VideoThese days, executives have plenty of reasons to seek out the sage advice of corporate counsel. But whether or not they will feel comfortable enough to actually ask for that advice is another matter.
Indeed, some experts insist that the Securities and Exchange Commission's new rules governing attorney conduct threaten to chill the relationship between lawyers and their corporate clients, making it less likely that management will confide in corporate lawyers. The rules, which went into effect on August 5, require both in-house and outside lawyers who see evidence of "material" wrong-doing to report it up the corporate ladder.
The mere threat of corporate counsel turning in a client would likely stifle relationships with senior management, warns Stephen Glover, a partner at Gibson, Dunn, and Crutcher LLP, a Los Angeles-based law firm. "CFOs might be reluctant to go to general counsel for advice on tough decisions," he explains. "They don't want reports to be made to the board or outside the company."
Attorneys are scared, too: they fear that an activity or transaction that previously appeared aboveboard could draw fire from regulators if serious improprieties arise later on. "They don't want personal liability or exposure to SEC sanctions," adds Glover. As a precaution, some lawyers may overreport internally, he says.
Bad-News Bearers
Under the approved "report up" rules, attorneys representing public firms must report evidence of accounting fraud or other material violations of securities laws or breaches of fiduciary duty to a chief legal officer or the CEO. If the officers don't take appropriate action to address the violation, the lawyer then must inform the audit committee, another committee of independent directors, or the full board.
Critics, however, say the new rules leave lots of gray areas. "The wording is terribly ambiguous," says Anthony Pacheco, an attorney with Proskauer Rose LLP. He says descriptions of circumstances that would trigger the reporting requirement are abstract. "I think it's going to be a nightmare to sort this out," he says.
It's unclear, Pacheco explains, when, precisely, an attorney has to report wrongdoing within an organization, what exactly to report, and what further obligation the attorney has after informing senior management or the board of bad behavior. And, Pacheco adds, the SEC is vague about whether it's necessary to immediately call in outside counsel when an in-house lawyer does the reporting.
While lawyers and corporate executives get used to the new rules, which were legislated by the Sarbanes-Oxley Act of 2002, the SEC is considering a second set of provisions that could have an even bigger impact on the role of corporate counsel. If approved, the so-called noisy withdrawal rule would require attorneys to file a notice with the SEC, in certain cases, that they were withdrawing from an engagement due to "professional considerations." Bart Schwartz, general counsel of financial-services firm The MONY Group Inc., says this is basically "code for 'wrongdoing.'" The SEC has also proposed an alternative that would require the company to file the notice.
This second set of rules, which could be passed as early as this year, is being hotly contested by companies and lawyers alike, who warn that it would trample the sacred ground of attorney-client privilege and make it harder for both sides to communicate openly.
Attorneys, who argue that confidentiality is sacrosanct, are fighting tooth and nail to keep the privilege intact, lest they effectively become agents of the government. But the debate brings up the important question of just who the client is. Proponents of the rule are quick to point out that the company itself, not its managers, is the client of corporate counsel. That view upsets a firmly held belief among CFOs and CEOs that the corporation's lawyers are their lawyers. In a speech last year, former SEC chairman Harvey L. Pitt warned lawyers of the new responsibility. "Lawyers for public companies represent the company as a whole and its shareholder-owners," he said, "not the managers who hire and fire them." Indeed, the rule enforces the principle that the attorney's first priority is to the company, not to the executives, says Schwartz.
In August, the American Bar Association's House of Delegates amended the ABA's model rules for attorney conduct, which may keep the SEC from having to come down harder on the profession. The group decided to allow, but not require, lawyers to share information that would prevent a financial crime or fraud, or to rectify serious corporate crimes after the fact. The narrow margin of the vote, 218 to 201, indicates the divisiveness of the issue among ABA members. In fact, delegates voted against a similar proposal just two years ago.
Still, the ABA guidelines are effective only when the states' highest courts adopt them. But the ethics rules in 42 of them already permit—and 4 (Florida, New Jersey, Virginia, and Wisconsin) require—lawyers to disclose confidential information to prevent or rectify a client's fraud. Few lawyers are arguing that this option has ruined attorney-client communication in those states that require disclosure in certain client-fraud situations.
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