(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Lawyer Conduct Rules Proposed by SEC

Following the mandate of the Sarbanes-Oxley Act, the SEC proposed rules that prescribe minimum standards of professional conduct for attorneys appearing and practicing before the Commission. As proposed, the rules would affirmatively state that an attorney representing an issuer represents the issuer as an entity rather than the officers of the company. The rules would also state that the attorney is obligated to act in the best interests of the issuer and its shareholders.

The standard would require an attorney to report evidence of a material violation of securities laws or breach of fiduciary duty or similar violation by the company or any of its agents to senior management, and to take further steps if management does not respond properly. Under the rules as proposes, the duty to report evidence of a "material violation" would be triggered when an attorney "reasonably believes" that a material violation has occurred, is occurring or is about to occur. The proposed rule would not require an attorney to "know" that a violation has been committed. Such a duty would, however, be limited to instances in which disclosure would be appropriate to protect investors.

Reporting Obligation

The attorney would be initially directed to make this report to the issuer's chief legal officer, or to both the issuer's chief legal officer and chief executive officer. The attorney also would be obligated to take reasonable steps under the circumstances to document the report and the response thereto and to retain such documentation for a reasonable time. According to the SEC, requiring the attorney to take such reasonable steps would protect the attorney in the event his or her compliance with the proposed rule is put in issue at some future proceeding.

Executive Response

When presented with a report of a possible material violation, the rule would obligate the issuer's chief legal officer to determine whether to conduct an inquiry into the reported material violation to ascertain whether in fact a violation has occurred, is occurring or about to occur. A chief legal officer who reasonably concludes that there has been no material violation would have to provide notice to the reporting attorney of this conclusion, and take reasonable steps to preserve relevant documentary evidence. A chief legal officer who concludes that a material violation has occurred, is occurring or is about to occur would be required to take reasonable steps to ensure that the issuer adopts appropriate remedial measures, including appropriate disclosures.

The chief legal officer would also be required to report "up the ladder" within the issuer what remedial measures have been adopted, and to advise the reporting attorney of his or her conclusions. A reporting attorney who receives an appropriate response within a reasonable time and has documented his or her report and response would have satisfied all obligations under the rule. The Commission believes that most situations involving reporting to the chief legal officer or chief legal officer and CEO by an attorney will be resolved in this manner.

In the event a reporting attorney does not receive an appropriate response within a reasonable time, the lawyer would be required to report the evidence of a material violation to the issuer's audit committee, another committee of independent directors, or to the full board. Similarly, if the attorney reasonably believes that it would be futile to report evidence of a material violation to the chief legal officer and CEO, the attorney may report directly to the issuer's audit committee, another committee of independent directors, or to the full board. A reporting attorney who has reported a matter all the way "up the ladder" within the issuer and who reasonably believes that the issuer has not responded appropriately would be required to take reasonable steps under the circumstances to document the response and to retain any such documentation for a reasonable time.

The SEC proposal goes beyond the statutory mandate of Sarbanes-Oxley by addressing what lawyers should do if they feel the company is not adequately dealing with the situation. Under the rules as proposed, lawyers who believe their concerns have not been sufficiently addressed would be obligated to disaffirm submissions to the SEC, which the SEC describes as a "noisy withdrawal." The rule would provide that such a disaffirmation would not be a violation of attorney-client privilege.

In addition, the proposal deals with in-house lawyers differently from outside lawyers, in recognition of the fact that the personal cost of a disaffirmation is higher for a company lawyer. The rule also provides for an alternative method, allowing, but not requiring, companies to set up qualified legal compliance committees, which would hear evidence of wrongdoing. These committees would need at least one member of the audit committee, and two or more independent board members. The committee could take items to the SEC if the company failed to make amends, instead of requiring the lawyer to disaffirm a SEC filing.

Privilege

To address the problem of attorney-client privilege, the rule proposal sets up a number of guidelines. Lawyers could use their own records to defend against charges of misconduct, under a system that the SEC staff says is similar to many state ethics rules for lawyers. The proposal is intended to create an incentive for lawyers to create contemporaneous records. Furthermore, the rule would allow lawyers to give confidential information to the SEC as part of an effort to prevent fraud upon the SEC, or financial injury to the issuer. The attorney could also disclose private material to rectify illegal activity, if such activity was advanced by the company's use of the attorney's services. Under the proposal, violations of the new rule could result in injunctions, cease and desist orders, and the barring of individuals to serve as officers or directors.

The proposing release is available at ¶86,802.