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It is important to consider the role of legal counsel. If a transaction is not illegal and has been approved by the appropriate levels of a corporation’s management, lawyers, whether corporate counsel or with an outside firm, may appropriately provide the requisite legal advice and opinions about legal issues relevant to the transactions. In doing so, lawyers are not approving the business judgment of their clients. – Prepared witness testimony of Vinson & Elkins managing partner Joseph Dilg at March 14 congressional hearing on the Enron collapse Some of the people … who could have prevented the crash are sitting before us today. They could have acted before matters got out of hand. They could have been more skeptical of the proposals and promises of the business teams. They could have looked to learn what was really happening and warned Enron leadership about what they found. … The attorneys are the people others rely on to make sure matters are OK, are legal, are not going to put a company at undue risk. They’re the adult supervision. – Prepared statement of Rep. Billy Tauzin, R-La., at the same hearing The American Bar Association’s Task Force on Corporate Responsibility showed up in force in New York on Oct. 25 for the group’s second public hearing on its proposals to change the Model Rules of Professional Conduct. It was an august assemblage addressing very weighty issues. Should corporate lawyers be required to disclose client wrongdoing to authorities? Will lawyers be forced to perform probing investigations of their own clients? If new standards are adopted, will law firms be more likely to face civil liability? The give-and-take between committee members and such witnesses as Cadwalader, Wickersham & Taft partner Edwin David Robertson and New York University School of Law professor Stephen Gillers was, as one might expect, as fascinating as a good ethics class. Almost no one heard it. Rows of empty seats, allotted for spectators who didn’t show up, surrounded the task force members. Well, listen up, you ostriches: The practice of business law is on the verge of enormous, fundamental change. Not only are there the ABA task force proposals, which would require lawyers who “reasonably should know” that clients are engaging in fraud to report them to authorities. There’s also � 307 of the Sarbanes-Oxley Act. The provision’s sponsors said they wanted to remind corporate lawyers that they represent the corporation as a whole, not particular executives; so the act mandates that lawyers report evidence of material violations of securities law to a company’s general counsel or CEO, and then, if those executives fail to respond appropriately, to the board. But don’t be lulled by the apparent inside-the-company limits: It’s up to the Securities and Exchange Commission to devise the rules to enforce � 307. And the SEC has proposed that lawyers who haven’t gotten an appropriate response by going up the ladder be obliged in certain circumstances to disaffirm documents and filings. The agency has also recommended that lawyers be permitted to reveal client confidences to the SEC to prevent fraud. BE AFRAID. BE VERY AFRAID Supporters of reform say that scandals such as Enron Corp. and Tyco International Ltd., in which the conduct of lawyers has been scrutinized and criticized, prove that things need fixing. “All we’re saying,” says Weil, Gotshal & Manges partner Ira Millstein, a longtime corporate governance hawk, “is, ‘For God’s sake, please follow the law!’ … This is just a pendulum shift. It’s saying, ‘Please remember that the CEO is not your client.’” Yet even Millstein concedes the inexorability of the law of unintended consequences. Here, those consequences aren’t hard to predict. Federal incursion into lawyer regulation. Increased risk of law firm liability. Erosion of client confidence in lawyers. And perhaps even the squelching of business innovation. The SEC won’t finalize its rules until January, and the ABA task force will likely modify its proposals before the House of Delegates gets them. But if the most drastic reforms are enacted, lawyers are facing historic change, a big rip in the cloak of client confidentiality. Sarbanes-Oxley and the ABA proposals have the potential to turn lawyers into watchdogs who will have to worry about covering their own backs even as they worry about clients. Sensitive securities lawyers may start including in their retainer agreements Miranda-style warnings. Boards will have independent counsel, and so will every self-respecting CEO. Legions of lawyers will tramp all over corporate landscapes. Is this really what the reformers wanted? We’ve been here before. Under the SEC’s 70-year-old rules, specifically rule 102(e), the agency has always been able to bar certain misbehaving lawyers and accountants from practicing before it. But the rule, as it applied to lawyers, was more or less untested until the 1970s, and by 1982 was virtually abandoned, following a firestorm in a case called In the matter of Carter, Johnson. In 1981 an administrative law judge ruled that two prominent New York lawyers had abetted a client’s disclosure violations. The SEC overturned the ruling. It also, however, proposed a new interpretation of rule 102(e). According to Cleary, Gottlieb, Steen & Hamilton partner David Becker, the agency called for lawyers who knew that clients intended illegal actions to resign the engagements or take “all efforts within reason” to avoid or end the illegality, including notification of the corporation’s board. The ABA, says Becker, who was the SEC’s general counsel until last May, strenuously objected to the new interpretation, arguing that the SEC had no authority over lawyer ethics and that the agency was threatening the sanctity of attorney-client privilege. The SEC’s general counsel at the time, Edward Greene (now a Cleary Gottlieb partner), decided the wisest course was to leave the regulation of lawyers’ ethical violations to state disciplinary bodies, barring lawyers from practicing before the SEC only as a follow-up to court action. “I was concerned about whether we had the authority,” says Greene, “and didn’t see that we had much to gain if we tested it.” At about the same time, the ABA also decided not to impose reporting requirements on corporate lawyers faced with client wrongdoing. In the early 1980s the ABA was in the final stages of formulating its Model Rules of Professional Conduct. One of the hottest debates centered on exceptions to the attorney-client privilege. Most states, and the ABA’s old code, permitted disclosure of confidences to prevent an economic crime or substantial economic harm to a third party, says current ABA president Alfred Carlton Jr. But after much talk about turning corporate lawyers into client police, the ABA House of Delegates scaled back exceptions to the privilege. The model rules that were adopted in 1983 permitted the disclosure of client confidences only to allow lawyers to defend themselves or to prevent criminal acts likely to result in imminent death or substantial physical injury. Since then the ABA has held firm on attorney-client privilege, most recently refusing to expand exceptions to the privilege in August 2001. A commission headed by the chief justice of the Supreme Court of Delaware, E. Norman Veasey, had conducted an exhaustive four-year review of the model rules. The commission proposed, among other refinements, three expansions of the exceptions to attorney-client privilege. The first was to prevent “reasonably certain death or substantial bodily harm,” and was approved by the House of Delegates. The other two involved economic harm. Calling the model rules “out of step with public policy,” Veasey’s commission proposed that lawyers be permitted to disclose client confidences to prevent a crime or fraud in which the lawyer’s services were being used; and to prevent or rectify injury to the financial interests of another party. More than 40 states either permit or, in a handful of cases, mandate disclosure to prevent client crime or fraud, but in August 2001 the ABA House of Delegates rejected the Veasey group’s proposals. Then the world changed. In March 2002, as corporate scandals and the accompanying criticism of corporate lawyers mounted, the ABA formed its task force on corporate responsibility. By the time the task force started its work, a group of law professors had already written to then-SEC chairman Harvey Pitt, calling for the SEC to begin enforcing rule 102(e) and regulating lawyers. The oversight subcommittee of Congressman Billy Tauzin’s House Committee on Energy & Commerce had called lawyers from Vinson & Elkins to testify about their role in the Enron collapse. The snowball, says ABA president Carlton, was rolling down the hill, and the ABA leadership was worried about what Congress might do. Carlton says he was in regular contact with members of the Senate Commerce Committee, reminding them that for 200 years lawyers have been monitored by their own state supreme courts, not by the feds. Nevertheless, on July 10 Senators John Edwards, Michael Enzi and Jon Corzine introduced a last-minute amendment to Sarbanes-Oxley, calling for the SEC to regulate lawyers. “With Enron and WorldCom and all the other corporate misconduct we have seen,” said Edwards, a presidential aspirant and former trial lawyer, “it is again clear that corporate lawyers should not be left to regulate themselves, [any] more than accountants should be left to regulate themselves.” The ABA task force released its preliminary report on July 16, as the Sarbanes-Oxley bill went to conference. But if it was an attempt to persuade Congress that lawyers should retain the power to police their own, it failed. The Sarbanes-Oxley bill emerged from conference with the Edwards amendment intact. Edwards claimed that he merely intended to enforce up-the-ladder reporting of wrongdoing, which itself merely reinforces a fact no one disputes: When a lawyer represents a corporation, the client is the company, meaning, ultimately, the board and the shareholders. The ABA model rules already codify this notion, and permit up-the-ladder reporting, but, in the rules’ current incarnation, lawyers are required to minimize the disruption to the company. The corporate responsibility task force has recommended that the rules more forcefully require attorneys to report, first up the ladder and then to outside authorities. Plenty of people believe that, on its own, up-the-ladder reporting by outside counsel, even to boards, is good corporate governance. “I don’t think a lawyer’s duty has changed,” says lawyer and shareholders’ rights advocate Nell Minow. “I think people had forgotten their duty. … I’ve been concerned about [lawyers'] timidity. That’s exactly how accountants got into trouble.” Weil Gotshal’s Millstein sketches a hypothetical in which outside counsel uses the responsibility to report as a bludgeon to persuade an executive not to proceed with potentially illegal behavior — exactly what Sen. Edwards said on the Senate floor that he intended the amendment to accomplish. “We’ve been part of the problem,” says Millstein, who has testified on behalf of lawyer accountability. “We’re on the inside. We know everything.” Millstein’s scenario only ends well, of course, if the board is an effective bludgeon — the independent body envisioned by the new New York Stock Exchange and Sarbanes-Oxley regulations. “Will [the lawyer reforms] deter wrongdoing?” asks Edwin David Robertson, a Cadwalader partner and head of the New York County Lawyers’ Association’s corporate responsibility task force. “Sarbanes-Oxley is trying to get the problem to someone who’s independent, on the assumption that an independent person is more likely to do the right thing. If that assumption is correct, then yes, it will deter.” What if the board is not independent and declines to act? The SEC rules call for “noisy withdrawal” or, in some circumstances, the lawyers’ disavowal of documents and filings. The ABA task force proposals call for lawyers to report the wrongdoing to authorities. Both proposals introduce their own new concerns. Lawyers, as Stephen Gillers cautioned the ABA task force at the Oct. 25 meeting, can make only so much difference in corporate governance. That’s the benefit side of the reform analysis — a lot of maybes and ifs. Now consider costs. Start with the premise of federal regulation. “It’s very troubling,” says Womble Carlyle Sandridge & Rice partner Burley Mitchell Jr., a former chief justice of the Supreme Court of North Carolina and a member of the ABA task force. The power to regulate lawyers has always rested with states. But if Congress has empowered the SEC, what’s to stop other federal agencies from asserting regulatory power and enacting rules for lawyers? Then a lawyer who is working on an initial public offering for a telecommunications company, explains Simon Lorne, a partner at Munger, Tolles & Olson, would suddenly have to keep in mind the ethical guidelines of the SEC, the Federal Communications Commission and the state bar. If those rules are all different, the potential for confusion is dizzying. As is the potential for liability. Robert Creamer of the Attorneys’ Liability Assurance Society Inc., testified at the first of the ABA hearings on the task force recommendations, in Chicago on Sept. 20. He predicted drastic consequences. “What conscientious, well-informed, risk-averse lawyer — the very kind of lawyer society should want advising senior corporate managements — will be willing to practice in areas where the rules of professional conduct have been tailored to maximize the lawyer’s exposure for wrongful or mistaken client disclosure decisions?” he said. “This is not an imaginary concern. From our work with ALAS member firms, we know that there are already many thoughtful lawyers who are seriously questioning the wisdom of staying involved in securities work.” Since 1994 lawyers (and accountants) have been shielded from civil liability for “aiding and abetting” in securities frauds committed by their clients by the U.S. Supreme Court’s ruling in Central Bank of Denver v. First Interstate Bank of Denver. But Sarbanes-Oxley and the changes proposed by the ABA task force create new duties for corporate lawyers — duties that Melvyn Weiss of plaintiffs powerhouse Milberg Weiss Bershad Hynes & Lerach says can be used as a wedge to reintroduce lawyers as defendants in securities class actions. “It’s going to help make the argument that lawyers are primary actors,” Weiss says. Consider, for instance, a lawyer who executes disclosure documents relying, as the rules used to require, on representations of the client and accountants. Things go bad, and the client is sued for fraud. Now, under the language proposed by the ABA task force, the lawyer is responsible for what she “reasonably should have known,” so, if her firm didn’t investigate the facts, she could be on the hook. If she or another member of her firm found any matter of concern — and remember, the standard in Sarbanes-Oxley is the loosey-goosey “evidence of a material violation of law” — and she didn’t report up the ladder, she could be in trouble with the SEC. And under the task force proposals, if she didn’t report suspicions to authorities, she could face shareholder suits. “Breach of [the duty to disclose suspect client behavior],” Creamer testified, “could subject [lawyers] to civil damage claims for failure to prevent client conduct that may not have been clearly criminal at the time but that — with the benefit of hindsight — is found to have been criminal and to have damaged third parties. … Lawyers will cease to be advisers to clients on what is and is not lawful conduct, and will become instead regulators of client conduct.” This potential change in the nature of the relationship between lawyers and clients — inevitable when lawyers have to keep their own liability in mind when dealing with clients — is perhaps the most troubling consequence of the Sarbanes-Oxley and ABA reforms. “Several of the proposed changes, particularly mandatory disclosure and the notion of outside counsel sitting in judgment on inside counsel and management, will certainly put significant stresses and major uncertainties on the relationship between corporations and their lawyers,” says John Villa, a Williams & Connolly partner who frequently defends law firms. “You’re going to erode the whole system,” adds Gordon Greenberg of the Los Angeles office of McDermott, Will & Emery. Ill-chosen language compounds the conflict. Consider the task force’s proposed “reasonably should know” standard. Task force member Aulana Peters explained at the New York hearing that the group was concerned about lawyers who abetted client misbehavior through willful blindness — deliberately failing to ask questions that would expose the client’s wrongful intentions. That’s why the task force proposed the low “reasonably should know” standard, rather than, for instance, a “clear and convincing evidence” standard. Everyone can agree that willful blindness is wrong; indeed, it is precisely what Congressman Tauzin and other critics say took place at Enron and Tyco. But in the real world, when corporations may employ hundreds of outside lawyers to handle discrete matters, holding all of them responsible for what they “reasonably should know” places a potentially crippling new duty to investigate on lawyers. “[It] requires the lawyer to be suspicious, indeed to become something of a detective,” testified professor Thomas Morgan of The George Washington University Law School at the task force’s first public hearing in Chicago. “In short, it would turn the lawyer into a client’s auditor, a role that would transform the ordinary lawyer-client relationship from helper to critic.” The Sarbanes-Oxley standard, “evidence of a material violation,” is even looser. What’s “evidence”? What’s “material”? Who’s to say that a client’s definition of these terms is the same as his lawyer’s? And how can a client be completely confident in revealing everything to a lawyer if the client has to worry that the lawyer, simply to protect himself, must constantly sift for “evidence” of wrongful intent? As BellSouth Corp. associate general counsel Marc Gary says: “This has the potential to make relationships with outside counsel more of a tentative dance than it should be.” What are the consequences of casting a cloud of mutual suspicion over talks between lawyers and clients? Optimists may predict that executives will be less likely to pursue potentially illegal behavior, knowing that lawyers are, to quote Congressman Tauzin, acting as “adult supervision.” Skeptics suggest instead that clients will stop being honest with their lawyers. In the real world, clients most need legal guidance when the line between right and wrong isn’t thick and black. In those situations, candor is the cornerstone of the attorney-client relationship: Lawyers can help clients tease out consequences only if the clients are honest about the decisions they’re contemplating. If clients are worried about consulting their lawyers in delicate situations, or aren’t honest with their lawyers, we could see more ill-considered or even illegal client behavior than before — just the opposite of what reformers intend. Even if lawyers and clients operate with the best of intentions, the result of these purported reforms could be business paralysis. By turning lawyers into the arbiters of client behavior, the rules ask lawyers to make business judgment decisions. We’re also requiring them to make these decisions with the threat of liability hanging over their heads. Risk aversion, says BellSouth’s Gary, is the inevitable result. Warned Morgan: “Lawyers will be forced as a matter of self-protection to inundate the corporation with all manner of warnings of theoretical problems that will create repeated burdens of investigation but very little useful information.” John Villa likes to lay out a scenario to illustrate the implications. Sarbanes-Oxley, he says, can be read to require lawyers to challenge actions by a corporate officer that could be a breach of fiduciary duty. Let’s say the client is a CEO who is buying up large amounts of assets when everyone else is selling. Should the lawyers second-guess the CEO’s judgment as putting shareholders at risk? Depending on the rules that are ultimately adopted, Villa says, the lawyer may feel obliged to. Here’s the punchline in Villa’s scenario: The client is Warren Buffett, who has made billions by taking risks and operating contrary to conventional wisdom. “Lawyers are not well-suited to [second-guess] their clients’ business judgment,” asserts Villa. “We’re pushing lawyers into decisions, somehow believing that because lawyers are presumed more objective, they’re better suited to make these decisions. They’re not, and in suggesting they are, we’re putting lawyers in peril.” Could the Sarbanes-Oxley Act and the regulation reforms under consideration by the ABA have made a difference in the corporate scandals of last year? It’s very hard to know. Probably not in the telecom swaps that brought down WorldCom Inc., Global Crossing Ltd. and Qwest Communications International Inc. Perhaps in the executive self-dealing at Tyco and Adelphia Communications Corp. We still don’t know enough about the conduct of Enron’s outside counsel to be able to form a clear picture of the law firms’ role in that collapse; maybe if they’d asked more questions about the deals they documented, those allegedly fraudulent deals wouldn’t have happened. But maybe they would have. Martin Lipton of Wachtell, Lipton, Rosen & Katz, the dean of corporate advisers, says he has never run into a situation in which a client refused to follow his advice on a matter of compliance or ethics. But he’s pretty sure the new rules won’t deter corporate blowups. “The most difficult thing for a lawyer is having the wrong client,” he says. “I don’t think these new rules will prevent people who are bent on doing something wrong from achieving it.” And, of course, we have no idea of how many scandals didn’t happen because a client felt comfortable speaking in absolute candor to a lawyer, and because the lawyer was able to provide advice without worrying about his own civil liability. We can all agree that it does the profession no good when lawyers are sued for fraud, grilled in Congress and indicted for embezzlement. The pressure to keep clients happy and the cozy relationships that counsel can develop with powerful CEOs — they’re undoubtedly dangers. Corporate lawyers need to remind themselves all the time that they represent the entire company, and that they have a duty to truth and morality as well. But the best way to enforce that duty isn’t to call for federal regulation or increased lawyers’ exposure to liability. It’s to remind lawyers to look in the mirror every morning and ask themselves: Who am I?
Sarbanes-Oxley Act of 2002: What Lawyers Need to Know

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