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Attorney Conduct
One controversial rule the commission did suggest — the "noisy withdrawal" proposal, which would have required attorneys who are unable to stop an ongoing fraud to resign and inform the SEC — was tabled for further review.
In the commission's opinion, Sarbanes-Oxley's "reporting up" requirement (which, with some modifications, the SEC did pass) — obligating lawyers to report corporate misconduct "up the ladder" to the audit committee or the board if management wouldn't correct the problem — did not go far enough. But the overwhelming objection to the added "reporting out" proposal, noted in almost all of the 171 comment letters received by the SEC, was that it violated attorney-client confidentiality.
That concern was shared by CFOs. "It did seem to me to be troubling to erode attorney-client privilege," notes CFO Harlan Plumley of Burlington, Massachusetts-based Lightbridge Inc., who says the SEC's apparent retreat "struck me as a good thing." Adds CFO Stephen Giusto of Costa Mesa, California-based Resources Connection Inc., "I would say lawyers and investment bankers have traditionally gotten off a lot easier than the accountants have, and certainly they share in the blame for some of these screw-ups. But you are going down a very slippery slope if you start to chip away at the attorney-client privilege."
Not everyone felt that privilege should be so inviolate, however. "Is there any reason to treat lawyers differently from the auditors and accountants when fraud is involved?" asked commissioner Harvey Goldschmid during the SEC's open meeting on January 23. "To me, the absolute emphasis [of the legal profession] on confidentiality is incomprehensibly out of balance."
Perhaps in part to avoid such criticism, many lawyers had noted that the proposed rules would also conflict with or preempt state laws: 9 states and the District of Columbia prohibit attorneys from revealing confidential client information, even to prevent the client from committing fraud (37 other states allow such an action, and 4 require it). "The primary problem is the SEC is trying to propose a uniform federal rule on an area that is currently the purview of the states," says attorney Fred Baumann of Denver-based Rothgerber, Johnson & Lyons LLP. "The issue here is whether Congress gave the SEC permission to do this."
However, the SEC staff and Pitt himself dismissed both the state preemption question and criticism of their go-slow approach during the open meeting. "There has been some suggestion that by not adopting what we put out, the commission is cutting back on protections for investors. I find these suggestions to be offensive and in any event completely wrong," said Pitt during the meeting. "I reject the suggestion of some that we didn't have authority to do everything we proposed, but more significantly, because the issue is one that is significant, it makes sense to have more time to consider it. That is not a withdrawal. That to me is the essence of responsible government."
The noisy withdrawal requirement is probably now a dead letter, although the SEC will likely revisit it late this month. In its place, however, is an alternative, apparently devised and favored by Pitt, that still requires attorneys to resign, but shifts the responsibility for informing the SEC to the company, which would have to report the resignation in an 8K report, much as it now must do when it changes auditors. That alternative seemed to have wide support, at least among the commissioners. "I frankly think this is one of those rare compromises that essentially solves all [the concerns] of the various interests," said commissioner Roel C. Campos.
Mutual Fund Disclosure
The broad wording of the Sarbanes-Oxley Act meant that section 302 — requiring CEO and CFO certification — as well as other sections covering disclosures regarding financial experts and codes of ethics, applied not only to public companies but also to managed investment companies, such as mutual funds. The SEC voted on rules that specifically applied these requirements to mutual funds. It also included a rule of its own, not mentioned in the act, requiring mutual funds and other managed investment companies to disclose how they vote their proxies. This was an issue that Pitt had championed from his first day on the job, and it won him rare praise from both his critics and corporate-governance hawks, for whom proxy-voting disclosure has long been a cause célèbre.
"In thinking about these recommendations," Pitt noted in his opening remarks at the January 23 meeting, "I start from the fundamental and unassailable proposition that mutual fund securities are held for the benefit of individuals who own mutual fund shares." Yet this was also the only vote that was not unanimous among the commissioners. Paul S. Atkins voted nay, dismissing 7,000 of the 8,000 comment letters received as form letters and noting that funds often have to "beg and plead" just to get fund-holders to return proxy statements. "We are subjecting funds to significant costs and additional burdens," he warned, "at a time when fund-holders are concerned with only one thing: returns."
Throughout the two weeks, the chairman's last stand was classic Pitt: the new rules had something in them to upset just about everyone. But while few would dispute Pitt's record of political clumsiness, the adversarial relationship that has developed between investors and corporate management runs deeper than the legacy of one SEC official. The question now is whether corporations, accountants, lawyers, and mutual funds will have time to digest these rules and regain investor trust through their actions, or whether these rules will be the source of more violations that undermine that trust.
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