Proposed Rules Establishing Standards of Professional Conduct for Attorneys Preparing SEC Filings or Otherwise Practicing Before the Commission

(November 2002, Public Company Materials)

On November 21, 2002, the U.S. Securities and Exchange Commission (“SEC”) published proposed rules intended to implement Section 307 of the Sarbanes-Oxley Act of 2002 (the “Act”), which requires the SEC to prescribe minimum standards of conduct for attorneys appearing and practicing before the SEC in the representation of issuers.  As with other recent proposals by the SEC under the Act, this rulemaking would establish requirements that are not specifically referred to in the Act.  The proposed rule, if adopted as proposed, would put in place:

• an expansive view of what constitutes “appearing and practicing” before the SEC “in the representation of issuers,” including as such any participation in the preparation of SEC filings;
• an “up the ladder” reporting requirement on attorneys with respect to any “evidence” they become aware of concerning “a material violation” of the securities laws, fiduciary duties or similar requirements by issuers or their directors, officers, employees or other agents, including requirements regarding the creation and preservation of documentation relating to such reports; and
• if the misconduct reported “up the ladder” is not “appropriately” explained, corrected or remedied, a “noisy withdrawal” requirement (including reporting to the SEC the disavowal by the attorney of SEC submissions he or she participated in preparing); this is a provision that is not explicitly required by Section 307, but which the SEC believes is important to an effective “up the ladder” reporting system.

The rule is applicable both to attorneys employed “in-house” by an issuer and to outside counsel.  The scope of the rule is global in that it is specifically designed to cover foreign attorneys who participate in the preparation of submissions to the SEC by foreign issuers (even if those submission are not considered “filed” with the SEC for purposes of the securities laws).  Comments to the SEC on the rule proposals will be due by December 18, 2002.  The text of the rule proposals is available at http://www.sec.gov/rules/proposed/33-8150.htm.

The following discussion summarizes the salient elements of the rule proposal, which would become a new Part 205 of the SEC’s rules, supplementing and in part replacing the existing rules (Rule 102(e)) regarding the conduct of professionals appearing before the Commission.

Appearing and Practicing Before the SEC
The proposed rule defines broadly what constitutes “appearing and practicing” before the SEC to include, but not be limited to, an attorney’s:

• transacting any business with the SEC, including communication (oral or written) with the SEC or its staff;
• representing any person in connection with an SEC administrative proceeding, investigation, inquiry, information request or subpoena;
• participating in the process of preparing any report, statement, opinion or other writing, which the attorney has reason to believe will be filed with or incorporated into any SEC filing or submission; or
• advising any party that:
• a statement, opinion or other writing need not or should not be filed with or incorporated into any SEC filing or submission; or
• the party is not obligated to make an SEC filing or submission.

Under this definition, participation in the preparation of a filing or submission would encompass “both adding and excluding information or a particular characterization of information.”  Similarly, an attorney who advises an issuer not to make a filing or submission would also be considered to be appearing and practicing before the SEC.

The term “attorney” would refer to any person who is admitted, licensed or otherwise qualified to practice law in any jurisdiction (domestic or foreign), as well as any person who holds himself or herself out as admitted, licensed or otherwise qualified to practice law.  This definition would cover attorneys practicing law in foreign jurisdictions, whether or not they are also admitted to practice in the United States.

The proposed rule also broadly defines what constitutes “in the representation of an issuer” to mean acting in any way on behalf, at the behest or for the benefit of an issuer, whether or not an attorney is employed or retained by the issuer.  For this purpose, “issuer” is defined, in the same manner as in the Act, as any company which has any securities registered under section 12 of the Securities Exchange Act of 1934 or which is required to file reports with the SEC under section 15(d) of that Act or which has filed a registration statement under the Securities Act of 1933 which has not yet become effective and has not been withdrawn.  Thus, it includes all publicly owned, “SEC reporting” companies (foreign and domestic) and all companies seeking to “go public.”  The definition of “representation of an issuer” captures within the ambit of the proposed rule an attorney employed or retained by a non-public subsidiary of a public parent when he or she is assigned work by the parent which is consolidated into a parent SEC filing or submission.  It also reaches attorneys who investigate or represent an issuer in responding to a report of misconduct submitted “up the ladder” in accordance with the rule.

“Up the Ladder” Reporting Requirements
The proposed rule would require an attorney representing an issuer to report evidence of a material violation “up the ladder” to the company’s chief legal officer (“CLO”) or to its CLO and chief executive officer.  This reporting obligation arises only when the attorney becomes aware of information that would lead an attorney reasonably to believe that a material violation of the securities laws, a material breach of fiduciary duty or a similar violation has occurred, is occurring or is about to occur.  The attorney would also have an obligation to take reasonable steps to document the report and the response to the report, and to retain such documentation for a reasonable time.  A subordinate attorney may satisfy his or her obligation by reporting to his or her supervisory attorney.

After receipt of a report of a possible material violation, a CLO must conduct a reasonable inquiry to determine whether the reported violation has occurred, is occurring or is about to occur.  A CLO who reasonably concludes that there has been no material violation must notify the reporting attorney of this conclusion.  A CLO who concludes that a material violation has occurred, is occurring or is about to occur must take reasonable steps to ensure that the issuer adopts appropriate remedial measures (including appropriate disclosures) and/or imposes appropriate sanctions to stop any material violation that is occurring, prevent any material violation that is about to occur and/or to rectify any material violation that has already occurred.  The CLO must also report “up the ladder” the remedial measures taken and sanctions imposed, and to advise the reporting attorney of his or her conclusions.

A reporting attorney who does not receive an appropriate response within a reasonable time would be obligated to go “up the ladder” and report the evidence of a material violation to the audit committee, another committee of independent directors or the full board.  The proposed rule wouldalso permit a reporting attorney to go “up the ladder” in the first instance if he or she reasonably believes that it would be “futile” to report evidence of a material violation to a company’s CLO or chief executive officer.

The proposed rule would permit, but not obligate, an issuer to establish a “qualified legal compliance committee” (a “QLCC”).  In addition to meeting certain independence and composition requirements, the QLCC must have the authority and responsibility to conduct the inquiry into the reported evidence and require the issuer to adopt appropriate remedial measures.  If the reported violation is not appropriately remedied, the QLCC must also have the authority and responsibility to notify the SEC of a material violation and disaffirm any tainted SEC filing or submission.  As an alternative, an attorney may report evidence of a material violation to the QLCC in the first instance and thereby meet his or her reporting obligation under the proposed rule.  Likewise, a CLO who receives a report of a material violation may ask the QLCC to investigate the report in lieu of conducting his or her own inquiry.

“Noisy Withdrawal” Provisions
Under the proposed rules, a reporting attorney who has reported a material violation by or on behalf of an issuer all the way “up the ladder” and who reasonably believes that the issuer has not responded appropriately would be permitted (notwithstanding any contrary local professional responsibility rules) and, in certain instances, be required to effect a “noisy withdrawal” from his or her representation of the issuer.  Specifically, an attorney who has made a report without appropriate response, and who reasonably believes that the reported material violation is (1) ongoing or is about to occur and (2) likely to result in substantial injury to the financial interest of the issuer or investors is required to:

• in the case of an outside attorney:
• withdraw from the representation;
• notify the SEC of his or her withdrawal based on “professional considerations”; and
• disaffirm any tainted SEC filing or submission that he or she participated in preparing; or
• in the case of an in-house attorney:
• notify the SEC of his or her intention to disaffirm; and
• disaffirm any tainted SEC filing or submission that he or she participated in preparing.

It is worth emphasizing that the proposed rule would not require an in-house reporting attorney to resign.

If a reporting attorney reasonably believes that a material violation has already occurred, but has no ongoing effect, the attorney would be permitted, but not required, to take the foregoing steps, provided, however, that he or she also reasonably believes that the reported material violation is likely to have caused substantial injury to the financial interest of the issuer or investors.  If an attorney formerly employed or retained by an issuer reasonably believes that he or she was discharged because he or she fulfilled the reporting obligation imposed by the proposed rule, the attorney would be permitted, but not required, to notify the SEC of his or her belief that he or she was discharged for reporting evidence of a material violation and also disaffirm any tainted SEC filing or submission that he or she participated in preparing.

Finally, to avoid the situation where a successor attorney is left unaware that the previous attorney reported a material violation, the proposed rule would require the issuer to notify any attorneys retained or employed to replace a withdrawn attorney that his or her predecessor withdrew based on professional considerations.

Disclosure of Confidential Information
The proposed rule identifies specific circumstances under which an attorney would be authorized to disclose confidential information related to his or her appearance and practice before the SEC in the representation of an issuer.  First, an attorney would be permitted to use the documentation he or she prepared under the rule to defend against charges of misconduct.  In addition, the proposed rules would permit disclosure of confidential information to the SEC to the extent necessary to prevent the commission of an illegal act which the attorney reasonably believes will result either in perpetration of a fraud upon the SEC or substantial injury to the financial interests of the issuer or of investors.

Please get in touch with your contact at Weil, Gotshal & Manges if you have any questions or if we can be of further assistance.