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Sarbanes-Oxley and Professional Conduct for Attorneys
Kenneth B. Abel
410-347-7394
kbabel@ober.com
In January 2003, the SEC adopted final rules (the "Rules") regarding attorney conduct as directed by the Sarbanes-Oxley Act. The Rules become effective on August 5, 2003. The following is a brief outline of the Rules. Please contact Kenneth Abel (410-347-7394) if you have any questions regarding the Rules.
- Do the Rules apply to me?
The Rules only apply to "issuers." In general, an "issuer" is a company that files reports under the Securities Exchange Act of 1934 (e.g., 10-Qs and 10-Ks) and companies in the process of an initial public offering (an IPO) registered with the SEC.
- Do the Rules apply to me as an attorney?
The Rules only apply to attorneys "appearing and practicing before" the SEC. In general, this is limited to:
- Transacting any business with the SEC;
- Representing an issuer in an SEC administrative proceeding or in connection with any SEC investigation, inquiry, information request or subpoena;
- Providing advice in respect of the U.S. securities laws or the SEC'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 SEC, including the provision of such advice in the context of preparing, or participating in the preparation of, any such document; or
- Advising an issuer as to whether information or a statement, opinion, or other writing is required under the U.S. securities laws or the SEC'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 SEC.
The third item is the $64,000 question. Does it apply to regulatory lawyers who comment on an SEC filing? Is such advice "in respect of" the U.S. securities laws? Arguments can be made on both sides. Please note that the proposing release used the term "participating in the preparation” as opposed to "providing advice in respect of."
- If the Rules apply to me or my attorney, what do I need to look out for?
The Rules require an attorney who becomes aware of "evidence of a material violation" by an issuer or any officer, director, employee or agent of the issuer to report the evidence to the issuer.
"Evidence of a material violation" means "credible evidence, based upon which it would be unreasonable, under the circumstances, for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is ongoing, or is about to occur."
The SEC's commentary accompanying the final Rules states that the "circumstances" that an attorney should weigh when determining whether a material violation has occurred include, among others, the attorney's professional skills, background and experience, the attorney's time constraints, the attorney's previous experience with the client and the availability of other lawyers with whom the lawyer may consult.
The SEC's commentary also states that to be "reasonably likely," a material violation must be more than a mere possibility, but it need not be more likely than not.
"Material violation" means "a material violation of an applicable United States federal or state securities law, a material breach of fiduciary duty arising under United States federal or state law, or a similar material violation of any United States federal or state law."
The SEC's commentary refers to the Supreme Court's definition of the term "material." The Court stated that a fact is material if there is a substantial likelihood that its disclosure would have been considered significant by a reasonable investor.
"Breach of fiduciary duty" refers "to any breach of fiduciary or similar duty to the issuer recognized under an applicable federal or state statute or at common law, including but not limited to misfeasance, nonfeasance, abdication of duty, abuse of trust, and approval of unlawful transactions."
Essentially, if an attorney discovers something that may be evidence of a material violation, the attorney should ask himself or herself the following question: Would it be unreasonable for me not to conclude that a material violation will probably occur or has already occurred? If the answer is yes, then the attorney has a reporting requirement under the Rules; if the answer is "no," then he or she does not.
- What must an attorney do if he or she becomes aware of evidence of a material violation?
If an attorney becomes aware of evidence of a material violation and the company has not appointed a Qualified Legal Compliance Committee (QLCC) (see below), the attorney must report the evidence to the company's chief legal officer (CLO) or its CLO and chief executive officer (CEO). (This assumes the attorney is not a "subordinate lawyer," who has slightly different obligations, including reporting the violation to his or her supervisory attorney.)
If the attorney receives from the CLO what he or she reasonably believes is an appropriate and timely response, then the attorney has no further obligation.
If the attorney does not receive an appropriate and timely response, he or she must report the evidence to (i) the company’s audit committee (if it has one), (ii) a committee of independent directors if the company does not have an audit committee or (iii) the full board of directors if the company does not have an audit committee or a committee of independent directors. If he or she believes disclosing the matter to the CLO and CEO would be futile, the attorney can go directly to this approach. A further discussion of what happens next is beyond the scope of this memo.
A QLCC is a committee of independent directors at least one of whom is a member of the company's audit committee. The committee must be established by the board of directors to determine whether an investigation is necessary with respect to any report of evidence of a material violation. In general, if the attorney reports evidence of a material violation to a QLCC, the attorney has no further obligations under the Rules.
- What if the client takes no action in response to the attorney's report? Must the attorney report the client to the SEC?
The Rules do not include the controversial "noisy withdrawal" requirement that was included in the proposed rules. In general, this would have required attorneys who were not satisfied with their client's response to a report of evidence of a material violation to notify the SEC that the attorney is resigning for that reason. However, the SEC has proposed a modified "noisy withdrawal" requirement which would essentially require the client to report to the SEC if its attorney resigns for this reason. The SEC also resubmitted the "noisy withdrawal" provisions for further comment.
However, the Rules permit attorneys, without the consent of their clients, to reveal confidential information to the SEC if the attorney reasonably believes it necessary:
- To prevent the company from committing a material violation that is likely to cause substantial injury to the financial interests or property of the company or investors;
- To prevent the company in an SEC investigation or administrative proceeding from committing or suborning perjury or to prevent the company from committing an act to perpetrate a fraud on the SEC; and
- To rectify the consequences of a material violation by the company that caused or may cause substantial injury to the financial interest or property of the company or investors in the furtherance of which the attorney's services were used.
- What about state professional responsibility rules, such as onfidentiality requirements? Do they still apply?
The Rules state that where the standards of a state where the attorney is admitted or practices conflicts with the Rules, the Rules shall govern.
(Please note that other aspects of the Rules apply in the event an attorney is engaged to investigate an allegation of "evidence of a material violation"). |
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