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Despite a crisis of leadership at the Securities and Exchange Commission, the agency managed to press forward last week with a controversial array of new rules that could have a dramatic impact on corporate lawyers across the United States and overseas. At a public meeting on Nov. 6, the SEC agreed on the set of proposed requirements for attorneys “appearing and practicing” before the agency. The night before, SEC Chairman Harvey Pitt, facing growing criticism for his handling of appointments to a new accounting oversight board, announced his resignation. For the time being, Pitt remains on the commission and was an active participant at the Nov. 6 meeting. Private securities lawyers and in-house counsel sharply criticized the proposals as unwieldy and intrusive, and argued that they threaten to transform legal advisers into a de facto securities police force. At the same time, advocates who had urged Congress to demand the new guidelines expressed dismay at the SEC’s proposals and said they appear weaker than lawmakers intended. The proposed rules are mandated, in part, by the Sarbanes-Oxley Act of 2002, which calls for the SEC to finalize the rules by January 2003. In the wake of allegations that in-house and outside lawyers turned a blind eye toward securities law violations at companies like the Enron Corp., the corporate reform statute aims to force attorneys to alert a corporate client’s senior management, and ultimately its board, to evidence of wrongdoing. At press time, the embattled commission had not yet released the full text of the proposed rules. But after a lengthy discussion of the rules at last week’s commission meeting, which was followed by a dense four-page summary of the proposals, critics hastened to attack them, and began gearing up to make their cases during a month-long public comment period. The American Bar Association, which resisted the provision of the Sarbanes-Oxley Act that calls for the new attorney regulations, formed a new task force last week to tackle the issue. ABA President Alfred Carlton Jr., who says he met with Pitt a few weeks ago to discuss the proposed rules, will chair the new group. The American Corporate Counsel Association, which counts several thousand in-house lawyers as members, is also preparing to comment on the SEC’s proposals. And the largest legal malpractice insurer in the country, the Attorneys’ Liability Assurance Society, or ALAS, was expected to weigh in as well. The insurer, which boasts some 250 law firms as members, has retained George Washington University Law School professor Thomas Morgan, a well-known legal ethics expert. Morgan participated in an Oct. 31 telephone conference of ALAS members that was devoted to the forthcoming SEC regulations. “We’re already very much aware [of the SEC's proposals] and involved,” says ALAS board member and Steptoe & Johnson D.C. partner John McLaughlin. As the rules are currently conceived, he warns, there’s no question that “lawyers are going to be subject to greater liability.” REPORTING REQUIREMENT The SEC’s summary of the proposed rules makes clear that the commission has opted to cover more territory than Sarbanes-Oxley specifically requires. The statute directs the agency to draft a regulation that forces attorneys to report “evidence” of wrongdoing at a client-company up the corporate ladder, and ultimately to the company’s board if management “does not appropriately respond.” The SEC’s proposals appear to flesh out that reporting requirement, most notably by specifying that it is triggered when an attorney “reasonably believes” that a “material violation has occurred, is occurring, or is about to occur.” But the agency’s proposals also include several controversial features not addressed by Sarbanes-Oxley, including a “noisy withdrawal” requirement and a duty to disavow attorney work-product under certain circumstances. According to the SEC’s summary, an attorney who takes evidence of misconduct all the way up to a client-company’s board, but still gets no meaningful resolution, may in some cases be required to withdraw from the representation and alert the SEC to that fact. An attorney in that scenario may also be required to “disaffirm a submission to the Commission” that the attorney “reasonably believes” is “tainted” by the underlying client misconduct, according to the SEC. In effect, securities lawyers and ethics experts say, this amounts to federal whistle-blowing requirement for corporate lawyers. “This has the potential to fundamentally change the relationship between lawyers and clients,” says Gibson Dunn & Crutcher D.C. securities partner John Sturc, a former deputy director of the SEC’s Enforcement Division. “It turns a lawyer from an adviser into a policeperson.” The agency also proposes to “allow” an attorney to disclose confidential client information to the SEC in some instances, such as “to prevent the commission of an illegal act which the attorney reasonably believes” will result in “fraud upon the Commission,” according to the agency’s summary of the proposed rules. Legal ethics rules in many states now permit lawyers to violate client confidences in order to thwart a client’s would-be fraud. But a few jurisdictions, including California and the District of Columbia, do not. For a lawyer in these strict jurisdictions, would the SEC rule trump local ethics canons? Legal ethicists say they’re unsure. “It appears that an attorney may be either required or permitted under this rule to do things he or she may very well be prohibited from doing” in some jurisdictions, observes Williams & Connolly partner John Villa, an expert in legal malpractice. “Does the SEC intend to pre-empt state law here?” ‘REASONABLE BELIEF’ Champions of the original Sarbanes-Oxley provision on lawyers focused on a threshold question: When would a lawyer need to report a client’s wrongdoing? As described by the SEC, the proposed rules would require an attorney to act when the lawyer formed a “reasonable belief” that misconduct was afoot. Two law professors who were key proponents of the Senate amendment that ultimately led to the Sarbanes-Oxley provision on lawyers say that “reasonable belief” standard threatens to undermine the entire provision. Professor Richard Painter, an expert on securities law and legal ethics at the University of Illinois College of Law, says that while other aspects of the proposed rules seem to go in “the right direction,” this trigger is “extremely vague, quite low, and very subjective.” Indeed, Painter suggests, it “arguably conflicts with the statutory language.” “It’s up to the board of directors to decide” whether evidence of misconduct amounts to a serious violation of the securities laws, Painter says. The purpose of the Sarbanes-Oxley provision is to compel lawyers who run across suspicious conduct to alert the board and, thereby, prevent unscrupulous managers from concealing fraud or trickery, Painter adds. “For the lawyer to make that judgment call, while under pressure from the client, doesn’t comport with the statute. It should be the client who gets to decide,” Painter says. Susan Koniak, a legal ethicist and Boston University Law School professor, made the point more strenuously. The reasonable belief standard “guts the provision,” Koniak says. “It makes an excuse for lawyers to never report anything. If the ABA was smart, they’d keep their mouths shut, because this looks great, but means nothing.” Some securities lawyers, meanwhile, tentatively endorsed the “reasonable belief” language. “It looks like [the SEC has] made it clear that you don’t have evidence of a material violation unless you’ve reached a conclusion” on the subject, says Dixie Johnson, who heads up the securities team in the D.C. office of Fried, Frank, Harris, Shriver & Jacobson. “That clarity is very helpful.” ABA President Carlton, however, acknowledges that his corporate governance task force now faces “resistance” to the reasonable belief standard, which had first been proposed by an ABA report earlier this year. “Some folks who’ve testified” before the ABA on the topic contend that “actual knowledge” of a violation is a more workable standard, Carlton says. It was unclear what standard the ABA will recommend in comments to the SEC. At press time, it appeared that the SEC’s Office of General Counsel, which is responsible for the proposed regulations, was still fine-tuning the new rules. Deputy General Counsel Meyer Eisenberg says the standard in the proposed rule is “not meant to be subjective.” “People should wait until the final rule text is out before raising concerns about it,” he adds. “Clearly the comment period is an opportunity to comment further.” WHAT CONSEQUENCES? Beyond the technical questions about the new rules, veteran securities lawyers, former SEC officials, and legal malpractice experts agreed that the SEC’s rule making represents a dramatic step in the history of the regulation of the legal profession. But these observers differed as to the consequences of that step. Villa, the Williams & Connolly partner, suggests that “we are making a fundamental shift” in the way lawyers are expected to function in society “without really thinking about it.” Historically, he notes, ethics rules have been designed and enforced with an eye toward “prohibiting lawyers from getting involved in misconduct, not prohibiting clients from committing misconduct.” Sarbanes-Oxley, and the SEC’s proposed rules under that law, appear aimed at legislatively enlisting lawyers in the project of reining in corporate skulduggery, Villa says. “What are the costs of that shift?” Villa asks. “And what are the benefits?” At the same time, Ralph Ferrara, a senior D.C. partner at Debevoise & Plimpton and a former SEC general counsel, urges his colleagues in the bar to accede to the broader needs of the U.S. market. “We are a nation in crisis. American corporations are in crisis,” Ferrara says. “At this point in history, lawyers and accountants have to step up to lend credibility” to Corporate America. “This is not the time for the bar to be parochial.”
Sarbanes-Oxley Act of 2002: What Lawyers Need to Know

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