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Seven months after the passage of the Sarbanes-Oxley Act, attorneys report that they are adjusting to the realities of the new law and are creating systems within their firms to guide them through maze of demands. Under Section 307 of the law, outside counsel must report material violations of securities law that come to their attention. Regulations of the Securities and Exchange Commission (SEC) require attorneys to report a potential material violation “up-the-ladder” within a company. If the client’s general counsel or senior managers fail to respond appropriately, the attorney must bypass them and report concerns directly to the company’s audit committee or board of directors. These requirements, known as Part 205 rules, appeared to threaten the traditional role of outside counsel built over centuries. Law firms resisted them at first, then adjusted with internal training and the creation of teams of specialists to ensure compliance. The rules have led to one notable public break between a law firm and a client. In December, Akin Gump Strauss Hauer & Feld resigned as outside counsel of TV Azteca, Mexico’s second largest broadcaster. Its resignation, which caused the SEC to launch an investigation and led to a drastic drop in TV Azteca’s stock, was the first publicized example of the difficulties firms face in complying to the new regulatory regime. When viewed as a test case of the rules, it highlighted the tensions and unanswered questions troubling practitioners, particularly with the “noisy withdrawal” provisions still under consideration by the SEC. Work in Progress Despite widespread reluctance to discuss specifics, interviews with law firm attorneys and others familiar with the subject have produced a snapshot of the professional changes made since the rules went into effect, showing a work in progress. Attorneys say an environment of watchfulness has swept the industry, creating heightened sensitivity to potential pitfalls without causing major changes in day-to-day interactions with clients. Most firms quickly instituted committees and procedures to deal with Sarbanes-Oxley as they slowly adapted to their redefined role, proceeding cautiously in this new climate. Law firms have responded to Section 307 through a variety of mechanisms but they have one theme in common � a renewed commitment to ethics. The SEC’s regulations “will cause people to refocus,” said Susan Hackett, senior vice president and general counsel of the Association of Corporate Counsel, making it “more an issue of awareness than change.” For experts, a firm’s renewed focus trumped all other efforts. Firms also instituted structural reforms. James Jones of the consulting company Hildebrandt International, said that “firms are taking risk management much more seriously,” by training lawyers about the new rules, formalizing once loosely drawn processes, and creating internal groups to study and solve problems. The most important step has come in the form of internal committees empowered to develop policies and respond to questions that may arise among their practicing attorneys. Securities lawyers and members of a firm’s ethics group usually staff such committees, said Peter Moser, of counsel to Piper Rudnick. These committees educate practitioners and provide an objective viewpoint said Simon Lorne, a former member of Munger, Tolles & Olson and now a corporate general counsel, because individual practitioners tend to advocate too vigorously on behalf of clients. Mr. Moser said that an attorney’s responsibilities normally end when an attorney reports a potential problem to a committee. Mr. Lorne said he disagrees with the idea that once an attorney brings an issue to a committee that lawyer’s responsibility ends. The regulations govern individual behavior, he said, not law firms. The better approach, he said, is to leave it to the lawyer to decide whether to consult with the firm’s committee or go directly to the client. In-House at the Firm Some law firms have created the position of general counsel � the law firm’s lawyer � to lead its risk management. This concentrates the duties onto one person undistracted by other work, according to Hildebrandt’s Mr. Jones. These high-level partners often act as substitutes for internal committees or work alongside them. Law firms historically have had ethics committees, but Part 205 prompted them to formalize loosely operating committees and clarify duties so that problems would not go overlooked, Mr. Jones said. The act has pointed out the need to oversee once largely independent practice groups and individual lawyers, said Mr. Jones. Firms should “institutionalize risk decisions that were once left to individual partners,” he said. A practice group, he warned, “may be pushing the envelope really far and you may not even know about it.” With firms growing larger and stretching geographically, managing partners cannot possibly oversee everything, particularly in areas where they lack expertise, he said. He recommended that firms grant additional powers to practice group leaders and place responsibility squarely on their shoulders since they possess the prerequisite expertise and can reasonably monitor the daily activities of their group’s members. Redefining Roles The new role of outside counsel envisioned by the SEC prompted warnings that attorney-client relations would be eroded. Months after the regulations went into effect, however, its effects have been moderate, according to those interviewed. “There has been precious little evidence of actual adverse effects” in attorney-client relations, said Mr. Lorne, a member of an American Bar Association task force surveying law firm responses to Section 307. He predicted that only when the SEC takes an enforcement action against a law firm will “the theoretical risk . . . turn into a practical risk.” Kevin Rosen, head of Gibson, Dunn & Crutcher’s legal malpractice defense group, said that “lawyers are more aware of the changing perception of their role and as a result . . . are taking certain steps to ensure recognition that they are complying.” He saw firms asking more inquisitive questions of clients and documenting oral conversations and internal decisions. “In the past,” said Gray Cary’s Shirli Weiss, who advises corporate boards, “I think sometimes law firms would be satisfied with a direct conversation with the CFO or CEO.” But now, a firm will go up the chain until “it is satisfied that the situation has been fixed.” Fear of Needless Fear Companies fear that Part 205 may trigger unnecessary alarms, however, as jittery lawyers report every tiny concern up-the-ladder, causing corporations to launch costly and time-consuming investigations, the experts said. “It can undermine the lawyer client relationship,” warned Mr. Lorne, who is now vice chairman and chief legal officer of Millennium Partners. “I want to know about it but I don’t want a formal report under Part 205.” He encouraged law firms to communicate their concerns but not under the guise of Sarbanes-Oxley so that every report wouldn’t trigger a new investigation. The SEC’s guidelines contribute to these fears. “The threshold level of evidence that requires going up-the-ladder under Part 205 is set much lower than it is under the ethical rules,” said John Villa, a well-known legal malpractice lawyer and a partner at Williams & Connolly. ABA Model Rule 1.13 requires an attorney to report up-the-ladder when she “knows” her client has acted wrongly. The SEC displaced this standard and instead held that “a material violation must be more than a mere possibility, but it need not be ‘more likely than not.’” Some companies have responded by asking firms to enact clear protocols and provided suggestions to smooth communications with outside lawyers, said experts. Ms. Hackett of the Association of Corporate Counsel recommended that firms send a monthly report to a client’s audit committee, for instance. “This consistent form of communication,” she said, allows firms to air their concerns without launching unneeded investigations and communicate smaller issues that might otherwise go unreported. Like other alternatives this approach must contend with the great unknown. Open Questions Indeed, many questions remain open despite the commission’s efforts to provide guidance. What is a “material violation”? And to whom is it material: executives, shareholders, the SEC? How quickly must firms report these alleged violations? And, will firms continue to provide advice on the vanguard of the law � the kind of advice that corporations pay large firms for? “It’s very hard to tell,” said Mr. Lorne, but “I’m sure the new rules are running in the background of people’s minds.” Some warned that lawyers will tread carefully to the limits of the law, perhaps declining to exploit loopholes or create new, and otherwise legal, mechanisms to circumvent limitations. A lawyer presents a client with a “spectrum of behavior,” Ms. Weiss explained, and under this atmosphere, “lawyers will clump their advice . . . in a conservative bent.” The forecasts of problems appeared to be borne out last December when Akin Gump resigned as outside counsel of TV Azteca. In a letter leaked to the press, the firm cited an ongoing dispute with company officials regarding the disclosure of a self-dealing arrangement that would profit the company’s chairman and controlling shareholder by about $100 million. The New York Times quoted the letter as saying said that Akin Gump remained dissatisfied with the company’s unwillingness to disclose the transaction “pursuant to U.S. securities law” and therefore resigned. The resignation led to a precipitous decline in TV Azteca’s stock, according to Bear Stearns analyst Christopher Recouso who covers the company. Remaining Questions The Akin Gump matter leaves a number of questions hanging, some observers say. What if Azteca and the SEC, after investigating the matter thoroughly, find nothing wrong? Does it leave the law firm open to accusations by TV Azteca that it breached its duty to its client? Is the law firm responsible for reducing the value of shareholders’ holdings? How will other clients view the law firm’s action? These are many of the questions experts asked in deliberating the new SEC rules, particularly the “noisy withdrawal” rules now under consideration. If enacted by the SEC, the “noisy withdrawal” rule will obligate firms to resign and notify the SEC when their client does not satisfy their concerns in regard to potential wrongdoing. The current rules allow � but do not mandate � notification. SEC Commissioner Harvey Goldschmid, speaking not as a representative of the commission, told a group at a New York City Bar Association luncheon in mid-February that he saw no problems with mandating disclosure. Firms have barraged the SEC with comment letters warning of severe problems if the rule is adopted. Regardless of how the SEC proceeds, some experts predicted a new era of increased risk for law firms. “Major changes in public policy have moved toward criminalizing” a great deal of behavior, Mr. Jones warned. This trend blurred the traditional distinction between lawyers and clients by conflating companies with outside counsel, including the law firm among the web of putative wrongdoers, he said. Some congressmen have even discussed the possibility of measures to expand the rights of individuals to file claims against law firms.

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