December 18, 2002          

By e-mail (rule-comments@sec.gov.)

U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549

Attn: Jonathan G. Katz, Secretary
          Re: File No. 33-8150.wp
          Comments Regarding S7-45-02

Mr. Chairman and Honorable Commissioners:

A. Introduction

We write to comment on the Commission's proposed rules under Section 307 of the Sarbanes-Oxley Act of 2002, which rules would establish standards of professional conduct for attorneys who appear and practice before the Commission on behalf of issuers. Under the new law, the standards must include a rule requiring the attorney to report evidence of a material violation of securities laws 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 of the company (or the equivalent); and, if they do not respond appropriately to the evidence, requiring the attorney to report the evidence to the audit committee, another committee of independent directors, or the full board of directors.

The Commission proposes to add a new Part 205 to Title 17, Chapter II, of the Code of Federal Regulations ("Proposed Rules") establishing standards of professional conduct for attorneys who appear and practice before the Commission in the representation of issuers, under the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, the Investment Advisers Act of 1940, and the Sarbanes-Oxley Act of 2002 ("Act").

We believe that, the Proposed Rules upset the Act's cautious balance between rooting out corporate misconduct and violating the attorney-client privilege. If the Proposed Rules are adopted without modification, they are likely to have effects completely contrary to the intent and purposes of the Act. Indeed, the release containing the Proposed Rules ("Release") makes reference to certain of these potential problems, acknowledging that the rules may "encourage issuers to handle more legal matters in-house to avoid the possibility of a noisy withdrawal".¹ In addition, irreparable harm may be caused to the reputation and shareholder value of companies due to premature and panicked withdrawals by attorneys more pre-occupied with protecting themselves from the Proposed Rules' sanctions than concerned about protecting shareholders from ill-considered "whistle-blowing". Also, encouraging such behavior is likely to increase market volatility and further damage public confidence in the US securities markets.

B. Comments

What follows are our specific comments to the Proposed Rules.

1. Definitions.

The Proposed Rules include defined terms that lead to an excessively broad application of the reporting mechanism, well beyond the Act's statutory mandate to the Commission. We have selected several definitions to illustrate this problem.

Appearing and Practicing

As defined in §205.2(a) of the Proposed Rules, "appearing and practicing" before the Commission is an all-encompassing term whose scope would apply to any attorney who:

As written, the Proposed Rules apply to virtually any attorney who has virtually any involvement in virtually any matter with almost any connection with the Commission. The term "practicing and appearing" before the Commission, for example, would extend to attorneys who are not securities lawyers and who are not retained as such by an issuer, including a lawyer who negotiates or reviews a contract later filed with the Commission as an exhibit to a periodic report. It would also include attorneys licensed solely in foreign jurisdictions who represent foreign private entities before the Commission.

In addition, the Proposed Rules as currently drafted, give a subordinate attorney the right to report "up the ladder" and "over the top" to the Commission against the better judgment of his or her supervising attorney. In our view, the Commission should not encourage junior attorneys who lack the experience and judgment that come with years of practice in the field to go over the heads of their supervising attorneys where the latter have determined that there has not been a material violation.

Appropriate Response

The term "appropriate response" as defined in §205.2 (b) requires that the attorney reasonably believe: (1) "That no material violation . . . is about to occur…" Requiring an attorney to deem a response "appropriate" or "inappropriate" based upon whether a material violation is about to occur seems to be an impossibly predictive standard.

Furthermore, as defined, a response is only deemed appropriate if the issuer has adopted remedial measures but not if the issuer, as a result of the attorney's report, is in the process of adopting them. Accordingly, in order not to risk being sanctioned by the Commission, an attorney might feel compelled to make a "noisy withdrawal" even as the issuer is working diligently to adopt remedial measures but has not yet completed the process.

In the Representation of an Issuer

The term "in the representation of an issuer" as defined in §205.2(f) means acting "in any way on behalf, at the behest, or for the benefit of an issuer, whether or not employed or retained by the issuer." As indicated in the introduction above, this extremely broad definition would seem to extend the Proposed Rules' applicability to all advice, not just securities-related, and to attorneys who, having reviewed the issuer's documents and found them deficient, decline to accept representation, as well as to non-practicing attorneys who render advice to an issuer about non-legal matters.

Material

The term "material" as defined in §205.2(h) refers to "conduct or information about which a reasonable investor would want to be informed before making an investment decision". This seems to require the attorney to be a financial expert as well, a facility shared by some, but hardly all, of the attorneys who would be swept into the Proposed Rules by their breadth, and a facility held by none who can asses at the time of the decision what facts might later be called "material" with the perfect clarity of post-event judgment.

Evidence of a Material Violation

The term "evidence of a material violation" as defined in §205.2(e) means "information that would lead an attorney reasonably to believe that a material violation has occurred, is occurring or is about to occur." We are concerned that irreparable damage will be caused to issuers and shareholders based upon somebody's belief. Mere belief has no place in corporate law, particularly where it can damage shareholder property. Attorneys who suspect misconduct must be given the time to substantiate their suspicions before they make their suspicions public. The ABA Model Rule 1.13 which requires that an attorney "knows" rather than "believes" there to be a violation of law and that such lawyer proceed as reasonably necessary in the best interest of the shareholders is a more responsible standard. It takes into account not only the damage caused by not reporting a violation of law but also the damage caused by making "violations of law" public which upon more careful consideration would have transpired not to be violations of law.

2. Attorney-client privilege and Preemption.

Section 205.1 of Proposed Rules states that "[w]here the standards of a state where an attorney is admitted or practices conflict with this part, this part shall govern." The Proposed Rules thus instantly create a conflict with the laws of every state which regulate closely the attorney-client relationship, as well the laws of non-US jurisdictions with respect to local attorneys advising companies subject to the Act.

In our judgment, the Proposed Rules are a federal incursion into state law which historically has regulated questions of attorney-client privilege and the duties of a lawyer to protect client confidences and secrets. It is also an incursion by an administrative agency of the Executive Branch into the jurisdiction of the Judiciary which adjudicates attorney-client privilege issues. These incursions are not authorized or supported by the Act..

3. The Attorney Whistle-blower Provisions.

We believe that the most serious mischief of the Proposed Rules is contained in the "whistle-blowing" provisions of §205.3(d), which require an attorney who has reported evidence of a material violation all the way up the internal ladder and has not received an appropriate response or has not received a response in a reasonable time, to make a "noisy withdrawal" and disaffirm filings with the Commission. These attorney whistle-blowing provisions exceed the Act's express authority and its stated intent.

With respect, this so-called "noisy withdrawal" is nowhere required by the Act; we have searched in vain for any support whatsoever for this aspect of the Proposed Rules. In our judgment, the "noisy withdrawal" requirement far exceeds the Commission's mandate under the Act; indeed, the Release concedes that "providing notification to the Commission goes beyond what the Act expressly directed the Commission to do".² The "noisy withdrawal" requirement goes well beyond the Commission's own precedents; even in the case of re Gutfreund, 51 SEC 93 (Dec 3, 1992) where the Commission required a person in a supervisory position to disclose misconduct to regulatory authorities, it was careful to qualify this as being subject to the applicable Code of Professional Responsibility and Canons of Ethics. Also, the "noisy withdrawal" requirement turns the traditional attorney-client relationship on its head. As has been mentioned by other commentators to the Proposed Rules,³ this requirement, among other things, has the effect of replacing the considered legal judgment of the client's internal reviewing officers and the business judgment of the client's audit committee and it's board of directors with the legal and business judgments of an attorney.

Furthermore, the Proposed Rules do not define the length of the "reasonable time" within which the issuer's response to the attorney's report of evidence of a material violation must be received to be deemed appropriate. Nor does it furnish an objective standard against which such time might be measured. In cases where the violation of law revolves around inappropriate disclosure and particularly in view of the real time disclosure requirements under §409 of the Act, there may not be time reasonably available for the issuer to complete an appropriate response. To be safe rather than sorry, an attorney might jump the gun and make a "noisy withdrawal" only because he or she does not want to risk waiting for an otherwise appropriate response.

The Proposed Rules also state that if an attorney who has not received an appropriate response or who has not received a response in a reasonable time reasonably believes that a material violation has occurred and is likely to have resulted in substantial injury to the financial interest or property of the issuer or of the investors but it is not ongoing, the attorney may, but is not required to make a "noisy withdrawal". We are concerned that certain violations of securities laws, such as misstatements in disclosures will always be in danger of being considered ongoing, because one can never know the extent to which investors continue to rely on past disclosures. Accordingly, attorneys may feel obliged to make a "noisy withdrawal" even though this may in fact not be required.

The Proposed Rules attempt to provide comfort that the notification to the Commission prescribed by the "noisy withdrawal" requirements does not breach the attorney-client privilege. Sadly, we observe that merely saying so does not make it so. The Proposed Rules also attempt to provide comfort that applicable privileges still survive, which is a simply extraordinary conclusion given the publicity certain to accompany any "noisy withdrawal." In fact, the major threat of any "noisy withdrawal" is the certainty that it will attract immediate publicity and result in the loss of confidential treatment of the issue.

In addition, the Proposed Rules provide that an attorney specifically may use confidential information of the issuer to prevent perceived substantial financial injury, or fraud on the Commission, or to "rectify an illegal act," but, with respect, courts and bar associations are not necessarily bound by the Commission's judgment on these questions, even insofar as they relate to attorneys who may have been discharged by the issuer as the result of a whistle-blowing incident or threat. In effect, the Proposed Rules turn the Commission into the client, making the attorney's obligations run to the Commission.

Furthermore, access to the public securities markets in the United States was never before thought to involve the waiving of the traditional benefit of having qualified, trusted, confidential legal advisors available and willing to counsel the company on delicate legal matters; neither the Act nor it's legislative history explicitly or implicitly state this. Sometimes counseling clients includes reviewing and acting on issues where the regulators have taken a flatly contrary position, and sometimes the courts have agreed with the private litigants rather than with the regulators. The Proposed Rules in this critical respect would turn counsel into a private regulatory arm of the federal government, and require public disclosure of probably the most sensitive matters, even apparently in cases where the attorney flatly disagrees with the Commission's position on an issue, and believes, firmly and in good faith, that the Commission's position would never survive in court.

Proposed Rule §205.3(b)(7) requires that even the attorney who receives an appropriate and timely response to a report must nonetheless document his or her report, which could later surface as baseless but still relevant evidence in other wholly unrelated proceedings. Even the requirement contained in §205.3(b)(2) to retain relevant documentation could be contrary to the client's best interests, when there is no then-existing legal or other obligation to do so. In some cases the best representation of a client also involves the destruction of evidence of baseless claims which could later be used to the detriment of the client and this decision should be left with counsel, absent, independent legal requirements.

4. Shunning Legal Advice and Representation. 

In our judgment, the Proposed Rules, if enacted in their current form, will discourage clients from consulting with their lawyers about a wide variety of topics and across a broad swath of commonplace corporate activities, including but not limited to press releases, annual reports, and communications to investors and the marketplace. There is a strong probability that many issuers will perceive (perhaps correctly) that the Commission has turned their lawyers into independent investigators, enforcement officers and adjudicators; such issuers are unlikely to seek guidance from attorneys, be they inside or outside the corporate structure, about disclosure questions and other matters.

Furthermore, we are extremely troubled by §205.3(d)(1)(i) of the Proposed Rules as interpreted by the Commission. In the Release,⁴ this provision is viewed as requiring an attorney who is defending any person in a Commission investigation that, in the course of such defense becomes aware of evidence of a material violation and who has not received an appropriate response or a response within a reasonable time, to make a "noisy withdrawal". This obligation is of grave concern because it might discourage persons from seeking legal representation in the first place. In addition, this obligation might cause the termination of representation of those persons who have sought the assistance of counsel, leaving them in a position where they might have to defend themselves against the Commission's legal staff. Certainly, any lawyer involved in a contested matter should not be covered by the Proposed Rules.

5. Sanctions.

Finally, we believe that the substantial sanctions proposed by §205.6 of the Proposed Rules must be accompanied by a better and significantly more detailed treatment of what exactly might constitute intentional versus negligent conduct.

C. Conclusion.

In short, we submit, along with other commentators, that the Proposed Rules' "noisy withdrawal" provisions and the far-ranging exceptions (or breaches) of the attorney-client privilege, coupled with the sanctions, will have far-reaching and unintended negative consequences.⁵ Beyond those previously discussed in this letter, the deleterious effects of the Proposed Rules include driving the capital markets from the United States to overseas jurisdictions, which in some cases may be less regulated, and in many cases are far less accessible to domestic investors. Examples of companies which might participate in this flight of capital include non-US companies choosing to delist (or not list at all) in the US, global companies or those resulting from cross-border mergers deciding to move their US corporate headquarters to a non-US location and to select non-US exchanges as their trading markets, as well as US companies deciding to list their securities only on non-US exchanges, thus further facilitating the movement of liquidity to overseas jurisdictions.⁶

In our judgment, it is an intriguing fallacy, but a fallacy nonetheless, to identify the lawyers as the principal actors in the financial frauds of the last 18 months in corporate America, and therefore to propose solutions as poorly adapted to a real remedy, and so certain of significant bad effects, as the Proposed Rules. To be sure, the Act's strict timetable for adoption of rules under its various sections left little time for analysis and debate, but the remedy for that problem is not to adopt requirements which so seriously impair the classic attorney-client relationship, and give rise to serious investor and marketplace harm. Instead, we urge the Commission to adopt rules which meet the clearly-required statutory mandates.

The members of the drafting committee, Faith Colish, Raphael S. Grunfeld, Mary Joan Hoene, Robert A. McTamaney, Kathleen H. Moriarty and Ira L Sorkin would be honored to provide a further explanation of our views should this be of assistance to the Commission.