Risk & Compliance

You Have the Right to an Attorney

But will you be comfortable asking for advice? A new SEC rule governing attorney conduct puts a strain on relations between finance executives and ...
Craig SchneiderAugust 20, 2003

Signing off on a company’s financial results is one more good reason that CFOs might seek out the sage advice of corporate counsel. Whether they will feel comfortable enough to ask for that advice is another matter.

Under a Securities and Exchange Commission rule that went into effect August 5, in fact, the relationship between CFOs and attorneys — both inside and outside counsel — may have gotten a whole lot icier. If an attorney representing a public company comes across evidence of such things as a material violation of federal or state securities law or a “breach of fiduciary duty,” he or she must report the misstep up the chain of command — way up.

That means either the chief legal officer or the CEO, according to the SEC rule, which was mandated under Section 307 of the Sarbanes-Oxley Act. If the officers don’t respond appropriately — by taking remedial action or issuing sanctions, for instance — lawyers must take the matter to the audit committee, another committee of independent directors, or the full board.

The new rule also allows for a way that reporting attorneys can give management an even wider birth. Instead of heading for their bosses or the CEO, lawyers could go straight to a qualified legal compliance committee (QLCC) of the board of directors, if the corporation has set one up. It’s unlikely that many CFOs would go for the idea, however, since “management loses control of the process,” says Mark Bonenfant, a partner at Buchalter, Nemer, Fields & Younger.

Even without a QLCC, finance chiefs might well feel left out of the information loop. “CFOs and their staff work directly with securities lawyers on a regular basis, but they don’t get the [attorney’s] report,” says Diane Frankle, partner at Gray Cary and co-chair of the law firm’s corporate governance advisory group. “It’s got to create some concern.”

An even worse worry is the possibility that a misinterpreted question to an attorney might land a finance executive before the SEC. That could make CFOs wary of sharing information with corporate counsel or seeking advice from them on tough reporting decisions, thinks Stephen Glover, a partner with Gibson, Dunn, and Crutcher.

For their part, attorneys might start to over-report as a precaution, fearing that an activity that previously appeared legal could draw fire from regulators if serious improprieties later arise, according to Glover. “They don’t want personal liability or exposure to SEC sanctions,” he says.

The proposed “noisy withdrawal” rule pending before the SEC could open up even wider rifts. Depending on the circumstances, lawyers reporting violations would be permitted — perhaps even required — to alert the commission that they’re pulling out from representing the company.

At issue in such withdrawals is the sticky wicket of attorney-client privilege. How sacred the privilege is, when it comes to the relationship between corporate executives and corporate lawyers, is apparently up for grabs. Last week, in fact, the American Bar Association amended its rules of professional conduct so that corporate counsel are allowed (but not required) to sacrifice attorney-client privilege and bring otherwise confidential information to government authorities.

To be sure, the ABA’s rules are simply guidelines for conduct, and the SEC might never choose to ratify its own related proposals. But even the fear that attorney-client privilege might be eroding could make finance executives tight-lipped around corporate counsel. And holding back on information could compromise the legal advice CFOs do get, says Jonathan Newton, a partner at Baker & McKenzie.

More broadly, the SEC rule upsets a firmly held belief among CFOs and CEOs that the corporation’s lawyers are their lawyers. Indeed, the rule enforces the principle that the attorney’s first priority is to the company, not to the executives, says Bart Schwartz, general counsel of The MONY Group, a financial services company.

The legal star does appear to be on the rise at many corporations. Even setting aside the new rule, governance and compliance duties have “raised the general counsel to almost the same level [as] the CFO,” says Thom Weatherford, a retired finance chief of software provider Business Objects who serves on the boards of three publicly traded companies.

The increased independence that the new rule seems to confer on attorneys, however, could be a boon to some CFOs. “In companies that react in the most constructive way, these rules will actually strengthen the relationship between the CEO and CFO and general counsel and cause them to spend more time together,” says MONY’s Schwartz. “Certainly where the issue involves an area of disclosure or accounting for financial transactions, it would be natural for me, before going to the CEO, to go the CFO and work through the issue with him.”