potential effects of SEC regulation of attorney conduct under the Sarbanes-Oxley Act, The

Georgetown Journal of Legal Ethics, The, Summer 2003 by Kim, Chi Soo, Laffitte, Elizabeth

INTRODUCTION

Under section 307 of the Sarbanes-Oxley Act, the Securities and Exchange Commission ("SEC") issued rules establishing "minimum standards of professional conduct for attorneys appearing and practicing before" the SEC on January 29, 2003.1 Section 307 only required an internal reporting rule, giving the SEC discretion to establish other rules governing the minimum conduct of attorneys.2 The SEC rules include the reporting requirement expressly required by Sarbanes-Oxley that attorneys must "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."3 If the chief legal officer ("CLO") or chief executive officer ("CEO") fails to "appropriately" respond to the evidence submitted, the rules require attorneys to report the evidence to the audit committee, another committee comprised of members not employed by the corporation, or the board of directors.4 In addition to the internal reporting rule, the SEC also issued rules for disclosure of confidential information, supervisory and subordinate lawyers, sanctions, and proposed rules for "noisy withdrawal."5

Two weeks before Sarbanes-Oxley was enacted, the American Bar Association Task Force on Corporate Responsibility ("Task Force") released a preliminary report proposing changes to the Model Rules of Professional Conduct ("Model Rules") and recommending the creation of communication channels between counsel and independent directors.6 The Task Force also recommended that the American Bar Association ("ABA") develop best practices for law firms.7 In remarks before the ABA Business Law Section in August 2002, former SEC Chairman Harvey Pitt communicated his support and agreement with various aspects of the Task Force's recommendations.8 The SEC regulations reflect the sentiments of both Pitt and the Task Force that the attorney's "true" client is the corporation and its shareholders, not senior management or general counsel.9

This note addresses preemption issues and the effects of SEC regulation of attorney conduct as governed by the rules promulgated subsequent to section 307 of the Sarbanes-Oxley Act. In examining the preemption issues, Section I reviews the historic interplay between the SEC and the ABA, focusing on the question of whether or not ethics rules should be federalized. Additionally, Section I summarizes the reactions within the legal community to the Sarbanes-Oxley Act which codified the SEC's authority to regulate attorney conduct. In examining the effects of the Act, Section II provides an overview of the SEC regulations and commentary within the legal profession by the Task Force, law professors, and practicing securities attorneys. Section II then addresses how the proposed SEC regulation may affect the Model Rules, securities practice within firms, and in-house practice within corporations. Finally, Section II addresses attorney compliance and SEC enforcement and discipline.

I. SHOULD ETHICS RULES BE FEDERALIZED?

In passing the Sarbanes-Oxley Act, Congress mandated that the SEC promulgate rules for attorneys appearing before it.10 While many significant issues arose with this Act, "the main bone of contention is the question of who should be regulating the conduct of attorneys. Until now, it has been the province of [the states] and of the [ABA] whose previous ethical rules have been widely adopted by the states."11 Part A of this section analyzes the historic dialogue about ethics rules between federal and state levels. The historical background illustrates that SEC regulation of attorney conduct has been an underlying theme for many years. Part B of this section compiles the various reactions within the legal community to the regulatory power finally codified by the SEC.

A. HISTORY OF ETHICS RULES

Beginning to recognize the potential for attorney misconduct, the SEC first attempted to clamp down on attorney conduct in SEC v. National Student Marketing Corp12 National Student Marketing Corporation merged with Interstate National Corporation, an insurance holding company.13 The lawyers approved a deal that eventually led to financial downfall for the shareholders.14 Not long after the merger, the value of the stock drastically decreased.15 The SEC argued that

the attorneys should have refused to issue the opinions in view of the adjustments revealed by the unsigned comfort letter, and after receipt of the signed version, they should have withdrawn their opinion with regard to the merger and demanded resolicitation of the Interstate shareholders.16

The SEC tried to tighten its reigns over attorney conduct by charging them for their failure to take any action against the fraud, for issuing an opinion with respect to the merger, for failure to withdraw that opinion and disclose proper information, and for issuance of a letter confirming stock validity.17 Concluding that those actions did not facilitate the merger, the court did not impose liability on the attorneys.18 Though injunctive relief was not granted, the SEC publicly argued for the first time that there was an obligation to the agency itself.19