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While once-venerable retailer Spiegel Inc. spent the beginning of 2004 selling off stores and reorganizing under bankruptcy, corporate counsel were wondering what impact the company’s crash would have on proposed Securities and Exchange Commission rules for “noisy withdrawal.” What should in-house and outside lawyers do when, as in the Spiegel case, a company ignores counsel’s advice and potentially violates the law? Should the attorneys quit? The report of an independent examiner appointed by the U.S. District Court in Chicago suggests that maybe this should have happened at Spiegel. The Downers Grove, Ill.-based company went into a financial tailspin in 2000 and hit bottom last March, when it filed for Chapter 11 bankruptcy. Throughout 2002 Spiegel’s top U.S. management � including GC Robert Sorensen � urged the company to file required 8-K and 10-K reports with the SEC. But Spiegel’s Germany-based owner, Michael Otto, refused because he did not want to reveal the company’s shaky financial footing, according to the examiner’s report. Spiegel went 15 months without filing SEC-required disclosures, leaving its investors, vendors, and creditors in the dark. The SEC filed a civil action against Spiegel in U.S. District Court on March 7, 2003, alleging failure to file periodic reports and failure to disclose its auditors’ doubts about whether the business could remain a “going concern.” Spiegel filed for bankruptcy 10 days later. Spiegel declined through a spokesperson to comment, as did the SEC’s Chicago office, which heads the investigation. But there is plenty of comment about what happened and why in the Sept. 12 report of the independent examiner, Stephen Crimmins. It details repeated efforts by GC Sorensen and outside counsel, Chicago-based Kirkland & Ellis, to get the company to comply with SEC rules. In the 215-page report, Crimmins srites, “By mid-May 2002, Kirkland & Ellis had plainly advised Spiegel that it was violating the law by not filing its Form 10-K, and that this illegal act could have serious consequences, including action by the SEC. Sorensen plainly concurred in this advice.” Crimmins, a partner in the Washington, D.C., office of Pepper Hamilton, declined to comment for this article. On May 30, Spiegel’s Chicago management team held an “emotional meeting,” according to the Crimmins report, at which Sorensen “laid out the consequences of nonfiling, including possible criminal prosecution, and was very clear in describing the consequences.” Later that day, management sent a memo to Otto and the board in Germany, warning that Nasdaq was going to de-list Spiegel, and “that there was now a significant risk of an SEC action based on Nasdaq’s determination that Spiegel acted with ‘willful disregard’ in not filing its Form 10-K.” Sorensen also faxed the memo to Carter Emerson at Kirkland & Ellis, with the comment that Spiegel management was “fully prepared to file financial statements today at the risk of being fired, or to be forced to resign in the face of a direct order from the chairman of the board to continue with this unlawful behavior,” the Crimmins report says. But on May 31, Otto and the Spiegel board decided not to file the SEC forms, and the management team did not resign. As the Crimmins report notes, “Kirkland & Ellis and Sorensen reported ‘up the ladder’ to Spiegel’s audit committee and its board committee. However, this was a case where reporting ‘up the ladder’ was not enough. The advice from the lawyers here was rejected by Spiegel’s audit and board committees, and the material information that should have reached investors was kept under wraps.” After May 31, Spiegel’s German directors considered Kirkland & Ellis and Sorensen to be “black painters” � a German phrase meaning pessimists who exaggerate the seriousness of a situation. During that summer, Otto considered replacing Kirkland & Ellis and Sorensen, according to the report, but U.S. management convinced him not to do so in midcrisis. USEFUL LESSONS Stanley Keller, a veteran securities lawyer not connected with the case, says the Crimmins report offers useful lessons for in-house attorneys. “Lawyers need to think harder about when to go over the heads of the board to the public, to the shareholders, and to the SEC.” Keller, a partner at Boston’s Palmer & Dodge and former chair of the American Bar Association committee on federal regulation of securities, asks, “At what point do lawyers need to step out of the situation and realize their efforts are futile?” Keller notes that most state ethics rules now permit a lawyer to disclose executives’ illegal behavior to protect the company. But he declines to “second-guess” Spiegel’s attorneys and points out that the company’s problems began before the adoption of the Sarbanes-Oxley Act of 2002, which requires up-the-ladder reporting. The Crimmins report suggests a need for the so-called noisy withdrawal rule, now being considered by the SEC. It states: “None of Spiegel’s legal advisers withdrew � ‘noisily’ or otherwise � from representing Spiegel. If the SEC’s proposed withdrawal rule had then been in effect, the SEC would have been alerted to take action sooner, and investors would have received information they could have acted on to make informed investment decisions about Spiegel. . . . The absence of a ‘noisy withdrawal’ requirement allowed Spiegel to keep investors and the SEC in the dark.” Richard Painter, a law professor at the University of Illinois and one of the leading academic proponents of Sarbanes-Oxley, says the Spiegel case does not point to an absolute need for a noisy withdrawal rule. Situations where the full board is notified of a problem and still refuses to act are “very rare,” he notes. But he adds, “At a minimum, [Spiegel's problem] makes the case for lawyers to resign under existing ethics rules . . . or expose [themselves] to civil suits and other problems.” Sorensen and other Spiegel executives in Chicago potentially face just these sorts of problems. They have hired Theodore Sonde, of Washington, D.C.’s Crowell & Moring and a former associate director of the SEC’s Enforcement Division, to help them respond to the SEC investigation. Sonde argues that a noisy withdrawal rule “could have been helpful” to Sorensen and Kirkland & Ellis, although he doesn’t think it’s necessarily the best way to avert situations like Spiegel’s. Sonde adds that every one of his clients from Spiegel wanted to inform the SEC about the German owner’s refusal to file. What about the outside counsel? Kirkland & Ellis has retained Simon Lorne, a partner at Munger, Tolles & Olson and a former GC of the SEC. He argues that noisy withdrawal would not have given the SEC any more notice of what was wrong at Spiegel than it already had when Spiegel did not file its Form 10-K. The lesson for companies, says Lorne, is that when “outside counsel gives the right advice, if that advice isn’t followed, you are going to be in a very difficult situation. And the general counsel doesn’t always have the power” to see that the advice is followed. Sue Reisinger is a free-lance journalist and lawyer based in East Hampton, N.Y. This article first appeared in the March 2004 issue of the American Lawyer Media magazine Corporate Counsel.

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