Litigation Section of the State Bar of CaliforniaBy e-mail: rule-comments@sec.gov Jonathan G. Katz, Secretary
Dear Mr. Katz: Reference is made to (1) Release Nos. 33-8185; 34-47276; IC 25929 (File No. S7-45-02) issued by the Securities and Exchange Commission on January 29, 2003, adopting a rule as Part 205 in 17 CFR (hereinafter referred to as the "Rule"), on Implementation of Standards of Professional Conduct for Attorneys, pursuant to Section 307 of the Sarbanes-Oxley Act of 2002, and (2) Release Nos. 33-8186; 34-47282; IC 25920 (File No. S7-45-02) also issued by the Commission on January 29, 2003, proposing certain alternate additions to the Rule concerning withdrawal from representation of issuers (hereinafter referred to as the "Proposed Rule"). This letter respectfully requests that the Commission consider carefully the following comments on proposed Part 205. These comments are provided on behalf of the Litigation Section of the State Bar of California. The Litigation Section represents more than 8,715 attorneys admitted to practice in California who represent clients in court, before administrative bodies (such as the Commission) and in alternative dispute resolution procedures. Membership in the Litigation Section, and on the Executive Committee thereof, is voluntary and funding for activities of them, including all legislative activities, is obtained entirely from voluntary sources. The Section recognizes that the Congress has required the Commission to adopt regulations that protect the capital markets and investing public while also respecting the traditions of the attorney client relationship in American law. The maintenance of high levels of professionalism and ethics within the profession are essential to clients, to the administration of justice and the investing public. The Section appreciates the effort that the Commission has gone to draft and adopt thoughtful rules that are intended to achieve these ends. In particular, the Section appreciates the changes made by the Commission to the rules originally proposed in November 2002, and the Commission's deferral of its current proposals to obtain additional comment. In this process, all interested parties must be conscious of the extent to which the proposed regulations risk interfering with well-established precepts of legal ethics and state rules of professional responsibility. Therefore, we again urge the Commission to proceed incrementally and consider carefully the breadth of the requirements that it proposes. Imprudent rules could adversely affect both the nature of the attorney-client relationship and the operation of the adversarial system. These principles have been the foundation of Anglo-American law for more than 200 years. They deserve the respect of the Commission and the lawyers who seek to live up to their high ideals. Consistent with its focus and goals, the Section focuses its comments on the manner in which the proposed rules may affect the operation of the adversarial system in California, particularly in the following areas:
I. Obligations of Direct or Indirect Disclosure of a Client's Confidences. According to the January 29, 2003 release, the Commission continues to consider the adoption of rules that would require either the direct or indirect disclosure of confidential information of a client by an attorney who believes that the client may be committing (or is about to commit) a material violation of the securities laws.
On December 18, 2002, the Section previously provided comment on the Commission's original proposed rules, which would have required a direct disclosure of a client's confidential information by attorneys. The Section discussed its opposition to an obligation on the part of an attorney to disclose client confidences to the Commission or the public by means of a "noisy withdrawal." The Section will not repeat those comments here, but emphasizes that the previously proposed obligation:
These changes would fundamentally alter the role of an attorney as an advocate for, not an auditor of, a client. If the Commission is continuing to consider the adoption of any provision permitting or mandating the disclosure of client confidences, including the Commission's November proposals or the newly proposed section 205.3(f), the Section urges the Commission not to adopt a "noisy withdrawal" requirement.
In its January 29, 2003 release, the Commission also proposes the possibility of various indirect mechanisms by which the potential for a present or future material violation may be communicated to the Commission or its staff. In the opinion of the Section, these proposals do not eliminate the concerns previously stated. First, pursuant to the professional rules in California, a lawyer cannot use indirect means to achieve a result that would be unethical if the lawyer himself took the action. Depending on the structure of the final regulations adopted by the Commission, compliance by California attorneys may still violate California's statutes and ethical rules, including California's strict limitation on permitting or causing the disclosure of a client's confidential information. The Section previously noted that, despite the Commission's position that its rules preempt California's laws, the necessary requirements for preemption may not exist. See Section I of the Section's December 18, 2002 response. In light of the deference that federal authorities have traditionally shown to the regulation of the conduct of attorneys by state courts and legislatures, we respectfully urge the Commission not to adopt regulations that would conflict with the obligations imposed by California law. In the view of the section, circumstances do not warrant forcing California practitioners to make a "Hobson's" choice. Second, the Commission should carefully consider the manner in which an issuer's obligation to report publicly information provided by its attorney may itself fundamentally shift the relationship between attorney and client. Clients who seek out rigorous and comprehensive legal advice could thereby be placed at risk of substantial economic and financial consequences based solely on an honest, albeit strong, disagreement with their attorneys about the facts, law or impact of the client's actions. As a result, clients may choose not to seek legal advice or may choose to withhold information for fear that an attorney might suspect the existence of a "material violation" where one does not exist. The law should encourage individuals and corporations to seek legal advice and to speak candidly with their attorneys. Only a candid and complete exchange of information can assure that legal violations are prevented before they occur. Effective legal counsel, which prevents future harm, depends on the bedrock understanding that an issuer can trust and communicate freely with its attorneys. Even indirect requirements to disclose confidential communications could disrupt that trust. II. Effect of the Obligation to Withdraw on Other Litigation. The present rules and proposed regulations leave two questions unresolved that could have a significant impact on the progress of litigation pending in tribunals other than before the Commission. The final rules place the obligation to report evidence of a material violation on "an attorney appearing and practicing before the Commission in the representation of an issuer." Proposed section 205.3(d)(1)(A) requires that "an attorney retained by the issuer shall withdraw from representing the issuer." Finally, proposed section 205.3(d)(2) provides that "an attorney" need not withdraw "if the attorney would be prohibited from doing so by order or rule of any court, administrative body or other authority with jurisdiction over the attorney, after having sought leave to withdraw from representations or to cease participation or assistance in a matter." These rules do not state how the proposed rules affect attorneys practicing in firms or what the source of authority is for the Commission's regulation of practice before other tribunals. The Commission should recognize that the same attorneys who are "appearing and practicing before the Commission" also frequently serve clients in connection with related or unrelated litigation in state or federal courts. Especially in the case of unrelated litigation, the proposed requirement of withdrawal has three undesirable effects. First, clients may be left without any legal representation in related litigation precisely at the moment when the law should be most interested in encouraging clients to obtain ongoing and knowledgeable legal counsel. If a client is on the verge of potentially illegal behavior, it is not clear that the public is better protected by depriving the issuer of legal advice regarding securities or derivative litigation in another court. Second, clients will be prejudiced in unrelated litigation by the withdrawal of an attorney, especially because there is no nexus to the potential violation. By seeking to withdraw without explanation (or with the explanation that withdrawal is required by undisclosed ethical rules), the client may be deprived of counsel at a very sensitive moment in a litigation whose financial impact on the issuer and its shareholders may be substantial. Worse, a court may erroneously draw the conclusion that the ethical misconduct may arise from the client's action in connection with the litigation before it. Thereafter, the court's judgment may be colored by this misimpression. Finally, if the attorney successfully withdraws, third parties may be seriously and prejudicially affected. A worthy plaintiff's case against an issuer could be set back by many months due to an application to withdraw that is granted. Depending on the context, this might seriously delay settlement, a recovery and impose substantial additional attorney's fees on the innocent plaintiff, who has no connection or interest in the conduct that led to the withdrawal. Issuers are involved in a wide variety of litigation and the impact of an attorney's withdrawal may therefore extend far beyond the steps of the Commission's offices. All of the foregoing will occur in state courts, federal courts, and other administrative bodies for which the Commission has no jurisdiction and no policy making authority. Intrusion by the Commission into the operation of these bodies is neither mandated nor warranted. Neither section 307 of the Sarbanes Oxley Act nor its legislative history suggests that Congress intended that the Commission adopt rules that would have significant collateral effects on other courts and tribunals. To the contrary, the statute explicitly limited itself to a mandate to adopt rules that ensure that attorneys report evidence of material violations to the Board of Directors and the Audit Committee. The Commission should be conscious of the potential limits of its authority pursuant to the statute. The potential damage from a requirement of withdrawal would be expanded substantially if the Commission also concludes that the requirement of withdrawal by "an attorney who is retained by the issuer" extends to all members of the affected attorney's law firm. If so, the judgment of one attorney doing securities work in New York, who is subject to the Commission's jurisdiction, may derail or interfere with dozens of cases and controversies concerning patent, environmental, products liability, or general negligence liability in courts in Los Angeles, San Diego, and San Francisco, which are not subject to the Commission's jurisdiction. A material violation of a securities law by an issuer is a very serious matter. If and when violations occur, the law should be enforced vigorously, and the Commission should impose appropriate penalties. Nonetheless, these laws do not authorize the Commission to take action that would prejudice an issuer's position in unrelated litigation in the courts. If all attorneys within a firm have a duty to withdraw, these unintended consequences will occur. Unless the Commission states clearly and unequivocally that an obligation to withdraw affects only the individual attorney, who is appearing and practicing before the Commission, these collateral effects are almost certain to occur. The Section requests that the Commission expressly provide such guidance. The Section recognizes the difficulty of adopting rules in this area and appreciates the Commission's efforts thus far. The Commission has been prudent by taking the process in steps. In light of the potentially significant effects that these regulations may have on the operation of courts and the legal system, the Section urges the Commission to adopt rules that are only as broad as its authority and that account for the collateral damage that its regulations may have.
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