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The recent case of People v. Belnick provides a good opportunity to examine the changing responsibilities of general counsel after Sarbanes-Oxley. On July 15, Mark A. Belnick, former general counsel of Tyco International, Ltd., was acquitted of charges of grand larceny, securities fraud, and falsifying business records for accepting more than $30 million in the form of unauthorized loans and bonuses. The central argument of the defense throughout the case — in its motion for mistrial, its legal challenges to the juror charge, and particularly in summation — was that the prosecution’s case was built on a fundamental misunderstanding of the general counsel’s role in ferreting out corporate fraud. The prosecution asserted that Mr. Belnick had to have known about Tyco’s misdeeds and that the failure to uncover and disclose irregularities in his $30 million compensation package was part of a cover-up.1 According to the defense, Mr. Belnick relied (and was entitled to rely) upon the word of former CEO Dennis Kozlowski and former CFO Mark Swartz for guidance on issues of board approval and compensation. DEFENSE’S CLAIM The defense claimed the state’s case depended on a dramatically expanded view of the general counsel’s role in detecting corporate wrongdoing. The defense underscored this point in a compelling summation, stating that in the prosecution’s eyes, Mr. Belnick “was not the general counsel, he was the inspector general and this attitude pervades every part of their case.”2 The jury ultimately acquitted Mr. Belnick. However, it is worth exploring whether there is a basis for a change in prosecutors’ views of the general counsel of a public corporation. Mr. Belnick’s trial came at a significant cost to his reputation, and enforcement actions and civil suits still loom for Messrs. Belnick, Kozlowski, and Swartz. While most commentators would agree that formal rules of corporate governance have not changed significantly, even in the wake of Enron and other corporate scandals,3 the evolving perception that rules have changed presents new challenges for general counsel.4 While general counsel have not been saddled with the full responsibilities of an “inspector general,” this means that counsel need to take more aggressive steps to ensure the information they receive is both quantitatively and qualitatively competent. NEW REGIME? Sarbanes-Oxley, as well as revised American Bar Association rules, were designed in the wake of Enron to improve corporate governance. In enacting Sarbanes-Oxley in 2002, Congress turned its attention to the duties of potential “gatekeepers” of corporate fraud, including corporate attorneys. Section 307 of Sarbanes-Oxley introduced what was at the time a controversial provision affecting lawyers. The act compelled the Securities and Exchange Commission to adopt new rules of professional conduct applicable to attorneys “practicing before it” in the representation of issuers. The new rules included: (1) requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof, to the chief legal counsel or chief executive officer of the company (or the equivalent thereof); and (2) if the counsel or officer does not appropriately respond to the evidence (adopting, as necessary, appropriate remedial measures or sanctions with respect to the violation), requiring the attorney to report the evidence to the audit committee of the board of directors of the issuer or to another committee of the board.5 In response, the SEC proposed rules in November 2002 and issued final rules in January 2003.6 Despite its far-reaching potential, Sarbanes-Oxley and the SEC final rules do not depart significantly from past professional ethical standards. The system envisioned by the statute has been described as “up the ladder” reporting. An attorney is required to report evidence of material violations up the chain of command, and if management does not “adequately respond,” the attorney must proceed as far as the board of directors or another committee of the board. In the event the board fails to respond, the SEC also proposed a rule that required attorneys to quit and notify the SEC (“mandatory noisy withdrawal”).7 However, the SEC deferred consideration of the rule after drawing widespread criticism from the bar, including the ABA, that the rule threatened private attorney-client communications. The SEC has indicated that the mandatory “noisy withdrawal” provision remains on the table, and a lawyer may still voluntarily resign and report misconduct if the corporation’s board insists on illegal conduct under SEC or traditional ethics rules. ABA RULES The ABA, anticipating the potential federalization of professional ethics rules, released revised standards for corporate governance as well in March 2003.8 New ABA model rules are significantly more flexible than SEC rules, but have the potential to apply to a wider array of conduct because they do not just apply to attorneys practicing before the SEC. Under the ABA rules, reporting is triggered only if the attorney actually knows of a current legal violation.9 The ABA rules anticipate “up-the-ladder” reporting to, “if warranted, the highest authority that can act on behalf of the organization,” but unlike Sarbanes-Oxley, does not explicitly contemplate a multi-step process. Moreover, the ABA rules contain what one commentator has described as an “off-switch” — that is, if a lawyer reasonably believes, in the best interests of the organization, she should not report, then the lawyer is relieved of her professional obligation.10 “Noisy withdrawal” is also permitted, but not required, under the ABA model rules. Taken together, the SEC and ABA rules simply reinforce conduct that most in-house counsel already expect from peers and outside counsel under traditional rules of organizational representation. The old version of ABA Model Rule 1.13 allowed an attorney to report evidence of a constituent’s misbehavior to a higher authority in the organization. Moreover, the vast majority of states recognize that an attorney’s primary duty is to the corporation, and already permit or require disclosure within and without the organization to prevent or rectify client fraud.11 A lawyer may still voluntarily resign and report if the corporation’s board insists on illegal conduct. To the extent the SEC contemplated rules requiring a “noisy withdrawal” — a rule it says is still under consideration — significant exceptions applied for in-house counsel and for corporations with “qualified legal compliance committees.”12 INFORMATION GATHERERS However, the new rules do depart from past practice in three significant ways. First, the SEC rules expand the obligation for an attorney to detect fraud. The rules are triggered not when an attorney “knows” of a material violation of the law, but when there is objective “evidence of a material violation.” While the purpose of this objective standard was to deter lawyers from recklessly or carelessly aiding and abetting fraud, the significance of discarding the “actual knowledge” standard recommended by the ABA has caused concern for some commentators. They believe the new rule attempts to solve corporate governance problems indirectly by assigning to the attorney the role of an “information intermediary,” a role which ironically may hinder the flow of information between attorneys and corporate actors by threatening client confidentiality. Second, under SEC rules reporting “up the ladder” is now mandatory. Unfortunately, this requirement may lead to over-reporting — the inevitable result of outside lawyers trying to avoid lawsuits while maintaining a good relationship with management. A mandatory reporting regime may turn “up the ladder” reporting into a ritualized practice where regularly drafted disclosures are sent to the client to report misconduct, however immaterial. While the potential for over-reporting may itself be mitigated by the threat of civil liability, the effect of mandatory reporting on outside counsel and in-house counsel may be to dilute the significance and detail of what is in fact reported. Third, under federal statute and SEC regulations, general counsel’s conduct is measured objectively. A general counsel must “appropriately respond” to evidence of a material violation and adopt “appropriate remedial measures.”13 In practice, such remedial measures will ultimately include risk management systems that require the corporate counsel to reasonably know what is going on under his or her watch.14However, the SEC provides little guidance as to what steps “down the ladder” general counsel must take to ensure that information received is competent. A NEW ROLE The Tyco case illustrates the importance of the general counsel’s need to have internal controls that ensure good information gets to the top in light of changing professional rules and changing perceptions of those rules. The combined effect of the SEC changes to corporate governance puts general counsel in a challenging position. As the general counsel assumes — and prosecutors and regulators perceive — a greater responsibility for knowing what is going on in the organization, there is an increased possibility that more information, and less meaningful information, will be reported up the ladder to the general counsel. The absence of codified rules for attorneys did not hamper past SEC enforcement efforts against inside and outside counsel. Despite the absence of defined standards of “improper professional conduct” in the SEC rules of practice, the SEC once maintained a number of proceedings under SEC regulations and federal securities laws.15 In each of these proceedings, the SEC found sufficient bases for regulating the conduct of lawyers through theories that the lawyers owed fiduciary duties to their corporate clients. However, in an environment of increasingly codified ethical standards, general counsel will need to think carefully about the effects of risk management on the flow of reported information in the organization. To ensure candor between client and general counsel, this means clearly defined risk management policies and practices, so that both in-house attorneys and staff understand the protections and limits of attorney-client confidentiality. This is particularly necessary as attorneys assume a greater role in providing advice on business as well as legal issues. In order to combat the risk of over-reporting, general counsel need to take concrete steps to encourage open dialogue with outside counsel, including potential whistleblower protection policies, and to require outside law firms to have strong systems of internal control themselves. Jay K. Musoff is of counsel at Orrick, Herrington & Sutcliffe. Adam S. Zimmerman is an associate at the firm. Endnotes: 1. Anthony Lin, “Belnick Bonus Tied to Cover-Up, Prosecutor Insists in Closing”, NYLJ, July 8, 2004, at 1. 2. Transcript of People v. Belnick at 6382:16, July 6, 2004. 3. See Comments of Susan P. Koniack, et al., to Jonathan G. Katz, SEC (Dec. 17, 2002). 4. While U.S. prosecutors’ charging decisions have not yet been affected significantly by Sarbanes-Oxley, see Musoff, “White-Collar Crime: Criminal Provisions of Sarbanes Have Yet to Make an Impact,” NYLJ, July 19, 2004, the new climate after Sarbanes-Oxley informed the factual arguments made in Belnick’s prosecution. 5. Sarbanes-Oxley Act, �307 (2002), codified at 17 U.S.C. �7245 (1) (2003) 6. Final Rule: Implementation of Standards of Professional Conduct for Attorneys, Securities and Exchange Commission, 17 C.F.R. �205 (2004); Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys, Securities and Exchange Commission (Nov. 21, 2002), at www.sec.gov/rules/proposed/33-8186.htm. 7. See Proposed Rule, supra. 8. Report of the American Bar Association Task Force on Corporate Responsibility (March 2003). 9. Model Rules of Prof’l Conduct R. 1.13(b) (2004). 10. Note, Developments in the Law — Corporations and Society, 117 Harv. L. Rev. 2227, 2235 (2004) (describing Rule 1.13(b). 11. See Comments of Susan P. Koniack, et. al., supra. 12. A qualified legal compliance committee (QLCC) is comprised of at least one audit committee member and two independent directors. See 17 C.F.R. �205.2. Under SEC rules, once an attorney reports to the QLCC, he or she is relieved of any additional duty to report to another authority, including the SEC. 13. 17 C.F.R. �205 (d) comments. 14. The U.S. Sentencing Guidelines already provide for reductions when the corporation has an “effective corporate compliance program,” so long as “high level personnel” is not “willfully blind” to the offense. See U.S.S.G. �8C2.5(f) (2004). 15. See, e.g., SEC v. Nat’l Student Mktg. Corp., 457 F. Supp. 682 (D.D.C. 1978); see also Mary Jo White, et al., Lawyer’s Roles After Enron and Sarbanes-Oxley: Advocate, Counselors, and … Gatekeepers Too?, 1343 PLI/Corp. 1295 (2002) (describing cases).

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