X

Thank you for sharing!

Your article was successfully shared with the contacts you provided.
Section 307 of the Sarbanes Oxley Act of 2002 required the Securities and Exchange Commission “to prescribe minimum standards of professional conduct for attorneys appearing and practicing before the SEC in any way in the representation of issuers.” [FOOTNOTE 1]On Jan. 29, 2003, the SEC published final rules implementing � 307. This article focuses on the qualified legal compliance committee (QLCC) — a special board committee that issuers may create under the new rules — and considers what a company stands to gain by setting up a QLCC. Under the new attorney-conduct rules, when a lawyer appearing and practicing before the commission [FOOTNOTE 2]in the representation of an issuer becomes aware of evidence of a material violation [FOOTNOTE 3]by the issuer or its officers, directors, employees or agents, the lawyer must report the evidence to the issuer’s chief legal officer (CLO) or to both the CLO and the CEO. The CLO must inquire into the evidence that she reasonably believes is appropriate to determine if the material violation described in the attorney’s report has occurred, is ongoing, or is about to occur. If the CLO determines no material violation has occurred, is ongoing, or is about to occur, the CLO must notify the reporting attorney and advise the reporting attorney of the basis for the determination. If the CLO in a company without a QLCC believes that a material violation has occurred, is ongoing or is about to occur, the CLO must take all reasonable steps to cause the issuer to respond appropriately and must advise the reporting attorney. But if the issuer has created a QLCC before a material violation has been reported, the CLO may instead refer the request to the QLCC instead of taking ongoing responsibility for the inquiry. [FOOTNOTE 4] ‘UP-THE-LADDER’ REPORTING After an attorney reports a material violation, the best outcome is that the CLO or CEO provides an appropriate and timely response. If the attorney does not reasonably believe the response is appropriate and reasonably timely, though, she must report the material violation “up the ladder,” meaning (i) to the audit committee of the issuer’s board of directors; (ii) if the issuer’s board of directors does not have an audit committee, to another committee of the issuer’s board of directors consisting solely of outside directors; or (iii) if the issuer’s board of directors does not have a committee consisting solely of non-employee directors, to the issuer’s board of directors. If an attorney believes that reporting a material violation to the CLO or CEO would be futile, the attorney can follow the up-the-ladder reporting procedures without prior reporting to the CLO or CEO. A lawyer who receives an appropriate and timely response to a report of a material violation need do nothing further. A lawyer who has reported a material violation all the way up the ladder and still has not received what an appropriate and reasonably timely response must explain to the CLO, CEO and any directors to whom the attorney has reported why he or she does not believe there has been an appropriate and timely response. REPORTING TO QLCC As an alternative to up-the-ladder reporting, an attorney appearing and practicing before the SEC in the representation of an issuer who becomes aware of evidence of a material violation by the issuer, or any of its officers, directors, employees or agents, may report the evidence to a QLCC, if the issuer has previously formed such a committee. [FOOTNOTE 5] A duly qualified QLCC is a committee (which also may be an audit or other committee) consisting of at least one member of the issuer’s audit committee (or if the issuer has no audit committee, one member from an equivalent committee of independent directors) and two or more additional outside directors. The committee must have adopted written procedures for the confidential receipt, retention, and consideration of any report of evidence of a material violation under the new rules. In addition, the committee must have been duly established by the board of directors, with the authority and responsibility: (i) to inform the issuer’s CLO and CEO of any report of evidence of a material violation; (ii) to determine whether an investigation is necessary regarding any report of evidence of a material violation by the issuer, its officers, directors, employees or agents and, if it determines an investigation is necessary or appropriate, to take pursue any of the following courses of action: � notifying the audit committee or the full board of directors; � initiating an investigation, which may be conducted either by the CLO (or the equivalent thereof) or by outside attorneys; � retaining such additional expert personnel as the committee deems necessary. The committee must also be authorized, at the conclusion of any such investigation, to � recommend, by majority vote, that the issuer implement an appropriate response to evidence of a material violation; and � inform the CLO and the CEO and the board of directors of the results of any investigation and the appropriate remedial measures to be adopted. Finally, the committee must have the authority and responsibility, acting by majority vote, to take all other appropriate action, including the authority to notify the SEC in the event that the issuer fails in any material respect to implement an appropriate response that the QLCC has recommended to the issuer. [FOOTNOTE 6] To assess the value of a QLCC, it is necessary to consider two alternative proposals for further attorney-conduct rules now pending before the SEC. ‘NOISY WITHDRAWAL’ Under the first alternative, a lawyer who reports evidence of a material violation all the way up the ladder without receiving an appropriate and timely response from the issuer would have to notify the SEC if she reasonably believes that the material violation is ongoing or is about to occur and is “likely to result in a substantial injury to the financial interests or property of the issuer or investors.” Outside counsel would be required: � to withdraw from the representation of the issuer; � within one day of such withdrawal, to provide written notice to the SEC that the withdrawal was for “professional considerations”; and � to disaffirm promptly to the SEC submissions and filings that the attorney helped to prepare and which the attorney reasonably believes are or may be materially false and misleading (a “noisy withdrawal”). In-house lawyers would not be required to resign, but would have to notify the SEC in writing, within one day, of their intent to disaffirm. They would have the same duty as outside counsel promptly to disaffirm SEC submissions and filings. The issuer’s CLO would have to inform any attorney replacing a reporting attorney who has withdrawn under these circumstances that the first lawyer withdrew because of “professional considerations.” The first alternative proposal would also permit, rather than require, noisy withdrawal when an attorney reasonably believes that a material violation has already occurred but is not ongoing and is likely to have resulted in a substantial injury to the financial interests or property of the issuer or investors. [FOOTNOTE 7] Under the second proposed alternative, if, after reporting a material violation all the way up the ladder without receiving an appropriate and reasonably timely response, an attorney reasonably concludes that there is “substantial evidence” of a material violation that is ongoing or is about to occur and “is likely to result in substantial injury to the financial interests or property of the issuer or investor,” outside counsel would be required to withdraw from representation of the issuer and to provide notice to the issuer in writing that the withdrawal is based on “professional considerations.” In-house counsel would be required to cease participating or assisting in any matter relating to the material violation and to notify the issuer, in writing, that such counsel believes the issuer has not provided an appropriate and timely response. The CLO would be required to inform any attorney replacing an attorney who had provided such written notice that his or her predecessor has given such notice. Within two business days of receipt of the notification, the issuer would be required publicly to disclose the notification and the related in an appropriate SEC filing. If the issuer failed to make such public disclosure, the reporting attorney would be permitted (but not required) to notify the SEC of the notice. These duties would apply only in the context of an up-the-ladder reporting. Outside or in-house counsel who reasonably believe they have been discharged for reporting a material violation in compliance with the new rules would then be required to notify the issuer’s CLO. The CLO would be required to inform any attorney replacing an attorney who had provided such written notice of the fact that the prior lawyer had given such a notice. An issuer receiving a discharged attorney’s written notice would be required to publicly disclose the notification and the related circumstances in an appropriate SEC filing; if the issuer failed to do so, the discharged attorney would be permitted to notify the SEC of the written notice provided to the issuer. [FOOTNOTE 8] BENEFITS OF A QLCC An issuer that creates a QLCC affords itself and its lawyers additional procedural options when material violations are reported. As discussed above, a CLO who receives a report of a material violation may refer the report to the QLCC, rather than taking continuing responsibility for the inquiry. In addition, a lawyer representing an issuer with a QLCC may report material violations to the QLCC, rather than following the up-the-ladder reporting procedures. An attorney’s reporting obligations could therefore be satisfied with a single report, and the attorney would have no obligation to assess the response to the report. In its release adopting the new rules, the SEC encouraged issuers to create QLCCs as a means of effective corporate governance. [FOOTNOTE 9]Yet, while it is certainly simpler for attorneys to make one report and thereby satisfy their obligations without having to do anything further, it is curious to think this would be the end of lawyers’ responsibilities in connection with material violations. To allow an attorney to raise such a serious question and then have no duty to follow up on the matter while continuing to represent the issuer puts the lawyer in an unusual position and one of questionable utility to the client. Whether to create a QLCC may become a larger issue in the event either of the two sets of proposed up-the-ladder reporting rules is adopted. While the new rules currently in effect do not impose any additional obligation on an attorney who has reported a material violation all the way up the ladder without receiving an appropriate and reasonably timely response, the proposed rules contemplate disclosure outside of the issuer in such scenarios. Creating a QLCC could provide outside counsel an opportunity to avoid withdrawing from representation of an issuer and eliminate many of the obligations of a reporting attorney or an issuer to report evidence of a material violation outside of the issuer. Under the first proposed alternative, reporting to a QLCC would obviate an attorney’s obligation to disaffirm SEC submissions and filings; the second proposed alternative would generally impose an obligation on the issuer to make public disclosure when a lawyer reports a material violation to the issuer’s QLCC. Especially in today’s environment, public disclosure of even an allegation of a violation by an issuer can have serious negative effects on stock price and public sentiment. Having the option to keep the investigation in-house, without public disclosure, may be a sufficient reason for issuers to consider creating a QLCC. Bart Schwartz is senior vice president and general counsel of The Money Group Inc. Jonathan Freedman is a partner with Dewey Ballantine practicing in the area of corporate and securities law. Joseph Cosentino assisted in preparing this article. If you are interested in submitting an article to law.com, please click here for our submission guidelines. ::::FOOTNOTES:::: FN1 SeeSarbanes Oxley Act of 2002 � 307; The term “issuer” includes an issuer (as defined in section 3 of the Securities Exchange Act of 1934, (the ’34 Act”) the securities of which are registered under section 12 of the ’34 Act, or that is required to file reports under section 15(d) of the ’34 Act, or that files or has filed a registration statement under the Securities Act of 1933 that has not been withdrawn. 17 CFR 205.2. FN2“Appearing and practicing before the Commission” includes transacting any business with the Commission, including communications, representing an issuer in an SEC administrative proceeding or in connection with an SEC investigation, providing advice on US securities law or SEC rules and regulations regarding documents that the attorney has notice will be filed, submitted or incorporated by reference into a filing with the SEC or advising an issuer regarding whether information or a statement, opinion or other writing is required under US securities laws or SEC rules and regulations. 17 CFR 205.2. FN3“Evidence of a material violation” means credible evidence, based upon which it would be unreasonable, under the circumstances, for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is ongoing, or is about to occur; this includes material violations of federal or state securities laws, a material breach of fiduciary duty arising under U.S. federal or state law, or a similar material violation of any federal or state law. 17 CFR 205.2. FN417 CFR 205.3 FN5 Id. FN617 CFR 205.2 FN7SEC Release No. 33-8186 (Jan. 29, 2003). FN8 Id. FN9SEC Release No. 33-8185 (Jan. 29, 2003).

This content has been archived. It is available exclusively through our partner LexisNexis®.

To view this content, please continue to Lexis Advance®.

Not a Lexis Advance® Subscriber? Subscribe Now

Why am I seeing this?

LexisNexis® is now the exclusive third party online distributor of the broad collection of current and archived versions of ALM's legal news publications. LexisNexis® customers will be able to access and use ALM's content by subscribing to the LexisNexis® services via Lexis Advance®. This includes content from the National Law Journal®, The American Lawyer®, Law Technology News®, The New York Law Journal® and Corporate Counsel®, as well as ALM's other newspapers, directories, legal treatises, published and unpublished court opinions, and other sources of legal information.

ALM's content plays a significant role in your work and research, and now through this alliance LexisNexis® will bring you access to an even more comprehensive collection of legal content.

For questions call 1-877-256-2472 or contact us at [email protected]

 
 

ALM Legal Publication Newsletters

Sign Up Today and Never Miss Another Story.

As part of your digital membership, you can sign up for an unlimited number of a wide range of complimentary newsletters. Visit your My Account page to make your selections. Get the timely legal news and critical analysis you cannot afford to miss. Tailored just for you. In your inbox. Every day.

Copyright © 2020 ALM Media Properties, LLC. All Rights Reserved.