The Commission voted to propose a new Part 205 to 17 CFR, Standards of Professional Conduct for Attorneys Appearing and Practicing before the Commission, that includes: (1) "up the ladder" reporting, and (2) other related provisions the Commission believes are important components of an effective reporting regime.
The proposed rule recognizes that attorneys interact with the Commission on behalf of issuer clients in a number of ways, and reflects that Section 307 was intended to protect investors by imposing the "up the ladder" reporting requirement on all attorneys who appear or practice before the Commission on behalf of an issuer. Accordingly, the proposed rule would adopt an expansive view of who is an attorney subject to the rule, covering all attorneys who are admitted, licensed or otherwise qualified to practice law whether employed in-house by an issuer or retained to perform legal work on behalf of an issuer. In addition, the proposed rule would cover attorneys licensed, or otherwise qualified to practice, in foreign jurisdictions who appear and practice before the Commission, although it would seek comment on how to ensure that the requirements of the rule do not conflict or inappropriately interfere with the activities of non-U.S. lawyers. The proposed rule would incorporate several additional provisions that the Commission believes are important components of an effective "up the ladder" reporting system. These provisions embody standards of conduct that legal commentators and the American Bar Association have been considering for years, and are similar in important respects to ethical rules that have already been enacted in a number of jurisdictions.
Subsection 205.3 would represent the core of the proposed rule. Subsection 205.3(a) would affirmatively state that an attorney representing an issuer represents the issuer as an entity rather than the officers or others with whom the attorney interacts in the course of that representation, and that the attorney is obligated to act in the best interests of the issuer and its shareholders. Subsection 205.3(b) would prescribe the duty of an attorney who appears or practices before the Commission in the representation of an issuer to report evidence of a "material violation." The proposed rule would not require an attorney to "know" that a violation has been committed. The rule's reporting obligation would be triggered when an attorney "reasonably believes" that a material violation has occurred, is occurring or is about to occur, limiting the instances in which the reporting duty prescribed by the rule will arise to those where it is appropriate to protect investors. The attorney would be initially directed to make this report to the issuer's CLO, or to the issuer's CLO and chief executive officer. The attorney also would be obligated to take reasonable steps under the circumstances to document the report and the response thereto, and to retain such documentation for a reasonable time. Requiring the attorney to take such reasonable steps would protect the attorney in the event his or her compliance with the proposed rule is put in issue at some future proceeding. When presented with a report of a possible material violation, the rule would obligate the issuer's CLO to determine whether to conduct an inquiry into the reported material violation to ascertain whether in fact a violation has occurred, is occurring or about to occur. A CLO who reasonably concludes that there has been no material violation would have to provide notice to the reporting attorney of this conclusion, and take reasonable steps to preserve relevant documentary evidence. A CLO who concludes that a material violation has occurred, is occurring or is about to occur would be required to take reasonable steps to ensure that the issuer adopts appropriate remedial measures and/or sanctions - including appropriate disclosures. Furthermore, the CLO would be required to report "up the ladder" within the issuer what remedial measures have been adopted, and to advise the reporting attorney of his or her conclusions. A reporting attorney who receives an appropriate response within a reasonable time and has documented his or her report and response would have satisfied all obligations under the rule. The Commission believes that most situations involving reporting to the CLO or CLO and CEO by an attorney will be resolved in this manner. In the event a reporting attorney does not receive an appropriate response within a reasonable time, he or she would be required to report the evidence of a material violation to the issuer's audit committee, another committee of independent directors, or to the full board. Similarly, if the attorney reasonably believes that it would be futile to report evidence of a material violation to the CLO and CEO, the attorney may report directly to the issuer's audit committee, another committee of independent directors, or to the full board. A reporting attorney who has reported a matter all the way "up the ladder" within the issuer and who reasonably believes that the issuer has not responded appropriately would be required to take reasonable steps under the circumstances to document the response and to retain any such documentation for a reasonable time.
Subsection 205.3(d) would deal with the obligation of an attorney who has not received an appropriate response from the issuer and, in certain instances, requires or permits a "noisy withdrawal." While this provision is not specifically mandated by Section 307, a provision that obligates a reporting attorney under certain circumstances to disaffirm a submission to the Commission which the attorney believes has been tainted by a material violation (and permits the attorney to disaffirm under other circumstances) is important to the effective operation of the reporting obligation in those instances where an issuer does not respond appropriately. The provision would distinguish between outside attorneys retained by the issuer and attorneys employed by the issuer because attorneys employed by an issuer face greater potential obstacles to compliance, and because the personal cost of compliance to an attorney employed by the issuer is greater. The provision would impose an affirmative obligation on attorneys to disaffirm a document or filing where they believe a violation is ongoing or prospective because of the greater potential of harm to investors inherent in such violations. The rule would provide that where an attorney files a notification with the Commission as part of a "noisy withdrawal," no violation of the attorney/client privilege occurs (205.3(d)(1)(iii), (d)(2)(iii). As an alternative process for considering reports of material violations, an issuer may (but is not required to) establish a qualified legal compliance committee (QLCC) comprised of at least one member of the issuer's audit committee, and two or more members of the issuer's board, all of whom must be independent, for the purpose of investigating reports made by attorneys of evidence of a material violation. The QLCC would be authorized to require the issuer to take remedial action. If the issuer were to fail to act as directed by the QLCC, each QLCC member would have the responsibility to notify the Commission. Attorneys who report evidence of a material violation to a QLCC would not be subject to the rule's "noisy withdrawal" requirement.
Subsection 205.3(e) would set forth the specific circumstances under which an attorney is authorized to disclose confidential information related to his or her appearance and practice before the Commission in the representation of an issuer. Pursuant to this provision, an attorney would be allowed to use the contemporaneous records he or she creates to defend against charges of attorney misconduct, a right which is similar to the "self-defense" exception contained in the Model Rules and state ethical rules. This provision would provide an incentive for attorneys to take adequate steps to create the contemporaneous records prescribed under the rule. Subsection 205.3(e)(2) also would allow an attorney to reveal confidential information to the Commission to the extent necessary to prevent the commission of an illegal act which the attorney reasonably believes will result either in perpetration of fraud upon the Commission or in substantial injury to the financial or property interests of the issuer or another. Similarly, the attorney would be allowed to disclose confidential information to rectify an issuer's illegal actions when such actions have been advanced by the issuer's use of the attorney's services.
Finally, Subsection 205.3(e)(3) would provide that an issuer does not waive any applicable privileges by sharing confidential information regarding misconduct by the issuer's employees or officers with the Commission pursuant to a confidentiality agreement. The Commission believes that allowing cooperative issuers and attorneys to produce internal reports under a confidentiality agreement without waiving privilege will significantly assist the expeditious conduct of Commission investigations.
Responsibilities of Supervisory and Subordinate Attorneys
Subsections 205.4 and 205.5 would detail the respective responsibilities of supervisory and subordinate attorneys, both those employed in-house by the issuer and those serving as outside counsel retained by the issuer.
Sanctions for Violations of the Rule
Subsection 205.6 would describe the manner in which violations of the rule would be prosecuted by the Commission. Pursuant to Section 3(b) of the Act, a violation of any rule issued by the Commission under the Act constitutes a violation of the Exchange Act. Accordingly, violation of the proposed rule would subject the violator to all the remedies and sanctions available under the Exchange Act, including injunctions, cease and desist orders, and officer and director bars for attorneys who are officers and directors. The full text of the detailed release concerning this proposal will be posted to the SEC Web site as soon as possible. Comments will be collected for 30 days following publication of the proposal in the Federal Register.
