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If you have questions about the Securities and Exchange Commission’s new proposals for regulations interpreting Section 307 of the Sarbanes-Oxley Act, you’re not alone. Since the American Corporate Counsel Association is in the midst of writing its comments to the SEC, I would like to share some of our conclusions and concerns. What are the regulations about? In the aftermath of Enron and similar debacles, Section 307 of the Sarbanes-Oxley Act is intended to make lawyers more accountable and professionally responsible for detecting, preventing, and, in some cases, reporting corporate financial wrongdoing. The legislation imposes a mandatory “up the ladder” reporting obligation if an attorney reasonably believes that a “material violation of securities law or breach of fiduciary duty or similar violation” has occurred, is occurring, or is about to occur. Under Section 307, the SEC is required to issue new attorney conduct rules for lawyers practicing or appearing before the SEC, which includes a major swath of the corporate bar. The recently released proposed regulations (at www.sec.gov/rules/proposed/33-8150.htm) go further than the legislation by suggesting that Section 307 reporting should not end at the board. In the event that management and the board do not act responsibly, the outside attorney must make a “noisy withdrawal” (which involves notifying the SEC of the withdrawal and disaffirming any “tainted” documents already filed there); and the in-house counsel must disaffirm any tainted documents, but is not required to resign. In neither case does the lawyer actually tell the SEC “my client is a crook,” but the reporting obligations will clearly trigger an SEC investigation and an almost insurmountable presumption of client wrongdoing. These notification and disaffirmation obligations are mandatory except when the evidence relates to a past violation or breach. In that case, they are voluntary. In the alternative, the proposed regulations would permit a lawyer to report a suspected violation to a Qualified Legal Compliance Committee, made up of one member of the company’s audit committee and two independent directors. This committee would handle the reporting requirements to the chief legal officer and/or the chief executive officer, the board, and any outsiders such as the SEC. This option would relieve the lawyer of the professional concerns raised by a “noisy withdrawal” since the responsible party for these actions now becomes the QLCC. Who’s subject to these new rules? If you’re in-house, it’s very possible that you will be subject to the rules even if you aren’t a securities lawyer. Section 307 applies to lawyers “appearing and practicing before the commission in any way in the representation of issuers,” which the SEC is interpreting very broadly. So if you work on a client matter that is relied upon in an SEC form filing, for instance, you could be covered by this rule even if you didn’t prepare the form or collect the information. Even foreign attorneys are subject to Section 307. The inclusion of so many practitioners under the SEC’s regulatory authority is a major bone of contention. What’s the buzz on the street? Everyone acknowledges that we need to do something post-Enron to restore public trust in corporations, and, more particularly, in corporate financial matters. The problem lies in understanding how, actually, to address the concerns that Enron raised about the role of lawyers. Frankly, it appears that the vast majority of post-Enron proposals are designed to give comfort to the public, but may have little practical impact on malfeasant clients — and may have a perversely deleterious effect on the ability of lawyers to prevent such debacles in the future. Most sophisticated in-house lawyers will tell you that the SEC proposals are not really that threatening. Many live in highly regulated worlds already, where the concepts of reporting up and out are well-established. Sarbanes-Oxley will not change the way they work with their management or legal staff. Indeed, most general counsel at larger companies are taking their cue from management and welcoming some of the changes in an effort to reinstill confidence in corporate America and stem the need for further legislative regulation. Because Enron-like debacles are not widespread problems, most assume they are unlikely to ever have to grapple with a situation that would give rise to the act’s reporting requirements. All the general counsel I know believe that their boards would respond to a legal concern when the board members know that ignoring the general counsel’s warning could trigger an SEC investigation. So what’s wrong with these proposed rules? Even if you don’t anticipate ever having to report under the rules, there are a few issues that you should understand. These regulations make policy changes that go beyond changing the practice of lawyers working with a few errant companies. They change the design of our ethics rules — as John Villa of Williams & Connolly puts it — from a focus on prohibiting lawyers from getting involved in or facilitating client misconduct to a focus on making lawyers responsible for rooting out client misconduct. The SEC’s proposals change this focus by offering a rather novel approach to the age-old in-houser’s question: Who is the client? The technical answer is the entity, but most in-house counsel know that the practical reality is that the entity works only through the actions of its management and board. They treat the management of the company as the day-to-day client, so long as the management stays within the law. If management acts inappropriately and will not change course, the lawyer reminds the manager in question that the client is actually the company, and the lawyer begins a climb up the ladder of authority seeking redress under Model Rule of Professional Conduct 1.13. If management is intransigent, the lawyer goes to the board. If the board does not take responsible action, then the in-house lawyer has to consult the rules in her state to understand what her options or mandates are. Under the current rules of professional conduct, in virtually every scenario, the lawyer would end up leaving the representation as a result of the client’s refusal to act appropriately. The SEC regulations, however, say that the entity’s best interests require the lawyer to report to the SEC, since the management and the board can’t represent the client’s interests if they are acting illegally. That argument may be intellectually appealing, but it suffers from a few pesky faults. If the board and management are no longer valid representatives of the client, who exactly is the lawyer reporting to and representing? It’s certainly not the SEC. In an era when stockholders can number in the millions, it is unreasonable and imprudent to assume that stockholders are the client. Stockholders are primarily interested in protecting the price of their shares — which is probably the last thing we want to encourage lawyers to facilitate. The SEC’s proposed regulations move in-house counsel away from their traditional roles and toward a role as the representative of the public’s larger interests — a policeman of sorts. While no one disputes that lawyers have public or civic responsibilities, it’s quite another thing to suggest that the lawyer’s client is the public. What about the attorney-client privilege, then? First, we have to remember the difference between confidentiality (which our profession requires us to maintain) and the attorney-client privilege (an evidentiary standard that prevents another party from gaining access to client confidences). The SEC argues that the attorney-client privilege will remain intact under its regulations since the lawyer will not have to divulge the client’s confidences. But it’s clear that an SEC investigation is forthcoming anytime a lawyer notifies the SEC that he’s withdrawing for professional reasons or anytime a lawyer disaffirms previous filings for unexplained reasons. While the lawyer may not waive the privilege in her initial report, it’s also foreseeable that she’ll soon be asked to do so as the process unfolds. The lawyer who made the judgment call to go to the SEC under these rules would be opening the floodgates to litigation and would likely be the subject of the first deposition requested. Remember that companies that don’t “cooperate” fully with government investigations are given demerit points under the Federal Sentencing Guidelines. Also remember that at the Department of Justice, the so-called Holder Memorandum encourages prosecutors to require corporate clients to waive the attorney-client privilege in order to be eligible to even consider settlement options. Finally, while “guilty” companies might deserve the treatment they receive as a result of these rules, there are times when a lawyer might be wrong about activities that she suspects are evidence of a material violation of securities laws or other fiduciary duties that could cause financial harm to third parties. There may be times when the management legitimately disagrees with the assessment of its lawyer. Think back to your first few years as a practitioner, when you saw almost every proposed corporate action as one that could potentially lead to a legal crisis. Under the SEC’s rules, the lawyer has the ultimate veto power over client actions, unless the company has created a QLCC. In the world of corporate financial dealings and risk assessment, it is dangerous for lawyers to be required to overrule their clients’ aggressive or risky (but legitimate) business judgments. How can a mere reporting requirement diminish the role of in-house lawyers as effective counselors? Unfortunately, in trying to address the problems raised by Enron, et al., the SEC is using the wrong tools and not considering other tools that might be more effective. To some degree, regulators are simply following the lead of Sarbanes-Oxley. On the other hand, the SEC’s proposals go further to alter professional rules than the law requires. Deputizing lawyers to act as remedial policemen diminishes the lawyer-client relationship. The SEC’s proposals could have the perverse effect of marginalizing the work of lawyers who could otherwise prevent crimes from arising. Instead, we should be looking for ways to increase the influence of lawyers as ethical leaders and compliance counselors who specialize in preventive law skills. Every corporate counsel knows that in order to practice preventive law, you have to be a welcome and respected participant in creating the corporate culture. There is no way that a lawyer can force himself into client activities where he’s not welcome or trusted and expect to hear anything important. How ineffective and excluded will in-house counsel be if placed in the role of deputy-on-the-spot for the SEC? When I came to work at ACCA, I learned what distinguishes the thousands of in-house lawyers from their outside counterparts: Their primary interest is keeping the client’s milk in the glass, rather than cleaning it up (or reporting it) after it’s been spilled. Preventive law practices are premised on the confidence of the client that the lawyer is an effective and trusted part of the corporate team. Post-Enron, a preventive focus should be twice as desirable for the public as the “too late” service of a lawyer who reports wrongdoing already done. We think it is misguided to focus so much attention on changing the Model Rules of Professional Conduct when we could be offering the means to achieve realistic and workable solutions that foreclose ethical lapses. ACCA’s attention will be focused on creating and disseminating compliance-based resources for corporate lawyers, helping them target the needs and preventive concerns of their clients. Susan Hackett is senior vice president and general counsel of the American Corporate Counsel Association. She can be reached at [email protected] ACCA’s comments to the SEC will be posted at www.acca.com by Dec. 18.

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