(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.)

SEC's Attorney Conduct Proposal Debated

The SEC's proposal on up-the-ladder reporting by corporate lawyers has generated a significant amount of comment and debate as the Commission enters the uncharted waters of federal regulation of attorneys. The Sarbanes-Oxley Act, in Section 307, directs the SEC to adopt rules requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty by the company or one of its agents to the chief legal counsel or the chief executive officer. If corporate officials do not appropriately respond, the attorney must report the evidence to the board's audit committee or to another board committee comprised solely of directors not employed directly or indirectly by the company, or to the board of directors. This mandate is within the broader statutory direction to establish minimum standards of professional conduct for attorneys appearing or practicing before the Commission in any way in the representation of public companies.

At the recent Practising Law Institute Securities Law Institute in New York City, SEC officials and members of the bar engaged in a robust discussion of the proposal. Alan Beller, director of the Division of Corporation Finance, noted that, while the proposal covers both inside and outside counsel, it was not meant to dampen the ardor with which lawyers represent clients within the bounds of the law, nor was it designed to second guess the general counsel. Rather, said Mr. Beller, the proposal was developed to deal with issues arising from a strict up-the-ladder concept.

Section 307 does not define its terms. The SEC proposal defines the term "appearing" and "practicing" before the Commission to include all communications with the Commission on behalf of an issuer, as well as all conduct involving the preparation of any document submitted to or filed with the Commission. While admitting this is a broad definition, Mr. Beller said it was consistent with what this has historically meant under Rule 102(e). The definition recognizes that attorneys interact with the SEC in a number of ways on behalf of issuers.

In a comment letter, former SEC Commissioner Edward H. Fleischman objected to subsuming within the phrase "appearing and practicing before the Commission" the rendering of lawyer-to-client legal advice that a company is not obligated to file a registration statement or other document with the Commission. Mr. Fleischman spoke for himself and for other prominent members of the securities bar, including former SEC Commissioner Roberta Karmel.

Similarly, the SEC would broadly define attorney to encompass those admitted in any foreign or domestic jurisdiction, including corporate employees who are admitted to a bar but who do not occupy legal positions with the company. In his comments, former Commissioner Fleischman contended that subjecting lawyers licensed solely by foreign countries to professional discipline by the SEC for shortcomings under U.S. standards, with which they are often quite unfamiliar, is an extraordinary assertion of extraterritorial jurisdiction overriding foreign professional standards. The SEC has announced it will hold an interactive roundtable on December 17, 2002, to discuss the international impact of the proposed attorney conduct rules. The Commission expects the roundtable discussions to provide valuable information as it prepares to finalize the rules by the statutory deadline of January 26, 2003.

The rule proposal would also obligate attorneys to report evidence of a material violation, which is defined as information that would lead an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur. Director Beller described this as an objective standard for a lawyer of reasonable competence. When prompted further, he explained that an analysis in deciding if a material violation is about to occur is whether the SEC would win the Section 13(a) case.

In his comments, Mr. Fleischman objected to a standard for up-the-ladder reporting of whether the lawyer, acting reasonably, should believe that the enforcement division would prevail in an administrative proceeding under Section 13(a). He described these as proceedings requiring neither bad faith nor fraudulent intent but merely omission or misstatement of facts determined in the clear vision of hindsight to have been material.

The proposal outlines an alternative process under which attorneys can satisfy their up-the-ladder duty by reporting evidence of a material violation to a qualified legal compliance committee composed of board members. The committee would then notify the CEO and the chief legal officer and decide if an investigation is warranted. Mr. Beller described this as a workable alternative, stressing that going the committee route is not required. Panelists at the PLI seminar said it was a course that most attorneys would probably follow since it was more attractive than reporting directly to the CEO or the chief legal officer.

The SEC proposal requires or allows, under certain circumstances, a "noisy withdrawal" by an attorney who has not received an appropriate response from the company. Pursuant to such a noisy withdrawal, a term not mentioned in the Sarbanes-Oxley Act provision, outside attorneys who have presented evidence of an ongoing or prospective material violation, and have not received an appropriate response, must withdraw from representation, notify the SEC of their withdrawal, and disaffirm any tainted submission to the SEC. Attorneys employed by the company must also disaffirm any tainted submission, but are not required to resign. In addition, attorneys are permitted, but not required, to take these steps when they believe a violation has already occurred.

Commenting on this aspect of the proposal, former Commissioner Fleischman objected to requiring lawyers who have decided to dissociate themselves from client conduct to do so by means of a noisy withdrawal, thereby substituting the lawyer's legal judgment for that of the client's chief internal reviewing officer and equally substituting the lawyer's business judgment for that of the client's audit committee or its board of directors.