One definition of ethics is: "the principles of right and wrong that are accepted by an individual or a social group." This leaves the question: where do those principles of right and wrong come from? Some subscribe to the naturalist theory: "whatever is, is right"; while others suggest these standards come from the majority view: whatever the majority believes is right. Still others believe the standards come from power: whatever the person in charge believes is right (consider a parent telling a child they cannot do something "because I said so").
In the case of lawyers, our "principles of right and wrong" come from a variety of additional sources. This article will describe three sources applicable to Delaware lawyers: the recent rules propounded by the SEC under its directive from the Sarbanes-Oxley Act of 2002; the Delaware Rules of Professional Conduct ("DLRPC"), as modified by the Ethics 2000 initiative; and the Principles of Professionalism for Delaware Lawyers.
THE ATTORNEY ETHICS PROVISIONS OF THE SARBANES-OXLEY ACT OF 2002
The Sarbanes-Oxley Act (affectionately known at "SOX" or "SarbOx") was signed into law by President Bush on July 30, 2002. Its cited purpose is "to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes." Its actual purpose, according to many, is to improve investor confidence and thereby boost the American economy following the corporate scandals surrounding the collapse of Enron and WorldCom.
The majority of SOX is aimed at improving the quality and quantity of disclosures made by corporations to the SEC and the public, as well as mandating requirements for internal and external auditors and directors, particularly those who serve on audit committees. SOX also addressed the role of attorneys in corporate governance, and mandated the SEC to issue and adopt a rule that included at least the following provisions:
- requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof, to the chief legal counsel or the chief executive officer of the company (or the equivalent thereof); and
- if the counsel or officer does not appropriately respond to the evidence (adopting, as necessary appropriate remedial measures or sanctions with respect to the violation), requiring the attorney to report the evidence to the audit committee of the board of directors of the issuer or to another committee of the board of directors comprised solely of directors not employed directly or indirectly by the issuer, or to the board of directors.
Pursuant to this directive, the SEC, following a notice and comment period, issued a final rule on January 29, 2003, which became effective on August 5, 2003 (hereinafter "the SEC Rule"). What follows is a summary of the provisions of the SEC Rule.
As an initial matter, the SEC Rule applies only to attorneys who provide legal services to a company and have an attorney-client relationship with that company. In addition, the application is limited to those attorneys who:
- Transact business with the SEC on behalf of an issuer;
- Represent an issuer in an SEC administrative proceeding or in connection with an SEC investigation, inquiry, information request or subpoena;
- Provide advice with respect to U.S. securities laws or the SEC's rules regarding any document that the attorney has notice will be filed with the SEC;
- Provide advice to an issuer as to whether information or a statement, opinion or other writing is required under U.S. securities law or the SEC's rules to be filed with the SEC.
The SEC Rule explicitly excludes from the scope of its application non-appearing foreign attorneys. A non-appearing foreign attorney is defined as an attorney who is admitted to practice in a country other than the U.S., who does not hold themselves out as practicing U.S. securities law, or give legal advice regarding U.S. securities law, and who appears only incidentally before the SEC in the course of practicing law outside of the U.S. or appears only in consultation with a U.S. attorney.
Attorney Reporting Requirements Under the SEC Rule
The "meat" of the SEC Rule is contained in Section 205.3(b). That section requires an attorney who becomes aware of evidence of a material violation by the issuer or by any officer, director, employee, or agent of the issuer, to report such evidence to the issuer's chief legal officer ("CLO") or to both the CLO and the chief executive officer ("CEO").
Evidence of a Material Violation
A "material violation" is a material violation of an applicable United States federal or state securities law, a material breach of fiduciary duty arising under federal or state law, or a similar material violation of any federal or state law.
Whether or not an attorney becomes aware of "evidence of a material violation" is an objective determination. The SEC Rule defines such evidence as "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."
"Up the Ladder" Reporting
Once the attorney has reported the evidence of a material violation to the CLO and/or CEO, his or her duties under the SEC Rule are not completely discharged. The attorney must then evaluate the CLO and/or CEO's response to determine if it is "appropriate." If the response is not appropriate, within the meaning of the SEC Rule, the attorney must report the evidence to the issuer's audit committee. If the issuer has no audit committee, the attorney must report to any committee made up of independent directors. If there is no such independent committee, then the attorney must report to the Board of Directors as a whole.
An "appropriate response" is defined as a response that provides a basis for an attorney to reasonably believe that:
- No material violation has occurred;
- The Company has adopted appropriate remedial measures that can be expected to stop any material violation, prevent any material violation or appropriately address a past violation;
- The Company has retained or directed an attorney to review the evidence of material violation and either:
- Has substantially implemented any remedial recommendations made by such attorney after reasonable investigation; or
- Has been advised by such attorney that the issuer has a colorable defense to any investigation or proceeding related to the alleged material violation.
Qualified Legal Compliance Committee
Attorneys may have an alternative to reporting "up the ladder" if the issuer has established a Qualified Legal Compliance Committee ("QLCC"). An issuer may establish (but it is not required to establish) a QLCC.
If the issuer has established such a committee, then an attorney can discharge all of his or her duties under the SEC Rule by reporting evidence of a material violation to the QLCC.
Composition of the QLCC
The QLCC must be comprised of at least one member of the issuer's audit committee and two or more independent members of the issuer's board of directors. If the issuer has no audit committee, the QLCC must have at least one member of an equivalent committee of independent directors.
Duties of the QLCC
The QLCC must inform the CLO and CEO of any reports of evidence of material violations. The QLCC must also decide, based on these reports, if further investigation is necessary. At the conclusion of an investigation, the QLCC must recommend by majority vote that the issuer implement an appropriate response, and inform the CLO, CEO and Board of Directors of the results of the investigation and the appropriate responses to be adopted.
Sanctions and Discipline
Violation of the SEC Rule would subject an attorney to all remedies and sanctions available under the Securities Exchange Act of 1934. In addition, an attorney who violates the SEC Rule will have engaged in improper professional conduct and may be subject to administrative disciplinary proceedings that may result in censure or suspension.
Nothing in the SEC Rule creates a private right of action against any attorney, law firm or issuer for violations of the SEC Rule.
The proposed form of the SEC Rule contained a provision, called a "noisy withdrawal" provision that, in some cases, would require an attorney to withdraw from his or her representation of an issuer and report directly to the SEC.
Specifically, the original proposal provided that an outside attorney who:
- believes that the company has not responded appropriately to the report of evidence of a violation;
- believes that the violation is ongoing or about to occur; and
- believes the violation is likely to result in substantial injury to the financial interest or property of the issuer or investors
- withdraw from representing the issuer and notify the SEC within one business day of such withdrawal and indicate that the withdrawal was based on professional considerations; and
- promptly disaffirm to the SEC any statement that the attorney has participated in preparing that the attorney reasonably believes is or may be false or misleading that has been filed with SEC.
In-house attorneys would only be required to take step 2, but would not be required to resign from their employment with the issuer.
After the comment period, the SEC elected not to adopt the "noisy withdrawal" proposal and instead issued an alternative proposal, with an additional comment period. The alternative proposal would require an outside attorney to withdraw from representation in the same circumstances as the original proposal, but the attorney would not be required to disaffirm any statements made to the SEC, nor would the attorney be responsible for informing the SEC of his or her withdrawal. Instead, the issuer would have the obligation to report that the attorney had withdrawn for professional considerations.
The SEC is likely to adopt some form of a noisy withdrawal or reporting-out provision this spring, especially given two recent scandals involving prominent law firms and their organizational clients. The first involved Spiegel Inc. and its corporate counsel, Kirkland & Ellis. Spiegel went bankrupt last year and a fraud case rose out of the bankruptcy. The Court in the Northern District of Illinois, which tried the fraud action, appointed an independent examiner to report on the Spiegel bankruptcy. According to the report of the examiner (Stephen Crimmins of Pepper Hamilton), a corporate lawyer at Kirkland & Ellis knew that Spiegel was breaking the law by refusing to file their annual report with the SEC. The attorney complied with his duties under the SEC Rule by informing Spiegel's top executives that they were breaking the law, but he apparently never received an appropriate response. Counsel elected not to withdraw and instead filled out forms to postpone the required filing. Under a noisy withdrawal provision, counsel would have been required to withdraw from his representation, which would have sent up a red flag to the public and the SEC.
Lawyers and companies alike discovered some of the consequences of a noisy withdrawal December of last year. A partner in Akin Gump Strauss Hauer & Feld in New York, who represented TV Azteca, Mexico's second-largest broadcaster, wrote to the TV Azteca board informing them of evidence of various material violations and informing the board that Akin Gump was withdrawing from its representation of the company. The letter specifically cited the "up the ladder" reporting requirements of the SEC Rule. It became synonymous with a "noisy withdrawal" when that letter was leaked to the press.
The consequences of Akin Gump's noisy withdrawal were seen the next day, when Reuters reported a 9% drop in TV Azteca's ADRs.
Confidentiality and Permissive Disclosures Under SEC Rule
The SEC Rule permits (but does not require) an attorney to reveal confidential information without the company's consent to the extent it is necessary to:
- Prevent the commission of a material violation that is likely to cause substantial injury to the financial interest or property of the company or its investors;
- Prevent the company from perpetrating a fraud on the SEC; or
- Rectify a company's material violation that caused, or may cause, substantial injury to the financial interest or property of the company or its investors when the attorney's services have furthered such actions.
The American Bar Association created the Ethics 2000 Committee in 1997 to review and propose amendments to the Model Rules of Professional Conduct. The findings and recommendations of the committee were debated and discussed at various meetings, and the Rules were eventually amended in 2002.
In October 2001, Delaware established its own Permanent Advisory Committee on the DLRPC. The Advisory Committee issued its own report in October 2002. The Supreme Court adopted the changes on April 29, 2003 and they went into effect on July 1, 2003.
The most significant change affecting corporate attorneys was to Rule 1.6 (Confidentiality). Under the old Rule, an attorney could not reveal a client's confidential information unless such disclosure was necessary to prevent the client from committing a crime that the lawyer believed was reasonably certain to result in death or substantial bodily harm. A lawyer was also permitted to reveal confidential client information in an action or proceeding between the attorney and the client for malpractice or payment for services.
The new Rule significantly expands the circumstances where a lawyer may reveal confidential client information. Under the new Rule, in addition to the circumstances permissible under the old Rule, a lawyer may disclose confidential information to the extent necessary to:
- Prevent death or substantial bodily harm
- Prevent the client from committing a crime or fraud that is reasonably certain to result in substantial injury to the financial interests or property of another and in furtherance of which the client has used or is using the lawyer's services.
- To prevent, mitigate, or rectify substantial injury to the financial interest or property of another that is reasonably certain to result or has resulted from the client's commission of a crime or fraud in furtherance of which the client has used the lawyer's services
The comments to the new Rule indicate that while confidentiality is a fundamental principle of the lawyer-client relationship, the Advisory Committee felt that some circumstances merit exceptions — i.e. where death or substantial bodily harm may result.
The comments also suggest that the Advisory Committee believed the exceptions relating to injury to financial interests were appropriate because they are limited to circumstances where the client has used the lawyer's services in furtherance of the crime or fraud. The client, therefore, can be deemed to have waived any right to confidentiality because of their misuse of the lawyer's services.
Although this rule allows for permissive disclosure, an attorney should keep in mind other rules that may require it. For example, Rule 4.1 (Truthfulness in Statements to Others) provides that a lawyer shall not knowingly fail to disclose a material fact when disclosure is necessary to avoid assisting a criminal or fraudulent act by a client, unless disclosure is prohibited by Rule 1.6.
The comments also recognize the difficulties attorneys may face when representing organizations, rather than individuals: "the lawyer may be in doubt whether contemplated conduct will actually be carried out by the organization." In these situations, the comments advise the attorney to make inquiry within the organization as indicated in Rule 1.13(b) (Organization as Client).
The new Rules of Professional Conduct are potentially in conflict with the SEC Rule. For example, consider the situation where an attorney to a corporation becomes aware that the corporation intends to make a fraudulent filing with the SEC, but in which the client did not use the attorney's services. Under the SEC Rule, the attorney would be allowed to disclose the information. Such a disclosure would, however, violate the Delaware Rules. Obviously, the attorney can comply with both by remaining silent, as both rules are permissive. But what would happen if he did disclose the information? The SEC has indicated that should an attorney in a state like Delaware, whose rules may not allow disclosures to the extent of the SEC Rule, disclose information as allowed under the SEC Rule, the attorney may not be prosecuted for violation of the State rule.
At least one state's bar association has addressed this issue. The Washington State Rules of Professional Conduct provide that an attorney may disclose information where necessary to prevent a client from committing a crime. Thus, they do not permit some disclosures that the SEC Rule permits. The Washington State Bar Association has recently issued an interim ethics opinion concluding:
To the extent that the SEC Regulations authorize but do not require revelation of client confidences and secrets under certain circumstances, a Washington lawyer should not reveal such confidences and secrets unless authorized to do so under the [Washington rules].
In response, the SEC's general counsel, Giovanni P. Prezioso, issued a letter informing the Washington State Bar Association (and all other Bar Associations, presumably) that the SEC Rule preempts conflicting state rules, citing authority from two U.S. Supreme Court cases: Sperry v. Florida and Fidelity Federal Savings & Loan Assn v. de la Cuesta. In Sperry, the Supreme Court held that a federal statute authorizing the Commissioner of Patents to issue regulations allowed the Commissioner to adopt a rule preempting a Florida law requiring attorneys to be licensed by the state. In Fidelity, the Supreme Court upheld the ability of the Federal Home Loan Bank Board to permit federal savings and loans to exercise "due on sale" clauses in a manner not allowed by same states.
The conflict that arises here between some state rules and the SEC Rule is slightly different from those cited by Mr. Prezioso, because in this case, it is possible for an attorney to comply with both rules by not disclosing information. Thus the rules are not directly in conflict. The final outcome of this conflict remains to be determined. To date, no attorney has been prosecuted under a state's rule for a disclosure permissible under the SEC Rule.
PRINCIPLES OF PROFESSIONALISM FOR DELAWARE LAWYERS
The Delaware State Bar Association and the Delaware Supreme Court jointly adopted the Principles of Professionalism for Delaware Lawyers ("PPDL"), effective November 1, 2003.
The PPDL cannot be used as the basis for any litigation, lawyer discipline or sanctions, but were adopted to "promote and foster the ideals of professional courtesy, conduct and cooperation. These Principles are fundamental to the functioning of our system of justice and public confidence in that system."
Although all of the principles apply to all attorneys, including those admitted pro hac vice, the first principle seems particularly relevant to corporate attorneys.
The first principles are general and apply to an attorney's conduct both inside and outside of the courtroom. The principles state: "a lawyer should be mindful of the need to protect the standing of the legal profession in the view of the public and should bring these Principles to the attention of other lawyers when appropriate."
This principle seems particularly timely given the public's perception of the attorneys involved in the Enron and WorldCom scandals. Of course, attorneys have never had a very good reputation in the eyes of the general public. The DLRPC seek to change this perception by holding lawyers to standards of personal integrity, compassion, civility, diligence and public service, as well as fair and efficient conduct of litigation.
Given current public sentiment, the PPDL seem to counsel in favor of disclosure of confidential information, even where the SEC Rule or the DLRPC only allow it. In the wake of Enron and WorldCom, the public seems more concerned with accountability than confidentiality. Thus, if a lawyer is to improve public sentiment regarding lawyers, the attorney better serves that principle by disclosing information where permissive. There may come a time, however, when confidentiality concerns once more come to the forefront. Thus, under the PPDL, an attorney must constantly reevaluate conduct and how it may be perceived by the public, and how his or her conduct reflects on the practice of law in general.