Up The Ladder: Litigator Responsibilities Under The Sarbanes-Oxley Act - Part I

Wednesday, December 1, 2004 - 00:00

Part II of this article appears in the January 2005 issue of The Metropolitan Corporate Counsel, Part III in the February 2005 issue and Part IV in the March 2005 issue.

On the morning of July 30, 2002, President Bush strode into the elegant ivory and gold East Room of the White House, one of his administration's favorite locations for important bill signings. He was accompanied by the Senate majority and minority leaders, four Cabinet secretaries, the FBI director, the Securities and Exchange Commission (SEC) chairman, and two guests from whom the bill he was signing took its name: Senator Paul Sarbanes and Representative Michael Oxley. The president signed the Sarbanes-Oxley Act of 2002 into law while sitting at a small desk festooned with a blue sign reading "Corporate Responsibility," next to a full-length Gilbert Stuart portrait of President Washington, who seemed to be gesturing with his right hand toward his 42nd successor.

The Act was the Congress' and the administration's most forceful and publicized response to the Enron, WorldCom, and other corporate scandals of recent years. In his prepared remarks, the president described its most important provisions and summarized, one at a time, what each "says" to those it affects: dishonest corporate leaders ("You will be exposed and punished"); honest corporate leaders ("Your integrity will be recognized and rewarded"); corporate accountants ("The auditors will be audited"); shareholders ("[T]he financial information you receive from a company will be true and reliable"); workers ("We will not tolerate reckless practices"); and all Americans ("There will not be a different ethical standard for corporate America").

The president did not explain what the Act "says" to attorneys. In fact, he did not even mention attorneys during his speech. This was perhaps understandable, as only one sentence in the 50-page Act is devoted to attorneys. Buried among lengthy provisions that established the Public Company Accounting Oversight Board and addressed auditor independence, corporate manager responsibility for accurate financial statements, and stock analyst conflicts of interest, among other high-profile topics, section 307 of the Act directed the SEC to establish new rules of professional responsibility for attorneys who appear and practice before the Commission and become aware of certain misdeeds at a public company. In a popular phrase (albeit one not used by the Act), attorneys must report evidence of such misdeeds "up the ladder" to higher and higher authorities inside the corporation until one of those authorities responds appropriately.

Securities lawyers are no doubt already familiar with the SEC's regulatory response, an elaborate set of rules that took effect on August 5, 2003, and that governs when and how both in-house and outside counsel must report misdeeds up the ladder (along with a proposed rule, still under consideration, that would require outside counsel to end its relationship with any client that does not respond appropriately to reports of misdeeds). Ordinary litigators who do not specialize in securities work, however, may have reasoned that they could safely ignore Sarbanes-Oxley, at least until a client needed representation before the five commissioners. The purpose of this article is to disabuse litigators of this notion and to explain the workings of the SEC regulations to which they may now be subject.

Appearing And Practicing

In most situations, it is obvious to an attorney that he is appearing and practicing before a particular tribunal and therefore is subject to its rules of professional conduct. For members of a particular tribunal's bar, say the Trial Bar of the U.S. District Court for the Northern District of Illinois (Chicago), the attorney files a notice of appearance, alerting the court to his representation of one or more parties in a particular case. Non-members accomplish this by filing and having granted a motion to appear pro hac vice. Either way, the attorney is an officially recognized participant in the case, entitled to appear in court, to take part in status and motion hearings, and to examine witnesses and address the court and jury at trial. No competent attorney, having formally enrolled in and joined the proceedings in this manner, could misunderstand the duty to comply with the court's professional responsibility (and other) rules.

If the situation at the SEC were the same - if appearing and practicing before the SEC meant that an attorney had placed his name on file with regard to a particular matter, made his way to the SEC's Washington, DC, headquarters, and stood before the Commission's semicircular bench on behalf of a client - there would be no cause for confusion over application of the new Sarbanes-Oxley professional responsibility rules. Unfortunately, the reality of appearing and practicing before the SEC under Sarbanes-Oxley is not nearly so simple. The Act itself directed the SEC to regulate attorneys who are "appearing and practicing before the Commission in any way" (emphasis added), and the SEC took the breadth of this instruction to heart, asserting its authority over a variety of attorneys who would not be considered to be appearing and practicing from a traditional (non-securities) perspective.

As a preliminary matter, the regulations apply only to attorneys who appear and practice before the SEC "in the representation of an issuer." 17 C.F.R. § 205.1. Licensed attorneys who are not acting as attorneys, for example, attorneys acting as ordinary businesspeople who do not provide legal services to the corporation, are exempt. See id. § 205.2(a)(2)(i). The rules are directed at attorneys qua attorneys, both in-house and outside counsel. See id. § 205.2(g). In addition, the regulations apply only to attorneys representing "issuers," a defined term that broadly includes public companies already regulated by the SEC, as well as the other entities, such as subsidiaries, that they control. See id. § 205.2(h).

Attorneys representing issuers are subject to the regulations in two basic situations. First, the regulations apply to such attorneys whose work brings them into contact with the SEC, that is, attorneys who transact business or communicate with the SEC; represent an issuer in an SEC administrative hearing or investigation; or represent an issuer in responding to an SEC inquiry, information request, or subpoena. See id. § 205 .2(a)( l)(i), (ii). Although this list is in some respects quite broad because it includes merely responding to a request for information, these activities generally accord with a litigator's traditional understanding of appearing and practicing. This aspect of the new regulations' coverage is not likely to surprise most litigators who are aware of the new regulations.

What might surprise litigators is the possibility that they may appear and practice before the SEC without ever directly encountering the SEC itself, for the new regulations also apply to attorneys who come into contact with or give advice about SEC filings. In the words of the regulations, attorneys are subject to the rules if they are (1) "[a]dvising an issuer as to whether information or a statement, opinion, or other writing is required under the [federal securities laws and regulations] to be filed with or submitted to" the SEC; or if they are (2) "[p]roviding advice in respect of the [federal securities laws and regulations] regarding any document that the attorney has notice will be filed with or submitted to" the SEC, "including the provision of such advice in the context of preparing, or participating in the preparation of, any such document." Id. § 205.2(a)(iii), (iv). Instead of referring to attorneys who appear and practice before the SEC, it might be more accurate if the regulations stated that they apply to attorneys who appear or practice in the vicinity of the SEC.

Litigators, of course, sometimes are asked by their corporate clients to practice in the SEC's neighborhood without ever visiting the SEC's house. Each Form 10-K, the annual report issuers file with the SEC, contains a section describing the corporation's legal proceedings, and a litigator could be asked to draft this section. Litigators sometimes also prepare non-securities documents that are used as exhibits to SEC filings. For instance, issuers may use Form 8-K to notify investors and shareholders of important events, such as litigation settlements, that materially affect the issuer's financial condition or operations. The settlement agreement itself - drafted by a litigator - may be attached as an exhibit to the form.

Application of the regulations to attorneys who prepare or help prepare SEC filings or exhibits has proved to be controversial - and confusing. The original proposed regulations applied to attorneys who are "[p]reparing, or participating in the process of preparing, any statement, opinion, or other writing which the attorney has reason to believe will be filed with or incorporated into any" SEC filing. Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys 67 Fed. Reg. 71,670, 71,675 (Dec. 2, 2002) (Proposed Rule I). The SEC acknowledged that the proposed rule was broad enough to cover the "conduct of attorneys in practice specialties other than securities law." Id. at 71,676. During the comment period, the American Bar Association (ABA) (among others) expressed concern that the proposed rule would cover attorneys with "only limited or tangential involvement with particular SEC filings and documents. For example, it could inappropriately encompass non-securities specialists who do no more than prepare or review limited portions of a filing. . . and lawyers preparing documents that eventually may be filed as exhibits." Final Rule: Implementation of Standards of Professional Conduct for Attorneys, 68 Fed. Reg. 6296, 6297-98 (Feb. 6, 2003) (Final Rule). The practical implication of this comment is that such attorneys (including litigators), with no securities experience and with no involvement in the corporation's business or operations, generally would not be in a good position to help guarantee the accuracy of SEC filings (which is the prime purpose of the new regulations, see Proposed Rule I at 71,670-71), making the imposition of the new rules potentially costly while providing little benefit.

Responding to these and other comments, the SEC revised the rule to provide that attorneys who prepare or help prepare documents that will be filed with the SEC are covered by the rules if they provide advice "in respect of" the federal securities laws and regulations regarding that document. 17 C.F.R. § 205.2(a)(1)(iii). Unfortunately, it is not clear whether this rewording worked any change in the provision; it is not even clear what it means to provide advice "in respect of" certain laws. Although this portion of the final rule could be read as applying only to attorneys who advise whether a certain document must be filed with the SEC, a separate part of the rule (recited above) already covers such advice. Contributing to the confusion are statements by SEC staff members, made after the SEC approved the final rule, indicating that the rule does cover attorneys who simply prepare or help prepare documents that they know will be filed with the SEC. See Comments of Attorneys' Liability Assurance Society, Inc. (ALAS) (Mar. 28, 2003), www.sec.gov/rules/proposedls74502/attorneyslial.htm. The SEC's own comments accompanying the final rule add fuel to this fire by failing to explain the new language. See Final Rule at 6297-98. And although the ABA reads the new language as covering only attorneys who prepare a document and also provide securities advice, the bar association has asked the SEC to "confirm this reading." Comments of ABA at 9 (Apr. 2, 2003), www.sec.gov/rules/proposed/s74502/aba040203.htm.

Faced with this regulatory muddle, prudent litigators must proceed at present on the assumption that the new rules cover them not only when they deal directly with the SEC but also when they prepare or help prepare an SEC filing; prepare or help prepare an exhibit to an SEC filing; give advice about an SEC filing; or, in one final wrinkle, when they supervise another attorney who is doing any of those things. See 17 C.F.R. § 205.4(b).

Dan K. Webb is a Partner at the Chicago office of Winston & Strawn LLP and the head of the firm's Litigation Department. He can be reached at (312) 558-5856. Scott P. Glauberman is an Associate in the firm's Litigation Department. He can be reached at (312) 558-8103.

Please email the authors at dwebb@winston.com or sglauberman@winston.com with questions about this article.