Emerson Electric Co.
April 7, 2003
Jonathan G. Katz
RE: Comments on the Proposed Rule: Implementation of Standards of Professional
Dear Mr. Katz:
I am Senior Vice President, Secretary and General Counsel of Emerson Electric Co. I am writing to provide the Commission with my comments on its Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys, Release Nos. 33-8186; 34-47282; IC-2920; File No. S7-45-02 (the "Proposed Rule"), wherein the Commission (i) extended the comment period regarding the "noisy withdrawal" and "disaffirmance" provisions previously proposed in Release Nos. 33-8150; 34-46868; IC-25829 (the "Proposing Release") and (ii) solicited comments on its alternative proposal to require an issuer who has received notice of withdrawal from its attorney to report the notice and the circumstances related thereto to the Commission (the "Alternative Proposal" and, together with the Proposed Rule, the "Proposals"). By previous correspondence dated December 18, 2002, I provided the Commission with my comments on the Proposing Release.
As indicated in my December 18th letter, I support the goals of the Sarbanes-Oxley Act of 2002 (the "Act") to enhance corporate responsibility and to protect investors by improving the accuracy and reliability of corporate disclosures under the securities laws. The "up-the-ladder" reporting provisions adopted in the Commission's Final Rule: Release Nos. 33-8185; 34-47276; IC-25919 (the "Final Rule") will further these goals. As I stated in that letter, however, I am firmly opposed to the Proposed Rule's noisy withdrawal and disaffirmance provisions; I am likewise opposed to the Alternative Proposal for similar reasons, which I summarize as follows:
Accordingly, I respectfully urge the Commission not to adopt either the Proposed Rule or the Alternative Proposal. The above points are discussed in more detail below.
1. Neither of the Proposals is explicitly or implicitly required or authorized by Section 307 of the Act or any other provision of the Act.
While Section 307 of the Act directs the Commission to issue rules setting forth minimum standards of professional conduct for attorneys practicing before the Commission that were to specifically include the up-the-ladder reporting requirement (which, alone, would not intrude upon the attorney-client relationship and, indeed, is imposed by most state ethics rules), nothing in the Act requires or authorizes any intrusion by the Commission on the attorney-client privilege or the adoption by the Commission of any attorney withdrawal or external reporting requirement.
The legislative history of the Act clearly indicates that Congress did not intend there to be any external reporting requirement, whether by the Proposed Rule's noisy withdrawal and disaffirmance requirement, the Alternative Proposal, or otherwise. In fact, nothing in the Act's legislative history gives any indication that a single member of either the House or the Senate even considered requiring noisy withdrawal or external reporting as contemplated by the Proposals. To the contrary, during Senate discussion on Senator John Edwards' amendment that would eventually become Section 307 of the Act, the following on-the-record discussion took place between Senator Edwards and Senator Paul Sarbanes (the chief Senate sponsor of the Act):
Senator Sarbanes: It is my understanding that this amendment, which places responsibility upon the lawyer for the corporation to report up-the-ladder, only involves going up within the corporate structure. He doesn't go outside of the corporate structure. So the lawyer would first go to the Chief Legal Officer or the Chief Executive Officer, and if he didn't get an appropriate response, he would go to the Board of Directors. Is that correct?
It is a fundamental precept that a federal administrative agency such as the Commission may not exercise authority that has not been properly delegated to it by Congress. See, for example, L.A. Pub. Serv. Commission v. F.C.C., 476 U.S. 355, 374 (1986) ("a federal agency may pre-empt state law only when and if it is acting within the scope of its congressionally delegated authority" and "may not confer power upon itself"); see also Ernst & Ernst v. Hochfelder, 425 U.S. 185, 214 (1976) ("the rulemaking power granted to an administrative agency charged with the administration of a federal statute is not the power to make law. Rather, it is `the power to adopt regulations to carry into effect the will of Congress as expressed by the statute.'" [internal citations omitted]).
Furthermore, Section 3(a) of the Act merely authorizes the Commission to adopt rules that are in furtherance of the Act, not rules that were not intended by Congress in enacting the statute and that find no support in it. Because it is well settled that the Commission does not have the power to make law absent clear authority delegated by Congress, the Commission lacks the statutory authority to adopt either the noisy withdrawal/disaffirmance requirement of the Proposed Rule or the Alternative Proposal.
2. The Commission would clearly exceed its authority in purporting to have either of the Proposals preempt long-established state laws and court rules governing the attorney-client privilege, attorney professional responsibility and the attorney-client relationship.
All aspects of the attorney-client relationship, including the attorney-client privilege, are already subject to a comprehensive system of evidentiary and professional responsibility rules. These are established primarily at the state level, generally under the direction of the highest court of each state. They are based upon the fundamental and well-tested principles that the prerequisite to effective legal representation is full and frank disclosure by the client to his lawyer, and that the client will be reluctant to make such disclosure if he is not assured that his confidences will be protected. See Fisher v. U.S., 425 U.S. 391, 403 (1976).
It is well settled that the Commission's authority is not to be interpreted expansively by the courts where such an interpretation would infringe upon well-established and comprehensive state regulatory schemes that Congress has not seen fit to preempt. See, for example, SEC v. Variable Annuity Life Insurance Company of America, 359 U.S. 65, 68 (1959) (in addressing the Commission's authority to regulate annuity contracts, the U.S. Supreme Court proceeded with a "reluctance to disturb the state regulatory schemes that are in actual affect"); see also, United States v. Locke, 529 U.S. 89, 108 (2000) (the Supreme Court will defer to traditionally established state regulatory schemes when analyzing federal preemption issues, holding that where "Congress legislated...in a field which the States have traditionally occupied", the Court "start[s] with the assumption that the historic police powers of the States were not to be superseded by the Federal Act unless that was the clear and manifest purpose of Congress " [emphasis added], quoting Rice v. Santa Fe Elevator Corp., 331 U.S. 218, 230 (1947)).
Given the absence of any manifest purpose of Congress to go beyond up-the-ladder reporting requirements-indeed, given the Act's legislative history expressly to the contrary-there is no reason to believe that courts would defer to either of the Proposals and hold that an issuer's or its attorney's notice to the Commission of the attorney's withdrawal and, as applicable, the circumstances related thereto, do not constitute a waiver or negation of the attorney-client privilege. For the same reason, compliance with the noisy withdrawal and disaffirmance requirement of the Proposed Rule could expose attorneys to civil liability and state bar disciplinary actions for violation of client confidences, putting them in the untenable position of being in violation of someone's professional responsibility rules no matter which course of action they take. It is also difficult to believe that courts would themselves penalize, or allow the Commission to sanction, issuers for refusing to follow the Alternative Proposal and to waive their right to assert the attorney-client privilege.
3. Compliance with either of the Proposals would vitiate the attorney-client privilege and chill the relationship of trust and confidence between issuers and their counsel, thus providing a strong disincentive for issuers to consult with counsel for assistance in complying with the securities laws and degrading the overall quality of disclosure.
For example, if an issuer were to disagree in good faith with its attorney's advice concerning compliance with the securities laws-and even if it were to obtain a reasoned second opinion countering such advice-it would have to anticipate the attorney's withdrawing from the representation for fear of violating the Commission's professional responsibility rules. Whether the attorney would then be compelled to notify the Commission of his/her withdrawal and disaffirmation, or whether the issuer itself would be compelled to notify the Commission of the withdrawal and related circumstances under the Alternative Proposal, the practical effect would be the same: the conscription of the attorney into the Commission's enforcement arm and a consequent Commission investigation of the issuer-even if there is in fact no underlying securities law violation.
The Alternative Proposal would have an even more drastic effect: by obligating the issuer to report its attorney's notice of withdrawal and related circumstances on Form 8-K, 20-F or 40-F within two business days of receipt of such notice, the specter of a material securities law violation-even though unfounded-would be raised with the investing public, with potentially devastating consequences to the issuer's share price and the interests of its shareholders. Eliminating the requirement that the issuer report the circumstances related to the withdrawal would not ameliorate this effect; merely reporting the fact of the attorney's withdrawal would put immense pressure on the issuer to disclose the circumstances in any event.
Confronted by such prospects, issuers likely would be reluctant to consult with their counsel on complex securities law compliance issues-the very issues on which they most need competent advice and assistance. It is likewise not difficult to predict that outside counsel (reinforced by their malpractice insurers) would be reluctant to provide advice on such issues, for fear of being drawn into an ethical quagmire.
4. Compliance with either of the Proposals would effectively deny issuers due process of law under the Fifth Amendment to the U.S. Constitution by depriving them of their right to counsel.
I incorporate by reference the comments on this point that I made in my December 18th letter.
5. Investors will still be adequately protected if neither of the Proposals is adopted, and this is implicitly acknowledged in certain applications of the Proposed Rule.
One of the fundamental changes wrought by the Act-and reflected in the Final Rule-is the enhancement of the authority and responsibilities of issuer audit committees. The audit committee, with its independent members, will now be solely responsible, among other things, for preapproval of audit and non-audit services provided by the issuer's public accounting firm; appointment, compensation and oversight of the work of such firm; receipt of reports from such firm; and receiving reports from attorneys going "up the ladder" with evidence of a material violation of the securities laws. These changes indicate Congress' confidence that the audit committee will be uniquely positioned within a corporate issuer to ensure compliance with the securities laws, and that the audit committee is therefore best suited to protect the interests of investors. I question, therefore, why the Commission would deem it necessary to impose withdrawal and external reporting requirements on attorneys, or on issuers effectively reporting on behalf of their attorneys.
In fact, certain provisions of the Proposed Rule are inconsistent with the notion that external reporting requirements are necessary to protect investors' interests. Under section 205.3(d) of the Proposed Rule, an attorney who has not received an appropriate response in a reasonable time to his report of evidence of an ongoing or impending material violation, is obligated to make a noisy withdrawal and/or disaffirmance to the Commission only if he has previously reported "up the ladder" to the audit committee or the full board of directors. He is not so obligated if he has reported to the issuer's qualified legal compliance committee ("QLCC"), and in such case has no further obligation to report or to assess the issuer's response. The same inconsistency arises in section 205.3(e) of the Alternative Proposal: the issuer must report the attorney's notice of withdrawal and the related circumstances only if the attorney has reported "up the ladder" to the audit committee or the full board, not if he has reported to the QLCC.
Given the fact that an audit committee can constitute a QLCC pursuant to section 205.2(k) of the Final Rule, one can only conclude from the foregoing inconsistencies that the audit committee-or its QLCC analog-provides the necessary and adequate means of safeguarding investors' interests without external reporting requirements, which, indeed, will cause more harm than good to those interests.
For the reasons discussed herein and in my December 18th letter, I respectfully urge the Commission to withdraw both Proposals. I appreciate the opportunity to comment on this important matter. Should the Commission have any questions regarding my comments, please do not hesitate to contact me.