SEC Wants Attorneys to Stand Up to Companies’ Misconduct
“It is the duty of an attorney: . . . (e) to maintain inviolate the confidence, and at every peril to himself or herself to preserve the secrets, of his or her client.”
California Business & Professions Code section 6068(e)
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WASHINGTON -- First came tough new rules for accountants. Next, regulators unveiled steps to keep financial analysts on the straight and narrow.
Now -- and much to their discomfort -- it is the lawyers’ turn for a new code of conduct.
In one of the final pieces of regulatory business inspired by Enron Corp. and other corporate debacles, the Securities and Exchange Commission wants to require lawyers to, in effect, blow the whistle on financial misconduct if a company refuses to fix it after repeated, in-house warnings.
Critics are using such terms as “Orwellian” to describe the proposal, which the SEC could vote on as early as this summer. The plan is drawing fierce resistance from the legal bar, which views it as an assault on attorney-client privilege -- the long-standing practice of keeping communications between attorneys and their clients confidential -- and an unnecessary federal incursion into a domain largely controlled at the state level.
The SEC proposal also may be prompting questions inside corporate boardrooms about the privacy of lawyer-client conversations that always have been considered secret.
“In my view this is not in the public interest,” said Hayward D. Fisk, vice president and general counsel at Computer Sciences Corp. in El Segundo. The proposal could backfire, he warns, in effect taking “the lawyer out of the inner circle of senior executive deliberations.”
Under the proposal, corporate lawyers who discover ongoing financial misconduct would be obliged to quit and report their resignation to the SEC. They would not have to disclose what they found, but the act of resigning could serve as a warning flag to federal investigators.
Although the rule wouldn’t apply to every corporate attorney, it still would hit a significant segment of the bar -- those lawyers who advise companies in a broad range of matters involving the SEC, from routine quarterly reports to documents disclosing major financial events. It would apply to outside attorneys as well as to in-house counsel. An alternative SEC plan, which also has drawn criticism, would require companies to specify whether a lawyer quit for ethical reasons.
“How far they will intrude as a federal agency into the private self-regulation of this guild -- my profession -- is one of the largest questions on the SEC’s current agenda,” said John C. Coffee Jr., a law professor at Columbia University in New York.
The outcome, he added, is far from clear, given the bar’s stiff opposition.
“It’s still an open question whether there’s going to be significant regulation of attorneys,” he said.
The SEC proposal seeks to answer a question that regulators have asked for decades.
“Where were the outside accountants and attorneys?” U.S. District Judge Stanley Sporkin, a onetime SEC enforcement chief, asked in a 1990 ruling on the savings and loan crisis, the high-profile financial scandal of the time.
More recently, lawyers and other professionals have been accused of failing to sound the alarm on conflicts of interest, deceptive accounting practices, shady tax schemes and similar misdeeds at such firms as Enron and Global Crossing Ltd., among others. With that in mind, Congress called on the SEC to upgrade ethical standards for lawyers, accountants and financial analysts when it passed the Sarbanes-Oxley corporate reform bill in July.
Regulators have made clear their plans for accountants and analysts. Earlier this year, the SEC approved a new rule to enhance the independence of accountants from the firms they audit. This month, regulators and 10 big Wall Street firms approved a $1.4-billion settlement that aims in part to ensure that stock analysts provide honest research.
But coming to terms with lawyers has taken longer. In January, the SEC approved a new rule specifying that lawyers should report ongoing, serious financial violations up the corporate chain of command and, if need be, ultimately to the board of directors.
It held off, however, on the controversial whistle-blower requirement, a policy dubbed “noisy withdrawal.” Regulators were still digesting a barrage of criticism from the legal and corporate establishment, including complaints from the American Bar Assn., Business Roundtable, American College of Trial Lawyers and the American Corporate Counsel Assn., as well as state and local bar groups.
One letter, signed by 77 law firms, warned that the SEC lacked congressional authority to impose such a rule. Attorneys voiced their concerns from as far away as Tokyo, Tel Aviv and Caracas, Venezuela.
Defenders of the overall concept maintain that such “reporting out” is a last-ditch remedy to prevent a recurrence of Enron-like corruption, and that in reality it would rarely be needed. Advocates further say that disclosing the resignation of a lawyer is a small price to pay if it short-circuits a potential scandal.
Such disclosure, said SEC Commissioner Harvey J. Goldschmid, himself a lawyer, “would put the lawyer in the position of saying: ‘This is going to kill the shareholders, this is going to kill the company, and you just have to correct it.’ ”
Goldschmid maintains that, as a practical matter, the less controversial, up-the-ladder rule passed in January, “should take care of the great majority of the problems likely to occur.”
Much of the uproar centers on the effect such rules would have on communication between executives and attorneys, and the traditional legal protections surrounding them.
Although one side wonders why honest managers should have anything to be shy about, others say the problem is more complex. Executives might be reluctant to discuss some topics out of concern that if an idea raises legal issues -- even inadvertently -- the lawyer might report them to the SEC.
“The fear is that if anybody has any concern that if something they’re doing is unusual or hasn’t been done before, they’ll be afraid to ask if it’s OK,” said Lydia Beebe, corporate secretary at ChevronTexaco Corp., the San Ramon, Calif.-based energy giant.
In other words, said Jon L. Rewinski, a Los Angeles attorney and chairman of an ethics panel for the Los Angeles County Bar Assn., the message corporate clients hear from their lawyers could be: “I want you to tell me everything that happened -- and remember, if it’s bad enough, I’ll have to tell the SEC.”
Beyond its effect in corporate conference rooms, the SEC proposal, in the view of many lawyers, cuts to the heart of attorney-client privilege, a strong if not air-tight protection around the information that clients pass on to their lawyers.
More than 40 states permit lawyers to disclose information from clients to prevent a crime, and more than a dozen states allow lawyers to sound the alarm to stop financial loss from fraud and other crimes, according to the ABA.
California has among the tightest limits in the nation, with ethical restrictions on lawyers designed to prohibit virtually any disclosure of confidential information about a client without a client’s permission.
Even to those who have some sympathy for the SEC’s approach, such criticisms may be hard to dismiss.
“Both sides of the debate have legitimate concerns,” said Stephen M. Bainbridge, a professor of law at UCLA.
Still, those concerned about the role lawyers may sometimes play in corporate misconduct contend that it is time to alter a culture in which relations between executives and corporate lawyers may get too cozy. Corporate attorneys’ true loyalty belongs to the corporate entity, they say, not individual executives they may be friends with and who control how much they are paid.
For all the uncertainties, some change may be in the offing. Coffee, a careful SEC watcher, puts the odds at 60-40 in favor of a tougher requirement from the SEC regarding disclosure by corporate lawyers. And just a few weeks ago, an ABA task force proposed that the legal profession formally accept a policy permitting lawyers to voluntarily disclose information to prevent serious crimes, including fraud, conforming its own model rules with the reality in most states.
The ABA will vote on the recommendations at an August convention in San Francisco. But on the proposal for required whistle-blowing, the task force drew the line.
Said Alfred P. Carlton, the bar’s president: “I’ve never seen the practicing bar -- all the different lawyers’ organizations -- so unified.”
