By Janis Reinken, Attorney/Director of Risk Management
The SEC regulations of the legal profession, adopted under the Sarbanes-Oxley Act, stand at the forefront of the Congressional initiative to corral corporate dishonesty and its after-effects on investors1. Federal oversight may reach even those attorneys who do not ordinarily represent the interests of publicly-traded entities and do not consider themselves to be securities law specialists. Conventional wisdom suggests that litigation will determine eventually whether State or federal enforcement mechanisms should control.
This brief article cannot possibly address all the effects of the SEC regulations upon attorneys who may be interpreted as “appearing and practicing” before the SEC2. Much more comprehensive treatment can be found in law periodicals and on the web. See, e.g., M. Steinberg, “Lawyer Liability After Sarbanes-Oxley—Has the Landscape Changed?” 3 Wyo. L. Rev. 371 (2003), and “Standards of Professional Conduct for Attorneys—Implementation of Section 307 of Sarbanes-Oxley,” Cravath, Swaine & Moore (February 25, 2003)3.
For a flowchart outlining SEC Rules compliance steps by counsel in reporting material violations, refer to D. Johnston and K. Millard, © Russell McVeagh, Dec. 2002 at http://www.clanz.org/files/RM-Table_SEC_revised_1_December_2002.PDF.4
Three of the most controversial SEC requirements concern the “reporting up”5 and “noisy out” disclosures by attorneys regarding corporate misconduct6; subsequent withdrawal; and the broad reach of the SEC’s interpretation of “providing legal services as an attorney for an issuer.”7 This article will emphasize the latter subject.
Some may be surprised by the revelation that liability exposure could fall upon attorneys who do not specialize in securities law but do provide legal services for individuals, subsidiaries, and other affiliated parties or entities that are controlled by or conduct business with publicly traded entities. Although it appears that Section 205.2(a) applies only to the conduct of attorneys when providing legal services for an issuer with whom they have an attorney-client relationship, Section 205.2(g) defines “in the representation of an issuer” as “providing legal services as an attorney for an issuer, regardless of whether the attorney is employed or retained by the issuer.”
In the SEC’s efforts to protect investors or stockholders of an “issuer” from detrimental yet justifiable reliance on such information, scrutiny of an attorney’s work product and conduct may be invoked regarding disclosure of opinion letters, expert reports, litigation evaluations for audits, and the like. See, e.g., Comments of the American Bar Association at endnote 8 of http://www.sec.gov/rules/final/33-8185.htm.
According to an SEC position paper, however, the final rule modified the definition so that “ . . . an attorney must have notice that a document he or she is preparing or assisting in preparing will be submitted to the Commission . . . ,” and that it would not constitute “appearing and practicing” before the Commission to prepare a document (such as a contract) that the attorney never intended or had notice would be submitted to the SEC or incorporated into a document submitted to the SEC, but which subsequently is submitted as an exhibit to or in connection with an SEC filing. See http://www.sec.gov/rules/final/33-8185.htm, Part II. Section-by-Section Discussion of the Final Rule (text following fn.10).
The SEC regulations and position paper also take the formidable position that, where State governance of attorney conduct is not as rigorous, the SEC regulations are intended to be controlling8. In contrast, many of the public comments challenged the authority of the SEC regulations to supplant State disciplinary rules as not having been empowered or mandated by Sarbanes-Oxley9.
Preemption issues aside, prior to the advent of Sarbanes-Oxley or the SEC regulations, the Texas disciplinary and evidentiary rules set forth permissive and mandatory guidelines for attorneys regarding their own truthfulness in representations to others, and for curbing past or future client dishonesty or criminal conduct10. TEX. DISCIPLINARY RULES of PROF. CONDUCT, Rules 1.02(c)-(f), 1.12(b), 4.01; see also TEX. R. EVID. 503(d)(1), (3).
Texas attorneys would be well-advised to interpret the State rules conservatively, although their full meaning is not always crystal-clear. In most instances, conservative compliance efforts under State guidelines would correspond generally to the kind of conduct permissible under applicable SEC regulations.
Traps for the Unwary: Practice Pointers for the Careful Practitioner
Whether or not you specialize in securities law, representation of your client may directly or indirectly subject your work to SEC regulatory compliance, so clarify how widely your work product will be spread to others. If provided by your client or an intended third party to others, your work or opinion could become part of a public offering, audit, or other report. It could then fall under SEC scrutiny, it could serve as material for a negligent misrepresentation claim under common law,11 or even worse, it might become evidence for criminal prosecution.12
Here are some areas in which to take precautions:
- A request to review or prepare documents, opinions or other legal services out of context without knowing the full picture;
- Representing subsidiaries, related partnerships, or other affiliates if the client expects to provide your work to other parties (possibly including an SEC-regulated entity);
- You may be within reach of potential scrutiny by SEC regulators even if not serving as general counsel or in-house counsel for a publicly traded entity;
- Document the identity of parties to whom the client might disclose your work product, and make disclaimers as to parties outside the zone of “justifiable reliance;”
- With regard to work or opinions for disclosure to a 3d party, inform the client about potential waiver of attorney-client privileges and document their consent;
- Avoid negligent misrepresentation complaints from non-clients. Use transmittal letters to clients to specify that your work is being provided exclusively for that client (and any identified third parties or internal or affiliated constituents), and further that disclosure to others could impair the attorney-client privilege;
- Avoid conflicts of interest between officers, directors and managers of an entity, and the entity itself;
- Review the Texas Disciplinary Rules as well as SEC regulations, if directed to do something you believe may be detrimental to a client entity; it may become necessary to go up the ladder or withdraw, if no one in charge will do what is right.
Texas attorneys still have reason to be mindful of Texas law and rules when confronted with issues of client dishonesty, whether the SEC Regulations will apply, and whether they might preempt State law or rules. How well you as the attorney manage borderline situations, being aware of the need for truthful disclosures and representations to clients and others, may keep you out of harm’s way.
1The SEC regulations adopted pursuant to Section 307 of the Sarbanes-Oxley Act of 2002, 15 U.S.C. 7245, became effective August 5, 2003. See 17 C.F.R. Part 205 [Release Nos. 33-8185; 34-47276; IC-25919; File No. S7-45-02] at http://www.sec.gov/rules/final/33-8185.htm. According to Release No. 33-8185, the SEC is still considering requiring "noisy withdrawal." Summary paragraph, SEC Release Nos. 33-8185; 34-47276; IC-25919; File No. S7-45-02 at http://www.sec.gov/rules/final/33-8185.htm.
2“Appearing and practicing” before the SEC means:
“(i) Transacting any business with the Commission, including communications in any form;
(ii) Representing an issuer in a Commission administrative proceeding or in connection with any Commission investigation, inquiry, information request, or subpoena;
(iii) Providing advice in respect of the United States securities laws or the Commission's rules or regulations thereunder regarding any document that the attorney has notice will be filed with or submitted to, or incorporated into any document that will be filed with or submitted to, the Commission, including the provision of such advice in the context of preparing, or participating in the preparation of, any such document; or
(iv) Advising an issuer as to whether information or a statement, opinion, or other writing is required under the United States securities laws or the Commission's rules or regulations thereunder to be filed with or submitted to, or incorporated into any document that will be filed with or submitted to, the Commission; but
(2) Does not include an attorney who:
(i) Conducts the activities in paragraphs (a)(1)(i) through (a)(1)(iv) of this section other than in the context of providing legal services to an issuer with whom the attorney has an attorney-client relationship; or (ii) Is a non-appearing foreign attorney.” 17 C.F.R. 205.2(1) (August 5, 2003) [emphasis added].
3Of the many Internet articles available, these two provide a brief overview of the SEC regulations and the statute. See, e.g., S. Poss, “SEC Adopts Standards of Professional Conduct for Attorneys, © 2003 Goodwin Procter LLP at http://library.lp.findlaw.com/articles/file/00338/009271/title/Subject/topic/Corporations%20%20Enterprise%20Law_Corporate%20Governance/filename/corporationsenterpriselaw_1_456, and M. Frantz, “Corporate Governance Redefined: The Sarbanes-Oxley Act of 2002 and Related Rulemaking,” © 2003 Miller Nash LLP, at http://library.lp.findlaw.com/articles/file/00302/009263/title/Subject/topic/Corporations%20%20Enterprise%20Law_Corporate%20Governance/filename/corporationsenterpriselaw_1_456.
4Neither TLIE nor the author of this article endorses nor suggests that the flow chart cited will be perfectly reliable; however, the reader may find it helpful as an aid in compliance to some degree.
5Texas Rule 1.12(a) recognizes that an attorney for a corporation represents the entity, not its constituents, and that when issues of misconduct arise, 1.12(b) requires a lawyer representing an organization to take “reasonable remedial actions” whenever the lawyer learns or knows that:
“(1) an officer, employee, or other person associated with the organization has committed or intends to commit a violation of a legal obligation to the organization or a violation of law which reasonably might be imputed to the organization;
(2) the violation is likely to result in substantial injury to the organization; and
(3) the violation is related to a matter within the scope of the lawyers representation of the organization.” See also, ABA Model Rules of Professional Conduct, Rule 1.13 (Approved Aug. 2002, as amended 2003) at http://www.abanet.org/cpr/mrpc/new_rule1_13.pdf.
6Report by an attorney of credible evidence of a “material violation” means one of applicable “federal or state securities law, a material breach of fiduciary duty [as defined] arising under United States federal or state law, or a similar material violation of any United States federal or statelaw.” 17 C.F.R. Sec. 205.2(i).
7For purposes of defining “appearing and practicing” and “in the representation of an issuer,” 17 C.F.R. Sec. 205.2(h) provides: “ . . . the term "issuer" includes any person controlled by an issuer, where an attorney provides legal services to such person on behalf of, or at the behest, or for the benefit of the issuer, regardless of whether the attorney is employed or retained by the issuer.” [Emphasis added.]
8“[T]his part does not preempt ethical rules in United States jurisdictions that establish more rigorous obligations . . . . [and] the Commission reaffirms that its rules shall prevail over any conflicting or inconsistent laws of a state or other United States jurisdiction . . . .” SEC Release Nos. 33-8185; 34-47276; IC-25919, at http://www.sec.gov/rules/final/33-8185.htm#P39_11575 [footnotes omitted]. 17 C.F.R. Sec. 205.7(b) states that the SEC has exclusive enforcement authority of the rules, and 17 C.F.R. Sec. 205.7(a) clearly negates any private right of action against any attorney, law firm or issuer based upon compliance or noncompliance with the rules. See also, Central Bank of Denver, N.A. v. First Interstate Bank of Denver, N.A., 511 U.S. 164 (1994).
9“[T]he correct question is whether Congress delegated authority to the SEC to preempt state law and to promulgate noisy withdrawal requirements. Absent that Congressional delegation of authority, the SEC lacks the legal basis to do so.” Letter of April 7, 2003 to SEC Chairman Katz, Association of the Bar for the City of New York “Comment to File No. S7-45-02” at http://www.sec.gov/rules/proposed/s74502/abcny040703.htm.
10Rule 1.02 of the Texas Disciplinary Rules of Professional Conduct states, in part,
“(c) A lawyer shall not assist or counsel a client to engage in conduct that the lawyer knows is criminal or fraudulent. A lawyer may discuss the legal consequences of any proposed course of conduct with a client and may counsel and represent a client in connection with the making of a good faith effort to determine the validity, scope, meaning or application of the law.
(d) When a lawyer has confidential information clearly establishing that a client is likely to commit a criminal or fraudulent act that is likely to result in substantial injury to the financial interests or property of another, the lawyer shall promptly make reasonable efforts under the circumstances to dissuade the client from committing the crime or fraud.
(e) When a lawyer has confidential information clearly establishing that the lawyer’s client has committed a criminal or fraudulent act in the commission of which the lawyers services have been used, the lawyer shall make reasonable efforts under the circumstances to persuade the client to take corrective action.
(f ) When a lawyer knows that a client expects representation not permitted by the rules of professional conduct or other law, the lawyer shall consult with the client regarding the relevant limitations on the lawyer’s conduct.. . .”
11Non-clients may seek recovery for actual damages resulting from justifiable reliance on negligent misrepresentations; privity is rarely a viable defense for an attorney against claims of negligent misrepresentation by a non-client third party. McCamish, Martin, Brown & Loeffler v. F. E. Appling Interests, 991 S.W.2d 787, 788 (Tex. 1999); see also, In re Enron Corp. Securities, 235 F.Supp.2d 549, 609-610 (U. S. Dist. Ct., S.D.Tex., 2002) and In re Sunpoint Securities, Inc., Debtor, 262 B.R. 384, (U. S. Bk.Ct., E.D. Tex., 2001).
12One accountant was fined $208 million and sentenced to 121 months in federal prison for money laundering and racketeering. See http://www.sec.gov/news/digest/dig081503.txt; see also http://www.usdoj.gov/dag/cftf/corporate_guidelines.htm, regarding a revised set of principles distributed to guide Department of Justice prosecutors in deciding whether to seek charges against a business organization.
