Legal Ethicists Support SEC Rule Changes Designed to Deter Fraud
In a bid to make lawyers involved in executing corporate transactions more accountable for addressing client fraud, legal ethicists and corporate law specialists have joined in support of a "noisy withdrawal" rule recently proposed by the Securities and Exchange Commission. The rule would require corporate lawyers faced with evidence of a material violation of law to report this evidence up the corporate ladder, and ultimately, in the absence of an adequate response from corporate officers and the board or relevant board committee, to withdraw from the representation, notify the SEC of the withdrawal, and disaffirm any materially false or misleading documents that the lawyers helped prepare.
George M. Cohen, a professor of law at U.Va. who teaches legal ethics and is a co-author of a forthcoming new edition of the prominent casebook, The Law and Ethics of Lawyering, worked with his co-authors Susan P. Koniak of Boston University and Roger Cramton of Cornell University, to respond to the SEC's draft rules. Their 45-page analysis of the new reporting requirements has been endorsed in principle by 48 other legal academics from around the country, including U.Va's Richard Balnave. (View the text of the comment letter and the list of endorsers in PDF format - Get Acrobat Reader.)
"That's a huge response from the legal academy and it cuts across all political and academic ideologies," Cohen said of the support their recommendations got as they circulated the comments for review to colleagues at many law schools. "I've never seen such a positive response from a group this large with such diverse backgrounds. This is a real mix and that's unusual. The fact that they all gave their general agreement is remarkable."
When Congress, following Enron's collapse, passed the Sarbanes-Oxley Act to impose greater accountability structures on publicly held companies, it included a provision requiring the SEC to propose new professional conduct standards for attorneys. The SEC drafted proposed rules, and solicited responses to its proposals. Law faculty, anticipating resistance to the proposals coming from the American Bar Association and other lawyer groups, spoke up.
"We wanted to weigh in because we can come at the problem from a disinterested perspective. The ABA has suggested that we don't understand the issues, but the fact is, we do understand them quite well," Cohen said. After Enron imploded, the lawyers who blessed its fraudulent schemes "managed to fly below the public radar," Cohen said. "But that is changing. Until investors see accountability structures on the legal profession strengthened, they won't know if they can believe in corporate financial statements."
"We're basically backing the direction the SEC is trying to go, especially in the 'noisy withdrawal' provision. That's key and we strongly support it," Cohen said. "'Noisy withdrawal' gives the lawyers the threat leverage that may on rare occasions be needed to induce compliance," Cohen said. "Moreover, the noisy withdrawal concept is nothing new. The ethics rules of almost every state already permit it, and an ABA ethics opinion says it may be required in some cases to avoid assisting in the fraud."
A second point the academics make is that the standards that trigger a lawyer's duty to report should be objective, and not overly restrictive. In particular, they argue that the SEC's rules should not use subjective standards, such as a lawyer's "belief," and that the rules should not undermine the "evidence of a material violation" trigger by turning it into a mere "violation" trigger.
"Lawyers are really good at wiggling out when there is a way to evade responsibility," he said. "A lawyer could easily convince himself that he did not actually know some fact, or that something was not an actual violation. We are saying if they are confronted with evidence that a prudent and competent attorney would conclude is credible, that triggers the duty to report."
For the time being the academics are forbearing criticizing the proposal to encourage the creation of new Qualified Legal Compliance Committees within the corporation to review evidence of possible illegal acts. Reporting to such committees would satisfy the lawyer's reporting obligations and eliminate the need for a noisy withdrawal. "The Qualified Legal Compliance Committees could provide a big loophole, but we aren't fighting them for now. They could work, because they would have their own reporting obligations to the SEC."
The ABA has been lobbying against the new rules, arguing that the SEC is overstepping its authority and that it is the prerogative of the states to regulate lawyers. But state bar counsel commonly don't go after lawyers at large firms who assist in corporate fraud because they would be outgunned by the resources of those law firms, Cohen said. Furthermore, other federal agencies, such as the Internal Revenue Service and the U.S. Patent Office, already have rules regulating lawyers.
Responses were due at the SEC Dec. 18 and it must forward its new rules to Congress in January.
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