(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.)

Atkins Views Duties of Corporate Lawyers in Wake of Sarbanes-Oxley

Touching on a controversial topic that he referred to as the "proverbial third rail," SEC Commissioner Paul S. Atkins examined the Commission's mandate under the Sarbanes-Oxley Act to establish federal parameters for the way lawyers representing public companies appear and practice before the SEC. In the mind of the ordinary investor, he asserted, lawyers are also part of the corporate reporting problem and need to be encouraged to be part of the solution.

By the end of January 2003, the SEC must adopt rules imposing an "up-the-ladder" reporting requirement when attorneys appearing and practicing before the Commission become aware of evidence of a material violation by the company or any of its officers, directors, or employees. The SEC has proposed a comprehensive regulatory regime embodying up-the-ladder attorney reporting. Noting that this is a "hot button" issue, Mr. Atkins asked members of the bar to suggest alternatives to the Commission's proposals, rather than offer blanket objections to them. The Commission is in "uncharted waters" with this new regime, explained Mr. Atkins, which has been described as the first significant effort by Congress to mandate the federal regulation of lawyers. While some will view these rules as unnecessary federal governmental encroachment into the private attorney-client relationship, he continued, others will view them as a necessary step toward bolstering investor confidence by forcing professionals serving public companies to help ferret out misdeeds.

Commissioner Atkins pointed out that the Public Company Accounting Oversight Board was created because of deep failings in the accounting profession's ability to regulate itself, adding that he does not believe the legal profession would like to see a similar organization created to regulate it in a similar fashion. In his view, the SEC rules should be viewed primarily as a codification of the principle that an attorney's client is the company and its shareholders, not the management that hired the attorney.

He said that Congress's mandate is misleadingly simple, as the new regulatory regime must set forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission. These attorneys must report evidence of a material violation of securities law to the company's chief legal counsel or CEO. If the chief legal counsel or CEO does not appropriately respond, the attorney has to make a report to the company's audit committee or full board of directors.

In implementing this concept, the SEC staff made choices as to how to fill in the statutory gaps and create an effective reporting regime. The proposal appropriately notes that attorneys appear and practice before the Commission in a variety of ways, said Mr. Atkins, and so it is expansive on which attorneys will be subject to the rule. The proposal states that all attorneys licensed or otherwise qualified to practice law, whether employed in-house by a company or retained as an outside legal advisor by the company, are considered to be appearing and practicing before the SEC. As proposed, the rule would also cover non-U.S. lawyers, although the SEC seeks specific guidance as to how and whether this rule should apply to foreign attorneys.

The rule will affirmatively state that the attorney's client is the company and not the officers or other individuals with whom the attorney interacts. An attorney is charged with reporting any material violation of the securities laws that he or she reasonably believes has occurred, is occurring, or is about to occur. Mr. Atkins noted that this is a lower standard of reporting than one requiring attorneys to report known material violations. The rule then describes what an attorney should do if a reportable event occurs. The attorney must take reasonable steps to preserve documentary evidence and must report this information to the company's chief legal officer or CEO. Depending on the response received from the chief legal officer, the attorney's duties are either discharged in the event of an appropriate response or will require the attorney to go "up the ladder" to the company's audit committee, another committee of independent directors, or the full board.

If an attorney has not received an appropriate response from the company, the rules permit, and sometimes requires, a noisy withdrawal. In this context, there is a significant distinction between in-house attorneys and outside counsel. If an outside legal advisor who has reported a material violation that is likely to result in substantial injury to the financial interest or property of the company has not received an appropriate response, counsel is, in some circumstances, required to withdraw from representation, notify the SEC of the withdrawal, and disaffirm any submission to the Commission that is tainted by the violation.

According to Commissioner Atkins, this issue is likely to generate the most forceful opposition since it is the first time that lawyers might be compelled to report information outside the organizational structure of their clients. Internal attorneys who have not received an appropriate response to a material violation that they have reported that is likely to result in substantial injury to the financial interest or property of the company are required to disaffirm any tainted submission, but are not required to resign. The rules will also provide for the confidential release of client information. The proposals would allow an attorney to use client information to defend against attorney misconduct or to the extent necessary to prevent an illegal act that may result in a fraud or in substantial injury to the financial or property interests of the company. The rules will also make clear that the company does not waive any attorney-client privilege by sharing confidential information with the SEC pursuant to the terms of the rules.

As an alternative process for considering material violations of law, a company may establish a qualified legal compliance committee, to be comprised of at least one member of the audit committee and two independent members of the company's board, for the purpose of investigating these reports about material violations of law. This committee would be authorized to require a company to take remedial action in response to the material violation. The rules also describe how violations will be prosecuted. Importantly, a violation of the rules will be treated as a violation of the Exchange Act and subject to all of the remedies and sanctions under the act, including injunctions and officer and director bars.

Commissioner Atkins invited debate as to whether the current state-based regulatory framework on attorney conduct is insufficient, thus requiring a new federal regulatory scheme of professional conduct. He noted that SEC Commissioner Cynthia A. Glassman has appropriately inquired whether there is any data on what type of impact the rules will have on preventing future violations of the securities laws. In his view, this is precisely the type of inquiry the SEC should be making as it continues to respond to Sarbanes-Oxley's mandate. In a perfect world, he continued, the rules will result in potential violations of the securities laws being reported up the ladder and remedied before SEC action is required. Any rule that produced that kind of outcome would certainly be considered a success story. Since the world is a notoriously imperfect place, however, he believes that the SEC must continue asking why a rule is being enacted.