On March 16, 2003, the Section’s Ethics Committee presented a hypothetical titled “On the Far Side of the Moon” at the 32nd Annual Conference on Environmental Law in Keystone, Colorado. The hypo concerned the adventures of Adrienne Fitch, in-house counsel at the Empire Strikes Mining Co., Larry Able, the company’s outside environmental counsel, and Frank Numbero, the company’s auditor.
The panel consisted of former in-house counsel Fern Fleischer Daves of Sedgwick Detert Moran & Arnold (Newark, New Jersey); David Bell, senior counsel at BP (Chicago, Illinois); Kristina Woods, senior counsel at Ashland Inc. (Dublin, Ohio); Gary Prascher of PricewaterhouseCoopers (Houston, Texas); Alan Gates of Mitchell, Williams, Selig, Gates & Woodyard (Little Rock, Arkansas); and Peter Nadel of Gorsuch Kirgis (Denver, Colorado).
The writer, who also is a former in-house counsel, began with a presentation on the Sarbanes-Oxley Act of 2002 (Pub L. No. 107- 204). Under Sections 302, 404 and 906, CEOs and CFOs of publicly-traded companies must set up internal disclosure systems in order to ensure that the company’s financial and management, discussion and analysis (MD&A) reports to shareholders comply with Securities and Exchange Commission (SEC law. In the year-end annual report, the company’s auditors have to “attest” to the system, a higher burden than an audit opinion. Accounting firms are setting up Sec. 302 internal reporting systems so that the CEO/CFO has backup when they sign the quarterly 10 Q with the attached Sec. 906 statement. That includes a system to capture any event that might be material, such as environmental issues. There have been two quarters submitted so far (the SEC rule was final at the end of August 2002). The accountants are meeting with company “inside” counsel to identify the liability side to the reporting system (environmental, EEOC, antitrust) and outside counsel to resolve newly discovered issues.
Accounting firms are also counseling companies on Sec. 404 internal control structures, usually modeled after the “Committee of Organizational Standards” or “COSO,” standard, so that the companies can receive an unqualified attestation from the auditors at year-end. The first year-end Sec. 404 reports from the CEO and CFO, with the attestation attached, will be due at the end of 2003. Lawyers with experience in corporate compliance systems, such as the U.S. Sentencing Commission’s guidance, and internal corporate investigations will have work in this area.
Since Sarbanes-Oxley requires that the auditors now report to the audit committee of the board, and not the CFO, the auditors themselves are working with both the company’s corporate counsel, in-house counsel, and, in some cases, counsel with no previous relation to the client on issues in which regular counsel may have a conflict of interest based on prior representation.
The general counsel — or a Qualified Legal Compliance Committee formed by the company — must respond to “evidence of material violations” presented by in-house or outside counsel. In August 2003, all lawyers who represent public companies are required to make such reports, and the company has a legal obligation to provide an appropriate response, which may include directing an outside attorney to make a “colorable defense” in response to the violation. Sarbanes-Oxley includes federal protection for whistleblowers, which may include in-house attorneys who have lost their job as a result of their material violation report.
The panel then discussed the “up-the-ladder” problem that in-house counsel Adrienne had when she learned from Larry that Empire Strike’s “Far Side Mining” subsidiary had been violating hazardous materials transportation or “HazMat” requirements by shipping hazardous moldy product back to Earth without an adequate manifest. In the context of the brave new world of “upstream certifications” to the CEO and CEO required by Sec. 302 and Sec. 404 of Sarbanes-Oxley, we focused on Larry’s disclosure to Frank without complying with the ABA’s Statement of Policy Regarding Lawyers’ Responses to Auditors’ Requests for Information.
As for direct conflicts of interest, we identified Larry’s representation of the Far Sides’ former parent before the company was sold to Empire. The sale agreement provided for an indemnity. The panel agreed that, in general, once Larry learned of facts that could trigger the indemnity, he needed to withdraw from representation of either party. Alan Gates advised that the ABA Model Rules required that Larry provide full disclosure of the subject of his past representation for Far Side’s old parent and obtain informed consent from Far Side’s new parent Empire Strikes, but that in the event of an actual conflict, he needed to withdraw.
The panel and the audience discussed whether Adrienne Fitch not only has to advise her client as to what the environmental issues are, but also whether she had to help them wrestle with whether HazMat violations were “material.” One question of particular interest was whether she or Larry needed to follow-up to see what the company did if either one reported the problem as a material violation under the SEC’s “up the ladder” reporting obligation under its new attorney ethics rules, mandated by Sec. 307 of Sarbanes-Oxley, and promulgated on Jan. 29, 2003 at 17 CFR 205.
Assuming the mold issue is a violation of law, and further that it could result in material fines, penalties and costs, the panel also discussed whether a “material violation” under an environmental statute would be a “material violation” subject to Rule 205 reporting. If we assumed that potential fines, penalties and costs are unknown, but the violation is as yet not detected or reported to EPA, and the agency has never imposed substantial fines — despite their authority to do so — is it still material, or does the SEC’s definition of materiality necessarily include only those violations with likely adverse financial consequences?
For example, can an improperly certified Title V compliance report by an officer, for which the “lunar” EPA has never imposed a fine — although it could — be a breach of a fiduciary duty, and therefore Adrienne must make a disclosure to Empire Strikes’ general counsel? If non-compliance with the Clean Air Act is similar to violation of a securities law, doesn’t she have to evaluate the general counsel’s response, and if not satisfied, bring the issue up with the audit committee of the Board? We also discussed whether Empire Strikes would or should recognize the inherent conflicts of interest in Adrienne’s position and should put a more “system” and less “staff oriented” corporate reporting structure in place, Gary Prascher reported that he believes that Sec. 302 and Sec. 906 certifications will fundamentally change corporate internal reporting structures and procedures.
We talked about problems Adrienne will face if she chooses to both escalate the issue and counsel the affected employees. The inhouse counsel on our panel discussed the need to preserve the goodwill and relations of the company’s employees in any internal investigation, but emphasized that the employees potentially involved in the violation need to be told that in-house counsel represented the entity, and not its constituents.
Environmental lawyers often learn of potential liabilities beyond the strict scope of our representation. Those potential liabilities may become apparent from our own application of environmental law to the facts as well as another professional’s judgment of the impact of those facts — such as an accountant in regard to potential accounting treatment, or an environmental scientist’s assessment of potential harm or remedial options.
Finally, the panel discussed to what extent Larry had to apply his legal knowledge of the import of facts he overheard from Far Sides’ employees. While we did not resolve the issue, we generally concluded that Larry would have a difficult time claiming he “knew nothing” under Rule 205.