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Prezioso Calls for Dialogue on Attorneys' Response to Corporate Misconduct

SEC General Counsel Giovanni Prezioso, in remarks at the spring meeting of the Association of General Counsel, reviewed the guiding principles for SEC sanctions against lawyers who violate the securities laws and the changes brought about by Sarbanes-Oxley Act Section 307. Mr. Prezioso also talked about the requirement for a chief compliance officer to cause a company to adopt an appropriate response when a violation has occurred, which he said is a serous responsibility that has received insufficient attention. He called for a dialogue between the SEC and the bar to outline procedural and substantive elements that would characterize an appropriate response.

Mr. Prezioso observed that recent SEC enforcement cases against lawyers serving as general counsel at public companies had provoked consternation among lawyers who believe the actions reflected a change in the agency's enforcement policy. That view is misplaced, according to Mr. Prezioso. He said the principles underlying the enforcement proceedings in the past year have been broadly consistent with the approach the SEC and the courts have taken for years.

Mr. Prezioso said the SEC has long recognized that many securities law violations could not occur without the participation of lawyers. At the same time, the SEC recognizes the importance of zealous advocacy in securities law matters, he advised, and has resisted policies that might chill that objective. Mr. Prezioso said that the debate about lawyers as gatekeepers needs to be separated from the consideration of their liability as principals. The SEC's approach to sanctioning lawyers who violate professional standards of conduct is distinct from its approach to sanctioning lawyers for participating in securities law violations, according to Mr. Prezioso.

Mr. Prezioso explained that, to preserve an appropriate level of advocacy, the SEC ordinarily will not sanction lawyers under the securities laws for giving bad advice, even if it is negligent "and perhaps worse." The SEC will sanction a lawyer for conduct that, if carried out by any other person, would give rise to an enforcement proceeding.

Mr. Prezioso gave an example of a lawyer who knowingly provides an opinion letter or drafts a disclosure document that contains a misstatement of fact or law that will be relied upon in the purchase or sale of securities. In that situation, the lawyer may be held liable for securities fraud. In some cases, a lawyer's actions may involve a mixture of conduct and advice. The SEC will then consider the extent to which the decision-making process depended on the lawyer. He said that especially difficult issues can arise in the disclosure context, given the heavy reliance on lawyers to assist in drafting the documents.

A key indicator as to whether a lawyer was acting more as a decision-maker or was counseling a course of conduct is the extent to which the lawyer gave anyone else at the company legal advice on the relevant issue, according to Mr. Prezioso. For example, if the lawyer provides the CEO with a legal view which is then disregarded, there may be legitimate questions about the lawyer's obligations as a professional, but the lawyer will rarely be viewed as primarily, or even secondarily, liable under the securities laws absent further participation in the misconduct. On the other hand, if the lawyer makes a legal judgment on an issue that cannot fairly be viewed as immaterial and fails to inform anyone else at the company of the potential legal risks, it will be more difficult to argue that the lawyer played a purely advisory role, Mr. Prezioso explained. The lawyer's continuing participation in the activity without providing advice to others may constitute a course of conduct that effectively makes the ultimate business decision.

In close or difficult judgment calls, Mr. Prezioso said the SEC should not second-guess those decisions given the complexity of the securities laws. However, in cases where every securities lawyer should know the answer or a non-securities lawyer fails to seek advice, the lawyer may properly be held responsible for the corporate conduct in which he or she participated, in Mr. Prezioso's view. The SEC will also consider whether the lawyer's activities occurred during an investigation or an enforcement proceeding, or otherwise in direct representation of the client before the SEC or its staff. Unless there are misrepresentations or unethical conduct, Mr. Prezioso said there is a strong countervailing policy against sanctioning lawyers in that context.

The Sarbanes-Oxley Act altered one of the key underpinnings of the SEC's traditional approach to the oversight of lawyers, according to Mr. Prezioso. The Act eliminated any lingering questions about the SEC's authority. To fulfill its Congressional mandate, Mr. Prezioso said the SEC must devote more time and resources to developing its expertise in this area. The SEC has begun to deepen its understanding and to expand its capabilities in this area, he reported. While it does so, the staff is not searching for cases at the fringes, he advised. The staff is focusing on evidence of potentially serious misconduct such as the subornation of perjury, the alteration of documents and violations of the regulations adopted under Section 307.

The SEC oversees the enforcement process and ensures that it will not be used for retribution or to place inappropriate pressure on lawyers for aggressively representing their clients. The Office of the General Counsel reviews all enforcement matters and makes its own recommendations to the Commission. His office plays a heightened role in cases involving lawyers, Mr. Prezioso added. Investigations of professional misconduct by attorneys are not handled by lawyers in the Enforcement Division, but are referred to the Office of the General Counsel for investigation and, where appropriate, enforcement proceedings.

Mr. Prezioso discussed the heightened role now assigned to the chief legal officer of public companies under Section 307 and Congress's emphasis on the lawyer's responsibility in the corporate context for representing the entity, not senior management. The chief legal officer must place the company's interests first. When conducting an inquiry into a potential violation, Mr. Prezioso said that Congress gave limited guidance but made clear that some appropriate action must be taken. Chief legal officers must work "within a delicate framework" in assuring an appropriate corporate response, he noted, since an inquiry may expend significant resources and require input from managers and others.

Mr. Prezioso believes that everyone could benefit if public companies, chief legal officers and the SEC work together to outline the characteristics of an appropriate response to a violation. Defining an appropriate response is challenging, he said, but attorneys will rarely go wrong if they put the interests of the company and its shareholders ahead of the interests of its management or others.