SEC Plan Takes Disclosure Too Far

Robert M. Mattson Jr. is an Irvine-based partner with the law firm of Morrison & Foerster, LLP.

The spate of recent corporate scandals, beginning with Enron, has ensnared lawyers as well as accountants. In some cases, lawyers appear to have facilitated or turned a blind eye to management misconduct and inadequate public disclosure by those companies. In others, lawyers who knew of the management misconduct failed to bring it to the attention of other members of senior management or the boards of directors.

Under the rules of professional conduct in California, a lawyer with evidence of management misconduct may take such actions as the lawyer believes are in the best lawful interest of the corporation.

That can include informing senior officers or the board of directors of corporate misdeeds.

However, for securities lawyers, “going up the ladder” will soon be a requirement, not simply an option. The corporate reform bill recently passed by Congress requires the Security and Exchange Commission to establish minimum standards of professional conduct for attorneys.


Those minimum standards require counsel to report material evidence of a securities law violation or breach of a fiduciary duty to the corporation’s chief legal officer or chief executive and, if those individuals fail to respond appropriately, the lawyer is required to bring those concerns to the audit committee or the full board.

The SEC recently issued proposed rules of professional conduct for lawyers who practice before the commission. Those proposed rules incorporate Congress’ “up the ladder” reporting requirement.

However, the SEC proposals go further and also would require, in certain cases, that outside counsel effect a “noisy withdrawal” from further representation of a corporate client where the company’s board fails to take appropriate action.

In those cases, the lawyer would have to notify the SEC that he or she had terminated representation of the client “for professional considerations” and alert the commission of a refusal to abide further involvement in any securities filing of the former client.


Many lawyers are concerned that the proposed SEC rules will turn them into informants or whistle-blowers and have a damaging effect on the attorney-client relationship. Others are concerned that the SEC is intruding into an area that has been traditionally left to state bar groups and constitutes federal regulation of lawyers.

The law passed by Congress simply requires a lawyer to take the evidence of management misconduct to higher levels of authority within the company itself so that it can be acted upon by those who are charged to protect the corporation and its shareholders.

That has always been an option for attorneys in California and should not violate the attorney-client privilege, because the information would remain within the client corporation. However, the SEC’s mandated “noisy withdrawal” procedures are in direct conflict with the confidentiality requirements under the ethical rules for attorneys in California and some other jurisdictions.

Under existing California rules, information about corporate misconduct imparted to, or discovered by, a lawyer in the course of the lawyer-client relationship generally may not be disclosed by the attorney outside the corporation.

In contrast, the SEC’s “noisy withdrawal” procedures would require the lawyer to give notice of the misconduct outside the corporation, albeit through the code phrase of withdrawal “for professional considerations,” if the response of a company’s outside directors to misconduct is not, in the attorney’s judgment, appropriate. This not only conflicts with California’s ethical requirements but also substitutes the attorney’s judgment for the judgment of those who are charged with managing the affairs of the corporation.

It is regrettable that the SEC felt it necessary to go beyond the congressional mandate in its proposed rules. The SEC should let the new “up the ladder” reporting procedures have a chance to work before requiring outside disclosure. My experience suggests that outside directors of public companies will take their role seriously and deal with management misconduct that is brought to their attention by counsel. If they don’t, the SEC can then consider whether a “noisy withdrawal” requirement should be imposed.

The SEC is scheduled to adopt final rules of professional conduct this week. My hope is that those final rules will strike the proper balance between carrying out Congress’ mandate without undermining the lawyer-client relationship, the attorney-client privilege or professional self-regulation. I urge the SEC to eliminate the “noisy withdrawal” requirement at this time and revisit the issue only when “up the ladder” reporting within the corporate client proves to be an inadequate solution.