revised and narrowed).
Overview and Summary
As noted in the Proposing Release, the Commission has proposed the Alternative Proposal in an effort to address the negative response received by the Commission on the Noisy Withdrawal Proposal - particularly the concern that "noisy withdrawal" would cause attorneys to breach their ethical obligations to maintain client confidences. The key distinction between the two proposals is that the Alternative Proposal places the "reporting out" obligation on the issuer rather than on the attorney. Although the Alternative Proposal manifests the Commission's attempt to improve upon its Noisy Withdrawal Proposal in light of the criticisms of that proposal, the Alternative Proposal fails to address the most significant and core concerns stemming from noisy withdrawal.
Specifically, the Alternative Proposal suffers from the same cardinal defect as the Noisy Withdrawal Proposal - that is, the Alternative Proposal, no less than the Noisy Withdrawal Proposal, will result in a fundamental shift in the nature of the attorney-client relationship away from the attorney as trusted advisor and navigator through compliance matters and towards the attorney as a potential judge, jury and, ultimately, an extension of the government's enforcement machinery. Instead of the attorney "blowing the whistle" himself or herself, as would be the case under the Noisy Withdrawal Proposal, the Alternative Proposal has the attorney handing the whistle to the issuer, and the issuer then will be required to blow the whistle itself, with the continued threat of the attorney blowing the whistle if the issuer refuses to do so. In either case, the potential is created for the attorney to impose his or her will on the client, backed by the threat, directly or indirectly, of summoning the Commission.
Under either paradigm, clients will be less likely to seek legal advice and will be less forthcoming with the information they provide to counsel when they do seek legal advice. The inevitable consequences under the Noisy Withdrawal Proposal or the Alternative Proposal will be the same:
If the Commission nevertheless decides to adopt additional "reporting out" rules in connection with Part 205, we have set forth suggestions as to specific changes that should be made to improve the rules contained in the Alternative Proposal, as well as additional comments on the Noisy Withdrawal Proposal. Further, in light of the Commission's request for comments on the Final Rules in connection with the potential adoption of either of the two proposals, we also provide additional suggestions to improve the Final Rules.
The Attorney-Client Relationship and the Public Interest
In our December 16, 2002 letter to the Commission commenting on proposed Part 205, we wrote at great length about the significant role played by attorneys in providing issuers with advice, assistance and judgment in complying with the requirements of the securities laws. These efforts are vital to the proper functioning of our public markets and serve not only the interests of issuers, but also those of the Commission and the investing public. We believe the Commission concurs with this view. See, e.g., Proposing Release, 68 Fed. Reg. 6,324, at 6,325 (Feb. 6, 2003) ("Attorneys also play an important and expanding role . . . ensuring compliance with applicable reporting and disclosure requirements, including requirements mandated by the federal securities laws.").
In determining whether and how to move forward with additional standards of attorney conduct, we again urge the Commission to recognize that the ability of attorneys properly to counsel clients in the conduct of their affairs in conformity with securities laws, fiduciary duties and similar laws is largely a function of the willingness of clients to consult with counsel, to provide counsel with full information and, when necessary, to engage in a robust dialogue and exchange of ideas. Full information is absolutely critical to the provision of quality legal services. Accordingly, the Noisy Withdrawal Proposal and the Alternative Proposal should be evaluated in light of whether they encourage and facilitate, are neutral toward or detract from the sharing of full information between client and attorney.
In large measure, the flow of information from client to attorney is the result of the trust upon which the attorney-client relationship is built. That trust, in turn, rests on a foundation of strict ethical obligations placed on attorneys and designed to ensure that such trust does not erode and endanger the benefits gained by society when clients confer openly and honestly with counsel in order to structure their dealings in accordance with applicable laws.
As we have previously written to the Commission, we believe the Noisy Withdrawal Proposal would materially and adversely alter the attorney-client relationship by casting the attorney as a potential whistleblower, causing the attorney to be viewed by the client as an extension of the government's enforcement arm and focused on his or her self-interest (i.e., career protection), rather than as a trusted advisor and counselor. The Commission states in the Proposing Release that it is putting forth the Alternative Proposal, as an alternative to "noisy withdrawal," because the Commission "does not want the rule to discourage issuers from seeking and obtaining appropriate and effective legal advice." Nevertheless, the Alternative Proposal, if adopted, would have precisely the same impact as a noisy withdrawal requirement.
Although the Alternative Proposal addresses the narrow concern that noisy withdrawal would require attorneys to breach their ethical obligation to maintain client confidentiality, the Alternative Proposal suffers from the same fundamental defect as the Noisy Withdrawal Proposal. In both cases, the proposals would intrude on the attorney-client relationship by creating the dynamic in which the lawyer, in effect, threatens to take a course of action if the client-issuer does not alter its conduct to satisfy the lawyer's view of what constitutes an "appropriate response." Although the Alternative Proposal does not require the attorney to notify the Commission, the attorney still effectively assumes the role of "whistleblower" by making the judgment that in his or her view an appropriate response has not been received and that he or she should therefore withdraw, thereby setting the events in motion that lead to Commission notification and, inevitably, Commission investigation of the issuer.
The different paths taken by the two proposals do not change the fact that both proposals have the same starting and ending points, i.e., the attorney's decision - made under the pressure of being second-guessed by the Commission in a potentially career-ending enforcement action - to withdraw from the representation and, following one form or another of "reporting out," the likelihood of a Commission investigation of the issuer. In either case, a fundamental change in the attorney-client relationship will occur and, as a result, clients will be less likely to seek legal advice and will be less forthcoming with the information they provide to counsel when seeking legal advice. Ultimately, compliance with the securities laws will suffer, confidence in the public markets will correspondingly diminish and the investing public will be gravely impacted. This is one of those instances where the proposed "cure" is far worse than the perceived "illness."
Additional Rulemaking is Unnecessary
The legislative history of Section 307 of the Sarbanes-Oxley Act of 2002 (the "Act"), under which Part 205 was promulgated, indicates that Congress only intended that Section 307 ensure that "attorneys are responsible for fully informing their corporate client of evidence of material violations of Federal securities laws."1 Under the Final Rules, the attorney is obligated to report evidence of a material violation to the issuer's chief legal officer ("CLO") or the CLO and chief executive officer ("CEO"). In the event that the attorney fails to receive an "appropriate response" from the CLO or CEO, the evidence of a material violation is reported "up the ladder" to the issuer's audit committee (or other independent committee or the full board). Thus, the Final Rules achieve the full objectives of Section 307 and senior officers and directors, now informed of evidence of a material violation, will exercise their business judgment to investigate such reports and take appropriate action. Although Section 307 permits the Commission to go beyond "up the ladder" reporting, a withdrawal and "reporting out" provision is not mandated by Section 307, is not required to achieve the Congressional aim and, in light of the negative impact that both of the "reporting out" proposals will have on the attorney-client relationship, is inadvisable and harmful.
Recommendations for Specific Changes to the Alternative Proposal
Although we hope the Commission will be persuaded that the Alternative Proposal does not serve the interests of issuers, the Commission or the investing public, set forth below are specific issues relating to the Alternative Proposal and our suggested revisions to address these issues.
1. Proposed § 205.3(d)(1): Exclude a Reporting Attorney When the CLO Refers the Report of Evidence of a Material Violation to the QLCC
As proposed, Section 205.3(d)(1) does not apply to an attorney who has reported evidence of a material violation to an issuer's qualified legal compliance committee ("QLCC"). In such case, the evidence has been provided directly to a committee of independent directors with the requisite authority to initiate an investigation and to recommend that the issuer take appropriate action. We believe that Section 205.3(d)(1) should be revised to exclude from its application an attorney reporting evidence of a material violation to the CLO when the CLO has referred the report to the QLCC. This modification provides consistency within the rule such that either route to the QLCC ends the obligation of the reporting attorney and is appropriate since, in either case, the QLCC will ultimately have the same responsibilities with respect to investigating any report and recommending appropriate action by the issuer.
2. Proposed § 205.3(d)(1)(iii)(A): Limit the Scope of an Attorney's Obligation to Withdraw
The Commission has specifically requested comments on the scope of the withdrawal to be required of a reporting attorney who has not received an "appropriate response." We believe that an unlimited withdrawal obligation would be unreasonable and unduly disruptive to companies that retain law firms to handle a diverse array of matters, many of which are unrelated to the securities laws, fiduciary duties or similar laws. In particular, many companies have determined that they benefit - in terms of quality of the representation, service and cost - by utilizing the services of a small number of law firms rather than spreading the work across numerous firms. If a reporting attorney's law firm is required to withdraw from all matters in which it represents the issuer, a significant portion of the issuer's legal work could come to a standstill and cause irreparable harm to the issuer and its shareholders. The resulting burden on issuers, in terms of both the time and expense required to hire successor counsel for numerous matters, for such counsel to sufficiently transition in so as to effectively represent the issuer and to deal with the consequences of the attendant delays, would be enormous if not ruinous.
We believe an appropriate limitation on the scope of the attorney's withdrawal obligation is to require withdrawal only with respect to (i) the matter to which the evidence of a material violation relates (if the reporting attorney is working on such matter) and (ii) matters on which the reporting attorney is appearing and practicing before the Commission in the representation of the issuer other than representations involving Commission administrative proceedings, investigations, inquiries, information requests or subpoenas. Accordingly, the withdrawal obligation would not apply to other matters on which the law firm is representing the issuer.
3. Proposed § 205.3(e): Permit an Issuer to Not Disclose an Attorney's Written Notice of Withdrawal Under Certain Circumstances
Under the Final Rules attorneys are required to make judgments regarding whether they have become aware of evidence of a material violation and whether the issuer has provided an appropriate response within a reasonable period of time. The Alternative Proposal would require further judgment as to whether withdrawal is required. Each of these judgments must be made by the attorney at the risk of being second-guessed by the Commission. As a result, an attorney fearing that a mistake could jeopardize his or her career or professional reputation may err in the direction viewed as less likely to result in Commission action against the attorney. Such defensive thinking - at odds with the attorney's ethical obligation to put his or her client's interests first - may result in a reporting attorney "jumping the gun" on withdrawal by not providing for a reasonable amount of time to allow an issuer to develop an appropriate response. In light of these significant concerns, issuers need the protection of a "back-stop" to address situations in which attorneys act unreasonably or hastily.
In response to the Commission's specific request for comment, for the reasons stated above, we believe the rules should permit an issuer to not disclose an attorney's written notice of withdrawal where a committee of independent directors determines, based on the advice of counsel not involved in the matters underlying the reported material violation, that (i) the attorney providing such written notice acted unreasonably in providing such notice or (ii) the issuer has, subsequent to such written notice, implemented an appropriate response.
4. Proposed § 205.3(f): Prohibit a Reporting Attorney from Informing the Commission that the Attorney has Provided Notice of Withdrawal in the Event the Issuer is Permitted to Not Disclose Such Notice
As a corollary to the Commission's request for comment described in the immediately preceding paragraph, the Commission requested comment on whether the attorney should be permitted to inform the Commission that he or she has withdrawn when the issuer's committee of independent directors finds appropriate circumstances to relieve the issuer of its disclosure obligation. Because a reporting attorney's notification to the Commission, even if done confidentially, will likely set off a series of events, including an investigation by the Commission, which inevitably will require the issuer to expend significant resources and time, and ultimately may require public disclosure that may unnecessarily sully the reputation of the issuer, the protection against an attorney acting unreasonably or hastily is incomplete without the ability to prohibit the attorney from notifying the Commission. If an attorney acting unreasonably or hastily could withdraw and, notwithstanding an appropriate finding by a committee of independent directors, ultimately cause serious injury to the client's reputation and to investors by creating the false impression that a material violation is ongoing or about to occur, the proposed revision to Section 205.3(e) described above would be of little benefit. Accordingly, in the event a committee of independent directors determines, based on the advice of counsel not involved in the relevant matters, that the attorney providing such written notice acted unreasonably in providing the notice or the issuer has subsequently implemented an appropriate response, the issuer must have the ability to provide written notice to the reporting attorney of the committee's determination, which should then preclude the reporting attorney from informing the Commission of his or her notice of withdrawal.
Additional Recommendations for Specific Changes to the Noisy Withdrawal Proposal
As stated above, we believe the Commission has achieved the goals of Section 307 of the Act without adopting either the Noisy Withdrawal Proposal or the Alternative Proposal. If the Commission nevertheless decides to adopt the Noisy Withdrawal Proposal, we again direct the Commission to the comments contained in our letter to the Commission, dated December 16, 2002, and we recommend the following additional modifications.
1. Proposed § 205.3(d)(1): Increase the Evidentiary Threshold for Noisy Withdrawal
Although we believe a noisy withdrawal requirement to be detrimental to investors and unnecessary to achieve the Congressional aim of Section 307, should the Commission adopt the Noisy Withdrawal Proposal, noisy withdrawal should be required only when the reporting attorney reasonably concludes that there is substantial evidence of a material violation that is ongoing or is about to occur and is likely to cause substantial injury to the financial interest or property of the issuer or of investors (i.e., the threshold for withdrawal under the Alternative Proposal).
We believe that this heightened trigger for noisy withdrawal achieves a more appropriate balance, given the importance of the attorney-client relationship and the detrimental effect "noisy withdrawal" will have on that relationship. Modifying the trigger from an attorney "becoming aware of evidence" to "concluding that there is substantial evidence" of a material violation provides a greater safeguard against intrusion into the attorney-client relationship.
2. Proposed § 205.3(d)(1): Exclude a Reporting Attorney When the CLO Refers the Report of Evidence of a Material Violation to the QLCC
As described above in connection with the Alternative Proposal, we believe once a report of evidence of a material violation has been referred to the QLCC, whether reported directly by the reporting attorney or referred by the CLO, the reporting attorney should be relieved of any further obligation under Part 205. In either situation, the QLCC has the same responsibility to initiate an investigation and recommend appropriate action. Thus, Section 205.3(d)(1) should be revised accordingly.
3. Proposed § 205.3(d)(1)(i)(A): Limit the Scope of an Attorney's Obligation to Withdraw
As discussed above in connection with the Alternative Proposal, we believe that the scope of the attorney's obligation to withdraw should be limited to certain prescribed matters. As stated above, we believe that withdrawal from all matters on which a law firm represents an issuer is unduly burdensome and disruptive, particularly given the time and expense of hiring successor counsel. Accordingly, we would propose that withdrawal be limited to (i) the matter to which the evidence of a material violation relates (if the reporting attorney is working on such matter) and (ii) matters on which the reporting attorney is appearing and practicing before the Commission in the representation of the issuer other than representations involving Commission administrative proceedings, investigations, inquiries, information requests or subpoenas.
4. Proposed § 205.3(d): Relieve Attorneys of the Withdrawal Obligation Where the Attorney Is Prohibited from Doing So by a Court or Other Authority
Should the Commission adopt the Noisy Withdrawal Proposal, we believe it would be appropriate to incorporate therein a provision similar to Section 205.3(d)(2) of the Alternative Proposal. Such a provision affords attorneys the necessary protection when a withdrawal obligation under Part 205 conflicts with an order of a court or other authority with jurisdiction over the attorney prohibiting withdrawal.
Additional Recommendations for Specific Changes to the Final Rules
The Commission has requested comments on the Final Rules in connection with the potential adoption of either of the proposals. In response to that request, set forth below are suggested revisions to the Final Rules.
1. Adopted § 205.3(c)(2): Specifically Provide That, in the Event the CLO Refers a Report of Evidence of a Material Violation to the QLCC, the Reporting Attorney Has Satisfied His or Her Obligations Under Part 205
Section 205.3(c)(1) provides that an attorney who reports evidence of a material violation to the QLCC has satisfied his or her obligations under Part 205. We believe that Section 205.3(c)(2) should be modified, consistent with Section 205.3(c)(1), to provide that the reporting attorney has satisfied his or her obligations under Part 205 in the event the CLO refers a report of evidence of material violation to the QLCC. As described above, a report that has been referred to the QLCC, regardless of whether it is made directly by a reporting attorney or indirectly via a referral from the CLO, has arrived at a committee of independent directors authorized to initiate an investigation of the report of evidence of a material violation and to recommend appropriate action. As a result, in either case, the reporting attorney should be relieved of any obligation to assess the issuer's response, report up the ladder and, potentially, withdraw from the representation.
2. Adopted § 205.3(b)(7): Expand Its Applicability So That an Attorney Investigating or Asserting a Colorable Defense is Relieved From His or Her Reporting Obligation if Retained by the Audit Committee or the Full Board
The Final Rules provide an attorney relief from his or her reporting obligation in connection with evidence of a material violation if such attorney is retained by the CLO (who must then report to the audit committee or full board) or the QLCC to investigate a report of evidence of a material violation or to assert, if one exists, a colorable defense thereto. However, the Final Rules fail to address the scenario in which such attorney is retained by the audit (or other) committee or the full board (either following a report "up the ladder" or following an initial report that bypasses the CLO and CEO because the attorney believes reporting to such persons would be futile) to investigate or assert a colorable defense to evidence of a material violation. We believe that the same rationale that resulted in the adoption of Sections 205.3(b)(6) and (b)(7) applies equally to the audit (or other) committee and the full board. Accordingly, we recommend expanding Section 205.3(b)(7) so that it applies to an attorney retained by the QLCC, the audit (or other) committee or by the full board.
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We appreciate this opportunity to comment on the Commission's Alternative Proposal, Noisy Withdrawal Proposal and Final Rules, and would be most pleased to discuss any questions the Commission or its Staff may have with respect to this letter. Any such questions may be directed to Peter Allan Atkins (212-735-3700), Colleen P. Mahoney (202-371-7900) or Michael P. Rogan (202-371-7550).
cc: Hon. William H. Donaldson, Chairman