Vol. 76, No. 3, March
2003
Sarbanes-Oxley Requirements
Determining Disclosure Under SEC Reporting Requirements
The SEC rules under the federal Sarbanes-Oxley
Act are complex; however, several familiar principles apply when
considering a lawyer's obligation to report confidential corporate
client information.
by Dean R. Dietrich
Dean R.
Dietrich, Marquette 1977, of Ruder, Ware & Michler
L.L.S.C., Wausau, is chair of the State Bar Professional Ethics
Committee.
Question
I heard about new federal legislation that requires a lawyer to
disclose confidential information about a corporate client. What does
this new legislation require and what obligations do I have to give out
client information?
Answer
In July, Congress passed the Sarbanes-Oxley Act, legislation that
addresses several issues regarding financial accounting standards and
financial reporting requirements for publicly traded companies. As a
part of this legislation, Congress required the Securities and Exchange
Commission (SEC) to develop rules that address the conduct of lawyers
who are representing publicly traded companies before the SEC.
Under the mandate of the federal legislation, the SEC initially
developed rules that addressed the requirement that a lawyer report any
inappropriate conduct of a publicly traded company or officers or
directors of that company to appropriate individuals within the company,
known as reporting "up the ladder," and required lawyers to withdraw
from representation and advise the SEC of the withdrawal (known as
"noisy withdrawal") if no corrective action was taken. Under the final
rule recently issued by the SEC, a lawyer is required to report material
violations of securities laws or accounting practices "up the ladder" to
corporate officials or boards. The SEC postponed issuance of the
proposed rule that required a lawyer who is aware of a material
violation of the law or fraudulent acts of a corporate officer to
withdraw from representation of the company and disavow any legal
opinions or statements that the lawyer participated in as part of the
representation of the publicly traded company. The proposed rule is
subject to a further comment period.
Guiding Principles. While the SEC rules are very
complex, there are several principles that apply when considering a
lawyer's obligation to report information if the lawyer reasonably
concludes that the company/client is acting in violation of the SEC
rules. First, under section 205.3 (a) of the rules, any attorney who is
appearing or practicing before the SEC in the representation of an
issuer is deemed to be representing the organization and is obligated to
act in the best interest of the issuer and its shareholders. This
concept is consistent with the language of SCR 20:1.13, which clarifies
that a lawyer representing an organization is actually representing the
entity itself and must act in the best interests of the entity, not
individual officers or directors of the entity.
Second, an attorney who becomes aware of "evidence of a material
violation by the issuer or by any officer, director, employee, or agent
of the issuer" must report any evidence of a material violation to the
entity's chief legal officer or both the entity's chief legal officer
and its chief executive officer. This requirement also is consistent
with a Wisconsin lawyer's obligation under SCR 20:1.13 if the lawyer
becomes aware of conduct by an individual that is harmful to the
organization that is the lawyer's client. A material violation is
defined to mean a material violation of the securities laws, a material
breach of fiduciary duty, or a similar material violation. A breach of
fiduciary duty would cover such types of conduct as misfeasance,
nonfeasance, abdication of duty, abuse of trust, and the approval of
unlawful transactions. The final draft of the rule contains a new
provision that defines the type of evidence that must be found for a
report of wrongdoing to be required as "credible evidence, based upon
which it would be unreasonable, under the circumstances, for a prudent
and competent attorney not to conclude that it is reasonably likely that
a material violation has occurred, is ongoing, or is about to
occur."
Third, the attorney who becomes aware of evidence of a material
violation must report the evidence either to the audit committee of the
entity's board of directors or to the board of directors of the entity,
if the attorney does not receive an appropriate response or a response
within a reasonable time from the chief legal officer and/or the chief
executive officer. This duty to report "up the ladder" to the board of
directors or appropriate committee is again consistent with SCR 20:1.13,
which requires a lawyer to report the evidence of the inappropriate
conduct to the highest appropriate authority.
If the lawyer receives a timely and appropriate response to the
report of evidence of a material violation, the lawyer does not need to
take any further action. If, however, the lawyer does not receive an
appropriate response or does not receive a response in a reasonable
time, the attorney must explain the reasons why he or she believes that
the response is not appropriate or is untimely to the chief legal
officer, chief executive officer, or board of directors to whom the
lawyer has previously reported the evidence of a material violation. In
effect, the lawyer is obligated to report a second time regarding the
evidence of a material violation if no response or an inappropriate
response is received after the first report is made.
Proposed Rule - Additional Reporting. The proposed
SEC rule that is under study for another 60-day comment period requires
the lawyer to go further in reporting evidence of a material violation.
If no appropriate action is taken after reporting "up the ladder," the
lawyer is then placed under a new obligation. If the lawyer believes
that a material violation is "ongoing or is about to occur and is likely
to result in substantial injury to the financial interest or property of
the issuer or of investors," the lawyer must:
1) withdraw from representation of the issuer entity and indicate to
the entity that the lawyer is withdrawing based upon "professional
considerations;"
2) give written notice to the SEC, within one business day of
withdrawing, that the attorney is withdrawing from representation based
"on professional considerations;" and
3) promptly disaffirm to the SEC "any opinion, document, affirmation,
representation, characterization, or the like in a document filed with
or submitted to the Commission ... that the attorney has prepared or
assisted in preparing and that the attorney reasonably believes is or
may be materially false or misleading."
This is known as a "noisy withdrawal." The attorney is not required
to disclose facts or evidence of the material violation to the SEC but
rather is only obligated to notify the SEC that the attorney is
withdrawing from representation for professional considerations and to
disaffirm any documents that the attorney was involved in preparing on
behalf of the entity to the extent the attorney may know that the
document is or may be materially false or misleading.
This obligation to engage in a "noisy withdrawal" is similar to the
obligation of SCR 20:1.6 (b), which requires Wisconsin lawyers to
disclose confidential attorney/client information if the lawyer
"reasonably believes (it) necessary to prevent a client from committing
a criminal or fraudulent act that the lawyer reasonably believes is
likely to result in death or substantial bodily harm or in substantial
injury to the financial interest or property of another." As can be
seen, the language of SCR 20:1.6, while relating to an obligation to
disclose information necessary to prevent an act from occurring, does
apply to information that could result in substantial injury to the
financial interest or property of another _which is the same language
incorporated in Rule 205.3.
Under the proposed rule, if a lawyer has reported evidence of a
material violation and does not receive an appropriate or timely
response and the lawyer believes that a material violation has already
occurred and is likely to have resulted in substantial injury to the
financial interest or property of the issuer or investors but is not an
ongoing violation, the lawyer may 1) withdraw from representing the
entity and indicate that the withdrawal is based on professional
considerations, 2) give written notice to the SEC of the withdrawal
based on professional considerations, and 3) disaffirm in writing any
opinion, document, affirmation, representation, characterization, or the
like in a document that the attorney prepared or assisted in preparing
if the attorney believes that the information may be materially false or
misleading. This requirement is similar to the language in SCR 20:1.6
(c), which provides that a lawyer may disclose information learned
during the course of representing a client in order to address the
consequences of a fraudulent or criminal act committed by the client
through the use of the lawyer's services. This language is permissive
instead of mandatory, which allows the attorney to determine whether or
not he or she wishes to disclose evidence of a material violation to the
SEC when the violation is not believed to be ongoing.
The proposed SEC rule still under study contains a somewhat different
procedure for persons employed by the issuer. In similar instances when
an attorney employed by the issuer becomes aware of a material
violation, the attorney must report the information to the appropriate
officer and "up the ladder" if necessary. If such report does not
resolve the matter, the attorney is obligated to: 1) notify the entity
in writing that the attorney intends to disaffirm some opinion,
document, affirmation, representation, characterization, or similar
statement in a document filed or submitted to the SEC that the attorney
has prepared or assisted in preparing if the attorney reasonably
believes that the document may be materially false or misleading; and 2)
promptly disaffirm any such document by notice to the SEC in
writing.
The final rule also provides that a lawyer practicing before the SEC
in the representation of an issuer may reveal confidential information
related to the representation if the lawyer reasonably believes it
necessary to prevent the issuer from committing an illegal act that the
lawyer reasonably believes is likely to result in substantial injury to
the financial interest or property of the issuer or investors; to
prevent the issuer from committing an illegal act that is likely to
perpetuate a fraud upon the SEC; or to rectify the consequences of an
issuer's illegal act in the furtherance of which the attorney's services
were used. These discretionary reporting requirements coincide with the
requirements of SCR 20:1.6 (c), which provides that the lawyer may
disclose information related to a client representation based upon
similar circumstances.
Conclusion
The practical effect of all these provisions is to place a limited
additional burden on Wisconsin lawyers to report information to the
client and perhaps to the SEC if the criteria of the rules are met. In
each instance, the lawyer must believe that a material violation of the
SEC rules is either occurring or has occurred. Similar obligations
already exist under Supreme Court Rule 20:1.6, although lawyers
practicing before the SEC may be required to give a "noisy withdrawal"
notice to their client and to the SEC if the circumstances of a material
violation are not properly addressed by the entity.
Lawyers practicing before the SEC or representing publicly traded
companies should be aware of their obligations under these rules as well
as under the Wisconsin Supreme Court Rules of Professional Conduct for
Attorneys.
Wisconsin
Lawyer