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A recent investigation of Spiegel Inc. by the Securities and Exchange Commission has revealed how the retail company fraudulently withheld negative financial information to hide the company’s ongoing financial and other problems. While Spiegel’s legal counsel, Kirkland & Ellis, advised the company that it was violating the law, the law firm did not withdraw as legal counsel when the company refused to change its practices. Instead, Kirkland continued to file reports on Spiegel’s behalf � signing above the warning: “ATTENTION: Intentional misstatements or omissions of fact constitute federal criminal violations.” These revelations about Spiegel have fueled speculation that the SEC might again issue the so-called noisy withdrawal provision under the Sarbanes-Oxley Act. It shouldn’t. THE SOUND OF FURY Noisy withdrawal was originally part of the SEC’s effort to stop the type of insider auditing and accounting practices that made the Enron and WorldCom scandals possible. Under the requirement, any attorney appearing and practicing before the commission would have to report possible securities violations up the corporate organizational ladder. If “appropriate actions” were not taken to correct the identified problem, the lawyer would have to report the matter to the SEC. The SEC initially abandoned the proposal because of opposition by lawyers who, in satisfying the requirement, would be required to breach confidences protected by the attorney-client privilege. The lawyers were right � the remedy is the wrong cure for the persistent problem of corporate wrongdoing. The probability that such a measure would be successful is, at best, slight. And there is an alternative measure that would be more successful in incorporating lawyers in the solution while staying true to ethical principles and the attorney-client privilege. The noisy withdrawal provision is unworkable because it leaves too many judgment calls to the lawyer, with too many potentially disastrous consequences. For noisy withdrawal to work, the lawyer must be convinced that what has been revealed to him by his client is a “material violation” of securities laws. If so, he must report his conclusions of illegality up the corporate hierarchy, and wait a sufficient amount of time for corrective measures to be taken. Assuming that the corporation doesn’t simply fire the lawyer, he will have to evaluate the corrective measures the client takes. Should he decide that the measures taken are not “appropriate,” the lawyer must withdraw as legal counsel and notifyi the SEC. None of these steps is black and white in the varied contexts of the real world. And what if the lawyer is wrong? What if he reveals client confidences improperly? It would be professional suicide. What corporation would want to run the risk of employing such a loose cannon? Such a mistake would also be a breach of the attorney’s professional ethics, which could lead to suspension or disbarment. Further, lawyers have a principled reason for being so reluctant to tell the SEC about their clients’ possible misdeeds. The attorney-client privilege is premised on confidentiality. What the client says to the attorney is held in the strictest of confidence because that assurance of secrecy encourages the client to be open and candid. With more complete information at their disposal, lawyers are better able to advise clients, and clients, in turn, are better able to conform their conduct to the requirements of the law. A noisy withdrawal provision would require the lawyer to violate the very confidence that ensures the success of the privilege. This would incline management to withhold vital information from the attorney in those instances where it is most needed � the close cases where informed advice is crucial. Management would fear that counsel would become a government collaborator. The consequence, of course, would be that advice would be least effective in the situations where it is most needed. So on the one side of the noisy withdrawal proposal is a raft of ambiguous standards. And on the other are certain and disastrous consequences, should the lawyer ever make a mistake. How can the SEC think that very human lawyers could satisfy such a legal obligation � especially, as the Spiegel matter shows, when lawyers already have no compunction about acquiescing in misrepresentations, even under the threat of criminal sanctions. A BETTER WAY There is a better solution, one that builds on the strengths of the attorney-client privilege. A bit of basic corporate law helps explain how. Corporations are fictitious legal entities, composed not only of different individuals, but of individuals with different roles within the organization � directors, managers, employees, and shareholders. The managers and the board of directors � not the shareholders � are the organization’s legal personification, even though the shareholders are the owners. As a consequence, corporate management can deny shareholders access to privileged communications between the officers, directors, and corporate counsel. The directors and officers can justify their actions as methods to promote effective management by protecting themselves from needless interference. The right of management to deny shareholders access to these privileged communications, however, does have its limits. Because directors do not manage for themselves, but for the benefit of shareholders, they and corporate legal counsel owe a fiduciary duty to the shareholders. This was the foundation for the 5th Circuit’s famous 1970 opinion in Garner v. Wolfinbarger, in which a shareholder derivative action was instituted against the directors for their negligent mismanagement of corporate assets. The court held that the plaintiffs demonstrated good cause by the validity of the claim, the amount in controversy, and the percentage of shareholders bringing the action, so that the shareholders should have access to relevant corporate attorney-client communications. This precedent has been followed throughout the country in myriad contexts. It is this fiduciary duty, owed by corporate counsel to shareholders, that can be the source of an alternative to the noisy withdrawal proposal. Rather than requiring legal counsel to withdraw and violate the confidentiality of the attorney-client relationship, the SEC should require all publicly held corporations of a designated size and breadth of ownership to establish a “shadow board” made up only of shareholders who are not on the corporate board of directors � perhaps the corporation’s largest shareholders who are willing to serve. This shadow board’s sole function would be to give legal counsel a place to go within the corporate structure when efforts to correct wrongdoing are unsuccessful � a means of fulfilling his fiduciary duty to the corporation without violating his professional responsibilities. This solution holds the added benefit of involving those whom the SEC is primarily interested in protecting � shareholders � in the solution to their own problems, without airing the corporation’s laundry in public and destroying the value of their stock. They would be armed with the information necessary to take corrective measures, and would have the incentive to do so quickly and with the least harm to the corporation. Resort to the SEC and the power it wields would only be an option if the shareholders decided that it would be to their benefit. Another advantage to this plan would be counsel’s willingness to employ this option earlier, rather than later, because doing so is not in conflict with his professional responsibilities and is far less likely to lead to dire consequences if his assessments are inaccurate. It might be argued that the shadow board is unnecessary if corporations fulfill their obligation under the Sarbanes-Oxley law to ensure that half of the members of their boards of directors are independent. But the current structure does not offer enough protection. Most companies have been slow to comply with the act’s independence provisions. Also, in the clubby world of corporate boards, technical “independence” can be a fa�ade for business as usual. And most important to the point we are making, it fails to address the problem of noisy withdrawal as it affects the attorney-client privilege. It has been suggested that shareholders would not be willing to sit on such a board because of the potential liability they could incur if appropriate actions are not taken after having been given notice by legal counsel. If this prediction had any merit, shareholders would also be unwilling to serve on corporate boards of directors, whose members can be sued for negligent mismanagement of corporate assets. A look at the makeup of such boards shows that this has not proved to be true. Financial compensation, insurance, and indemnity agreements are designed to alleviate this concern. It has also been suggested that if such a shadow board were required, the first reaction of its members to corporate improprieties would be to dump their shares. Such a suggestion, however, is nonsense because members of such a “shadow board” would be bound by the same obligations as the members of the board of directors, not to trade on inside information. There is no reason to believe that this proposal holds any greater risks of insider trading than currently exists with other board members. A final objection to our plan might be that if the shadow board refuses to correct problems and also refuses to contact the SEC, then the lawyer will have no way to avoid work he sees as unethical or illegal. But this argument ignores the fact that lawyers always have the option to quit � even if, to respect client confidences, they must do so quietly. STRIKING A DECENT BALANCE The alternative shadow board proposal that we make is certainly not a solution to the problem of corporate wrongdoing. That magic pill does not exist. But our proposal does at least offer a workable opportunity for corporations to review their practices, as opposed to the essentially unworkable proposal of a noisy withdrawal. Our shadow board would strike a fair balance between meeting the needs of public investors to expose and correct corporate wrongdoing, the legal and economic realities facing corporations, and the ethical conflicts for and obligations of attorneys. It would a step in the right direction. Paul R. Rice is a professor of law at American University Washington College of Law and author of Attorney-Client Privilege in the United States (West Group 2nd ed. 1999). Peter C. White is a third-year law student and deans fellow to professor Rice.

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