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SEC Proposed Professional Standards of Conduct for Attorneys Under the Sarbanes-Oxley Act
On November 21, 2002, the SEC issued proposed rules under Section 307 of the Sarbanes-Oxley Act ("Sox") in connection with minimum standards of professional conduct for attorneys appearing and practicing before the SEC.
Following is a summary of the highlights of the 93-page rule. A more detailed analysis is underway.
1. To whom does the proposed rule apply?
To any attorney, in-house or outside, whether formally engaged by the issuer or not, who renders advice in connection with SEC matters as well as to attorneys representing the issuer, its officers or directors or witnesses in SEC proceedings. The advice may include preparation of reports or even advice to the effect that an issuer need not file a report, a press release or other communication to shareholders or the SEC, or that the issuer's disclosure is appropriate. The proposed rule applies equally to foreign attorneys involved in the above activities.
2. What is an attorney obliged to do under the proposed rules?
2.1 If, in representing an issuer before the SEC, an attorney becomes aware of evidence that would lead a reasonable attorney to believe that a material violation of the securities laws or material breach of a fiduciary duty has occurred, is ongoing or is about to occur, the attorney must promptly report the matter to the issuer's chief legal officer ("CLO") or to both the CLO and CEO, and must document and retain the report. The reporting attorney, may, if he or she believes it is appropriate, bypass the CLO and CEO and report the violation directly to the issuer's audit committee or its equivalent.
2.2. "If the reporting attorney believes" the response is both appropriate and timely in the sense that the problem has been fixed, disciplinary actions within the issuer have been taken and preventative measures have been put in place, the reporting attorney need do nothing more.
2.3 If the reporting attorney believes that he or she has not received an "appropriate and timely" response from the persons the attorney reported to, a report of the violation should be made to the issuer's audit committee or its equivalent.
3. Is an attorney that did not receive an "appropriate and timely" response after reporting the violation to the issuer's audit committee obliged or permitted to report the violation to the SEC?
3.1 Yes, but in so doing he or she must strictly adhere to the following steps in the following order and report the violation in the following way. The reporting attorney must:
explain to the persons within the issuer to whom he or she reported the violation why the response is not appropriate or timely;
document those reasons; and
if the reporting attorney believes that the violation is ongoing or about to occur, (as opposed to a violation that has occurred and is not ongoing) and is likely to cause substantial injury to the issuer or investors, the reporting attorney must:
(a) immediately withdraw from representing the issuer;
(b) indicate that the withdrawal is for "professional reasons;"
(c) notify the SEC in writing within one business day of the withdrawal that he or she has withdrawn for professional reasons; and
(d) immediately disaffirm to the SEC anything that the reporting attorney has been instrumental in submitting to the SEC that is materially misleading.
If the reporting attorney is an in-house attorney, he or she must do all of the above except that he or she does not have to resign.
- if the reporting attorney believes that the violation has already occurred (as opposed to a violation that is ongoing or about to occur), and is likely to have caused substantial injury to the issuer or investors, the reporting attorney may, but is not obliged to take the steps described in (a) through (d) of this paragraph.
- In any event, the proposed rule provides that none of the above steps, if taken in accordance with the proposed rule, will be deemed a violation of attorney client privilege, even if this would constitute such a violation under state rules.
- A reporting attorney whom the issuer fired on account of the report, may, but is not obliged to notify the SEC of the discharge and disaffirm anything that the reporting attorney has been instrumental in submitting to the SEC that is materially misleading.
- Any report or response that an attorney has documented may be produced by the reporting attorney in any proceeding in which the attorney's compliance with his duties under Sox is in issue.
4. Is there any alternative open to an outside attorney other than notifying the SEC in the circumstances described in paragraph 3.1 (iii) above?
4.1 Yes, but he or she must follow the following steps and report the violation in the following way:
- The attorney must report the violation to a qualified legal compliance committee, ("QLCC"). A QLCC is a committee which the issuer may, but is not obliged to set up to investigate any report of a material violation. The QLCC must consist of at least one member of the issuer's audit committee and two or more independent directors.
- The outside attorney who has reported the violation to the QLCC is not obliged to follow the further steps described in paragraph 3.1 (i)-(iii) above and is not required to notify the SEC.
If the issuer has no QLCC, the attorney must follow the steps described in paragraph 3.1 (iii) above including notification to the SEC.
5. What is the responsibility of supervisory attorneys and what is the responsibility of attorneys subject to their supervision?
5.1 The definition of a supervisory attorney includes an attorney that has supervisory authority over a subordinate attorney that appears and practices before the SEC whether or not he or she in fact exercises that supervisory authority. Furthermore, by virtue of having such supervisory authority, the supervising attorney is deemed to be appearing and practicing before the SEC even if he or she never has in fact done so.
5.2 A supervisory attorney is responsible for complying with the Sox reporting requirements described above when a subordinate attorney has reported a violation.
5.3 The subordinate attorney has met his or her reporting obligation under the proposed rule after he or she reports the violation to the supervising attorney.
5.4 If the subordinate attorney disagrees with the conclusion of the supervising attorney not to take the matter further, the subordinate attorney may, but is not obliged to take the steps described in paragraphs 2, 3 and 4 above.
6. What sanctions can the SEC bring against attorneys who violate the proposed rules once they are effective?6.1 A violation by an attorney appearing and practicing before the SEC of the Sox reporting rules is considered a violation of the Securities Exchange Act of 1934. The attorney can be sanctioned under, among other provisions, Section 4C (a) of the Exchange Act for "improper professional conduct" This term includes negligent conduct even in a single instance of highly unreasonable conduct, or repeated instances of unreasonable conduct that results in a violation of the Sox reporting rules.
If an attorney violates the rules, the SEC can commence a civil action seeking injunctive relief as well as civil money penalties.
Carter Ledyard & Milburn LLP uses Client Advisories to inform clients and other interested parties of noteworthy issues, decisions and legislation which may affect them or their businesses. A Client Advisory does not constitute legal advice or an opinion. This document was not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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