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

Tuesday, March 1, 2005 - 01:00

Part I of this article appears in the December 2004 issue of The Metropolitan Corporate Counsel, Part II appears in the January 2005 issue and Part III in the February 2005 issue.

State Ethics Laws

The other side of the Sarbanes-Oxley sanctions and discipline coin is what will happen to an attorney who, in complying with the SEC's regulations, violates state ethics regulations. To this the SEC offers a very brisk answer: "An attorney who complies in good faith" with the SEC's regulations "shall not be subject to discipline or otherwise liable under inconsistent standards imposed by any state or other United States jurisdiction where the attorney is admitted or practices." Id. § 205.6(c); see also id. § 205.1. In other words, where the SEC regulations say "shall," the attorney must ignore state regulations that say "shall not"; and where the SEC regulations say "may," the attorney may choose to ignore state regulations that say "may not." State bars, however, may impose "additional requirements on the attorney that are consistent with the Commission's rules." Final Rule at 6314. (In light of the regulation's ambiguous reference to "other United States jurisdiction[s]," which could refer to state-like bar regulations in Guam and the District of Columbia or to attorney ethics codes adopted by a federal court, or to both, see Final Rule at 6297 (referring to "any jurisdiction where an attorney is admitted or practices" (emphasis added)), it is not clear what effect the SEC intends the regulations to have on federal court ethics regulations.)

The SEC shows every sign of taking seriously the supremacy of its regulations over contrary state regulations. After the final rules were announced (but before they went into effect), Washington state bar authorities released for comment a formal opinion addressing the effect of the Sarbanes-Oxley regulations on Washington attorneys. SEC General Counsel Giovanni P. Prezioso, on behalf of the commission, took strong issue with two provisions of that proposed formal opinion. First, the proposed formal opinion stated that bar members appearing and practicing before the Commission are prohibited - under threat of liability and bar disciplinary action - from disclosing to the Commission certain information that the Commission's rules permit them to disclose. Second, [it] . . . opines that a Washington attorney cannot claim to be complying in 'good faith' with the Commission's rules. . . if the attorney acts contrary to the Formal Opinion. See Letter Regarding Washington State Bar Association's Proposed Opinion on the Effect of the SEC's Attorney Conduct Rules 2 (July 23, 2003), www.sec.gov/news/speech/spch072303gpp.htm. Mr. Prezioso rejected both assertions, the first on account of the Constitution's Supremacy Clause and the second on the theory that the SEC, not the states, had the authority to interpret the SEC's rules.

Areas of conflict between the Sarbanes-Oxley regulations and various states' ethics rules may be growing smaller. Within one week after the former took effect, the ABA amended the Model Rules of Professional Conduct, on which many state ethics codes are based, to bring the Model Rules more in line with the SEC's regulations. Model Rule 1.13 now requires attorneys representing organizations to report up-the-ladder violations of legal obligations to the organization or violations that might be imputed to the organization, and it gives attorneys the option of reporting outside the organization if the organization's highest authority ignores the attorney's report. See Model Rule 1.13(b), (c). A contemporaneous amendment to Model Rule 1.6, which is addressed to attorneys generally rather than to attorneys representing organizations, allows attorneys to reveal client confidences when necessary "to prevent the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer's services." Model Rule 1.6(b)(2); see also Rule 1.6(b)(3). The amended Model Rules do not match the Sarbanes-Oxley regulations precisely - for example, amended Model Rule 1.13, unlike the regulations, requires that the violation be "related to the representation" to qualify for up-the-ladder treatment - but the two are close enough that most attorneys need not fear being tugged in different directions by otherwise competing rules of professional responsibility.

Noisy Withdrawal

The ABA's new Model Rules were widely and probably correctly viewed, at least in part, as an attempt to stave off further attorney regulation by the SEC. (The SEC was in fact awaiting the new Model Rules to determine whether further regulation was necessary. See Commissioner Paul S. Atkins, Remarks at Rocky Mountain Securities Conference 3 (May 30, 2003), www.sec.gov/news/speech/spch053003psa.htm.) Most ominously, the SEC is now considering whether to impose a further requirement on outside attorneys who report up the ladder (but not those who reported initially to a QLCC) and don't receive a timely, appropriate response: If the outside attorney "reasonably believes" that a material violation is "ongoing or about to occur" and is "likely to result in substantial injury to the financial interest or property of the issuer or of Investors," the attorney must (1) withdraw "from representing the issuer"; (2) give written notice of withdrawal to the SEC; and (3) disaffirm to the SEC any document filed with the SEC that the attorney prepared or helped prepare and the attorney "believes is or may be materially false or misleading." Proposed Rule: Implementation of Standards of Professional Conduct for Attorneys (Proposed Rule II), 68 Fed. Reg. 6324,6326 (Feb. 6, 2003).

This is commonly known as a "noisy withdrawal," although as with "up the ladder," the regulations do not use this term. If the violation already occurred and is not ongoing, the noisy withdrawal is optional. See id. at 6326-27. In-house attorneys are required, in the case of ongoing violations, or allowed, in the case of past violations, to disaffirm any tainted document filed with the SEC; but in-house attorneys need not resign. See id. at 6327. The corporation's CLO must inform any replacement attorney of the prior attorney's withdrawal. See id.

In response to widespread criticism of this proposed rule, including of the grievous wounds it would inflict on the attorney-client relationship and privilege, the SEC also proposed an alternative. Under the alternative rule, the attorney would need "substantial evidence" of an imminent or ongoing (but not past) material violation likely to cause substantial injury, and the withdrawal would not be accompanied by a disaffirmance of any document. See id. at 6335. In addition, the corporation rather than the attorney would notify the SEC. See id. at 6336. The attorney "may" notify the SEC if the corporation fails to do so. See id.

It is impossible to know whether the SEC will adopt either of these proposals, some other proposal, or no withdrawal provision at all; but three features of the pending proposals merit mention. First, the apparent safety valve in both proposals that limits mandatory withdrawal to "ongoing" violations is not much of a safety valve at all. "Ongoing" is a notoriously slippery concept. Take for example what appears to be the ultimate occurrence of a past, non-ongoing violation: a one-time material misstatement in a document already filed with the SEC. This violation is not ongoing in the ordinary sense of the word: No material misstatement is being made at present, and no material misstatement is expected to be made in the future. Yet the SEC refers to this sort of violation as having "an ongoing impact" because "investors may continue to rely" on it. Proposed Rule I at 71,677; see also id. at 71,692 (referring to the "ongoing effect" of the "past misconduct" of overstating earnings). Under either of the SEC's proposals or any similar proposal, it seems that most withdrawals will be mandatory.

Second, damage to the attorney-client relationship is inherent in any rule requiring the reporting to the SEC of material violations discovered by the attorney, no matter whether the attorney (first proposal) or the corporate client (alternative proposal) actually makes the report. The SEC proposed that the client make the report on the theory that forcing the attorney to do so would "risk destroying the trust and confidence many issuers have until now placed in their legal counsel, creating divided loyalties and driving a wedge into the attorney-client relationship." Proposed Rule II at 6329. Yet none of these effects depends on the identity of the informer; the first proposal calls for a breach in the attorney-client privilege, while the alternative proposal arguably calls for a forced waiver of that privilege. Either way, the privilege and the relationship will suffer.

Third, the proposed regulations call for the attorney to withdraw "from representing the issuer." Proposed Rule II at 6326, 6335. They do not specify whether the attorney must withdraw only with respect to the matter at issue (although remember that, because no nexus is required, the violation may not even be related to any matter on which the attorney is working) or whether the attorney must stop representing the issuer entirely. There is much to be said for the idea that "[r]equiring withdrawal from all matters ," including "general corporate work, securities work, litigation, tax advice, labor, criminal matters, IP etc.," "goes far beyond what is required to achieve the Commission's purposes and may seriously harm the issuer." Comments of 79 Law Firms at 5 (Apr. 7, 2003), available at www.sec.gov/rules/proposed/s74502/79lawfmnsl.htm; see also Comments of ALAS at 4. It remains to be seen, however, what rule, if any, the SEC will impose.

With that last point in mind, we close with the sage words of SEC Commissioner Cynthia A. Glassman, who, while commenting on the competing noisy withdrawal proposals, SEC Implementation of Sarbanes-Oxley: The New Corporate Governance 4 (Apr. 7, 2003), www.sec.gov/news/speech/spch040703cag.htm, offered advice applicable not only to those proposals but also to any developments in the law of professional responsibility: "Stay tuned."

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.