[Federal Register Volume 67, Number 231 (Monday, December 2, 2002)]
[Proposed Rules]
[Pages 71670-71707]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-30035]



[[Page 71669]]

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Part III





Securities and Exchange Commission





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17 CFR Part 205



Implementation of Standards of Professional Conduct for Attorneys; 
Proposed Rule

  Federal Register / Vol. 67, No. 231 / Monday, December 2, 2002 / 
Proposed Rules  

[[Page 71670]]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 205

[Release Nos. 33-8150; 34-46868; IC-25829; File No. S7-45 -02]
RIN 3235-AI72


Implementation of Standards of Professional Conduct for Attorneys

AGENCY: Securities and Exchange Commission.

ACTION: Proposed rule.

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SUMMARY: The Securities and Exchange Commission (``Commission'') is 
soliciting comments on a proposed rule that would establish standards 
of professional conduct for attorneys who appear and practice before 
the Commission on behalf of issuers. Section 307 of the Sarbanes-Oxley 
Act of 2002 requires the Commission to prescribe minimum standards of 
professional conduct for attorneys appearing and practicing before the 
Commission in any way in the representation of issuers. The standards 
must include a rule requiring an 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. Proposed Part 205 responds to this directive and is intended 
to protect investors and increase their confidence in public companies 
by ensuring that attorneys who work for those companies do not ignore 
evidence of material misconduct.

DATES: Comments should be received on or before December 18, 2002.

ADDRESSES: To help us process and review your comments efficiently, 
comments should be sent by hard copy or by e-mail, but not by both 
methods.
    Comments sent by hard copy should be submitted in triplicate to 
Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 
Fifth Street, NW, Washington, DC 20549-0609. Alternatively, comments 
may be submitted electronically to the following e-mail address: [email protected]. All comment letters should refer to File No. 33-
8150.wp; this file number should be included on the subject line if e-
mail is used. All comment letters received will be available for public 
inspection and copying in the Commission's Public Reference Room at the 
same address. Electronically submitted comments will be posted on the 
Commission's internet Web site (http://www.sec.gov).\1\
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    \1\ The Commission does not edit personal identifying 
information, such as names or electronic mail addresses, from 
electronic submissions. Interested persons submitting comments 
should only submit information that they wish to make publicly 
available.

FOR FURTHER INFORMATION CONTACT: Timothy N. McGarey or Edward C. 
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Schweitzer at 202-942-0835.

SUPPLEMENTARY INFORMATION: The Commission is proposing to add a new 
Part 205 to Title 17, Chapter II, of the Code of Federal Regulations 
\2\ 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.
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    \2\ 17 CFR part 205.
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Table of Contents

I. Purpose of This Rule Proposal
II. Commission Initiatives to Establish Professional Standards for 
Attorneys Appearing and Practicing Before the Commission
    A. The Role of Attorneys Who Appear before the Commission.
    B. The Commission's Ability to Discipline Attorneys under Rule 
102(e).
    C. Prior Commission Consideration of an Attorney's Obligation to 
Report Corporate Misconduct to Management.
III. Section 307 of the Sarbanes-Oxley Act
IV. Proposed Part 205
    A. General Overview
    B. Summary of Part 205
V. Section-By-Section Discussion of the Proposed Rule and Request 
for Comments
VI. Paperwork Reduction Act
VII. Costs and Benefits
VIII. Effect on Efficiency, Competition and Capital Formation
IX. Initial Regulatory Flexibility Analysis
X. Small Business Regulatory Enforcement Fairness Act
XI. Statutory Basis and Text of Proposed Part 205

I. Purpose of This Rule Proposal

    The purpose of this release is to solicit comments on proposed Part 
205,\3\ which prescribes Standards of Professional Conduct for 
Attorneys who appear and practice before the Commission in any way in 
the representation of issuers.
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    \3\ Proposal 17 CFR part 205.
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    Section 307 of the Sarbanes-Oxley Act of 2002 (the ``Act'') (15 
U.S.C. 7201 et seq.) mandates that the Commission

shall issue rules, in the public interest and for the protection of 
investors, setting forth minimum standards of professional conduct 
for attorneys appearing and practicing before the Commission in any 
way in the representation of issuers, including a rule--

    (1) Requiring an attorney to report evidence of a material 
violation of securities law 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 thereof); and
    (2) If the counsel or officer does not appropriately respond to 
the evidence (adopting, as necessary, appropriate remedial measures 
or sanctions with respect to the violation), requiring the attorney 
to report the evidence to the audit committee of the board of 
directors of the issuer or to another committee of the board of 
directors comprised solely of directors not employed directly or 
indirectly by the issuer, or to the board of directors.

    The proposed rule responds to this directive.\4\
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    \4\ The Act mandates that the Commission issue a rule 
establishing such minimum standards of conduct for attorneys within 
180 days of its enactment. The Act was signed into law by President 
Bush on July 30, 2002. Accordingly, the new rule must be issued by 
January 26, 2003. The Commission may, in the event it determines it 
appropriate in light of the mandate of Section 307, supplement the 
rule establishing minimum standards after that date.
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II. Commission Initiatives to Establish Professional Standards for 
Attorneys Appearing and Practicing Before the Commission

A. The Role of Attorneys Who Appear Before the Commission

    Attorneys play a varied and crucial role in the Commission's 
processes. Attorneys prepare, or assist in the preparation of, 
materials that are filed with or submitted to the Commission by, or on 
behalf of, issuers. These materials are relied upon by public investors 
in making their investment decisions. Thus, the Commission, and the 
investing public, must be able to rely upon the integrity of in-house 
and retained lawyers who represent issuers.
    Attorneys also play an important and expanding role in the internal 
processes and governance of issuers, ensuring compliance with 
applicable reporting and disclosure requirements (including, inter 
alia, requirements mandated by the federal securities laws). During the 
floor debate on the amendment that was subsequently adopted and enacted 
as Section 307 of the Act, Senator John Edwards emphasized the 
important function attorneys play at public companies. ``This amendment 
is about making sure those lawyers, in addition to the accountants and 
executives in the

[[Page 71671]]

company, don't violate the law and, in fact, more importantly, ensure 
that the law is being followed.'' \5\ Unfortunately, the actions of 
some attorneys have drawn increasing scrutiny and criticism in light of 
recent events demonstrating that at least ``some lawyers have forgotten 
their responsibility.'' \6\ Moreover, existing state ethical rules have 
not proven to be an effective deterrent to attorney misconduct.\7\ The 
July 16, 2002 Preliminary Report of the American Bar Association Task 
Force on Corporate Responsibility (hereinafter the ``Cheek Report'') 
noted that ``a disturbing series of recent lapses in corporations 
involving false or misleading financial statements and alleged 
misconduct by executive officers' has compromised investors' confidence 
in both the ``quality and the integrity'of the governance of public 
companies.\8\ Indeed, the Task Force concluded that ``the system of 
corporate governance at many public companies has failed 
dramatically.'' Moreover, the Task Force's preliminary report 
acknowledges that attorneys representing and advising corporate clients 
bear some share of the blame for this failure.\9\
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    \5\ See remarks by Senator John Edwards, 148 Cong. Rec. S6552 
(July 10, 2002).
    \6\ Id. at S6551. See also Speech by SEC Chairman Harvey L. 
Pitt: Remarks Before the Annual Meeting of the American Bar 
Association's Business Law Section (Aug. 12, 2002) (``recent events 
have refocused our attention on the need for the profession to 
assist us in ensuring that fundamental tenets of professionalism, 
ethics and integrity work to ensure investor confidence in public 
companies.''), available at http://www.sec.gov/news/speech/spch579.htm.
    \7\ See remarks by Senator Michael Enzi, 148 Cong. Rec. at S6555 
(``I am usually in the camp that believes that [s]tates should 
regulate professionals within their jurisdiction. However, in this 
case, the [s]tate bars as a whole have failed. They have provided no 
specific ethical rule of conduct to remedy this kind of situation. 
Even if they do have a general rule that applies, it often goes 
unenforced.'').
    \8\ See Cheek Report at 3-4.
    \9\ See Cheek Report at 7 (``It is a clear failure of corporate 
responsibility if executive officers aware of potential accounting 
irregularities sell millions of dollars of stock to public investors 
who are unaware of [earnings misstatements and self-dealing by 
corporate officers]. It is a clear failure of corporate 
responsibility for insiders to borrow enormous amounts from their 
companies without adequate security beyond inflated stock of the 
company itself. And it is a clear failure of corporate 
responsibility when outside directors, auditors and lawyers, who 
have important roles in our system of independent checks on the 
corporation's management, fail to avert or even discover--and 
sometimes actually condone or contribute toward the creation of--the 
grossest of financial manipulations and fraud.'').
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    Moreover, foreign attorneys are playing an ever greater role in 
connection with their representation of issuers making Commission 
filings. With the globalization of the U.S. capital markets, there has 
been a marked increase in the number of companies from non-U.S. 
jurisdictions registering securities with the Commission.\10\ At 
present, there are over 1,300 foreign private issuers from 59 countries 
that are filing reports with the Commission under the Exchange Act, as 
compared with approximately 400 issuers from less than 30 countries in 
1990. As a result, it is important to address how the proposed rule 
would apply to these foreign attorneys.
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    \10\ The Commission realizes that the application of Section 307 
and the rules we are proposing under Part 205 to foreign law firms, 
multijurisdictional law firms, and foreign lawyers employed by those 
law firms and foreign registrants, raises a number of significant 
and difficult issues. We are requesting comment on a broad range of 
questions in this area, including whether foreign law firms and 
foreign lawyers should be exempt from Part 205.
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B. The Commission's Ability To Discipline Attorneys Under Rule 102(e)

    Rule 102(e) of the Commission's Rules of Practice has been the 
primary vehicle available to the Commission to protect its processes 
and ensure the competence of professionals (including attorneys) who 
appear and practice before it.\11\ The Commission adopted Rule 102(e) 
as a ``means to ensure that those professionals, on whom the Commission 
relies heavily in the performance of its statutory duties, perform 
their tasks diligently and with a reasonable degree of competence.'' 
\12\ The rule permits the Commission to initiate disciplinary 
proceedings against attorneys who lack integrity or competence, engage 
in improper professional conduct,\13\ or who are determined to have 
violated provisions of the federal securities laws. The sanctions 
available in those proceedings include censure, temporary suspension, 
and permanent bar.
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    \11\ Rule 2(e), the predecessor to Rule 102(e), was promulgated 
in 1935. Rule 2(e) was redesignated Rule 102(e) in 1995. For the 
sake of uniformity, the rule will be referred to throughout this 
release as Rule 102(e).
    \12\ Touche Ross & Co. v. SEC, 609 F.2d 570, 582 (2d Cir. 1979). 
The Commission's existing Rule 102 addresses the conduct of 
attorneys, accountants, engineers and other professionals or experts 
who appear or practice before the Commission. 17 CFR 201.102(e)(2) 
and (f)(2).
    \13\ Rule 102(e) does not establish professional standards. 
Rather, the rule enables the Commission to discipline professionals 
who have engaged in improper professional conduct by failing to 
satisfy the rules, regulations or standards to which they are 
already subject, including state ethical rules governing attorney 
conduct, or generally accepted accounting principles (GAAP) or 
generally accepted auditing standards (GAAS) governing the conduct 
of accountants.
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    Professionals against whom the Commission has instituted Rule 
102(e) proceedings (particularly accountants) have challenged the 
Commission's authority to promulgate the rule. Every court that has 
ever considered the issue has concluded that the Commission possessed 
the authority to promulgate Rule 102(e), and the courts have recognized 
that it is appropriate for the Commission to use a disciplinary 
mechanism like Rule 102(e) to protect the integrity of its processes 
and to encourage professionals to adhere to minimum standards of 
competence.\14\ Nevertheless, as noted below, the Commission's use of 
Rule 102(e) has proven to be controversial,\15\ and until enactment of 
the Act, the Commission has never had express statutory authority to 
promulgate a rule establishing standards of conduct for attorneys 
representing issuers.\16\
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    \14\ See Touche Ross v. SEC, 609 F.2d 570 (2d Cir. 1979) (Rule 
2(e) was validly promulgated pursuant to the Commission's ``broad 
authority'' to adopt rules and regulations necessary to carry out 
the Commission's designated functions); Davy v. SEC, 792 F.2d 1418 
(9th Cir. 1986)(concluding that the Commission had statutory 
authority to adopt Rule 102(e)); Checkosky v. SEC, 23 F.3d 452, 456 
(D.C. Cir. 1994) (``'There can be little doubt that the Commission, 
like any other institution in which lawyers or other professionals 
participate, has authority to police the behavior of practitioners 
before it''') (Silberman, J., quoting Polydoroff v. ICC, 773 F.2d 
372, 374 (D.C. Cir. 1985)).
    \15\ Compare Norman S. Johnson & Ross A. Albert, ``Deja Vu All 
Over Again'': The Securities and Exchange Commission Once More 
Attempts to Regulate the Accounting Profession Through Rule 102(e) 
of its Rules of Practice, 1999 Utah L. Rev. 553, with Paul Gonson, 
The 1998 Amendment to SEC Rule 102(e) Will Withstand Judicial 
Scrutiny, 1999 Utah L. Rev. 609.
    \16\ In 1998, in response to the opinion from the U.S. Court of 
Appeals for the District of Columbia Circuit in Checkosky v. SEC, in 
which the Court criticized the Commission's interpretation of Rule 
102(e) to the extent it was applied to accountants, the Commission 
amended Rule 102(e) to clarify the Commission's standard for 
determining when accountants engage in ``improper professional 
conduct''. The Commission did not at that time amend the rule to 
address how it would apply the rule to misconduct by attorneys.
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    C. Prior Commission Consideration of an Attorney's Obligation to 
Report Corporate Misconduct to Management Even before enactment of the 
Act, the Commission had addressed the responsibility of attorneys 
appearing and practicing before the Commission to report to management 
evidence of misconduct of which they become aware during the course of 
their representation of a public company.
    In a 1981 decision, In the Matter of William R. Carter, Charles J. 
Johnson, Jr., 22 S.E.C. Docket No. 292, 1981 WL 384414, the Commission 
reversed an initial decision by a Commission Administrative Law Judge 
that concluded that two attorneys who failed to correct misstatements 
contained in a client's press releases and Commission filings 
concerning earnings had aided and abetted their client's violation of 
the federal securities laws. The Commission

[[Page 71672]]

concluded that existing ethical standards governing the conduct of 
attorneys did not unambiguously proscribe the behavior in question, and 
the Commission therefore did not sanction the attorneys. Nevertheless, 
the Commission announced that in the future it would interpret Rule 
102(e) to require an attorney who learns that a client is ``engaged in 
a substantial and continuing failure to satisfy'' disclosure 
requirements prescribed by the federal securities laws to ``take[] 
prompt steps to end the client's noncompliance'' in order to avoid 
violating professional standards. 1981 WL 384414 at *29-*31.\17\ The 
Commission indicated that the attorney can initially simply ``counsel[] 
accurate disclosure'' by the client. However, in the event the client 
does not cure the deficiency, the Commission stated that an attorney 
must take additional ``more affirmative steps'' including possibly a 
``direct approach to the board of directors or one or more individuals 
or officers'' or an attempt ``to enlist the aid of other members of the 
firm's management'' to correct the deficiency. Id. at *31. ``What is 
required, in short, is some prompt action that leads to the conclusion 
that the lawyer is engaged in efforts to correct the underlying 
problem, rather than having capitulated to the desires of a strong-
willed, but misguided client.'' Id. at *31.
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    \17\ The Commission specifically opined that ``[w]hen a lawyer 
with significant responsibilities in the effectuation of a company's 
compliance with the disclosure requirements of the federal 
securities laws becomes aware that his client is engaged in a 
substantial and continuing failure to satisfy those disclosure 
requirements, his continued participation violates professional 
standards unless he takes prompt steps to end the client's 
noncompliance.'' 1981 WL 384414 at *29.
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    The Commission announced in its decision in Carter and Johnson that 
it would solicit comments from the public regarding whether the newly 
articulated interpretation of ``unethical or improper professional 
conduct'' should be expanded or modified. Id. at *28. The release doing 
so stated that, based on the comments received, the Commission might or 
might not expand or modify its interpretation of the phrase ``unethical 
or improper professional conduct'' in Rule 102(e). ``Until that time, 
the present interpretation will govern all similar circumstances for 
purposes of proceedings pursuant to Rule [102](e) if the conduct 
occurred after February 28, 1981''--the date on which the Commission 
announced its interpretation in Carter and Johnson.\18\ The 
Commission's announcement in Carter and Johnson of the standard to be 
applied to similar cases in the future and its request for written 
comments engendered strong opposition from the private bar. The 
Commission, however, never amended the interpretation of ``unethical or 
improper professional conduct'' articulated in Carter and Johnson.\19\
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    \18\ Request for Comments on Standard of Conduct Constituting 
Unethical or Improper Professional Practice Before the Commission, 
1981 SEC LEXIS 730 at *3-*4 (Sept. 21, 1981).
    \19\ In a previous case, In the Matter of Keating, Muething & 
Klekamp, 1979 SEC LEXIS 1186 (July 2, 1979), the Commission 
instituted and settled a Rule 102(e) proceeding against a law firm 
which prepared Commission filings by a financial client. The 
Commission concluded that virtually every member of the firm knew 
that disclosures contained in the client's filings were inadequate 
and misleading, but that the internal procedures at the firm were 
inadequate to ensure that this information was properly evaluated in 
connection with the firm's preparation of Commission filings or 
reflected within the filings. The Commission specifically opined 
that ``[a] law firm has a duty to make sure that disclosure 
documents filed with the Commission include all material facts about 
a client of which it has knowledge as a result of its legal 
representation of that client.'' Id. at *27.
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    Subsequently, the Commission's then-General Counsel expressed 
concern in a speech regarding the Commission's lack of either ``the 
time or expertise'' to fashion a code of professional conduct for 
attorneys appearing and practicing before it.\20\ He further suggested 
that the Commission should focus its attention on bringing Rule 102(e) 
proceedings against attorneys when the alleged misconduct represents 
``a violation of established state law ethical or professional 
misconduct rules and has a direct impact on the Commission's internal 
processes,'' and indicated that the Commission generally should not 
institute Rule 102(e) proceedings against attorneys absent a judicial 
determination that the lawyer has violated the federal securities 
laws.\21\
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    \20\ See Edward F. Greene, Lawyer Disciplinary Proceedings 
before the Securities and Exchagne Commission, Remarks to the New 
York County Lawyers' Association, (Jan. 18, 1982), Fed. Sec. L. Rep. 
(CCH) ] 83,089.
    \21\ See Fed. Sec. L. Rep. (CCH) ] 83,089 (``When the attorney's 
alleged misconduct is predicated on theories of aiding and abetting 
liability, as it almost always is when the conduct involves the 
preparation and filing of documents, and the Commission is also 
proceeding against the principals in a simultaneous injunctive 
action, I believe that the wisest course for the Commission to 
follow is to add the attorney to the injunctive action as a co-
defendant. If that is not possible for unusual reasons, then an 
administrative proceeding under Rule [102(e)] could be commenced. 
And in those administrative proceedings based upon violations of 
standards of ethical or professional conduct, I believe that the 
Commission should use existing state law standards.'').
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    In 1988, the Commission issued a release announcing adoption of an 
amendment to Rule 102(e) to provide for public proceedings initiated 
under the rule. See Disciplinary Proceedings Involving Professionals 
Appearing or Practicing Before the Commission, 1988 SEC LEXIS 1365 
(July 7, 1988). The majority of the release discussed the basis for the 
Commission's conclusion that the benefit of conducting such proceedings 
in public outweighed the competing privacy concerns. The Commission 
noted in the release that it ``has generally utilized Rule [102(e)] 
proceedings against attorneys only where the attorney's conduct has 
already provided the basis for a judicial or administrative order 
finding a securities law violation in a non-rule [102(e)] proceeding'' 
and that it would continue to follow this policy. Id. at *22.
    Nevertheless, the Commission has continued to assess the actions of 
attorneys who learn of misconduct by public company clients outside of 
the context of Rule 102(e). In a subsequent case, In the Matter of 
George C. Kern, Jr., 50 S.E.C. 596, 1991 SEC LEXIS 1222 (June 21, 
1991), a Commission Administrative Law Judge concluded that an attorney 
serving both as outside counsel and as a director of a company caused 
his client to violate the Exchange Act by failing to amend his client's 
prior filing with the Commission to reflect more recent developments 
during the course of a tender offer. The ALJ nevertheless concluded 
that he lacked authority to enter an order directing future compliance 
pursuant to Section 15(c)(4) of the Exchange Act, and discontinued the 
proceedings. The Commission affirmed the order discontinuing 
proceedings.
    In another case, In the Matter of John H. Gutfreund, Thomas W. 
Strauss and John W. Meriwether, 51 S.E.C. 93 (Dec. 3, 1992), the 
Commission issued a report of investigation pursuant to its authority 
under Section 21(a) of the Exchange Act (15 U.S.C. 78u(a)) concerning 
the actions of the chief legal officer at a broker-dealer who was 
apprised of criminal wrongdoing by a corporate officer. While the chief 
legal officer was not named as a respondent, the Commission issued the 
report to emphasize its views on the supervisory responsibilities of 
legal and compliance officers who learn of misconduct by their employer 
or by a co-worker. The Commission concluded that such individuals are 
``obligated to take affirmative steps to ensure that appropriate action 
is taken to address the misconduct,'' including ``disclosure of the 
matter to the entity's board of directors, resignation from the firm, 
or disclosure to regulatory authorities.'' Id. at 113-114.\22\
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    \22\ In 1997, the Commission issued another report of 
investigation in a matter involving officers and directors of W.R. 
Grace Co. The Commission concluded that these individuals failed to 
take action to ensure full and prompt disclosure of substantial 
retirement benefits the company had agreed to pay to its former CEO 
in the company's annual report, a 10K filing, and a proxy statement. 
See Report of Investigation Pursuant to Section 21(a) of the 
Securities Exchange Act of 1934 Concerning the Conduct of Certain 
Former Officers and Directors of W.R. Grace & Co., 1997 SEC LEXIS 
2038 (Sep. 30, 1997). The Commission issued the report in order ``to 
emphasize the affirmative responsibilities of corporate officers and 
directors to ensure that the shareholders whom they serve receive 
accurate and complete disclosure of information required by the 
proxy solicitation and periodic reporting provisions of the federal 
securities laws.'' 1997 SEC LEXIS 2038, *3. Although none of the 
officers and directors named in the matter were attorneys, the 
report emphasizes the affirmative duty of an issuer's management to 
correct misconduct and make full disclosure of relevant matters to 
investors. See also cases discussed infra in n.31 and accompanying 
text.

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[[Page 71673]]

    In sum, while the Commission has opined on a case-by-case basis 
that lawyers appearing and practicing before the Commission have an 
obligation to report corporate misconduct to appropriate officers and 
directors, it has not adopted comprehensive standards directing 
attorneys to report instances of misconduct.

III. Section 307 of the Sarbanes-Oxley Act

    In the wake of sensational revelations concerning Enron and other 
public companies, a group of legal academics forwarded a letter to 
Chairman Pitt urging the Commission to impose an ``up the ladder'' 
reporting requirement on attorneys that would oblige attorneys who 
learn of misconduct at public companies to report this information to 
the management of the company.\23\ In a March 28, 2002 response, the 
Commission's then-General Counsel did not take issue with the 
academics' proposals but noted that there are good reasons why ``a 
significant change in established practice should be undertaken in the 
context of Congressional legislation, as opposed to agency 
rulemaking.''\24\ Senator John Edwards, the sponsor of Section 307, 
learned of this exchange of letters and concluded that it was time for 
Congress to act to provide a context of Congressional legislation for 
Commission rules imposing an ``up the ladder'' reporting requirement on 
attorneys representing public companies.\25\
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    \23\ See March 7, 2002 letter to Chairman Pitt from Richard 
Painter, et al., at http://www.abanet.org/buslaw/corporateresponsibility/responsibility_relatedmat.html.
    \24\ See March 28 letter from David Becker to Painter, et al., 
at http://www/abanet.org/buslaw/corporateresponsibility/
responsibility--relatedmat.html.
    \25\ See 148 Cong. Rec. S6524-02, S6551-6552 (July 10, 2002).
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    Section 307 of the Act requires the Commission to promulgate 
minimum ethical standards for attorneys representing issuers, including 
an ``up the ladder'' reporting requirement on attorneys as originally 
proposed by the Commission in Carter and Johnson \26\ as a means of 
addressing the same types of concerns regarding attorney behavior and 
shareholder protection as were described in the Cheek Report. The 
provision directs the Commission to issue rules applicable to all 
attorneys appearing and practicing before the Commission in the 
representation of issuers that require attorneys initially to report 
evidence of a material violation to appropriate officers within the 
issuer and, thereafter, to the highest authority within the issuer if 
the initial report does not result in an appropriate response.\27\
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    \26\ See 148 Cong. Rec. S6552 (July 10, 2002).
    \27\ Although legislative history for Section 307 is limited, 
comments made by its sponsors in speeches delivered on the Senate 
floor suggest that the sponsors' immediate goal was to impose an 
``up the ladder'' reporting system upon lawyers representing 
issuers. See remarks by Senator John Edwards, 148 Cong. Rec. S6552 
(July 10, 2002) (``This amendment is about making sure those 
lawyers, in addition to the accountants and executives in the 
company, don't violate the law and, in fact, more importantly, 
ensure that the law is being followed. * * * If you find out that 
the managers are breaking the law, you must tell them to stop. If 
they won't stop, you go to the board of directors, which represents 
the shareholders, and tell them what is going on. If they won't act 
responsibly and in compliance with the law, then you go to the board 
and say something has to be done; there is a violation of the law 
occurring. It is basically going up the ladder, up the chain of 
command. * * * This amendment acts in a very simple way. It 
basically instructs the SEC to start doing exactly what they were 
doing 20 years ago, to start enforcing this up-the-ladder 
principle.''). See also id. at S6555 (comments by Senator Enzi) 
(``When their counsel and advice is sought, attorneys should have an 
explicit, not just an implied, duty to advise the primary officer 
and then, if necessary, the auditing committee or the board of 
directors of any serious legal violation of the law by a corporate 
agent. Currently, there is no explicit mandate requiring this kind 
of conduct. It is clearly in the best interest of their client to 
disclose this type of information'') and S6556 (comments by Senator 
Corzine) (``The bottom line is this. Lawyers can and should play an 
important role in preventing and addressing corporate fraud. Our 
amendment seeks to ensure that. It seeks to go back to the old way: 
when lawyers know of illegal actions by a corporate agent, they 
should be required to report the violation to the corporation.'').
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IV. Proposed Part 205

A. General Overview

    Proposed Part 205 responds to Congress' mandate that the Commission 
adopt an effective ``up the ladder'' reporting system, and evidences 
the Commission's intention to implement a robust system in this regard. 
As set forth in greater detail in the discussion below, the proposed 
rule would adopt an expansive view of who is appearing and practicing 
before the Commission. This approach recognizes that attorneys interact 
with the Commission on behalf of issuer clients in a number of ways, 
and protects investors by reaching attorney conduct that may threaten 
the Commission's processes and harm shareholders.
    In addition to a rigorous ``up the ladder'' reporting requirement, 
the proposed rule incorporates several corollary provisions that are 
not explicitly required by Section 307, but which the Commission 
believes are important components of an effective ``up the ladder'' 
reporting system. Under certain circumstances, these provisions permit 
or require attorneys to effect a so-called ``noisy withdrawal'' and to 
notify the Commission that they have done so and permit attorneys to 
report evidence of material violations to the Commission. These 
provisions embody ethical principles that legal commentators and the 
ABA have been considering for years,\28\ and are similar in important 
respects to ethical rules that have already been enacted in a number of 
jurisdictions. At the same time, the proposed rule does not attempt to 
articulate a comprehensive set of standards regulating all aspects of 
the conduct of attorneys who appear and practice before the Commission. 
The Commission does not intend to supplant state ethics laws 
unnecessarily, particularly in areas (e.g., safeguarding of client 
assets, escrow procedures, advertising) where the Commission lacks 
expertise. The Commission believes that the proposed rule will deter 
instances of attorney and issuer misconduct and where misconduct has 
occurred, minimize its impact upon issuers and their shareholders.
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    \28\ Indeed, the ABA's ongoing evaluation of the Cheek Report 
focuses, in large measure, upon a provision which would impose a 
reporting obligation comparable to that in proposed Part 205. Cheek 
Report at 27-30.
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    At the same time, the Commission does not want the rule to impair 
zealous advocacy, which is essential to the Commission's processes. The 
Commission also does not want the rule to discourage issuers from 
seeking and obtaining effective and creative legal advice. Finally, the 
Commission is cognizant of the ongoing efforts by the ABA and other 
organizations to address many of the same issues that are covered by 
the rule, and will continue to monitor those efforts and review the 
content and operation of the rule, particularly insofar as any measure 
adopted by the ABA or some other organization or entity extends beyond 
the scope of Section 307.

[[Page 71674]]

B. Summary of Part 205

    Section 205.3(b) of proposed Part 205 prescribes the duty of an 
attorney who appears or practices before the Commission in the 
representation of an issuer to report evidence of a ``material 
violation.'' The rule's reporting obligation is triggered only when an 
attorney becomes aware of information that would lead a reasonable 
attorney to believe a material violation has occurred, is occurring, or 
is about to occur, thus limiting the instances in which the reporting 
duty prescribed by the rule will arise to those where it is appropriate 
to protect investors. The attorney is initially directed to make this 
report to the issuer's chief legal officer (``CLO''), or to the 
issuer's CLO and chief executive officer (``CEO''). Absent exigent 
circumstances, the attorney is also obligated to take reasonable steps 
to document his or her reports, as well as any response received from 
the CLO or CEO and retain the documentation for a reasonable time. 
Keeping such documentation will protect the attorney in the event his 
or her compliance with the proposed rule is put in issue in some future 
proceeding.
    When presented with a report of a possible material violation, the 
rule obligates the issuer's CLO to conduct a reasonable inquiry to 
determine whether the reported material 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 and/or 
sanctions, including appropriate disclosures. Furthermore, the CLO is 
required to report ``up the ladder'' within the issuer what remedial 
measures have been adopted or sanctions imposed and to advise the 
reporting attorney of his or her conclusions.
    A reporting attorney who receives an appropriate response within a 
reasonable time and has taken reasonable steps to document his or her 
report and the response to it has satisfied his or her obligations 
under the rule. In the event a reporting attorney does not receive an 
appropriate response within a reasonable time, he or she must report 
the evidence of a material violation to the issuer's audit committee, 
or (if the issuer does not have an audit committee) to another 
committee of independent directors, or (if the issuer does not have 
another committee of independent directors) to the full board. If the 
attorney reasonably believes that it would be futile to report evidence 
of a material violation to the CLO and CEO, the attorney may report 
directly to the issuer's audit committee, or (if the issuer does not 
have an audit committee) to another committee of independent directors, 
or (if the issuer does not have another committee of independent 
directors) to the full board. A reporting attorney who has reported a 
matter all the way ``up the ladder'' within the issuer and who 
reasonably believes that the issuer has not responded appropriately 
must take reasonable steps to document the response, or absence 
thereof.
    The proposed rule would also provide an alternative system for 
reporting evidence of material violations. See Section 205.3(c). 
Issuers may, but are not required to, establish a qualified legal 
compliance committee (``QLCC'') composed of at least one member of the 
issuer's audit committee, and two or more independent members of the 
issuer's board for the purpose of investigating reports of material 
violations made by attorneys. A QLCC must have the authority and the 
responsibility to conduct any necessary inquiry into the reported 
evidence, to require the issuer to adopt appropriate remedial measures 
to prevent an ongoing, or alleviate a past, material violation, and to 
notify the Commission of the material violation and disaffirm any 
tainted document submitted to the Commission. The QLCC would be 
required to notify the board, the CLO, and the CEO of the results of 
any inquiry and the remedial measures the QLCC decided were 
appropriate. In the event the issuer fails to take remedial measures as 
directed by the QLCC, each member of the QLCC, the CLO, and the CEO 
would each be individually responsible for notifying the Commission of 
the material violation and for disaffirming any tainted submission to 
the Commission. An attorney would satisfy his reporting obligation 
under the rule by reporting evidence of a material violation to a QLCC. 
Additionally, a CLO who receives a report of a material violation may 
refer the report to a QLCC in lieu of conducting his or her own 
inquiry.
    Paragraph 205.3(d) discusses the obligations of an attorney who has 
not received an appropriate response from the issuer. The provision 
distinguishes between outside attorneys retained by the issuer and 
attorneys employed by the issuer. Outside attorneys who have made a 
report and have not received an appropriate response and who reasonably 
believe that the reported material violation is ongoing or is about to 
occur and is likely to result in substantial injury to the financial 
interest of the issuer or of investors are required to withdraw from 
the representation, notify the Commission of their withdrawal, and 
disaffirm any submission to the Commission that they have participated 
in preparing which is tainted by the violation. In-house attorneys 
employed by an issuer who reasonably believe that the reported 
violation is ongoing or is about to occur and is likely to result in 
substantial injury to the financial interest of the issuer or of 
investors are required to disaffirm any tainted submission they have 
participated in preparing, but are not required to resign. In the event 
an attorney reasonably believes that a material violation has already 
occurred and has no ongoing effect, the attorney is permitted, but not 
required, to take these steps, so long as 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 of 
investors. Finally, an attorney formerly employed or retained by an 
issuer who reasonably believes that he or she has been discharged 
because he or she fulfilled the reporting obligation imposed by the 
rule may, but is not required to, notify the Commission of his or her 
belief that he or she was discharged for reporting evidence of a 
material violation and also disaffirm in writing any submission to the 
Commission that he or she participated in preparing which is tainted by 
the violation. A notification to the Commission under this section does 
not breach the attorney-client privilege.
    Paragraph 205.3(e) sets forth the specific circumstances under 
which an attorney is authorized to disclose confidential information 
related to his or her appearance and practice before the Commission in 
the representation of an issuer. Pursuant to this provision, an 
attorney may use the documentation he or she has prepared under the 
rule to defend against charges of attorney misconduct. Paragraph 
205.3(e)(2) also allows an attorney to reveal confidential information 
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 Commission or in substantial injury to 
the financial or property interests of the issuer or investors. 
Similarly, the attorney may disclose confidential information to 
rectify an issuer's illegal actions when such actions have been 
advanced by the issuer's use of the attorney's services.

[[Page 71675]]

    Sections 205.4 and 205.5 detail the respective responsibilities of 
supervisory and subordinate attorneys, both those employed in-house by 
the issuer and those serving as outside counsel retained by the issuer. 
Collectively, these provisions broadly define who is serving as a 
supervisory attorney, specifically providing that an individual serving 
as the CLO of an issuer (or who serves in an equivalent role) is a 
supervisory attorney under the rule. The provision also places the 
responsibility for compliance with the rule's reporting requirements 
and documentation obligations upon the supervisory attorney after he or 
she has been informed of evidence of a material violation by a 
subordinate. Subordinate attorneys are not exempt from the rule, though 
they will have complied with it where they report evidence of material 
violations they learn about to their supervisory attorney. In addition, 
a subordinate attorney who has reported evidence of a material 
violation to a supervisory attorney, and who believes that the 
supervisory attorney has failed to comply with the reporting 
requirement under the rule is permitted, but not obligated, to report 
the evidence ``up the ladder'' within the issuer.
    Section 205.6 describes the manner in which violations of the rule 
will be addressed by the Commission. Violation of the proposed rule 
will subject the violator to all the remedies and sanctions available 
under the Exchange Act, including injunctions, and cease and desist 
orders. An attorney who violates a provision of Part 205 will have 
engaged in improper professional conduct and may also be subject to 
administrative disciplinary proceedings that can result in a censure, 
or a suspension or bar from practicing before the agency. Paragraph 
205.6(b) incorporates the same state of mind requirements that were 
adopted for accountants by the Commission in the 1998 amendment to Rule 
102(e). Specifically, an attorney is subject to discipline for (1) 
intentional, including reckless, violations of the Part, and (2) 
negligent conduct in the form of a single instance of highly 
unreasonable conduct that results in a violation, or repeated instances 
of unreasonable conduct resulting in a violation of the Part. The rule 
provides that the Commission may impose discipline and sanction an 
attorney who violates the rule, even when the attorney is subject to 
discipline in the state where he or she practices or is admitted.

V. Section-by-Section Discussion of the Proposed Rule and Request for 
Comments

    The proposing release invites interested persons to submit comments 
on a large number of specific issues. However, the Commission invites 
any interested person to submit comments on any aspect of the proposed 
rule, whether or not comments have been specifically solicited.

Section 205.1 Purpose and Scope

    Section 307 of the Act expressly directs the Commission to adopt a 
rule imposing a reporting requirement upon attorneys ``appearing and 
practicing before the Commission in any way in the representation of 
issuers''. Section 307 mandates that the Commission ``shall issue rules 
* * * setting forth minimum standards of professional conduct * * * 
including a rule'' imposing an ``up the ladder'' reporting requirement. 
At the very least, this language directs the Commission to issue a rule 
requiring attorneys to report material misconduct within an issuer. The 
Commission may at some future date supplement or amend this rule to 
expand its scope and address additional ethical issues that are 
relevant to practice before the Commission.\29\ Interested persons are 
invited to comment on whether the Commission should promulgate 
additional rules, the issues those rules should address, how, in what 
form, and why.
---------------------------------------------------------------------------

    \29\ The Commission does not propose to create an ``SEC Bar'' 
with admission requirements, of which attorneys must be members to 
appear or practice before the Commission. See 5 U.S.C. 500(b) 
(prohibiting agencies from enacting their own supplemental admission 
requirements for duly admitted members of a state bar). However, the 
Commission ``like any other institution in which lawyers or other 
professionals participate, has authority to police the behavior of 
practitioners appearing before it.'' Polydoroff v. ICC, 773 F.2d 
372, 374 (D.C. Cir. 1985). This authority is confirmed, of course, 
in the new Section 4C of the Exchange Act and Section 307 of the 
Sarbanes-Oxley Act.
---------------------------------------------------------------------------

Section 205.2 Definitions

    Proposed Part 205 includes a section defining a number of terms 
that appear in the statute and are used throughout the rule. Section 
307 of the Act does not define any of its terms. The Act itself defines 
the term ``issuer,'' and that definition is incorporated into the rule. 
For several of the terms in the rule, the Commission has adopted the 
definitions contained in the ABA's Model Rules of Professional Conduct 
or a variation thereof. For others, the Commission has relied upon 
statutory definitions or adopted definitions from other sources, 
including the Restatement (Third) of the Law Governing Lawyers.
    For those terms in Section 307 that are included in the proposed 
rule but not specifically defined in the proposed rule (e.g., ``in any 
way'' and ``similar violations''), the Commission's intention is that 
their meaning shall be determined or interpreted according to 
Commission decisions. Interested persons are invited to comment on 
whether the Commission should leave these or other terms undefined in 
the rule or, alternatively, to propose definitions for these or other 
terms.

    (a) Appearing and practicing before the Commission includes, but 
is not limited to, an attorney's:
    (1) Transacting any business with the Commission, including 
communication with Commissioners, the Commission, or its staff;
    (2) Representing any party to, or the subject of, or a witness 
in a Commission administrative proceeding;
    (3) Representing any person in connection with any Commission 
investigation, inquiry, information request, or subpoena;
    (4) Preparing, or participating in the process of preparing, any 
statement, opinion, or other writing which the attorney has reason 
to believe will be filed with or incorporated into any registration 
statement, notification, application, report, communication or other 
document filed with or submitted to the Commissioners, the 
Commission, or its staff; or
    (5) Advising any party that:
    (i) A statement, opinion, or other writing need not or should 
not be filed with or incorporated into any registration statement, 
notification, application, report, communication or other document 
filed with or submitted to the Commissioners, the Commission, or its 
staff; or
    (ii) The party is not obligated to submit or file a registration 
statement, notification, application, report, communication or other 
document with the Commission or its staff.

    The definition of the term ``appearing and practicing before'' the 
Commission is based upon Rule 102(f).\30\ The wording of that 
definition has been modified to clarify and confirm that (as under 
existing Rule 102(f)) the term includes, among other things, 
representation of an issuer during the course of an investigation or 
inquiry conducted by the Commission and that an attorney appears and 
practices before the Commission if he or she advises an issuer either 
(1) that a statement, opinion, or other writing does not need to be 
filed with or incorporated into any type of submission to the 
Commission or its staff, or (2) that the issuer is not required to 
submit or file any registration statement, notification, application, 
report, communication or

[[Page 71676]]

other document with the Commission or its staff.
---------------------------------------------------------------------------

    \30\ The definition prescribed in Rule 102(f) is unaffected by 
the proposed rule.
---------------------------------------------------------------------------

    Moreover, the definition of the term has also been drafted to make 
clear that it covers all communications (oral or written) with the 
Commission or its staff on behalf of an issuer, as well as conduct 
involving the preparation of any statement, opinion, or other writing 
which is submitted to Commissioners, the Commission, or its staff which 
is incorporated into materials submitted to the Commission--or 
participation in the process of preparing such a statement, opinion, or 
other writing. Participation in that process covers both adding and 
excluding information or a particular characterization of information. 
The definition also makes clear that an attorney who advises an issuer 
not to make a filing or submission to the Commission is also appearing 
and practicing before the Commission.
    This broad definition is consistent with the position the 
Commission has taken as amicus curiae in cases involving liability 
under Section 10(b) of the Exchange Act (15 U.S.C. 78j(b)) in which the 
Commission has argued that attorneys should be held responsible for 
materials which they have drafted, or participated in drafting, that 
they knew would be included in a document to be filed with the 
Commission but which have been submitted without attribution or under 
another individual's signature.\31\ The modification also reflects the 
reality that materials filed with the Commission frequently contain 
information contributed, edited or prepared by individuals who are not 
necessarily responsible for the actual filing of the materials.
---------------------------------------------------------------------------

    \31\ The Commission has taken this position in several important 
recent cases, including Newby, et al. v. Enron Corp. (C.A. HO-13624) 
(S.D. Tex) (an ongoing private class action suit in which the 
Commission has submitted briefs as an amicus curiae) and Klein v. 
Boyd, 1998 U.S. App. LEXIS 2004 (3rd Cir. Feb. 12, 1998), vacated 
and reh'g, en banc, granted, 1998 U.S. App. LEXIS 4121 (3rd Cir. 
Mar. 9, 1998).
---------------------------------------------------------------------------

    An attorney ordinarily does not appear and practice before the 
Commission if his or her representation of an issuer involves no 
business or communication with the Commission, no participation in any 
way in a Commission process, and no assistance in the preparation of at 
least a portion of a document filed with or submitted to the 
Commission. The conduct of attorneys in practice specialties other than 
securities law will be covered by the proposed rule where their 
representation of an issuer involves contact with the Commission or 
where they have reason to believe they are assisting in the preparation 
of a document transmitted to the Commission, or where they supervise an 
attorney who does appear and practice before the Commission.
    The proposed definition of ``appearing and practicing'' is broad 
enough to include attorneys who do not serve in the legal department of 
an issuer or do not act in their capacities as attorneys, but who 
either transact business with the Commission or assist in the 
preparation of documents filed with or submitted to the Commission.
    Interested persons are invited to comment on any aspect of this 
definition, including its appropriate scope and whether the Commission 
should exclude any persons from the definition of ``appearing and 
practicing'' (e.g., in-house corporate attorneys working outside of a 
legal department who assist in preparing a document to be filed with 
the Commission). Interested persons are specifically invited to comment 
on whether, and how, the definition of ``appearing and practicing'' 
will impact upon attorneys representing issuers during the course of 
Commission investigations, inquiries, administrative proceedings or 
civil litigation, and whether and how the definition should be modified 
in those contexts. Does the definition need to be modified to make 
clear that an attorney defending an issuer in a civil injunctive action 
by the Commission in a district court is not appearing and practicing 
before the Commission, because the issuer is not transacting business 
with the Commission, even though the defense attorney is in contact 
with the Commission's staff who are representing the Commission in that 
litigation? In the event an attorney representing an issuer in an 
administrative proceeding fails to receive an appropriate response to 
evidence of a material violation that the attorney has reported, should 
the attorney's response be governed by the proposed rule or by the 
Commission's Rules of Practice? Why? Comment is also particularly 
invited on the breadth of ``participating in the process of preparing'' 
in paragraph (a)(4) and whether the ``has reason to believe'' standard 
in that paragraph is too high or too low (e.g., whether an attorney 
must have actual knowledge or give express consent for a document to be 
sent to the Commission in order to be appearing and practicing before 
the Commission).
    The concept of ``appearing and practicing'' also raises issues 
regarding foreign attorneys employed or retained by foreign issuers. 
Such attorneys may, for example, be involved in the preparation of 
documents for use in a foreign jurisdiction that might subsequently be 
used as the basis for other documents prepared by others for filing 
with the Commission, with or without the knowledge of the foreign 
attorneys who prepared the original documents. Interested persons are 
invited to comment on whether such foreign attorneys are ``appearing 
and practicing'' before the Commission; if not, how the proposed 
definition might be modified to make that clear; whether an express 
exclusion for such foreign attorneys is necessary and, if so, how it 
might be crafted.

    (b) Appropriate response means a response to evidence of a 
material violation reported to appropriate officers or directors of 
an issuer that provides a basis for an attorney reasonably to 
believe:
    (1) That no material violation, as defined in paragraph (i) of 
this section, is occurring, has occurred, or is about to occur; or
    (2) That the issuer has, as necessary, adopted remedial 
measures, including appropriate disclosures, and/or imposed 
sanctions that can be expected to stop any material violation that 
is occurring, prevent any material violation that has yet to occur, 
and/or rectify any material violation that has already occurred.

    The definition of the term ``appropriate response'' emphasizes that 
the actions of attorneys in evaluating possible instances of material 
violations and the appropriateness of the response made by an issuer 
apprised of possible instances of material violations will be evaluated 
against an objective reasonableness standard. The Commission's intent 
is to permit attorneys to exercise their judgment as to whether a 
response to a report is appropriate, so long as their determination of 
what is an ``appropriate response'' is objectively reasonable.
    For example, if an issuer responds to an attorney's report 
regarding the legality of a particular transaction by informing the 
attorney that a reputable law firm has reviewed the transaction and 
concluded that there has been no violation, and if the issuer provides 
a copy of the opinion to the attorney, the attorney could reasonably 
believe that the issuer's response was appropriate so long as the 
opinion satisfactorily addresses all of the reporting attorney's 
reasonable legal and factual concerns and is otherwise reasonable. 
Similarly, if an issuer responds to an attorney's report concerning 
another employee's potentially illegal conduct by, for example, 
disciplining or terminating the employee, and remedying any impact of 
the employee's misconduct, the attorney could reasonably believe that 
the issuer's response was appropriate. If, however, the issuer responds 
to the attorney's report by peremptorily

[[Page 71677]]

informing the attorney that the reported matter is not cause for 
concern, and fails to provide any factual or legal basis for the 
reporting attorney to conclude there was no violation, such a response 
may not reasonably be viewed as appropriate by the attorney.
    An appropriate response where there has been a disclosure violation 
would include disclosure of the material information or the correction 
of any material misstatement. Further, it could include an express 
directive forbidding the unlawful conduct at issue or, if it has 
already commenced, ordering that it cease at once. The definition also 
clarifies that past instances of misconduct may not need to be reported 
further where that misconduct has been addressed, for example, through 
the imposition of sanctions or other means. A past instance of 
misconduct that nevertheless may have an ongoing impact (e.g., a 
misstatement contained in a prior Commission filing that investors may 
continue to rely upon) will need to be rectified.
    Interested persons are invited to comment on any aspect of what is 
an appropriate response. Should an attorney's reasonable belief 
determine whether a response is appropriate? What circumstances would 
permit an attorney reasonably to believe either that no violation has 
occurred or that any violation has been rectified? Is there a better 
objective test to measure whether a response is appropriate and, if so, 
what is it?

    (c) Attorney refers to any person who is admitted, licensed, or 
otherwise qualified to practice law in any jurisdiction, domestic or 
foreign, or who holds himself or herself out as admitted, licensed, 
or otherwise qualified to practice law.

    The term ``attorney'' is defined broadly so that the proposed rule 
applies equally to lawyers employed in-house by an issuer and attorneys 
retained to perform legal work on behalf of an issuer, and covers 
persons who hold themselves out as attorneys, even if they are not in 
fact admitted, licensed, or otherwise qualified to practice law. 
Interested persons are invited to comment on the impact this definition 
will have upon attorneys in particular positions, or performing 
particular functions, and to identify situations in which the 
definition may reach too broadly. In particular, the Commission 
requests comment on whether the definition should require, with respect 
to in-house counsel, that the attorney actually provide legal services 
to the issuer such that an attorney-client relationship exists, so as 
to exclude attorneys employed by issuers in non-legal capacities, even 
if they prepare portions of documents submitted to or filed with the 
Commission.
    The proposed definition of ``attorney'' also covers lawyers 
licensed in foreign jurisdictions, whether or not they are also 
admitted to practice in the United States. Under the proposed 
definition, foreign attorneys who prepare filings or other materials 
that are submitted to the Commission would be covered by the rule to 
the extent they are appearing and practicing before the Commission 
within the meaning of the rule. Potential difficulties related to 
applying the term ``appearing and practicing'' to foreign attorneys 
have been discussed above. The Commission also recognizes that 
significant issues would be raised by application of the proposed rule 
to foreign attorneys, or attorneys representing or employed by 
multijurisdictional firms, who may be subject to statutes, rules, and 
ethical standards in these foreign jurisdictions that are different 
from, and potentially incompatible with, the requirements of this rule. 
As noted above, over 1,300 foreign private issuers from 59 countries 
are registered and reporting with the Commission. These foreign 
companies are represented by a wide-range of legal counsel. While U.S. 
lawyers at U.S. law firms often play the principal role in the 
preparation of disclosure documents filed with the Commission by 
foreign companies, foreign lawyers can also undertake significant roles 
in these filings. For example, foreign counsel is often called upon to 
file a legal or tax opinion as an exhibit to a registration statement 
filed by a foreign company. In addition, a number of non-U.S.-based law 
firms (principally firms based in the United Kingdom) have established 
significant legal practices under the U.S. federal securities laws, and 
may be the sole law firms representing a particular issuer before the 
Commission. Generally, such firms have attorneys who are licensed in 
the United States. Likewise, many U.S. law firms have expanded globally 
and now employ as partners, counsel and associates lawyers who are 
admitted to practice solely in jurisdictions outside the United States. 
These non-U.S. lawyers may play significant roles in connection with 
Commission filings by both foreign and U.S. issuers. Further, some non-
U.S. registrants have employed U.S. or non-U.S. lawyers to serve as 
their in-house counsel with respect to federal securities law 
questions.
    As proposed, Part 205 would cover lawyers who are licensed in 
foreign jurisdictions, although only to the extent they ``appear and 
practice'' before the Commission in the representation of issuers. The 
Commission recognizes that the application of Part 205 to foreign law 
firms, multijurisdictional law firms and foreign lawyers raises 
significant and difficult issues. Because of these issues, the 
Commission seeks comment on the application of Part 205 to these 
entities. In particular:
    Are there statutes, rules and ethical standards in foreign 
jurisdictions that govern the conduct of foreign attorneys that are 
different from, and potentially incompatible with, the requirements of 
Part 205 and, if so, what foreign authority conflicts with what 
specific provisions of Part 205?
    Are there provisions in Part 205 that could not be given effect (or 
would be nullified) under statutes, rules, or ethical standards in some 
foreign jurisdictions? If so, which provisions are affected, and how 
would this situation affect implementation of Part 205?
    How would the ``up the ladder'' rule apply to in-house and retained 
attorneys in jurisdictions where issuers use different internal 
corporate structures not contemplated by Part 205?
    What difficulties are likely to arise in applying the QLCC 
alternative to foreign issuers, and how, specifically, could the QLCC 
alternative be adapted to foreign private issuers?
    What are the difficulties in applying Part 205 to law firms that 
operate in multiple jurisdictions or that have partners, counsel and 
associates who are admitted to practice law in a foreign jurisdiction 
but not admitted to practice law in the United States and who 
participate in the preparation of documents filed with the Commission 
(or documents that form the basis for documents filed with the 
Commission)? Are there different considerations in the application of 
Part 205 in this circumstance depending on whether the law firm in 
question is principally based in the United States or outside the 
United States?
    What are the difficulties in applying Part 205 to an issuer's in-
house attorneys who are admitted to practice law in a foreign 
jurisdiction but are not admitted to practice law in the United States 
and who participate in the preparation of documents filed with the 
Commission (or documents that form the basis for documents filed with 
the Commission)? Are there different considerations in the application 
of Part 205 in this circumstance whether the issuer is incorporated in 
the United States or in a foreign jurisdiction? Any such special 
difficulties and considerations should be discussed with specificity.
    Are there mechanisms that satisfy the objectives of Part 205 that 
would apply

[[Page 71678]]

the rule to a narrower category of foreign-licensed attorneys--for 
example, by employing a variation of the proposed definitions of 
supervisory and subordinate attorneys or by identifying attorneys in 
the United States who would have responsibility for compliance with 
U.S. securities laws? How, specifically, would such mechanisms work?
    With respect to disciplinary proceedings, do foreign jurisdictions 
maintain procedures for disciplining attorneys for violations of 
statutes, rules or standards relating to ethical conduct and, if so, 
how do these procedures operate? Is a Commission proceeding against an 
attorney that violated Part 205 reconcilable with a disciplinary 
proceeding in the home jurisdiction?
    Should foreign attorneys be exempted in whole or in part from the 
application of Part 205, and if so, why? Are there protections under 
foreign statutes, rules and standards relating to ethical conduct that 
serve as an adequate substitute for the various provisions of Part 205? 
Should the Commission establish a process under which foreign attorneys 
may apply for exemptions on a case-by-case basis, and if so, what 
should this process be (for example, the submission of a legal opinion 
as to the incompatibility of some or all of Part 205 with foreign 
statutes, rules and standards, and whether those statutes, rules and 
standards serve as an adequate substitute for the various provisions of 
Part 205)?

    (d) Breach of fiduciary duty refers to any breach of fiduciary 
duty recognized at common law, including, but not limited to, 
misfeasance, nonfeasance, abdication of duty, abuse of trust, and 
approval of unlawful transactions.

    This definition is intended to identify typical common-law breaches 
of fiduciary duty. It is not intended to change the law.
    Interested persons are invited to comment on any aspect of the 
definition of ``breach of fiduciary duty,'' including whether the 
examples given should be expanded or narrowed, and, if so, how.

    (e) Evidence of a material violation means information that 
would lead an attorney reasonably to believe that a material 
violation has occurred, is occurring, or is about to occur.

    This objective standard is intended to preclude reports based on 
mere suspicion of a material violation while providing reasonable 
flexibility to attorneys when evaluating their reporting obligations 
under the proposed rule. An individual attorney is not excused from 
reporting evidence of a material violation on the grounds that he or 
she does not personally believe that a material violation has occurred, 
is occurring, or is about to occur. Under the definition of 
``reasonably believes'' in paragraph (l) of Section 205.2, any 
information that would lead an attorney, acting reasonably, to believe 
that a material violation has occurred, is occurring, or is about to 
occur must be reported--whether or not the reporting attorney 
subjectively believes it. An individual attorney is not, however, 
required to report within the issuer evidence of a material violation 
that the attorney thinks is insufficient to lead an attorney, acting 
reasonably, to believe that a material violation has occurred, is 
occurring, or is about to occur. The definition does not prescribe a 
process by which an attorney must evaluate evidence he or she learns 
about.
    Interested persons are invited to comment on any aspect of the 
definition of ``evidence of a material violation.'' Should a different 
standard be adopted than that proposed by the Commission and, if so, 
what should that different standard be? Should the test be subjective 
rather than objective? Where along the spectrum from actual knowledge 
to mere suspicion should the line be drawn? Is the correct measure 
``beyond a reasonable doubt,'' ``knows or should know,'' ``substantial 
credible information,'' a ``prima facie case,'' ``more likely than 
not,'' ``at least as likely as not,'' ``reason to believe,'' ``some 
credible information,'' ``a mere scintilla of information sufficient to 
raise suspicion,'' or another test and, if so, what? If reasonable 
belief is the appropriate standard, what should be reasonably believed: 
that a material violation has occurred, is occurring, or is about to 
occur or that a material violation may have occurred, may be occurring, 
or may be about to occur, or something else? Should the definition be 
revised to make clearer that the standard is objective rather than 
subjective and, if so, how?

    (f) In the representation of an issuer 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.

    The proposed rule includes a broad definition of what constitutes 
``in the representation of an issuer.'' A broad definition is essential 
to protect investors. Accordingly, the term is defined to cover 
attorneys providing any legal services at the request of, or for the 
benefit of, an issuer.
    For example, an attorney employed or retained by a non-public 
subsidiary of a public parent issuer is appearing and practicing before 
the Commission in the representation of an issuer when the subsidiary 
is covered by an umbrella representation agreement or understanding, 
whether explicit or implicit, under which the attorney represents the 
parent company and its subsidiaries, and can invoke privilege claims 
with respect to all communications involving the parent and its 
subsidiaries. Similarly, an attorney at a non-public subsidiary appears 
and practices before the Commission in the representation of an issuer 
when he or she is assigned work by the parent (e.g., preparation of a 
portion of a disclosure document) which will be consolidated into 
material submitted to the Commission by the parent, or if he or she is 
performing work at the direction of the parent and discovers evidence 
of misconduct which is material to the parent. The definition of the 
term is also intended to reflect the duty of an attorney retained by an 
issuer to report to the issuer evidence of misconduct by an agent of 
the issuer (e.g., an underwriter) if the misconduct would have a 
material impact upon the issuer.
    An attorney employed by a privately-held investment adviser who 
prepares, or assists in preparing, materials that the attorney has 
reason to believe will be submitted to or filed with the Commission by 
or on behalf of a registered investment company, or will be 
incorporated into any document filed with or submitted to the 
Commission, is appearing and practicing before the Commission. Such an 
attorney, though employed by a privately-held investment adviser, is 
representing the investment company before the Commission. Where such 
an attorney discovers evidence of a material violation by an officer of 
the investment adviser that is related to the investment company, the 
attorney is obliged to report that evidence to the CLO of the 
investment company under 205.3(b). The investment adviser is an agent 
of the investment company and owes the investment company a fiduciary 
duty under common law and under Section 36 of the Investment Company 
Act of 1940.\32\ Section 307 of the Act requires an attorney to report 
evidence of a material violation by any agent of an issuer to the 
issuer's CLO or CEO.
---------------------------------------------------------------------------

    \32\ 15 U.S.C. 80a-35.
---------------------------------------------------------------------------

    This reporting obligation does no violence to the attorney-client 
privilege. Because the attorney is providing legal services for the 
registered investment company, the attorney is reporting to his or her 
client evidence of a material violation that is related to his or her

[[Page 71679]]

representation of the client.\33\ In effect, an attorney employed by 
the investment adviser and representing the investment company before 
the Commission has joint clients. Fairness and candor between co-
clients regarding matters of common interest normally preclude any 
expectation of confidentiality regarding communications with their 
attorney, even regarding a communication of which one co-client was 
unaware at the time it was made.\34\ That analysis must apply with 
special force where the co-clients are both organizations, with the 
investment adviser owing a fiduciary duty to the investment company, 
and where the attorney employed by the investment adviser, like any 
attorney employed by an organization, represents the investment adviser 
as an organization, not officers or employees who may have engaged in 
misconduct injuring the investment company.
---------------------------------------------------------------------------

    \33\ See Restatement (Third) of the Law Governing Lawyers, 
section 14 and Comment c (``a client-lawyer relationship results 
when legal services are provided''), and Virginia Supreme Court Rule 
6:1-1(B) (``Generally, the relation of attorney and client exists, 
and one is deemed to be practicing law whenever he furnishes to 
another advice or service under circumstances which imply his 
possession and use of legal knowledge or skill.''). See also 
205.3(d)(2) (permitting an attorney appearing and practicing before 
the Commission in any way in the representation of an issuer to 
disclose client confidences to the Commission under specified 
circumstances).
    \34\ See Restatement (Third) of the Law Governing Lawyers, 
section 75 and Comment d (explaining that in a subsequent proceeding 
in which the co-clients' interests are adverse there is normally no 
attorney-client privilege regarding either co-client's 
communications with their attorney during the co-client 
relationship).
---------------------------------------------------------------------------

    Interested persons are invited to comment on the appropriate scope 
of the term, and its impact upon attorneys. Does the definition provide 
sufficient clarity and, if not, how could it be improved? Are there 
factual circumstances the definition would bring in that might better 
be excluded? Does the definition go far enough to protect investors?

    (g) Issuer means an issuer (as defined in Section 3 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78c)), the securities of 
which are registered under Section 12 of that Act (15 U.S.C. 78l), 
or that is required to file reports under Section 15(d) of that Act 
(15 U.S.C. 78o(d)), or that files or has filed a registration 
statement that has not yet become effective under the Securities Act 
of 1933 (15 U.S.C. 77a et seq.), and that it has not withdrawn.

    The definition for the term ``issuer'' adopts the definition set 
forth in Section 2(a)(7) of the Act, which in turn incorporates the 
definition contained in the Exchange Act. This definition raises a 
question regarding whether the rule should also apply to attorneys who 
represent various entities that are subject to comprehensive Commission 
regulation and oversight, and who regularly appear before the agency, 
but whose clients are not ``issuers.'' For example, many broker-
dealers, investment advisers, self-regulatory organizations, transfer 
and clearing agents are, by law, required to register with the 
Commission. Attorneys for these entities prepare documents that are 
filed with the Commission and interact regularly with the Commission. 
As a regulated entity that is not an issuer presumably does not have a 
board of directors or an audit committee, and perhaps not even a chief 
legal officer, imposing the proposed rule on such entities may be 
inappropriate.
    Certain foreign governments have listed debt securities that are 
registered under Section 12(b) of the Exchange Act. These foreign 
governments are thus issuers under the Act's definition. These foreign 
governments, however, may not have the organizational structure 
contemplated by the proposed rule in that the foreign governments may 
not have reasonable equivalents to a CEO, an audit committee, 
independent directors, or a board of directors. Thus, it may be 
difficult or inappropriate to apply the new Part 205 to such foreign 
issuers. It may be necessary for the Commission to create an exception 
or exemption for foreign governments that are issuers of listed debt 
securities.
    The Commission invites interested persons to comment on any aspect 
of this definition, including: whether some form of ``up the ladder'' 
reporting should be implemented for attorneys employed by regulated 
entities that are not issuers; whether there is good reason or a legal 
basis to alter the definition in Section 2(7) of the Act; and whether 
the Commission should create an exemption for foreign issuers--
providing, for example, that ``Part 205 shall not apply to foreign 
governments that are eligible to register [or ``that register''] 
securities under Schedule B of the Securities Act of 1933''--or should 
modify the definition of ``issuer'' to exclude foreign issuers--and, if 
so, how.
    (h) Material refers to conduct or information about which a 
reasonable investor would want to be informed before making an 
investment decision.

    The definition for the term ``material'' is derived from Supreme 
Court precedent, and is consistent with the remarks of Senator John 
Edwards, the sponsor of Section 307, who stated that ``the obligation 
to report is triggered only by violations that are material--violations 
that a reasonable investor would want to know about.''\35\
---------------------------------------------------------------------------

    \35\ See 148 Cong. Rec. at S6552 (July 10, 2002). See also TSC 
Indus. v. Northway, Inc., 426 U.S. 438 (1976); Basic, Inc. v. 
Levinson, 485 U.S. 224 (1988); Staff Accounting Bulletin 99, 99 WL 
1123037.
---------------------------------------------------------------------------

    Interested persons are invited to comment on this definition, 
particularly whether it provides sufficient clarity or, alternatively, 
whether another formulation would be preferable.

    (i) Material violation means a material violation of the 
securities laws, a material breach of fiduciary duty, or a similar 
material violation.

    The rule defines the term ``material violation'' to clarify that 
the term ``material'' in Section 307(b) modifies all three succeeding 
references to violations (i.e., ``violation of securities law,'' 
``breach of fiduciary duty,'' and ``similar violation''), and that only 
evidence of material misconduct triggers the rule's reporting 
obligation.
    The rule does not define what constitutes a ``violation of 
securities law'' since the term is well-understood. The Commission 
believes that the term covers violations of the federal securities 
laws, as defined in Section 2(a)(15) of the Act, as well as violations 
of state securities laws. The rule separately defines ``breach of 
fiduciary duty'' to cover those forms of breach of fiduciary duty 
recognized at common law, including misfeasance, nonfeasance, 
abdication of duty, abuse of trust and the approval of unlawful 
transactions.
    The rule does not define the term ``similar violation.'' However, 
it appears from the context in which it is used in Section 307 that the 
term is intended to extend beyond a breach of fiduciary duty or a 
violation of the securities laws.
    Interested persons are invited to comment on any aspect of the 
definition. Is there good reason to exempt violations of state 
securities laws from the definition? Should the term ``similar 
violation'' be defined and, if so, how? Does the definition encompass 
conduct about which the Commission should not be concerned? Would an 
alternate test be better? What test, and why?

    (j) Qualified legal compliance committee means a committee of an 
issuer that:
    (1) Consists of at least one member of the issuer's audit 
committee and two or more members of the issuer's board of directors 
who are not employed, directly or indirectly, by the issuer and who 
are not, in the case of a registered investment company, 
``interested persons'' as defined in Section 2(a)(19) of the 
Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19));

[[Page 71680]]

    (2) Has been duly established by the issuer's board of directors 
and authorized to investigate any report of evidence of a material 
violation by the issuer, its officers, directors, employees or 
agents;
    (3) Has established written procedures for the confidential 
receipt, retention, and consideration of any report of evidence of a 
material violation under Sec.  205.3(c);
    (4) Has the authority and responsibility:
    (i) To inform the issuer's chief legal officer and chief 
executive officer (or the equivalents thereof) of any report of 
evidence of a material violation (except in the circumstances 
described in Sec.  205.3(b)(5));
    (ii) To decide whether an investigation is necessary to 
determine whether the material violation described in the report has 
occurred, is occurring, or is about to occur and, if so, to:
    (A) Notify the audit committee or the full board of directors;
    (B) Initiate an investigation, which may be conducted either by 
the chief legal officer (or the equivalent thereof) or by outside 
attorneys; and
    (C) Retain such additional expert personnel as the committee 
deems necessary; and
    (iii) At the conclusion of any such investigation under 
paragraph (j)(4)(ii) of this section, to:
    (A) Direct the issuer to adopt appropriate remedial measures, 
including appropriate disclosures, and/or to impose 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; and
    (B) Inform the chief legal officer and the chief executive 
officer (or the equivalents thereof) and the board of directors of 
the results of any such investigation under paragraph (j)(4)(ii) of 
this section and the appropriate remedial measures to be adopted; 
and
    (5) Each member of which individually, together with the 
issuer's chief legal officer and chief executive officer (or the 
equivalents thereof) individually, has the authority and 
responsibility, in the event the issuer fails in any material 
respect to take any of the remedial measures that the qualified 
legal compliance committee has directed the issuer to take, to 
notify the Commission that a material violation has occurred, is 
occurring or is about to occur and to disaffirm in writing any 
document submitted to or filed with the Commission by the issuer 
that the individual member of the qualified legal compliance 
committee or the chief legal officer or the chief executive officer 
reasonably believes is false or materially misleading.

    A ``qualified legal compliance committee'' (``QLCC''), as here 
defined, is part of an alternative procedure for reporting evidence of 
a material violation. That alternative procedure is set out in Section 
205.3(c) of the proposed rule and is discussed below. Excluding 
``interested persons'' of a registered investment company from the 
investment company's QLCC is intended to ensure that the members of 
such a QLCC will be truly independent, as explained further in the 
discussion of Section 205.3(b)(4) below.
    Interested persons are invited to comment on any aspect of the 
definition of a QLCC, considered in light of Section 205.3(c), 
specifically including whether any changes should be made to the 
definition, either in light of Section 205.3(c) as proposed or in light 
of changes that the interested persons believe should be made to that 
section. Should the written procedures for the retention of reports, 
which a QLCC must establish pursuant to paragraph 205.2(j)(3), require 
the QLCC to retain paper or electronic copies of all reports submitted 
by attorneys? Should this requirement be expanded to obligate the QLCC 
to retain paper or electronic copies of responses to attorney reports?

    (k) Reasonable or reasonably denotes the conduct of a reasonably 
prudent and competent attorney.

    The definition of ``reasonable'' or ``reasonably'' is taken from 
Rule 1.0(h) of the ABA's Model Rules of Professional Conduct. 
Interested persons are invited to comment on whether this definition is 
sufficiently clear and whether alternative language would be an 
improvement.

    (l) Reasonably believes means that an attorney, acting 
reasonably, would believe the matter in question.

    This definition is based on the definition of ``reasonable belief'' 
or ``reasonably believes'' in Rule 1.0(i) of the ABA's Model Rules of 
Professional Conduct, modified to eliminate any implied subjective 
element. It is intended to define when belief is objectively 
reasonable. Interested persons are invited to comment on whether this 
definition is sufficiently clear and whether alternative language would 
be an improvement and, if so, what alternative language interested 
persons would propose. Would the definition of ``reasonable belief'' by 
New Jersey's Supreme Court, for example, be clearer: ``Reasonable 
belief for purposes of R[ule of ]P[rofessional] C[onduct] 1.6 is the 
belief or conclusion of a reasonable lawyer that is based upon 
information that has some foundation in fact and constitutes prima 
facie evidence of the matters referred to in paragraphs (b) or (c)''?

    (m) Report means to make known to directly, either in person, by 
telephone, by e-mail, electronically, or in writing.

    This definition emphasizes that an attorney who is obligated to 
report evidence of a material violation must do so directly rather than 
indirectly. Although the attorney is not required to communicate in 
person with the appropriate individual, the Commission believes that it 
is essential for any report to be made directly rather than through a 
third party to ensure clarity. In light of the report's importance, 
most attorneys would want to report directly in any event.
    Interested persons are invited to comment on any aspect of this 
definition. Should the attorney be required to make a written report, 
or to memorialize the substance of the report in writing shortly after 
making it? Should the attorney be required to keep a record of the 
report, including all supporting documentation? Should the Commission 
require that the report be made in person? Should the Commission 
prescribe a format for the report? Should the Commission require that a 
witness be present for each report? Should an attorney be permitted to 
delegate his or her reporting requirement to another and, if so, under 
what circumstances?

Section 205.3 Issuer as Client

    Section 205.3 is at the core of the Commission's proposed 
``Standards of Professional Conduct for Attorneys.'' It sets out the 
rule on reporting ``evidence of a material violation of securities law 
or breach of fiduciary duty or similar violation by the company or any 
agent thereof,'' as required by the Act. It also sets out related 
provisions addressing an attorney's obligations to the issuer.
Representing an Issuer
    Section 205.3(a) provides:

    (a) Representing an issuer. An attorney appearing and practicing 
before the Commission in the representation of an issuer represents 
the issuer as an organization and shall act in the best interest of 
the issuer and its shareholders. That the attorney may work with and 
advise the issuer's officers, directors, or employees in the course 
of representing the issuer does not make such individuals the 
attorney's clients.

    This paragraph of the proposed rule makes explicit that the client 
of an attorney representing an issuer before the Commission, in any 
way, is the issuer as an entity, not the issuer's individual officers 
or employees that the attorney regularly interacts with and advises on 
the issuer's behalf. Those officers and other employees, like the 
attorney, have a fiduciary duty to act in the best interests of the 
issuer and its shareholders.
    This paragraph is grounded in a lawyer's well-established duty to 
act with reasonable competence and diligence in representing a client 
and to take steps to prevent reasonably foreseeable harm to the 
client--

[[Page 71681]]

including harm from persons who work for the client.\36\ As the Cheek 
Report explains (at 27), the premise of the ABA's equivalent rule 
(Model Rule 1.13) is that, when a lawyer represents an organization 
(such as an issuer),
---------------------------------------------------------------------------

    \36\ See, e.g., Restatement (Third) of the Law Governing Lawyers 
(2000) section 96; Model Rules 1.1 and 1.2; FDIC v. O'Melveny & 
Myers, 61 F.3d 17, 19 (9th Cir. 1995) (incorporating verbatim the 
applicable section of its earlier opinion); FDIC v. O'Melveny & 
Myers, 969 F.2d 744, 748-49 (9th Cir. 1992), rev'd on other grounds, 
512 U.S. 79 (1994).

the organization is the lawyer's client and * * * the lawyer owes 
that client an obligation of protection from harm. Harm can result 
when an officer breaches a duty to the corporation (e.g. wastes or 
misappropriates corporate assets), when the corporation will be 
caused to injure a third party who will then have a claim against 
the corporation or when the corporation will be exposed to a fine or 
penalty. In any such case the lawyer's duty to protect the corporate 
client from harm requires the lawyer to serve the interest of the 
corporation and its shareholders rather than the interests of the 
---------------------------------------------------------------------------
individual officers or employees who are acting for the corporation.

    The attorney representing an issuer does not represent the issuer's 
officers and employees simply because the attorney necessarily 
interacts with them in representing the issuer, and the attorney should 
make that clear to those officers and employees. Any attorney-client 
privilege for information related to the issuer's affairs that the 
officers and employees communicate to the attorney belongs to the 
issuer.\37\
---------------------------------------------------------------------------

    \37\ See, e.g., United States v. Int'l Bhd. of Teamsters, 
Chauffeurs, Warehousemen & Helpers of America, AFL-CIO, 119 F.3d 
210, 215-17 (2d Cir. 1997).
---------------------------------------------------------------------------

    Interested persons are invited to comment on any aspect of this 
paragraph, including whether it should be expanded to address under 
what circumstances an attorney for the issuer may also represent 
officers, directors and employees, and, if an attorney does so, the 
related questions of: (1) The responsibilities of an attorney when 
there is a potential for a conflict of interest; (2) obtaining waivers 
from clients when there is a conflict of interest; and (3) terminating 
representation when an actual conflict arises.
Reporting Within the Issuer Evidence of a Material Violation
    Section 205.3(b) of the proposed rule clarifies and codifies an 
attorney's duty to protect the interests of the issuer the attorney 
represents by reporting within the issuer evidence of a material 
violation by any officer, director, employee, or agent of the issuer.
    Paragraph (b)(1) provides:

    (b) Duty to report evidence of a material violation. (1) If, in 
appearing and practicing before the Commission in the representation 
of an issuer, an attorney becomes aware of evidence of a material 
violation by the issuer or by any officer, director, employee, or 
agent of the issuer, the attorney shall report any evidence of a 
material violation to the issuer's chief legal officer (or the 
equivalent thereof) or to both the issuer's chief legal officer and 
its chief executive officer (or to the equivalents thereof) 
forthwith (unless the issuer has a qualified legal compliance 
committee and the attorney chooses instead to report the evidence of 
a material violation to that committee under paragraph (c) of this 
section). An attorney does not reveal client confidences or secrets 
by communicating information related to the attorney's 
representation of an issuer to the issuer's officers or directors.

    Paragraph (b)(1) describes the first step that an attorney 
representing an issuer is required to take after he or she becomes 
aware of information that would lead an attorney reasonably to believe 
that a material violation by an issuer or by any of the issuer's 
officers, directors, employees, or agents has occurred, is occurring, 
or is about to occur (unless the issuer has a qualified legal 
compliance committee, and the attorney chooses to report to it).\38\ In 
utilizing this standard, the rule seeks to balance the likelihood of 
increased compliance with the law as a result of having an appropriate 
triggering standard that prompts the bringing of potentially illegal 
conduct to the attention of the issuer's management against the 
likelihood of decreased compliance resulting from reduced consultation 
with an issuer's attorneys through adoption of too high a standard.
---------------------------------------------------------------------------

    \38\ This appears to have been the expectation of the Senators 
who drafted Section 307 of the Act. See 148 Cong. Rec. S6552 (July 
10, 2002) (statement of Sen. Edwards) (``the SEC shall make one rule 
in particular, and it is a simple rule with two parts. No. 1, a 
lawyer with evidence of a material violation has to report that 
evidence either to the chief legal counsel or the chief executive 
officer of the company. No. 2, if the person to whom that lawyer 
reports doesn't respond appropriately by remedying the violation, by 
doing something that makes sure it is cured, that lawyer has an 
obligation to go to the audit committee or to the board. It is that 
simple. * * * If the CEO can do a short investigation, for example, 
and figure out that no violation occurred, then the obligation stops 
there. But if there is a serious violation of the law, the 
appropriate response is clear: The CEO has to act promptly to remedy 
the violation. If he doesn't, the lawyer has to go to the board. It 
is that simple.'' ). Accord id. at S6555 (statement of Sen. Enzi) 
(``This amendment instructs the Commission to establish rules that 
require an attorney, with evidence of material legal violation by 
the corporation or its agent, to notify the chief legal counsel or 
the chief executive officer of such evidence and the appropriate 
response to correct it. If these officers do not promptly take 
action in response, the Commission is instructed to establish a rule 
that the attorney then has a duty to take further appropriate 
action, including notifying the audit committee of the board of 
directors or the board of directors themselves, of such evidence and 
the actions of the attorney and others regarding this evidence.''), 
S6556 (statement of Sen. Corzine) (``when lawyers are aware of a 
potential violation, they do have a duty to investigate. And if they 
determine there is a material violation of law--not some small 
violation, some insignificant rule--that violation should be 
remedied by the corporation. If it is not remedied, it is the duty 
of the lawyer, under our language, to report it to the board.'').
---------------------------------------------------------------------------

    As paragraph (b)(1) itself expressly states, an attorney does not 
reveal client confidences or secrets (or breach the attorney-client 
privilege) by communicating to the issuer's officers or directors 
information related to the attorney's representation of the issuer. 
This legal principle is not controversial.\39\ The Cheek Report, 
however, recommends incorporating into the ABA's Model Rule 1.13 a 
clear statement that Model Rule 1.6 does not prohibit communicating 
client confidences or secrets ``to higher authority within the 
corporation.'' \40\ The consensus of the Cheek Task Force was that the 
existing language of Model Rule 1.13(b) ``tends to discourage action by 
the lawyer to prevent or rectify corporate misconduct'' generally and 
to ``discourage[] a lawyer from seeking review by higher corporate 
authority,'' even though the lawyer's goal ought to be to ``minimiz[e] 
harm resulting from the misconduct.'' Id. The Commission has 
incorporated such an explicit statement of the legal principle into 
paragraph (b)(1) of this section.
---------------------------------------------------------------------------

    \39\ Information related to the issuer's affairs communicated to 
the attorney is effectively communicated to the issuer. The officer 
or employee thus cannot have any reasonable expectation of 
confidentiality against the issuer regarding such information, and 
the attorney breaches no confidence in communicating the information 
to the issuer's CLO, CEO, or directors. See, e.g., Int'l Bhd. of 
Teamsters, 119 F.3d at 215-17.
    \40\ Id. at 28 (original emphasis). The Cheek Report is 
available at http://www.abanet.org/buslaw/corporateresponsibility/preliminary_report.pdf. It reflects the consensus of the task force 
appointed by the ABA's President in March 2002 to re-examine ``the 
framework of laws and regulations and ethical principles governing 
the roles of lawyers, executive officers, directors, and other key 
participants'' so that the ABA could contribute to legislative and 
regulatory reform aimed at improving corporate responsibility after 
the Enron bankruptcy; as the report notes, however, not every member 
of the task force endorses every recommendation. Cheek Report at 1-
2. The Cheek Report recommends amending Model Rules 1.2, 1.6, 1.13, 
1.16, and 4.1, especially Rules 1.6 and 1.13. Id. at 27-33, 45-46.
---------------------------------------------------------------------------

    The report required in Section 205.3(b) to prevent or minimize the 
harm to an issuer resulting from a material violation is internal. It 
involves no disclosure of confidential information outside the 
issuer.\41\ The

[[Page 71682]]

report, moreover, is intended to prevent, if possible, misconduct that 
would injure the issuer and its shareholders, or at least to limit the 
injury. Accordingly, awareness of information leading an attorney 
reasonably to believe that a material violation has occurred, is 
occurring, or is about to occur appears to be the appropriate trigger 
for the obligation to make an internal report of the evidence of a 
material violation.
---------------------------------------------------------------------------

    \41\ See also discussion, above, of disclosure to the CLO, CEO, 
or directors of a registered investment company regarding misconduct 
by officers or employees of its investment adviser under Section 
205.2(f).
---------------------------------------------------------------------------

    As the reporter for the ABA's Commission of Evaluation of 
Professional Standards (``Kutak Commission'') wrote in 1984, explaining 
why he considered the ABA's present Model Rule 1.6 (on disclosure of 
confidential information to outsiders) inadequate,

there is an unavoidable tension between the proposition that the 
lawyer should act early, to prevent the fraud, and the requirement 
that he should act only on the basis of solid information. The 
longer the wait, the more solid the information, but also the 
greater the likelihood of the client's deeper inculpation.\42\
---------------------------------------------------------------------------

    \42\ Geoffrey C. Hazard, Jr., Rectification of Client Fraud: 
Death and Revival of a Professional Norm, 33 Emory L.J. 271, 286 
(1984).

Requiring more than ``a reasonable basis'' for believing that a client 
intends to commit, or has committed, fraud before allowing the lawyer 
to reveal confidential client information to outsiders ``would 
virtually preclude the possibility of the lawyer's action except in 
most egregious situations.'' Id. at 285-86. That analysis would appear 
to apply with even greater force where the disclosure is within an 
issuer, as required by Section 205.3(b).
    Proposed Section 205.3(b) would require an attorney representing an 
issuer to report within the issuer evidence of ``a material violation 
by the issuer or by any officer, director, employee, or agent of the 
issuer.'' The internal report of evidence of a material violation is 
not comparable to a judicial determination that a material violation 
actually occurred. There must, however, be some factual basis that 
would lead an attorney to reasonably believe that a material violation 
has occurred, is occurring, or is about to occur. The internal report 
then allows responsible officers of an issuer to consider the reported 
evidence, investigate where appropriate, and take actions necessary to 
prevent or minimize any threatened harm to the issuer.\43\
---------------------------------------------------------------------------

    \43\ Senator Edwards foresaw that a CEO to whom the evidence was 
reported might ``do a short investigation, for example, and figure 
out that no violation occurred.'' 148 Cong. Rec. S6552 (July 10, 
2002).
---------------------------------------------------------------------------

    The ABA's Model Rule 1.13 includes a similar but narrower reporting 
requirement for attorneys representing an organization, applicable only 
when the attorney knows that a violation is occurring or going to occur 
that is likely to result in substantial injury to the organization:

    If a lawyer for an organization knows that an officer, employee 
or other person associated with the organization is engaged in 
action, intends to act or refuses to act in a matter related to the 
representation that is a violation of a legal obligation to the 
organization, or a violation of law which reasonably might be 
imputed to the organization, and is likely to result in substantial 
injury to the organization, the lawyer shall proceed as is 
reasonably necessary in the best interest of the organization.

    Even though a securities lawyer ``may be taken as knowing what an 
alert lawyer would know upon looking with a professional eye at the 
totality of circumstances there to be seen,'' \44\ the ABA's Model Rule 
appears to set too high a standard for reporting within an issuer 
evidence of a material violation, both in requiring an attorney to know 
that an officer, employee or other person associated with the issuer 
organization is engaged in or intends a material violation and in 
requiring that material violation to result in substantial injury to 
the issuer. Such a high threshold for internal reporting would be 
inconsistent with Section 307's emphasis on the public interest and 
protecting investors.
---------------------------------------------------------------------------

    \44\ Hazard, Rectification of Client Fraud, 33 Emory L.J. at 283 
(citing cases). See also Cheek Report at 33-35.
---------------------------------------------------------------------------

    The proposed rule obligates an attorney to report information he or 
she has become aware of that would lead an attorney, acting reasonably, 
to believe that a material violation has occurred, is occurring or is 
about to occur. In the Commission's decision in Carter and Johnson and 
the order entered in Keating, Muething & Klekamp, the Commission 
addressed the responsibilities of an attorney who ``knows'' of a 
violation of law by the issuer or its officers. Because those cases 
dealt with situations where the attorneys knew, or should have known, 
about their client's misconduct, the Commission's discussion in both 
cases focused upon an attorney's obligation in that situation. Neither 
case, however, established actual knowledge of a client's misconduct as 
a minimum threshold for triggering an attorney's duty to report such 
misconduct. A rule which obligates an attorney to report only a 
material violation of which he or she ``knows'' could be interpreted as 
imposing an initial investigative obligation upon the attorney which he 
or she may be poorly situated to perform, and which section 307 
indicates should be borne by appropriate personnel within the issuer 
after an attorney has made a report.
    When an attorney ``becomes aware'' of information that would lead 
an attorney reasonably to believe in the existence of a material 
violation would turn, at least in part, on the attorney's training, 
experience, position and seniority. Attorneys are not necessarily 
expected to identify issues they are not equipped to see. What the 
reasonable, experienced securities lawyer might regard as a clear 
violation of the law may appear different--or not appear at all--to an 
unseasoned attorney with a different level of expertise.\45\
---------------------------------------------------------------------------

    \45\ See letter from SIA Ad Hoc Committee to Securities and 
Exchange Commission, dated Oct. 22, 2002.
---------------------------------------------------------------------------

    The evidence of a material violation that an attorney first becomes 
aware of may be the tip of an iceberg and, may, on its face, appear 
unlikely to result in substantial injury to the issuer. For example, 
evidence indicating that an issuer controls one or two of many special-
purpose entities, which individually do not qualify for the off-
balance-sheet treatment they have been given, might indicate a material 
misstatement in the issuer's financial statements, and a material 
violation of securities law, but not, without more, a material 
violation likely to result in substantial injury to the issuer.\46\
---------------------------------------------------------------------------

    \46\ The massive fraud perpetrated by O.P.M. Leasing Services, 
Inc. in the 1970s and early 1980s unraveled after an attorney 
noticed that payments for computers leased from O.P.M. by one of 
O.P.M.''s largest customers were being paid directly to O.P.M., even 
though the lease agreement called for the payments to be made to the 
lender that was providing financing. Investigation over several 
months turned up no documentation for two of the many leases at 
issue. Copies of the missing documentation supplied by the lender 
revealed that O.P.M. had fabricated the leases and related title 
documents. O.P.M. had arranged to have the customer's relatively 
small payments channeled through O.P.M. so that O.P.M. could use its 
own funds to make the inflated payments due to the lender on the 
fabricated leases. See Report of the Trustee Concerning Fraud and 
Other Misconduct in the Management of the Affairs of the Debtor at 
24-26, In re O.P.M. Leasing Services, Inc., Reorg. No. 81-B-10533, 
(Bankr. S.D.N.Y., filed April 25, 1983). Clearly, even two 
fabricated leases were qualitatively material. However, they were 
arguably unlikely, by themselves, to result in substantial injury to 
O.P.M.
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    The proposed rule, however, is not intended to impose upon an 
attorney, whether employed or retained by the issuer, a duty to 
investigate evidence of a material violation or to determine whether in 
fact there is a material violation. Of course, nothing in the proposed 
rule is intended to discourage any such inquiry. On the other hand,

[[Page 71683]]

the attorney cannot ignore evidence of a material violation of which he 
or she is aware.
    In proposing this rule, the Commission does not intend to inhibit 
the consultative process between an issuer and its attorney. The duty 
to report ``up the ladder'' under section 205.3(b)(2) does not arise 
from a consultation in which an attorney advises an officer or employee 
of an issuer that the law regarding a proposed course of action is 
unsettled and there is some possibility that a court might hold in the 
future that the action violated the securities laws. Nor does it arise 
where an officer actually pursues a course of action despite being 
advised by the attorney that the course of action has been held illegal 
by courts in three states, in none of which the issuer does business, 
even if the attorney thinks there is a reasonable argument that other 
courts would also be likely to find it illegal. The course of action is 
not clearly illegal, because its legality has not been addressed by 
courts in any state where the issuer does business. The duty to report 
does not even arise where the officer tells the attorney that he or she 
intends to pursue a course of action that the attorney thinks is 
clearly illegal where the issuer does business, because the officer 
might reconsider and not do what he or she said he or she would do. The 
attorney's reporting obligation is not triggered until the attorney can 
be sure that the officer or employee will actually pursue an illegal 
course of action.
    Interested persons are invited to comment on: Whether the 
``reasonably believes'' standard is an appropriate standard to trigger 
the requirement that an attorney make a report or whether the 
requirement should be triggered only in instances where the attorney 
``knows'' or ``reasonably should know'' of a material violation; and 
whether the standard should also address the quantity and/or quality of 
evidence required to trigger a report.
    The Commission also does not intend the proposed rule to chill 
zealous advocacy by an issuer's defense counsel. Under certain 
circumstances, however, the proposed rule would require an attorney 
defending an issuer to report ``up the ladder'' to the issuer's CLO 
evidence of any material violation that the attorney becomes aware of 
while defending the issuer. That reporting obligation exists whether or 
not the evidence of a material violation is directly related to a 
matter under inquiry or investigation by the Commission. Evidence of a 
material violation that an attorney learns about while defending an 
issuer does not pose any less a threat to the issuer and to investors 
than does evidence of a material violation that an attorney becomes 
aware of under other circumstances, and requiring defense counsel to 
report such evidence to the issuer-client's CLO--or even, under 
extraordinary circumstances, to appropriate directors of the issuer--
should not chill an attorney's ability to provide effective 
representation to the issuer. Indeed, the intended deterrent effect of 
the proposed rule would be significantly compromised if the rule did 
not apply when an attorney appears and practices during Commission 
inquiries, investigations and administrative proceedings. (As a rule of 
reason, the proposed rule should not be construed to require defense 
counsel to report to the CLO evidence of a material violation that the 
CLO has made the defense counsel aware of.) \47\
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    \47\ The fundamental purpose of reporting to the CLO, as Section 
205.3(b)(3) makes clear, is to have the CLO ``cause such inquiry 
into the evidence of a material violation as he or she reasonably 
believes is necessary to determine whether the material violation 
described in the report has occurred, is occurring, or is about to 
occur.'' Defense counsel may be effectively part of the issuer's own 
investigation. Because the defense counsel is investigating, there 
should be no need for defense counsel to report separately each 
piece of evidence that the defense counsel becomes aware of. 
Moreover, the ``noisy withdrawal'' provisions in Section 205.3(d) 
are triggered only when the issuer's response to evidence of a 
material violation is not appropriate. What response is appropriate 
must depend on the particular circumstances. Circumstances in which 
the Commission is already investigating an issuer and the attorney 
is defending the issuer may well be fundamentally different from 
circumstances in which an issuer is preparing a filing with or 
submission to the Commission and the attorney is participating in 
preparing that filing or submission.
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    Moreover, the rule's reporting obligation is consistent with 
defense counsel's ethical obligations to the issuer-client. ABA Model 
Rule 1.4 requires an attorney to ``keep a client reasonably informed 
about the status of a matter'' as ``reasonably necessary to permit the 
client to make informed decisions regarding the representation.'' \48\ 
In the context of a Commission inquiry, investigation, or 
administrative proceeding, the issuer cannot make informed decisions 
without knowing about evidence that its officers or employees are 
responsible for a material violation and, if so, what steps would be 
required to rectify it. In such a context, the issuer's CLO needs to be 
aware of information indicating that a material violation has occurred, 
is occurring, or is about to occur in order to participate 
intelligently with defense counsel in making decisions about the 
objectives of the representation and how to pursue them. In the context 
of an inquiry, investigation, or administrative proceeding by the 
Commission, one of the affected issuer's objectives should be to 
determine whether there has been any violation and, if so, to decide 
how best to rectify it. Accordingly, it should be important to ensure 
that the issuer's CLO knows about any evidence of a material violation.
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    \48\ As comment [1] to Model Rule 1.4 explains, ``[t]he client 
should have sufficient information to participate intelligently in 
decisions concerning the objectives of the representation and the 
means by which they are to be pursued, to the extent the client is 
willing and able to do so.''
---------------------------------------------------------------------------

    In an administrative proceeding, even where the Commission's staff 
asserts it has evidence of a material violation by an issuer, an 
attorney defending an issuer may assert any relevant and colorable 
affirmative defense on the issuer's behalf, and may require the 
Commission staff to prove its case against his or her client. It would 
not be an inappropriate response to reported evidence of a material 
violation for an issuer's CLO to direct defense counsel to assert 
either a colorable defense or a colorable basis for contending that the 
staff should not prevail. Such directions from the CLO, therefore, 
would not require defense counsel to report any evidence of a material 
violation to the issuer's directors under section 205.3(b)(4) of the 
proposed rule. On the other hand, if the CLO's sole response to 
reported evidence of a material violation from defense counsel is to 
direct defense counsel to argue in the proceeding that no violation has 
occurred and the CLO is conducting no internal inquiry and considering 
no remedial steps, defense counsel, acting reasonably, would probably 
believe that the CLO's response to the evidence of a material violation 
is inadequate and would be obligated to report the evidence of a 
material violation to the issuer's CEO under section 205.3(b)(1) or to 
appropriate directors under Section 205.3(b)(4) of the proposed 
rule.\49\ Such reporting ``up the ladder,'' however, would constitute--
not chill--zealous representation of the issuer's best interest. 
Responsible defense counsel should probably make such a report under 
those circumstances in any

[[Page 71684]]

event.\50\ The attorney's client is the issuer, not the issuer's CLO. A 
prudent defense counsel should report ``up the ladder'' in this 
situation to ensure that upper management is aware of the evidence and 
has an opportunity to take appropriate action. As the rule makes clear, 
reporting potential violations to officers and directors of the issuer 
does not reveal any client confidences.
---------------------------------------------------------------------------

    \49\ Moreover, if the attorney becomes aware during an 
administrative proceeding that the issuer intends to commit a fraud 
upon the Commission (e.g., by offering testimony which the attorney 
knows to be false), then the attorney would be obligated to take 
appropriate remedial steps to prevent or correct such fraud. The 
attorney could also report to the Commission pursuant to Section 
205.3(e)(2)(ii) of the proposed rule to prevent the client from 
committing an illegal act, such as suborning perjury, that would 
perpetrate a fraud on the Commission.
    \50\ See ABA Model Rules 3.1 (``A lawyer shall not bring or 
defend a proceeding, or assert or controvert an issue therein, 
unless there is a basis in law and fact for doing so that is not 
frivolous, which includes a good faith argument for an extension, 
modification or reversal of existing law. A lawyer for the defendant 
in a criminal proceeding, or the respondent in a proceeding that 
could result in incarceration, may nevertheless so defend the 
proceeding as to require that every element of the case be 
established.'') and 1.4 (quoted above). As comments [1] and [2] to 
Model Rule 3.1 elaborate:
    [1] The advocate has a duty to use legal procedure for the 
fullest benefit of the client's cause, but also a duty not to abuse 
legal procedure. The law, both procedural and substantive, 
establishes the limits within which an advocate may proceed. 
However, the law is not always clear and never is static. 
Accordingly, in determining the proper scope of advocacy, account 
must be taken of the law's ambiguities and potential for change.
    [2] The filing of an action or defense or similar action taken 
for a client is not frivolous merely because the facts have not 
first been fully substantiated or because the lawyer expects to 
develop vital evidence only by discovery. What is required of 
lawyers, however, is that they inform themselves about the facts of 
their clients' cases and the applicable law and determine that they 
can make good faith arguments in support of their clients' 
positions. Such action is not frivolous even though the lawyer 
believes that the client's position ultimately will not prevail. The 
action is frivolous, however, if the lawyer is unable either to make 
a good faith argument on the merits of the action taken or to 
support the action taken by a good faith argument for an extension, 
modification or reversal of existing law.
---------------------------------------------------------------------------

    If the attorney defending an issuer reports the matter all the way 
``up the ladder'' within the issuer and does not receive an appropriate 
response even from the issuer's directors, and if the material 
violation is ongoing or about to occur and is likely to result in 
substantial injury to the financial interest or property of the issuer 
or of investor, section 205.3(d)(1)(i) obligates an attorney retained 
by an issuer, even as an advocate, to withdraw from representation and 
notify the Commission that such withdrawal was for ``professional 
considerations.'' Section 205.3(d)(2)(i) permits, but does not require, 
an attorney retained by the issuer to take these steps if he or she 
reasonably believes the material violation has occurred and is not 
ongoing and is likely to have resulted in substantial injury to the 
financial interest or property of the issuer or of investors. The ABA's 
Model Rule 1.16 requires even an advocate in a criminal case to 
withdraw, unless ordered not to by a court, where continuing the 
representation ``will result in violation of the rules of professional 
conduct,'' as asserting frivolous defenses would, under Model Rule 3.4.
    An attorney defending an issuer in a civil injunctive action by the 
Commission in a district court would not be appearing and practicing 
before the Commission, because the issuer would not be transacting 
business with the Commission, even though the attorney may be 
interacting with Commission staff assigned to the litigation. However, 
if that attorney is also appearing and practicing before the Commission 
by defending the issuer in a Commission inquiry or investigation and 
becomes aware of evidence of a material violation by the issuer, the 
attorney will have the reporting responsibilities under the proposed 
rule discussed above, whether or not the evidence is related to the 
subject matter of the litigation. If the evidence of a material 
violation relates to the subject of the litigation, the attorney should 
also observe his or her duty of candor to the court.
    The Commission invites interested persons to comment on whether 
there is a potential chilling effect inherent in requiring an attorney 
to report within the issuer evidence of a material violation or make a 
``noisy withdrawal'' while representing an issuer in an inquiry, 
investigation, or administrative proceeding by the Commission, and 
invites interested persons to suggest how to address this situation. 
Should the definition of the term ``appropriate response'' in 205.2(b) 
be modified to explicitly recognize an attorney's obligation to 
continue to defend an issuer client in a Commission administrative 
proceeding, even if the attorney does not believe the client has a 
meritorious defense? Should the definition be modified to state that an 
issuer's decision to require the Commission to establish its claims 
against the issuer in an administrative proceeding constitutes an 
``appropriate response'' by an issuer, notwithstanding the fact that an 
attorney learns of evidence during the proceeding which indicates that 
the Commission's claims are valid? Should paragraphs 205.3(d)(1)(i) and 
205.3(d)(2)(i) be revised to explicitly state that an attorney is not 
required, or even permitted, to effect a ``noisy withdrawal'' under 
these circumstances?
Maintaining a Contemporaneous Record
    Paragraph (b)(2) of the proposed rule provides:

    (2) The attorney reporting evidence of a material violation 
shall take steps reasonable under the circumstances to document the 
report and the response thereto and shall retain such documentation 
for a reasonable time.

    Absent exigent circumstances, the attorney retained or employed by 
an issuer who reports ``up the ladder'' within the issuer evidence of a 
material violation is required to take reasonable steps to make and 
retain a contemporaneous record of his or her report and the response 
it receives.\51\ A subordinate attorney who reports evidence of a 
material violation to his or her supervising attorney is also required 
to take such steps. Such contemporaneous records would typically 
include the date, time, location, manner, and substance of the report 
and the response and the identity of witnesses to either. Much or all 
of this information would likely be included in the report or the 
response itself, if the report or the response is in written form. 
Requiring such a contemporaneous record of the report may protect the 
attorney in any proceeding in which his or her compliance with this 
rule is at issue by demonstrating that the attorney acted properly 
under the circumstances.\52\ The rule does not establish any 
requirement for documentation of an attorney's determination that 
information does not constitute evidence of a material violation 
(except where a supervisory attorney believes the information reported 
to the supervisory attorney by a subordinate attorney is not evidence 
of a material

[[Page 71685]]

violation). In close cases, it would be prudent for an attorney to do 
so.
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    \51\ Section 205.4(d) of the proposed rule would require a 
supervisory attorney to document the subordinate attorney's report 
and the supervisory attorney's response to it only where the 
supervisory attorney believes the information reported by the 
subordinate attorney is not evidence of a material violation.
    \52\ See Section 205.3(d)(1) of the proposed rule and Meyerhofer 
v. Empire Fire & Marine Ins. Co., 497 F.2d 1190, 1192-93 (2d Cir. 
1974) (Friendly, J.), cert. denied, 419 U.S. 998 (1974) (associate 
attorney who had resigned from a law firm because the partners 
ignored his concerns about the adequacy of disclosures in 
registration statements, parts of which the associate had worked on, 
was entitled to disclose to plaintiffs in a subsequent law suit, 
claiming that one of those registration statements was fraudulent 
and naming the former associate as a defendant, an affidavit that 
the associate had previously given to the SEC and that contained 
confidential client information; the affidavit convinced the 
plaintiffs' attorney that the associate had not participated in the 
fraud, and the associate was dropped as a defendant); Hazard, 
Rectification of Client Fraud, 33 Emory L.J. at 283-85 (explaining 
why ``an innocent lawyer--however competent and however watchful--is 
inevitably at risk in any transaction where the client could commit 
fraud'' and why ``the notion that competent lawyers can take care of 
themselves under a confidentiality rule that does not have an 
exception concerning client fraud'' cannot be taken seriously).
---------------------------------------------------------------------------

    In certain limited circumstances it may not be practicable or 
reasonable for the attorney to prepare a written record at the time. 
The attorney, for example, may learn of possible misconduct in the 
course of a fast-moving corporate deal. In this situation, it may 
appear more important to bring the evidence to the CLO's attention 
immediately than to memorialize it. Other exigent or extenuating 
circumstances also may result in the lack of a contemporaneous record, 
although the Commission believes that such cases will be rare. In some 
cases, the CLO's or management's written response may provide adequate 
documentation of the report as well as the response. Where it does 
provide adequate documentation, retaining a copy of the CLO's report 
would satisfy the requirements of (b)(2) and (7). Where it does not, 
the reporting attorney should endeavor to make a record of his or her 
report as soon as possible.
    Where a report is directed to an issuer's audit committee, to some 
other committee of the issuer's board of directors, or to the full 
board--either because the reporting attorney considered it necessary to 
bypass the CLO and CEO or because the response from the CLO or CEO was 
inappropriate or was unreasonably delayed--those circumstances may make 
it important for the reporting attorney to make and retain a 
contemporaneous record of his or her report.
    In the extreme and unlikely event that the issuer's audit 
committee, some other committee of the issuer's board of directors, or 
the full board of directors does not provide an appropriate response 
within a reasonable time, it may be essential for the reporting 
attorney to prepare and retain a contemporaneous written record 
documenting those circumstances. Accordingly, in that unlikely event, 
paragraph (b)(8) of the proposed rule would require the reporting 
attorney to take reasonable steps to document the response--typically 
preserving a copy of a written response--the attorney believes 
inappropriate, and to retain that documentation for a reasonable time. 
What is a reasonable time will depend on the circumstances but would 
probably not be shorter than the statute of limitations applicable to 
the material violation at issue.
    A prudent attorney is likely to make such a contemporaneous record 
whether or not the Commission requires it, and all attorneys should do 
so under the circumstances covered by Sections 205.3 (b)(1), (4), and 
(5) and 205.5(c). Section 205.3(d)(1) expressly authorizes an attorney 
who has made and retained such contemporaneous records under the 
proposed rule to use them in self-defense in the event his or her 
conduct is called into question.
    Interested persons are invited to comment on: (1) Whether the rule 
should require the attorney making a report to maintain a written 
record of that report; (2) whether the rule should prescribe in detail 
the form and content of the report, and if so, what form and content 
should or should not be prescribed; and (3) whether the rule should 
prescribe specific time deadlines for the preparation of the report, 
and if so, what time deadlines would or would not be appropriate.
Chief Legal Officer's Duty To Investigate
    Paragraph (b)(3) of the proposed rule would provide:

    (3) The chief legal officer (or the equivalent thereof) shall 
cause such inquiry into the evidence of a material violation as he 
or she reasonably believes is necessary to determine whether the 
material violation described in the report has occurred, is 
occurring, or is about to occur. If the chief legal officer 
reasonably believes no material violation has occurred, is 
occurring, or is about to occur, he or she shall so advise the 
reporting attorney. If the chief legal officer reasonably believes 
that a material violation has occurred, is occurring, or is about to 
occur, he or she shall take any necessary 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 chief legal officer shall promptly 
report the remedial measures adopted and/or sanctions imposed to the 
chief executive officer, to the audit committee of the issuer's 
board of directors, or to the issuer's board of directors, and to 
the reporting attorney. The chief legal officer shall take 
reasonable steps to document his or her inquiry and to retain such 
documentation for a reasonable time. In lieu of causing an inquiry 
under this paragraph (b), a chief legal officer (or the equivalent 
thereof) may refer a report of evidence of a material violation to a 
qualified legal compliance committee under paragraph (c)(2) of this 
section. If the issuer fails in any material respect to take any 
remedial measure that the qualified legal compliance committee 
directs the issuer to take in order 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 chief legal officer shall notify the Commission that a 
material violation has occurred, is occurring or is about to occur 
and shall disaffirm in writing any documents submitted to or filed 
with the Commission by the issuer that the chief legal officer 
reasonably believes are false or materially misleading.

    Paragraph (b)(3) would clarify the obligations of the issuer's CLO 
(or equivalent) under the proposed rule. The Commission has not imposed 
on attorneys making reports under Section 205.3(b) a duty to 
investigate independently the evidence before making their reports. 
Attorneys employed by the issuer or retained as outside counsel are 
often not in a position to conduct such an inquiry. In many cases, 
attorneys may lack the experience, resources, and access to records and 
other employees necessary to conduct an appropriate inquiry. Such an 
inquiry may be beyond the scope of outside counsel's representation. 
The issuer's CLO, however, is in a position to conduct an internal 
inquiry when appropriate. Moreover, a CLO has a clear duty to protect 
the issuer--as opposed to its other officers and employees--in every 
possible way.\53\ The proposed rule, accordingly, would expressly make 
the CLO responsible for having an inquiry conducted in response to a 
report under paragraph (b), unless the CLO makes a reasonable 
determination that it is not necessary to do so.
---------------------------------------------------------------------------

    \53\ See O'Melveny & Myers, 969 F.2d at 748-49 (holding that 
outside counsel had such a duty).
---------------------------------------------------------------------------

    Where an issuer has no general counsel or chief legal officer, the 
``equivalent'' would be the chief executive officer, who would, under 
the proposed rule, be responsible for having an inquiry conducted in 
response to a report under 205.3(b), unless he or she makes a 
reasonable determination that it is not necessary to do so. In most 
such cases, the CEO would probably authorize whatever attorneys the 
issuer normally uses for its legal work to conduct the inquiry or 
retain another law firm to do so.
    Interested persons are invited to comment on whether: (1) The chief 
legal officer should have an obligation to conduct an inquiry in 
response to a report and, if so, whether he or she should be permitted 
to retain or assign other counsel to conduct the inquiry; (2) the 
``reasonably believes'' standard is appropriate for determining whether 
the chief legal officer must cause an inquiry to be conducted; (3) the 
``reasonably believes'' standard is an appropriate guide for the chief 
legal officer's determination regarding whether a material violation 
has occurred: (4) the rule should further address when it is necessary 
for the issuer to take ``necessary steps'' in response to a material 
violation; (5) the rule should further address when remedial measures 
and/or sanctions are appropriate and the kinds of sanctions and 
remedial

[[Page 71686]]

measures that are acceptable under different circumstances; and (6) the 
rule should address what steps by an issuer are sufficient to ``stop,'' 
``prevent'' or ``rectify'' a material violation.
Reporting a Material Violation to the Issuer's Directors
    Paragraph (b)(4) of the proposed rule would provide:

    (4) If an attorney who has made a report under paragraph (b)(1) 
of this section reasonably believes that the chief legal officer or 
the chief executive officer of the issuer (or the equivalent 
thereof) has not provided an appropriate response, or has not 
responded within a reasonable time, the attorney shall report the 
evidence of a material violation to:
    (i) The audit committee of the issuer's board of directors;
    (ii) Another committee of the issuer's board of directors 
consisting solely of directors who are not employed, directly or 
indirectly, by the issuer and are not, in the case of a registered 
investment company, ``interested persons'' as defined in section 
2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a-
2(a)(19)) (if the issuer's board of directors has no audit 
committee); or
    (iii) The issuer's board of directors (if the issuer's board of 
directors has no committee consisting solely of directors who are 
not employed, directly or indirectly, by the issuer and are not, in 
the case of a registered investment company, ``interested persons'' 
as defined in section 2(a)(19) of the Investment Company Act of 1940 
(15 U.S.C. 80a-2(a)(19)).

    This paragraph applies where the issuer's CLO and/or CEO fail to 
respond appropriately to the reported evidence of a material violation, 
requiring the reporting attorney to report the evidence to the issuer's 
audit committee, another committee of independent directors, or to the 
full board of directors. The term ``appropriate response'' is defined 
in Section 205.2(b) and identifies the steps a CLO or CEO must take in 
responding to a report of evidence of a material violation, including 
making appropriate disclosures when the reported evidence demonstrates 
the existence of a disclosure violation.
    The statutory language refers to situations in which a CLO or CEO 
``does not appropriately respond to the evidence (adopting, as 
necessary, appropriate remedial measures or sanctions with respect to 
the violation).'' The proposed rule makes clear that providing no 
response at all within a reasonable time may be equivalent to not 
providing an appropriate response and no response may, under certain 
circumstances, require the attorney to report to a higher level of 
authority within the issuer--when, for example, a filing or submission 
that the attorney reasonably believes contains a misstatement of 
material fact is to be made the next day.
    The direction that the attorney must report ``up the ladder'' to 
the audit committee of the issuer's board of directors, if there is 
one; if there is no audit committee, then to another committee of the 
issuer's board of directors consisting solely of independent directors, 
if there is one; and if there is no committee of independent directors, 
then to the full board of directors is intended to implement the 
statutory language on reporting ``up the ladder '' \54\ while avoiding 
a situation in which one attorney might report some evidence of a 
material violation to one committee of directors while another attorney 
might report other evidence of a material violation to a second 
committee, obscuring the full, cumulative significance of reported 
evidence.
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    \54\ Section 307 of the Act calls for a rule requiring an 
attorney to ``report the evidence to the audit committee of the 
board of directors of the issuer or to another committee of the 
board of directors comprised solely of directors not employed 
directly or indirectly by the issuer, or to the board of 
directors.''
---------------------------------------------------------------------------

    Requiring that the committee of a registered investment company's 
board of directors to which an attorney is allowed to report evidence 
of a material violation--here and in paragraph (b)(5) of this section--
must exclude ``interested persons'' is intended to assure that the 
report will go to independent directors. That exclusion has the same 
rationale here as does excluding ``interested persons'' from an 
investment company's QLCC, as defined in Section 205.2(j). Usually, a 
director who is not ``employed directly or indirectly by the issuer'' 
is an independent director of the issuer. However, registered 
investment companies (including mutual funds) constitute an important 
group of issuers that typically are managed externally. As a result, a 
director of a registered investment who is ``not employed directly or 
indirectly'' by the investment company but is employed by the 
investment company's investment advisor may well not be independent. 
Independent directors of a registered investment company thus cannot 
include any ``interested person'' of the investment company as defined 
in Section 2(a)(19) of the Investment Company Act of 1940.
    The Commission solicits comment on any aspect of this section, 
including whether: (1) The ``reasonably believes'' standard is 
appropriate for the reporting attorney to determine whether he or she 
has received an ``appropriate response'' and, if not, what alternative 
standard should be used; (2) the ``reasonable time'' standard is 
appropriate or whether the rule should contain a more specific deadline 
(or deadlines) or one that is linked to the complexity of the issues 
presented by the report; and (3) the rule should specifically prescribe 
the form and content of any report to the audit committee or the board 
of directors and, if so, what form and content would or would not be 
appropriate.
    Paragraph (b)(5) of the proposed rule would provide for 
circumstances under which it may be appropriate to bypass the CLO and 
CEO:

    (5) If an attorney reasonably believes that it would be futile 
to report evidence of a material violation to the issuer's chief 
legal officer and chief executive officer (or the equivalents 
thereof) under paragraph (b)(1) of this section, the attorney may 
report the evidence of a material violation as provided under 
paragraph (b)(4) of this section.

    In the interest of expediting any required corrective action within 
the issuer, paragraph (b)(5) permits, but does not require, an attorney 
to bypass the CLO or CEO of an issuer and report evidence of a material 
violation directly to appropriate directors of an issuer--to the audit 
committee of the issuer's board of directors, if there is one; if there 
is no audit committee, then to another committee of the issuer's board 
of directors consisting solely of independent directors, if there is 
one; and if there is no committee of independent directors, then to the 
full board of directors--where the attorney reasonably believes that it 
is likely to be futile to report the evidence to the CLO or CEO. It 
provides a shortcut under the circumstances implicit in paragraph 
(b)(4), where the inappropriate response of a CLO and/or CEO can 
reasonably be anticipated. Reporting to the CLO or CEO might appear 
futile where those officers appear to be involved in the wrongdoing to 
be reported. Indeed, a report to participants in the wrongdoing might 
enable them to destroy relevant evidence. This is an amendment that the 
Cheek Report (at 29-30) recommends to Model Rule 1.13.
    Interested persons are invited to comment on any aspect of this 
section, including whether: (1) The rule should contain a bypass 
provision, such as this, allowing a reporting attorney to forego 
reporting evidence to the chief legal officer and, if so, what its 
advantages and disadvantages would be; (2) a reporting attorney's 
ability to bypass the chief legal officer should be limited to 
instances where it is ``futile'' or whether it should be expanded to 
other situations, what those other situations should be, and why; (3) 
the ``reasonably

[[Page 71687]]

believes'' standard is appropriate and, if not, what standard or 
standards would be appropriate; and (4) the rule should provide that 
the reporting attorney ``may'' bypass the chief legal officer or should 
it require that he or she do so under certain circumstances.
Attorneys Retained or Directed To Investigate a Reported Material 
Violation
    Paragraph (b)(6) of the proposed rule would address circumstances 
in which those to whom evidence of a material violation is reported 
direct others, either in-house attorneys or outside attorneys retained 
for that purpose, to investigate the possible violation:

    (6) An attorney retained or directed by an issuer to investigate 
evidence of a material violation reported under paragraph (b)(1), 
(b)(4), or (b)(5) of this section shall be deemed to be appearing 
and practicing before the Commission. Directing or retaining an 
attorney to investigate reported evidence of a material violation 
does not relieve the officers or directors of the issuer to whom the 
evidence of a material violation has been reported under paragraph 
(b)(1), (b)(4), or (b)(5) of this section of the duty to respond to 
the reporting attorney.

    Paragraph (b)(6) makes two points. First, the investigating 
attorneys would themselves be appearing and practicing before the 
Commission. They would therefore be bound by the requirements of the 
proposed rule. Second, the officer or directors who caused them to 
investigate remain obligated to respond to the attorney who initially 
reported the evidence of a material violation. Either the issuer's 
officer or directors or, under the officer's or directors' 
instructions, the investigating attorneys would make the reporting 
attorney aware of the inquiry, to keep the reporting attorney from 
concluding mistakenly that the required response was unreasonably 
delayed.
    Interested persons are invited to comment on all aspects of this 
section, including: (1) Whether it is appropriate for an attorney 
retained or directed to investigate a report to be deemed to be 
appearing and practicing before the Commission; and (2) to what extent, 
if any, the rule should permit the retained or directed attorney to 
fulfill the issuer's obligation to respond to the reporting attorney.
Assessment of the Issuer's Response to the Reported Evidence of a 
Material Violation
    Paragraph (b)(7) of the proposed rule would provide for 
circumstances in which the attorney receives an appropriate and timely 
response to the evidence he has reported:

    (7) An attorney who receives what he or she reasonably believes 
is an appropriate and timely response to a report he or she has made 
pursuant to paragraph (b)(1), (b)(4), or (b)(5) of this section from 
the issuer's chief legal officer, chief executive officer, audit 
committee, another committee of the issuer's board of directors 
consisting solely of directors not employed, directly or indirectly, 
by the issuer, or the issuer's board of directors and who has taken 
reasonable steps to document his or her report and the response 
thereto under paragraph (b)(2) of this section need do nothing more 
under this section regarding the evidence of a material violation.

    This paragraph confirms that the attorney would fully comply with 
proposed Section 205.3 once the attorney has reported evidence of a 
material violation and reasonably believes that the issuer's response 
to that reported evidence is appropriate, so long as there is a record 
of the report and the response.
    Interested persons are invited to comment on any aspect of this 
section, including whether the rule should have such a ``safe harbor'' 
and, if so, its scope.
    Paragraph (b)(8) of the proposed rule would provide for 
circumstances in which the attorney does not receive an appropriate 
response to the evidence he has reported or does not receive any 
response in a reasonable time:

    (8) If the attorney reasonably believes that the issuer has not 
made an appropriate response to the report or reports made pursuant 
to paragraph (b)(1), (b)(4), or (b)(5) of this section, or the 
attorney has not received a response in a reasonable time, the 
attorney shall:
    (i) Explain his or her reasons for so believing to the chief 
legal officer, chief executive officer, or directors to whom the 
attorney reported the evidence of a material violation pursuant to 
paragraph (b)(1), (b)(4), or (b)(5); and
    (ii) Take reasonable steps to document the response, or absence 
thereof, and to retain such documentation for a reasonable time.

    It should be truly extraordinary for an attorney reporting evidence 
of a material violation to receive an inappropriate response--one, for 
example, that simply asserted that the reported evidence is no cause 
for concern without any hint of evaluation or inquiry--or to receive no 
response at all within a reasonable time. Any attorney who believes 
that the response to evidence of a material violation is not 
appropriate or is unreasonably delayed is obligated to the client-
issuer to explain to the responsible officers or directors why he or 
she so believes. Where the attorney's explanation is unavailing and the 
attorney continues to believe that the issuer's response is not 
appropriate, that extraordinary event should be documented, and the 
attorney should retain that documentation for a reasonable time.\55\
---------------------------------------------------------------------------

    \55\ See Cheek Report at 28 (characterizing situations in which 
directors within a corporate client fail to act under such 
circumstances as ``extreme''); Thomas Riesenberg, Trying to Hear the 
Whistle Blowing: The Widely Misunderstood ``Illegal Act'' Reporting 
Requirements of Exchange Act Section 10A, 56 Business Lawyer 1417, 
1444-45 (2001) (noting that SEC received less than a dozen reports 
that an issuer had failed to take appropriate remedial action under 
Section 10A of the Securities Exchange Act of 1934, 15 U.S.C. 78j-1, 
in four years). Statements by Senators Edwards, Enzi, and Corzine in 
the floor debate regarding Section 307 of the Act indicate that they 
believed that an issuer's directors, once notified of evidence of a 
material violation, could be counted on to remedy it. E.g., 148 
Cong. Rec. S6552 (July 10, 2002) (statement of Sen. Edwards), S6555 
(statement of Sen. Enzi), S6556 (statement of Sen. Corzine). If that 
assumption is correct, Section 205.3(d) would never be applicable. 
But see Lincoln Savings & Loan Ass'n v. Wall, 743 F. Supp. 901, 910 
(D.D.C.1990) (Sporkin, J.) (finding that the directors of Lincoln 
Savings & Loan ``completely abdicated their duties to Lincoln'' by 
paying $94 million of Lincoln's assets to Lincoln's corporate 
parent, payments that the parent was ``under no circumstances'' 
entitled to and that ``led to a substantial dissipation of Lincoln's 
assets'').
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    Interested persons are invited to comment on any aspect of the 
rule, including: (1) Whether the ``reasonably believes'' standard is 
appropriate and, if not, what is an appropriate standard; (2) whether 
the rule should prescribe what is a ``reasonable time'' to permit the 
issuer to respond to a report; and (3) whether it is important to 
provide a ``safe harbor'' from civil suits for the attorney who reports 
evidence of a material violation under paragraph (b) or paragraph (c).
    Section 205.3(c) of the proposed rule would provide an alternative 
to the reporting requirements of paragraphs 205.3(b) and to 
requirements under 205.3(d) that become applicable where an attorney 
reporting evidence of a material violation under 205.3(b) does not 
receive an appropriate response:

    (c) Alternative reporting procedures for attorneys retained or 
employed by an issuer with a qualified legal compliance committee. 
(1) If, in appearing and practicing before the Commission in the 
representation of an issuer, an attorney becomes aware of evidence 
of a material violation by the issuer or by any officer, director, 
employee, or agent of the issuer, the attorney may, as an 
alternative to the reporting requirements of paragraph (b) of this 
section, report such evidence of a material violation to a qualified 
legal compliance committee, if the issuer has duly formed such a 
committee. Except as provided in paragraph (b)(3) of this section, 
an attorney who reports evidence of a material violation to a 
qualified legal compliance committee has satisfied his or her 
obligation to report evidence of a material violation within the 
issuer, is not required to assess the issuer's response to the 
reported evidence of a material violation, and is not

[[Page 71688]]

required to take any action under paragraph (d) of this section 
regarding the evidence of a material violation.
    (2) A chief legal officer (or the equivalent thereof) may refer 
a report of evidence of a material violation to a qualified legal 
compliance committee in lieu of causing an inquiry to be conducted 
under paragraph (b)(3) of this section. Thereafter, pursuant to the 
requirements under Sec.  205.2(j), the qualified legal compliance 
committee shall be responsible for responding to the evidence of a 
material violation reported to it under this paragraph (c) of this 
section.

    This alternative to the reporting requirements of paragraphs 
Sections 205.3(b) and (d) would allow, though not require, an attorney 
to seek expedited assessment of reported evidence of a material 
violation. It would also relieve the reporting attorney of any further 
obligation once he or she had reported such evidence to an issuer's 
QLCC. Such a provision may well encourage attorneys to report evidence 
of a material violation more promptly, since the reporting attorney 
would not have to worry that he or she might ultimately be obliged to 
decide whether the issuer's response was ``appropriate,'' and, if the 
attorney concluded the issuer's response was not appropriate, to go 
outside the issuer and provide notice of ``noisy withdrawal'' to the 
Commission. Junior attorneys employed by an issuer might be especially 
concerned about having to second-guess their superiors, and yet those 
junior attorneys might also be the first to find evidence of a material 
violation that the issuer would want to know about.
    The QLCC--itself a committee of the issuer's board of directors 
with special authority and special responsibility--is responsible for 
carrying out all the steps required by Section 307 of the Act: 
notifying the CLO of the report of evidence of a material violation 
(except where such notification would have been excused as futile under 
205.3(b)(5)); causing an investigation where appropriate; determining 
what remedial measures are appropriate where a material violation has 
occurred, is occurring, or is about to occur; reporting the results of 
the investigation to the CLO, the CEO, and the full board of directors; 
and notifying the Commission if the issuer fails in any material 
respect to take any of those appropriate remedial measures.
    More generally, the QLCC institutionalizes the process of reviewing 
reported evidence of a possible material violation. That would be a 
welcome development in itself.\56\ It may also produce broader 
synergistic benefits, such as heightening awareness of the importance 
of early reporting of possible material violations so that they can be 
prevented or stopped.
---------------------------------------------------------------------------

    \56\ See, e.g., Cheek Report at 37-41 (encouraging institutional 
changes providing for regular communications between a company's 
general counsel, outside counsel, and directors that would 
facilitate early disclosure of possible misconduct).
---------------------------------------------------------------------------

    Probably the most important respects in which Section 205.3(c) 
differs from Sections 205.3(b) and 205.3(d) taken together is that 
Section 205.3(c) relieves an attorney who has reported evidence of a 
material violation to a QLCC from any obligation ``to assess the 
issuer's response to the reported evidence of a material violation,'' 
to alert the Commission as to the material violations, or even to 
withdraw silently. If the issuer fails, in any material respect to take 
any remedial action that the QLCC has directed it to take, each member 
of the QLCC, as well as the CLO and the CEO, is individually 
responsible for notifying the Commission that a material violation has 
occurred, is occurring or is about to occur and for disaffirming any 
document submitted to or filed with the Commission by the issuer that 
the individual member considers false or materially misleading.
    Unlike Sections 205.3(b) and (d), Section 205.3(c) does not address 
a situation where an issuer's directors fail to stop, prevent, or 
rectify a material violation, or where it might be reasonable to 
consider an investigation unreasonably prolonged. On the other hand, 
Congress itself did not explicitly direct the Commission to address by 
rule what an attorney who had reported evidence of a material violation 
should do in the event that an issuer's directors did not respond 
appropriately. It might thus be argued that Section 205.3(c) of the 
proposed rule more accurately reflects Congressional intent than do 
Sections 205.3(b) and (d).
    Interested persons are invited to comment on any aspect of this 
section, including whether: (1) Section 205.3(c) better implements 
Congressional intent than do Sections 205.3(b) and (d) taken together; 
(2) Section 205.3(c) reasonably incorporates the two-step process for 
review of evidence of a material violation described in Section 307 of 
the Act; (3) Section 205.3(c) is a valuable alternative to Sections 
205.3(b) and (d), as it does not impose a requirement beyond reporting 
evidence of a material violation to an issuer's audit committee, a 
committee of independent directors, or its full board of directors; (4) 
Section 205.3(c) should specify circumstances under which an attorney 
may or should use that alternative and, if so, what would be 
appropriate circumstances; (5) Section 205.3(c) should indicate 
circumstances, if any, under which an attorney must not or should not 
use that alternative and, if so, what such circumstances should be; (6) 
an issuer's CLO should be able to make the same use of a QLCC as any 
other attorney employed by an issuer, with no obligation to assess the 
results of an investigation by outside attorneys who might be retained 
specifically to investigate evidence of a material violation; and (7) 
the QLCC alternative can be reasonably adapted to small issuers and, if 
so, how.
Notification to the Commission Where There Is No Appropriate Response
    Section 205.3(d) of the proposed rule would address the rare 
situation in which an attorney reasonably believes an issuer's 
directors have either made no response (within a reasonable time) to 
reported evidence of a material violation or have not made an 
appropriate response. That section of the proposed rule is broadly 
based on the ABA's Model Rules 1.13 and 1.16 and on Section 10A of the 
Exchange Act. It distinguishes between material violations that have 
already occurred and are not ongoing and material violations that are 
either ongoing or have not yet occurred and between outside attorneys 
retained by an issuer and in-house attorneys employed by an issuer.
    Section 205.3(d)(1) of the proposed rule would provide:

    (d) Notice to the Commission where there is no appropriate 
response within a reasonable time. (1) Where an attorney who has 
reported evidence of a material violation under paragraph 3(b) of 
this section rather than paragraph 3(c) of this section does not 
receive an appropriate response, or has not received a response in a 
reasonable time, to his or her report, and the attorney reasonably 
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:
    (i) An attorney retained by the issuer shall:
    (A) Withdraw forthwith from representing the issuer, indicating 
that the withdrawal is based on professional considerations;
    (B) Within one business day of withdrawing, give written notice 
to the Commission of the attorney's withdrawal, indicating that the 
withdrawal was based on professional considerations; and
    (C) Promptly disaffirm to the Commission any opinion, document, 
affirmation, representation, characterization, or the like in a 
document filed with or submitted to the Commission, or incorporated 
into such a document, that the attorney has prepared or assisted in 
preparing and that the attorney reasonably believes is or may be 
materially false or misleading;
    (ii) An attorney employed by the issuer shall:

[[Page 71689]]

    (A) Within one business day, notify the Commission in writing 
that he or she intends to disaffirm some opinion, document, 
affirmation, representation, characterization, or the like in a 
document filed with or submitted to the Commission, or incorporated 
into such a document, that the attorney has prepared or assisted in 
preparing and that the attorney reasonably believes is or may be 
materially false or misleading; and
    (B) Promptly disaffirm to the Commission, in writing, any such 
opinion, document, affirmation, representation, characterization, or 
the like; and
    (iii) The issuer's chief legal officer (or the equivalent) shall 
inform any attorney retained or employed to replace the attorney who 
has withdrawn that the previous attorney's withdrawal was based on 
professional considerations.

    Although such extreme situations should be rare, the proposed rule 
would probably be incomplete if it did not provide for them. Providing 
notification to the Commission, however, goes beyond what the Act 
expressly directed the Commission to do. The proposed rule, 
accordingly, sets a higher standard for notifying the Commission than 
for reporting ``up the ladder'' within the issuer. Paragraph (d)(1) 
addresses material violations that are ongoing or have yet to occur and 
distinguishes between in-house attorneys employed by an issuer and 
outside attorneys retained by the issuer. It requires the reporting 
attorney to take certain actions that paragraph (d)(2)--addressing past 
material violations that have no continuing effect--merely permits. 
Paragraph (d)(1), however, does not require even an outside attorney 
retained by the issuer to disclose evidence of the reported material 
violation, only to make a ``noisy withdrawal. ''\57\ An attorney would 
not be obligated to withdraw and notify the Commission unless paragraph 
(d)'s higher threshold is met.
---------------------------------------------------------------------------

    \57\ Senator Enzi stated in the floor debate over Section 307 of 
the Act that ``[t]he amendment [he] support[ed] would not require 
the attorneys to report violations to the SEC, only to corporate 
legal counsel or the CEO, and ultimately, to the board of 
directors.'' 148 Cong. Rec. S6555 (July 10, 2002). He was, however, 
contrasting the reporting requirement in what would be Section 
205.3(b) of the proposed rule with the reporting requirement in 
Section 10A(3) of the Exchange Act. As Senator Enzi explained, 
requiring an attorney to report evidence of a material violation 
first to senior officers of an issuer, and then, if they do not 
rectify the violation, to the board of directors, as Section 
205.3(b) would, is ``less onerous'' than Section 10A's requirement 
that an accountant must, as the Senator put it, ``report, both to 
the client's directors and simultaneously to the SEC, an[] illegal 
act if management fails to take remedial action.'' Id. (emphasis 
added). Senator Enzi nowhere suggested that an attorney representing 
an issuer should not be required (1) to withdraw in the unlikely and 
extreme event that the issuer's board of directors failed to prevent 
an ongoing material violation and (2) to notify the Commission that 
he had withdrawn for ``professional considerations.''
---------------------------------------------------------------------------

    The Commission is aware that the ABA is currently addressing the 
issues raised by this section and the Commission will be monitoring the 
progress of the ABA's efforts in assessing whether there is a need for 
the Commission's rule to reach this issue.
Outside Attorneys
    Where the material violation at issue is ongoing or has yet to 
occur, Section 205.3(d)(1) of the proposed rule would require an 
outside attorney appearing and practicing before the Commission in the 
representation of the issuer to give notice to the Commission of the 
issuer's inappropriate response to the reported evidence through the 
``signal'' or ``flag waving'' of ``noisy withdrawal'' that has long 
been recognized as a compromise between silent withdrawal and 
disclosure of specific confidential information.\58\ It requires that 
signal, however, only when the attorney actually believes that the 
material violation of which the attorney reported evidence is occurring 
or is about to occur and is, in addition, likely to result in 
substantial injury to the financial interest or property of the issuer 
or of investors.
---------------------------------------------------------------------------

    \58\ See Comment [14] to the ABA's Model Rule 1.6, Comment [3] 
to Model Rule 1.16, and the discussion of the history of the 
``signal'' of ``noisy withdrawal'' in Hazard, Rectification of 
Client Fraud, 33 Emory L.J. at 301-07. See also ABA Standing 
Committee on Ethics and Professional Responsibility, Formal Opinion 
92-366 (explaining that the ABA's Model Rules permit ``noisy'' 
withdrawal, which involves disavowing work product, only when the 
client's fraud is continuing or intended, not when it is past).
---------------------------------------------------------------------------

    That is, where the issuer's directors have responded 
inappropriately to evidence of a material violation that is ongoing or 
has yet to occur, and this additional threshold is met, an attorney 
retained by the issuer is required, under paragraph (d)(1)(i), to 
withdraw from representing the issuer, in all matters, ``forthwith.'' 
Within one business day after withdrawing, the attorney is required to 
notify the Commission that he or she has withdrawn and was required to 
do so for ``professional considerations.'' Use of the phrase 
``professional considerations'' to explain the withdrawal keeps 
confidential the particular facts underlying the withdrawal while 
signaling that the withdrawal reflects substantially more than a 
disagreement about the best legal strategy or a dispute over the cost 
of representation.\59\ A purely silent withdrawal would be likely to 
assist an issuer in carrying out an ongoing or intended violation.
---------------------------------------------------------------------------

    \59\ See Comment [2] to Model Rule 1.16, Comment [10] to Model 
Rule 1.2 and Comment [3] to Model Rule 4.1.
---------------------------------------------------------------------------

    Under these circumstances, the attorney retained by an issuer is 
also required, ``promptly,'' to disaffirm in writing to the Commission 
any opinion, document, affirmation, representation, characterization, 
or the like in a document filed with or submitted to the Commission, or 
incorporated into such a document, that the attorney has prepared or 
assisted in preparing and that the attorney reasonably believes is or 
may be materially false or misleading.
    The distinction between ``forthwith'' in 205.3(d)(i)(A), ``within 
one business day'' in 205.3(d)(i)(B), and ``promptly'' in 
205.3(d)(i)(C) recognizes that it may be impractical for an attorney to 
accomplish withdrawal, notification thereof, and disaffirmance of false 
or misleading statements in filings with or submissions to the 
Commission in a single day.
    The limited disclosure involved in the ``noisy withdrawal'' 
required by Section 205.3(d) should provide such a powerful incentive 
for an issuer to take actions appropriate to prevent or rectify a 
material violation that such ``noisy withdrawals'' should be rare. 
Requiring such ``noisy withdrawal'' appears appropriate to protect 
shareholders and investors, where the reported material violation 
appears likely to result in substantial financial injury to the issuer 
or investors, by effectively requiring an issuer's directors to act and 
by virtually ensuring an immediate inquiry by the Commission if they do 
not.
In-House Attorneys
    Even where the higher threshold under 205.3(d)(1) has been met and 
the material violation at issue is ongoing or has yet to occur, an 
attorney employed by the issuer is not required to resign. The in-house 
attorney is, however, required to notify the Commission that he or she 
intends to disaffirm an opinion or document within one business day of 
concluding that the issuer's response to the evidence reported by the 
attorney is inappropriate or unreasonably delayed, and is thereafter 
required to disaffirm in writing to the Commission any opinion, 
document, affirmation, representation, characterization, or the like in 
a document filed with or submitted to the Commission, or incorporated 
into such a document, that the attorney has prepared or assisted in 
preparing and that the attorney reasonably believes is or may be 
materially false or misleading. If the in-house attorney has not 
prepared or assisted in preparing any such submission or filing, the 
in-house attorney is not required to notify the

[[Page 71690]]

Commission. Requiring an in-house attorney employed by the issuer to 
resign when that attorney receives an inappropriate response to the 
attorney's reported evidence of an ongoing or impending material 
violation appears to be unreasonably harsh.
Notice to Successor Attorneys
    Paragraph (d)(1)(iii) of this section would require the issuer to 
notify any attorneys retained or employed to replace the attorney who 
has withdrawn that the previous attorney withdrew based on professional 
considerations. The purpose of this paragraph is to avoid a situation 
in which successor attorneys are unaware that the previous attorney 
waved a red flag in withdrawing. Under such circumstances, an issuer 
engaged in fraud may shift work previously done by outside attorneys to 
its own in-house legal staff, over which it has more control, and it 
may take the successor attorneys some time to become aware of the 
evidence of material violations that led the previous attorneys to 
withdraw.\60\ To provide substantial assurance that successor attorneys 
will be alerted to a potential material violation, the proposed 
paragraph (d)(1)(iii) would require the issuer's chief legal officer to 
inform any attorney retained or employed to replace the attorney who 
has withdrawn that the previous attorney's withdrawal was based on 
professional considerations.\61\ Proposed paragraph (d)(2)(iii) would 
impose the same obligation on the issuer's chief legal officer where an 
attorney has chosen to withdraw based on professional considerations 
regarding the issuer's response to evidence of a past material 
violation.
---------------------------------------------------------------------------

    \60\ When the law firm representing O.P.M. Leasing Services 
finally withdrew because of O.P.M.''s continuing fraud, after being 
informed by the attorney for the head of O.P.M.''s in-house 
accounting department that O.P.M. ``could not survive without 
continuing wrongdoing,'' the law firm agreed to characterize its 
withdrawal as a ``mutual determination'' to terminate the 
relationship. Report of the Trustee Concerning Fraud and Other 
Misconduct in the Management of the Affairs of the Debtor at 33-35, 
In re O.P.M. Leasing Services, Inc., Reorg. No. 81-B-10533, (Bankr. 
S.D.N.Y., filed April 25, 1983). As the law firm anticipated, O.P.M. 
retained replacement outside counsel and relied more heavily on its 
in-house legal staff, but neither the new CLO or the new outside 
counsel had any inkling of the reasons for the previous attorneys' 
withdrawal. Id. at 405-06, 411-13, 417-188. Those successor 
attorneys, in-house and outside, handled over $15 million in 
fraudulent transactions in last months of 1981, after O.P.M.''s 
original law firm withdrew. Id. at 405, 408.
    \61\ Both O.P.M.''s new outside law firm and its new chief legal 
officer wanted to know why the previous law firm had withdrawn. 
O.P.M. told both its new outside law firm and its new CLO that it 
had agreed not to discuss the reasons for the withdrawal but 
nevertheless led both to believe that it was the previous law firm's 
reputation that would be damaged by discussion because the parting 
of the ways had resulted from the law firm's exorbitant fees and its 
inability (because it was too small) to handle the ``peaks and 
valleys'' of work for O.P.M. Id. at 413, 418.
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Past Material Violations
    Section 205.3(d)(2) of the proposed rule would provide for 
situations in which the reported material violation has already 
occurred and is not ongoing. Here too, the threshold for action by the 
attorney is higher than for reporting ``up the ladder'' within the 
issuer and corresponds to the higher threshold in 205.3(d)(1):

    (2) Where an attorney who has reported evidence of a material 
violation under paragraph (b) rather than paragraph (c) of this 
section does not receive an appropriate response, or has not 
received a response in a reasonable time, to his or her report under 
paragraph (b) of this section, and the attorney 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 investors but is not ongoing:
    (i) An attorney retained by the issuer may:
    (A) Withdraw forthwith from representing the issuer, indicating 
that the withdrawal was based on professional considerations;
    (B) Give written notice to the Commission of the attorney's 
withdrawal, indicating that the withdrawal was based on professional 
considerations; and
    (C) Disaffirm to the Commission, in writing, any opinion, 
document, affirmation, representation, characterization, or the like 
in a document filed with or submitted to the Commission, or 
incorporated into such a document, that the attorney has prepared or 
assisted in preparing and that the attorney reasonably believes is 
or may be materially false or misleading; and
    (ii) An attorney employed by the issuer may:
    (A) Notify the Commission in writing that he or she intends to 
disaffirm some opinion, document, affirmation, representation, 
characterization, or the like in a document filed with or submitted 
to the Commission, or incorporated into such a document, that the 
attorney has prepared or assisted in preparing and that the attorney 
reasonably believes is or may be materially false or misleading; and
    (B) Disaffirm to the Commission, in writing, any such opinion, 
document, affirmation, representation, characterization, or the 
like; and
    (iii) The issuer's chief legal officer (or the equivalent) shall 
inform any attorney retained or employed to replace the attorney who 
has so withdrawn that the previous attorney's withdrawal was based 
on professional considerations.

    If the material violation at issue has already occurred and is not 
ongoing, the actions required of the attorney are more limited than if 
the violation is ongoing or has yet to occur. Under the proposed rule, 
an ongoing violation includes an inaccurate disclosure in a filing with 
or submission to the Commission that has not been corrected and may be 
relied on by investors. If the past material violation at issue has 
already occurred and is not ongoing and is likely to have resulted in 
substantial financial injury to the issuer, Section 205.3(d)(2)(ii) of 
the proposed rule would allow, but not require, the reporting attorney 
to withdraw, notify the Commission, and disaffirm false or misleading 
filings or submissions the attorney has prepared or assisted in 
preparing. The attorney's silence, under those circumstances, would not 
assist the violation. To the extent investors may continue to rely upon 
false or misleading statements in earlier filings or submissions, which 
have not been disaffirmed, the material violation would be ongoing and 
Section 205.3(d)(1) would apply.
    The Commission once again distinguishes between the obligations of 
outside attorneys retained by an issuer and in-house attorneys employed 
by an issuer because it believes that in-house attorneys, as a 
practical matter, have less freedom of action than outside attorneys 
and that requiring an attorney to resign is more severe than requiring 
an attorney to withdraw from a particular representation.
    Paragraph (d)(3) restates what is largely settled law:

    (3) The notification to the Commission prescribed by this 
paragraph (d) does not breach the attorney-client privilege.

    ``Noisy withdrawal'' signals that something is wrong without 
revealing any privileged communication between attorney and client.\62\ 
``Noisy withdrawal'' under Section 205.3(d), moreover, presupposes that 
the attorney actually believes that the material violation of which the 
attorney reported evidence has occurred, is occurring, or is about to 
occur and, in addition, likely resulted or will result in substantial 
injury to the financial interest of the issuer or of investors. Under 
such circumstances, nearly forty states, adopting the 1981 
recommendation of the Kutak Commission, permit disclosure of 
confidential information to the extent an attorney reasonably believes 
necessary to prevent a criminal or fraudulent act or to rectify the

[[Page 71691]]

consequences of a criminal or fraudulent act in which the attorney's 
services were used.\63\ The Commission's proposed rule would make clear 
that the attorney thus does not violate the attorney-client privilege 
in making the disclosures at issue here. Moreover, the attorney is not 
acting as the issuer's agent and accordingly also does not waive the 
issuer's attorney-client privilege in the information disclosed or any 
other privilege or protection that the issuer is entitled to assert 
regarding that information.\64\ These disclosures should in most cases 
also be covered by the whistleblower protections of 18 U.S.C. 1514A.
---------------------------------------------------------------------------

    \62\ See Comment [14] to the ABA's Model Rule 1.6, Comment [3] 
to Model Rule 1.16, and the discussion of the history of the 
``signal'' of ``noisy withdrawal'' in Hazard, Rectification of 
Client Fraud, 33 Emory L.J. at 301-07. But see ABA Standing 
Committee on Ethics and Professional Responsibility, Formal Opinion 
92-366 (explaining that the ABA's Model Rules permit ``noisy'' 
withdrawal, which involves disavowing work product, only when the 
client's fraud is continuing or intended, not when it is past).
    \63\ See Kutak Commission's Final Draft of the Model Rules of 
Professional Conduct, Rule 1.6 and related discussion of 
``Disclosure Adverse to Client''; Thomas D. Morgan & Ronald D. 
Rotunda, Model Code of Professional Responsibility, Model Rules of 
Professional Conduct, and Other Selected Standards (2001), at 146 
(stating that 41 states either permit or require disclosure to 
prevent criminal fraud; 18 either permit or require disclosure to 
rectify prior criminal fraud in which the attorney's services were 
used; and 40 require disclosure to rectify a prior fraud on a 
tribunal).
    \64\ See, e.g., Restatement (Third) of the Law Governing Lawyers 
(2000) Section 67 and comment c.
---------------------------------------------------------------------------

    Interested persons are invited to comment on any aspect of Section 
205.3(d)(1)-(3), including:
    (1) Whether the proposed rule should include any provision 
permitting or requiring notification to the Commission when an attorney 
receives an inappropriate response or whether this is a matter best 
left to the ABA or state bar associations;
    (2) Whether a higher standard should apply to notification to the 
Commission than to reporting ``up the ladder'' within the issuer and, 
if so, how much higher it should be;
    (3) Whether ``noisy withdrawal'' should be mandatory under some 
circumstances but permissive under others and, if so, what 
circumstances should make ``noisy withdrawal'' mandatory and what 
circumstances should make ``noisy withdrawal'' permissive, or whether 
``noisy withdrawal'' should be mandatory under all circumstances 
covered by Section 205.3(d) or should be permissive under all such 
circumstances;
    (4) Whether it is appropriate to distinguish between material 
violations that are ongoing or impending and material violations that 
are past and have no continuing effect;
    (5) Whether a distinction between material violations that are 
ongoing or impending and material violations that are past and have no 
continuing effect is meaningful regarding investors;
    (6) Whether the attorney who has reported evidence of a material 
violation to which the issuer has not made an appropriate response must 
know that the reported material violation has occurred, is occurring, 
or is about to occur before the attorney is required, or allowed, to 
make a ``noisy withdrawal'';
    (7) Whether an attorney should be required, or permitted, to make a 
``noisy withdrawal'' where the attorney has not received an appropriate 
response to reported evidence of a material violation, and the attorney 
reasonably believes that the reported material violation has occurred, 
is occurring, or is about to occur;
    (8) Whether there is a sufficient basis for a ``noisy withdrawal,'' 
under those circumstances, where the attorney believes that the 
reported material violation is likely to have occurred, to be 
occurring, or to be about to occur;
    (9) Whether there is a sufficient basis for a ``noisy withdrawal,'' 
under those circumstances, where the attorney believes that the 
reported material violation may have occurred, may be occurring, or may 
be about to occur;
    (10) Whether substantial injury to the financial interest of 
investors is an appropriate prerequisite to a ``noisy withdrawal'';
    (11) Whether substantial injury to the financial interest of the 
issuer-client is an appropriate prerequisite to a ``noisy withdrawal'' 
and, if so, whether such substantial injury to a financial interest 
must be certain, or likely, or merely possible;
    (12) Whether the rule should distinguish between outside attorneys 
and those employed by the issuer and, if so, under what circumstances, 
how, and why;
    (13) Whether an attorney who is employed by an investment adviser 
and who is appearing and practicing before the Commission in the 
representation of the investment company should be treated as an 
outside attorney retained by the investment company under paragraph 
(d)(1)(i) or should be treated as an in-house attorney under paragraph 
(d)(1)(ii);
    (14) Whether the rule should distinguish between United States and 
foreign attorneys;
    (15) Whether the rule should specify the content of a disaffirmance 
of an opinion or representation;
    (16) Whether the rule should require that any disaffirmance be in 
writing;
    (17) Whether there are any actions the rule should require an 
attorney to take when the attorney does not receive an appropriate 
response to his or her report of evidence of a material violation and, 
if so, which and why;
    (18) Whether it would be reasonable to require an attorney making a 
``noisy withdrawal'' to take all required steps within one business 
day;
    (19) Whether it is important to require any successor attorney to 
be notified that the previous attorney withdrew based on ``professional 
considerations'' and, if so, whether there is a better way to require 
such notification be made than is proposed in paragraph (d)(1)(iii);
    (20) Whether such notification should be required where ``noisy 
withdrawal'' is merely permissive; and
    (21) Whether it is important to provide a ``safe harbor'' from 
civil suits for the attorney who notifies the Commission that he or she 
has withdrawn based on professional considerations under paragraph (d).
Discharge of an Attorney for Reporting a Material Violation
    Section 205.3(d)(4) of the proposed rule addresses the situation 
where an issuer attempts to obstruct the proposed rule's notification 
requirements by discharging an attorney after the attorney had reported 
evidence of a material violation under 205.3(b) but before the attorney 
was obligated to notify the Commission under 205.3(d)(1) or allowed to 
do so under 205.3(d)(2). Under such circumstances, paragraph (d)(4) 
permits but does not require an attorney who reasonably believes he or 
she has been discharged for reporting evidence of a material violation 
to notify the Commission:

    (4) An attorney formerly employed or retained by an issuer who 
has reported evidence of a material violation under this section and 
reasonably believes that he or she has been discharged for so doing 
may notify the Commission that he or she believes that he or she has 
been discharged for reporting evidence of a material violation under 
this section and may disaffirm in writing to the Commission any 
opinion, document, affirmation, representation, characterization, or 
the like in a document filed with or submitted to the Commission, or 
incorporated into such a document, that the attorney has prepared or 
assisted in preparing and that the attorney reasonably believes is 
or may be materially false or misleading.
    The Commission was prompted to add this provision to Section 205.3 
by a decision of the Board of Governors of the Florida Bar Association 
in August 2002, holding, by a vote of 22-15, that a Florida attorney 
who had been discharged by a large corporation could not report his 
concerns about improper accounting to the SEC.\65\ The attorney

[[Page 71692]]

believed that the profits of the corporation he worked for had been 
inflated by several million dollars, preventing a slump in the price of 
its publicly-traded stock, when the company amortized over several 
years an expense that should have been recognized immediately. After 
taking his concerns to the company's ``top executives''--in effect 
reporting evidence of a material violation ``up the ladder'' as in 
proposed Section 205.3(b)--the attorney was fired. The Ethics 
Department of the Florida Bar decided that the attorney was prohibited 
from revealing confidential information about these improper accounting 
practices because it viewed them as past misconduct by a company that 
the attorney had learned about in connection with his prior 
representation of that company (even though the past misconduct had an 
ongoing effect). The Professional Ethics Committee agreed with the 
Ethics Department. The Board Review Committee on Professional Ethics 
voted 4-1 to endorse that opinion (because the continuing crime could 
not be disclosed without also disclosing the past crime). And the Board 
of Governors voted to bar disclosure.
---------------------------------------------------------------------------

    \65\ Gary Blankenship, May Lawyers Report Past Corporate 
Misconduct?, Florida Bar News, September 15, 2002, at 1. From the 
reported decision, it is not clear that the Florida attorney would 
be covered by the proposed rule, because it is not clear that the 
Florida attorney was appearing and practicing before the Commission.
---------------------------------------------------------------------------

    There is no reason to think such a scenario would not recur. Almost 
twenty years ago, the Reporter for the ABA's Kutak Commission wrote 
that ``an innocent lawyer--however competent and however watchful--is 
inevitably at risk in any transaction where the client could commit 
fraud.'' \66\
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    \66\ Hazard, Rectification of Client Fraud, 33 Emory L.J. at 
283-84. Section 806 of the Act foresaw that employees of an issuer 
might be discharged for providing information, or causing 
information to be provided, regarding fraudulent misconduct by an 
issuer's employees or agents and sought to protect such a discharged 
employee by adding 18 U.S.C. 1514A to provide for a civil action to 
obtain relief.
---------------------------------------------------------------------------

    Interested persons are invited to comment on any aspect of this 
section of the rule, including: (1) Whether the reporting attorney's 
reasonable belief that he or she has been discharged for making a 
report is an appropriate standard and, if not, what alternative 
standard would be more appropriate; (2) Whether the permissive 
disclosure to the Commission should be limited to ongoing or future 
violations or should extend to past violations.
Disclosure of Issuer Confidences
    Section 205.3(e) would allow an attorney to disclose, under 
specified circumstances, confidential information related to his 
appearing and practicing before the Commission in the representation of 
an issuer. Paragraph (e)(1) would provide:

    (e) Issuer confidences. (1) Any report under this section (or 
the contemporaneous record thereof) or any response thereto (or the 
contemporaneous record thereof), may be used by an attorney in 
connection with any investigation, proceeding, or litigation in 
which the attorney's compliance with this part is in issue.

    Paragraph (e)(1) would make clear that an attorney may use the 
contemporaneous records required by Sections 205.3(b) and 205.4(d) to 
defend himself or herself against charges of misconduct. It is 
effectively equivalent to the ABA's present Model Rule 1.6(b)(3), and 
corresponding ``self-defense'' exceptions to client-confidentiality 
rules in every state. The Commission believes that it is important to 
make clear in its proposed rule that the contemporaneous records that 
the rule would require attorneys to prepare can be used to protect 
honest attorneys, and are meant to be so used.
    Interested persons are invited to comment on any aspect of this 
section, including whether: (1) The rule should have a provision 
allowing the attorney to use documents generated under this rule in 
self-defense; and (2) the types of proceedings in which the documents 
may be used should be expanded or limited and, if so, why and in what 
way.
    Paragraph (e)(2) would provide:

    (2) An attorney appearing and practicing before the Commission 
in the representation of an issuer may reveal to the Commission, 
without the issuer's consent, confidential information related to 
the representation to the extent the attorney reasonably believes 
necessary:
    (i) To prevent the issuer from committing an illegal act that 
the attorney reasonably believes is likely to result in substantial 
injury to the financial interest or property of the issuer or 
investors;
    (ii) To prevent the issuer from committing an illegal act that 
the attorney reasonably believes is likely to perpetrate a fraud 
upon the Commission; or
    (iii) To rectify the consequences of the issuer's illegal act in 
the furtherance of which the attorney's services had been used.

    Paragraph (e)(2) corresponds to the ABA's Model Rule 1.6 as 
proposed by the ABA's Kutak Commission in 1981-1982 \67\ and by the 
ABA's Commission of Evaluation of the Rules of Professional Conduct 
(``Ethics 2000 Commission'') in 2000,\68\ and as adopted in the vast 
majority of states.\69\ It would provide additional protection for 
investors by allowing, though not requiring, an attorney to disclose 
confidential information relating to his appearing and practicing 
before the Commission in the representation of an issuer ``to the 
extent the attorney reasonably believes necessary (1) 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; (2) to prevent the 
issuer from committing an illegal act that the lawyer reasonably 
believes is likely to perpetrate a fraud upon the Commission; or (3) to 
rectify the consequences of the issuer's illegal act in the furtherance 
of which the attorney's services were used.
---------------------------------------------------------------------------

    \67\ Final Draft: Model Rules of Professional Conduct, pullout 
supplement to the November 1982 issue of the American Bar 
Association Journal, proposed a version of Model Rule 1.6(b)--
ultimately rejected by the House of Delegates--providing that a 
lawyer may reveal confidential information relating to the 
representation of a client ``to the extent the lawyer reasonably 
believes necessary:
    (1) to prevent the client from committing a criminal or 
fraudulent act that the lawyer reasonably believes is likely to 
result in * * * substantial injury to the financial interests or 
property of another;
    (2) to rectify the consequences of a client's criminal or 
fraudulent act in the furtherance of which the lawyer's services had 
been used. * * * '' Law Governing Lawyers (2000) section 67 and 
comment c.
    \68\ Report of the Commission on Evaluation of the Rules of 
Professional Conduct (November 2000) recommended permitting a lawyer 
to disclose confidential ``information relating to the 
representation of a client to the extent the lawyer reasonably 
believes necessary * * * to prevent the client from committing a 
crime or fraud that is reasonably certain to result in substantial 
injury to the financial interests or property of another and in 
furtherance of which the client has used or is using the lawyer's 
services.''
    \69\ Thirty-seven states permit an attorney to reveal 
confidential client information in order to prevent the client from 
committing criminal fraud. See Restatement (Third) of the Law 
Governing Lawyers (2000) section 67, Comment f, and Thomas D. Morgan 
& Ronald D. Rotunda, Model Code of Professional Responsibility, 
Model Rules of Professional Conduct, and Other Selected Standards, 
at 146 (reproducing the table prepared by the Attorneys' Liability 
Assurance Society (``ALAS'') cited in the Restatement). The ABA's 
Model Rule 1.6, which prohibits disclosure of confidential client 
information even to prevent a criminal fraud, is a minority rule. In 
its Carter and Johnson decision (1981 WL 384414 at n.78), the 
Commission expressly did not address an attorney's obligation to 
disclose a client's intention to commit fraud or an illegal act.
---------------------------------------------------------------------------

    New Jersey's Rule of Professional Conduct 1.6(b) requires an 
attorney to reveal confidential ``information relating to the 
representation of a client''

to the proper authorities, as soon as, and to the extent the lawyer 
reasonably believes necessary, to prevent the client:

    (1) From committing a criminal, illegal or fraudulent act that 
the lawyer reasonably believes is likely to result in * * * 
substantial injury to the financial interest or property of another;
    (2) From committing a criminal, illegal or fraudulent act that 
the lawyer reasonably

[[Page 71693]]

believes is likely to perpetrate a fraud upon a tribunal.

(Emphasis added.) The corresponding rule in Wisconsin is virtually 
identical to New Jersey's, though it makes no reference to ``proper 
authorities.''\70\ Florida's Rule of Professional Conduct 4-1.6 
requires a lawyer to reveal confidential information ``to the extent 
the lawyer reasonably believes necessary * * * to prevent a client from 
committing a crime.''\71\
---------------------------------------------------------------------------

    \70\ Wisconsin Supreme Court Rule 20:1.6 (available at http://www.courts.state.wi.us/supreme/sc_rules.asp).
    \71\ Available at http://www.flabar.org/ under ``Regulation.''
---------------------------------------------------------------------------

    The ABA's Cheek Task Force recommended making such disclosures 
mandatory in 2002.\72\ Even the ABA's Canons of Professional Ethics, in 
effect until 1970, provided in Canon 37:
---------------------------------------------------------------------------

    \72\ The Kutak Commission and the Ethics 2000 Commission, in 
their proposed versions of Rule 1.6(b)(2), both recommended 
permitting a lawyer to disclose confidential information to 
outsiders under similar circumstances. The Kutak Commission 
recommended permitting an attorney to reveal confidential 
information relating to representation of a client where New Jersey 
and Wisconsin require disclosure. The Ethics 2000 Commission 
recommended permitting disclosure ``to the extent the lawyer 
reasonably believes necessary . . . to prevent the client from 
committing a crime or fraud that is reasonably certain to result in 
substantial injury to the financial interests or property of another 
and in furtherance of which the client has used or is using the 
lawyer's services.'' The Ethics 2000 Commission considered the ABA's 
Model Rule 1.6 to be ``out of step with public policy and the values 
of the legal profession as reflected in the rules currently in force 
in most jurisdictions.'' Reporter's Explanation of Changes.

    The announced intention of a client to commit a crime is not 
included within the confidences [a lawyer] is bound to respect. He 
may properly make such disclosures as may be necessary to prevent 
---------------------------------------------------------------------------
the act or protect those against whom it is threatened;

and in Canon 41:

    When a lawyer discovers that some fraud or deception has been 
practiced, which has unjustly imposed upon the court or a party, he 
should endeavor to rectify it; at first by advising his client, and 
if his client refuses to forego the advantage thus unjustly gained, 
he should promptly inform the injured person or his counsel, so that 
they may take appropriate steps.\73\
---------------------------------------------------------------------------

    \73\ Reprinted in Morgan & Rotunda, Selected Standards, at 811-
12.

    The ``noisy withdrawal'' provision in Section 205.3(d) probably 
makes permissive disclosure of confidential information under the 
circumstances in Section 205.3(e) sufficient to protect investors.
    Moreover, the rules requiring disclosure in New Jersey, Wisconsin, 
and Florida raise a question about ``conflicts'' between such states' 
rules and the permissive disclosure provisions in the proposed rule. So 
do the rules forbidding disclosure in jurisdictions such as the 
District of Columbia.
    In theory, an attorney could simultaneously comply with the 
Commission's proposed rule permitting disclosure of confidential 
information and a state's rule forbidding disclosure by not disclosing 
the information, just as an attorney could simultaneously comply with 
the Commission's proposed rule permitting disclosure of confidential 
information and a state's rule requiring disclosure by disclosing the 
information. However, a Commission rule permitting disclosure would 
appear to preempt a state's rule forbidding disclosure. Accordingly, an 
attorney appearing and practicing before the Commission who is admitted 
in a jurisdiction that forbids disclosure of confidential information 
under circumstances where the proposed rule would permit disclosure, 
may disclose the information to the Commission, notwithstanding the 
contrary state rule.
    A different case exists when a state rule requires disclosure in a 
case where the proposed rule would merely allow it. In such a case 
there will likely be no conflict between the Commission rule and the 
state rule, and the attorney should thus be bound by the state rule 
requiring disclosure.\74\ The Commission, however, invites comments on 
whether an attorney appearing and practicing before the Commission and 
admitted in a jurisdiction that requires disclosure of confidential 
information under circumstances where the proposed rule would merely 
permit disclosure is required to disclose the information to the 
Commission.
---------------------------------------------------------------------------

    \74\ See the general discussion of preemption under Section 
205.6 below.
---------------------------------------------------------------------------

    Paragraph 205.3(e)(2)(ii) permits an attorney to reveal client 
information to the Commission to the extent the attorney reasonably 
believes necessary to prevent an issuer from committing ``an illegal 
act'' likely to ``perpetrate a fraud'' upon the Commission. The term 
``illegal acts'' in this paragraph refers to acts proscribed in 18 
U.S.C. 1001, as well the commission and subornation of perjury 
(proscribed, respectively, in 18 U.S.C. 1621 and 1622). The term 
``perpetrate a fraud'' in this paragraph is intended to cover conduct 
involving the knowing misrepresentation of a material fact to, or the 
concealment of a material fact from, the Commission with the intent to 
induce the Commission to take, or not to take, a particular action. 
Therefore, this paragraph would not apply to filings or submissions to 
the Commission which satisfy a general requirement imposed upon issuers 
by the Commission (e.g., 10-K or 10-Q filings). Rather, this paragraph 
is intended to apply to more specific submissions or contacts with the 
Commission by issuers which attempt to persuade the Commission to take, 
or not to take, particular actions, including, among other things, 
Wells submissions, applications for relief, and requests for ``no 
action'' letters.
    Interested persons are invited to comment on any aspect of this 
section, including whether: (1) The rule should permit an attorney to 
disclose client confidences in any circumstances or only in some, or 
all, of the instances in the proposed rule; (2) the Commission should 
delay any action on this section until the ABA has had an opportunity 
to determine its position on Model Rule 1.6 in connection with its 
current reconsideration of the Ethics 2000 proposal; (3) an attorney 
should be permitted to act under (e)(2)(i) to prevent other misconduct 
besides that which is ``illegal'; (4) ``substantial injury to the 
financial interest or property'' is an appropriate standard and, if 
not, what is an appropriate standard; (5) the rule should be limited to 
instances where only the issuer may be financially harmed; (6) the rule 
should specify when and in what way an attorney may rely upon the rule 
``to rectify'' the consequences of an illegal act; and (7) the rule 
should provide that disclosures to the Commission under this section 
are protected by the whistleblower provisions of 18 U.S.C. 1514A, added 
by the Act.
    Paragraph (e)(3) would provide:
    (3) Where an issuer, through its attorney, shares with the 
Commission, pursuant to a confidentiality agreement, information 
related to a material violation, such sharing of information shall not 
constitute a waiver of any otherwise applicable privilege or protection 
as to other persons.
    This paragraph would set forth the Commission's position on an 
unsettled question: whether an issuer waives attorney-client privilege 
and/or other protection (such as work-product protection) by sharing 
with the Commission, pursuant to a confidentiality agreement, 
confidential information regarding misconduct by the issuer's employees 
or officers? \75\
---------------------------------------------------------------------------

    \75\ See In re Columbia/HCA Healthcare Corp. Billing Practices 
Litigation, 293 F.3d 289, 294-95 (case law on selective waiver of 
attorney-client privilege ``in a state of hopeless confusion'') 
(citation and internal quotation marks omitted), 304-05 (work-
product protection may survive where attorney-client privilege has 
been waived) (Moore & Russell, JJ.), 307-08 (case law both limited 
and conflicting, with circuit courts of appeals ``deeply split on 
whether a disclosure of privileged information to the government, in 
the course of an investigation, waives the privilege as to all other 
parties'') (Boggs, J., dissenting) (6th Cir. 2002); Saito v. 
McKesson HBOC, Inc., No. 18553, 2002 WL 31458233, at *6-*11 
(adopting a selective waiver rule for disclosures made to law 
enforcement agencies pursuant to a confidentiality agreement because 
such a rule ``encourages cooperation with law enforcement agencies 
without any negative cost to society or to private plaintiffs'') 
(Del. Ch. Oct. 25, 2002).

---------------------------------------------------------------------------

[[Page 71694]]

    Allowing issuers to produce internal reports to the Commission--
including, but not limited to, those prepared in response to reports 
under 205.3(b)--without waiving otherwise applicable privilege or 
protection serves the public interest because it significantly enhances 
the Commission's ability to conduct expeditious investigations and 
obtain prompt relief, where appropriate, for defrauded investors.\76\ 
Even cooperative issuers are generally reluctant to produce internal 
reports to the Commission for fear that production will waive otherwise 
applicable privilege or protection as to third parties. Some parties to 
Commission investigations, however, have produced otherwise privileged 
or protected reports where they believe only the government--and not 
adversaries in private litigation--will have access to them.
---------------------------------------------------------------------------

    \76\ See, e.g., amicus briefs filed by the Commission during the 
last two years in Saito v. McKesson HBOC, Inc., No. 18553 (Del. 
Ch.); United States v. Bergonzi & Gilbertson, No. CR-00-05050MJJ 
(N.D. Cal.); Adler v. McKesson HBOC, Inc., No. 99-C-7980-3 (Gwinnett 
County, Georgia) (S-01-347-GC); McKesson HBOC, Inc. v. Adler, No. 
A01A1836 (Ga. Ct. App.) (all arguing that sharing with the 
Commission, pursuant to confidentiality agreements, reports of 
internal investigations by outside lawyers does not waive work-
product protection). In these briefs, the Commission has taken no 
position on selective waiver of the attorney-client privilege.
---------------------------------------------------------------------------

    Obtaining such otherwise privileged or protected reports furthers 
the public interest--and does not circumvent courts' rejection of the 
selective waiver doctrine--because the Commission enters into 
confidentiality agreements only when it has reason to believe that 
obtaining the reports will allow the Commission to save substantial 
time and resources in conducting investigations and/or provide more 
prompt monetary relief to investors.\77\ Limiting those instances where 
producing documents to the Commission will not waive privilege or 
protection to circumstances where the Commission enters into a 
confidentiality agreement, as the proposed rule would, should curtail 
any abuse of this provision by issuers, because the Commission intends 
to abide by its current practice of entering into confidentiality 
agreements only when it is in the public interest to do so.
---------------------------------------------------------------------------

    \77\ Cf. SEC v. Jerry T. O'Brien, Inc., 467 U.S. 735, 745-46, 
750-51 (1984) (recognizing the importance of speed in the 
Commission's enforcement of the securities laws).
---------------------------------------------------------------------------

    Although the Commission must verify that internal reports are 
accurate and complete and must conduct its own investigation, doing so 
is far less time-consuming and less difficult than starting and 
conducting investigations without the internal reports. When the 
Commission can conduct expeditious and efficient investigations, it can 
then obtain appropriate remedies for investors more quickly. The public 
interest is clearly served when the Commission can promptly identify 
illegal conduct and provide compensation to victims of securities 
fraud.\78\
---------------------------------------------------------------------------

    \78\ In one case, the Commission subpoenaed over forty boxes of 
documents related to a complex scheme that had defrauded investors. 
Through a confidentiality agreement, it also obtained notes and 
interview memoranda from an internal investigation that had cost the 
company over $9 million, and Commission staff benefitted from 
presentations by the internal investigators that explained the 
scheme and helped the staff understand the subpoenaed materials more 
quickly. That otherwise protected work product allowed the 
Commission to file civil enforcement actions and obtain disgorgement 
of millions of dollars (ultimately distributed to investors and 
other injured parties) sooner than it otherwise could have.
---------------------------------------------------------------------------

    Moreover, preserving the privilege or protection for internal 
reports shared with the Commission does not harm private litigants or 
put them at any kind of strategic disadvantage. At worst, private 
litigants would be in exactly the same position that they would have 
been in if the Commission had not obtained the privileged or protected 
materials.\79\ Private litigants may even benefit from the Commission's 
ability to conduct more expeditious and thorough investigations. 
Indeed, many private securities actions follow the successful 
completion of a Commission investigation and enforcement action. 
``Without the exception, much otherwise disclosed material would stay 
completely in the dark, under the absolute cover of privilege.'' 
Columbia/HCA, 293 F.3d at 312 (Boggs, J., dissenting). Consequently, 
allowing the Commission access to otherwise privileged and inaccessible 
internal reports but denying access to others would not be unfair to 
private litigants but is appropriate in the public interest and for the 
protection of investors.
---------------------------------------------------------------------------

    \79\ See Westinghouse Electric Corp. v. Republic of the 
Philippines, 951 F.2d 1414, 1426 (3d Cir. 1991) (refusing to adopt 
the rationale that ``it is inherently unfair for a party to 
selectively disclose privileged information in one proceeding but 
not another'' when rejecting the selective waiver theory because 
``when a client discloses privileged information to a government 
agency, the private litigant in subsequent proceedings is no worse 
off than it would have been had the disclosure to the agency not 
occurred'').
---------------------------------------------------------------------------

    These arguments apply with special force to internal reports and 
responses to them that the Commission would require under the proposed 
rule.
    The Commission believes that Congress authorized it to adopt a 
regulation providing for such an exception, by directing the Commission 
to ``promulgate such rules and regulations, as may be necessary or 
appropriate in the public interest or for the protection of investors, 
and in furtherance of this Act''--as the Commission believes such an 
exception is. Moreover, such a rule would be consistent with the 
confidentiality provisions that Congress itself enacted regarding 
investigations by the Public Company Accounting Oversight Board (the 
``Board'') in Section 105 of the Act, 15 U.S.C. 7215.
    Section 105(b)(1) of the Act authorizes the Board to ``conduct an 
investigation of any act or practice, or omission to act, by a 
registered public accounting firm * * * regardless of how the act, 
practice, or omission is brought to the attention of the Board.'' 
Section 105(b)(5)(A) of the Act further provides that documents and 
information ``received by * * * the Board * * * shall be confidential 
and privileged'' until the documents or information are used in a 
public proceeding. Section 105(b)(5)(B) of the Act provides that 
documents and information received by the Board continue to be 
confidential and privileged, even if the Board shares them with the 
Commission--and even if the Board discloses them to the Attorney 
General of the United States, an appropriate Federal regulator, state 
attorneys general, or any ``appropriate State regulatory authority''--
so long as the Board determines that those disclosures are ``necessary 
to accomplish the purposes of this Act or to protect investors.'' The 
Attorney General, appropriate Federal regulators, state attorneys 
general, and appropriate State regulatory authorities with which the 
Board shares confidential information are required to keep it 
confidential. Id.
    The Commission's proposed rule would establish a provision for 
attorneys and the officers and directors of an issuer consistent with 
Section 105(b)(5)'s provision for accountants and accounting firms. 
Like Section 105(b)(5) of the Act, proposed section 205.3(e)(3) would 
facilitate investigations by the Commission and protect investors by 
maintaining the

[[Page 71695]]

privileged or protected status of internal reports shared with the 
Commission.\80\
---------------------------------------------------------------------------

    \80\ Section 307 of the Act does not contain a similar 
confidentiality provision, but the Act's treatment of attorneys is 
much briefer and much less detailed than its treatment of 
accountants, we believe in part because the treatment of accountants 
in Section 10A of the Exchange Act is much more detailed than the 
treatment of attorneys. (Compare, e.g., the treatment of accountants 
and attorneys in 17 CFR 201.102.) Section 105(b)(5) of the Act 
indicates that a similar confidentiality provision is an appropriate 
part of proposed Part 205, which elaborates on standards of conduct 
that attorneys appearing and practicing before the Commission must 
meet.
---------------------------------------------------------------------------

    Interested persons are invited to comment on any aspect of this 
section, including: (1) Whether the rule should contain such a 
provision; (2) the disadvantages and advantages of such a provision and 
its potential impact on private securities litigation where plaintiffs 
may seek to discover such documents from the issuer or the Commission; 
(3) whether the rule should reflect the Commission's long-standing 
policy of not entering into confidentiality agreements covering 
purportedly privileged materials except where it believes it would be 
in the public interest to do so; (4) whether the rule should reflect 
that even where the Commission enters into such confidentiality 
agreements, such agreements do not impact the Commission's ability to 
use the privileged materials in performing its statutory 
responsibilities; and (5) whether the rule should be limited to certain 
types of privileged or protected information and, if so, which ones.

Section 205.4 Responsibilities of Supervisory Attorneys

Section 205.4 would provide:

    (a) An attorney supervising, directing, or having supervisory 
authority over another attorney is a supervisory attorney. An 
issuer's chief legal officer (or the equivalent) is a supervisory 
attorney under this rule.
    (b) A supervisory attorney shall make reasonable efforts to 
ensure that a subordinate attorney, as defined in Sec.  205.5(a), 
that he or she supervises, directs, or has supervisory authority 
over in appearing and practicing before the Commission conforms to 
this rule and complies with the statutes and other rules 
administered by the Commission. To the extent a subordinate attorney 
appears and practices before the Commission on behalf of an issuer, 
that subordinate attorney's supervisory attorneys also appear and 
practice before the Commission.
    (c) A supervisory attorney is responsible for complying with the 
reporting requirements in Sec.  205.3 when a subordinate attorney 
has reported to the supervisory attorney evidence of a material 
violation.
    (d) A supervisory attorney who reasonably believes that 
information reported to him or her by a subordinate attorney under 
Sec.  205.5(c) is not evidence of a material violation shall take 
reasonable steps to document the basis for the supervisory 
attorney's belief.

    Proposed Section 205.4 is based, in part, on Rule 5.1 of the ABA's 
Model Rules, which (1) mandates that supervisory attorneys (including 
partners at law firms and attorneys exercising similar management 
responsibilities at law firms) must make reasonable efforts to ensure 
that attorneys at the firm conform to the Rules of Professional 
Conduct; and (2) provides that a supervisory attorney may be held 
liable for violative conduct by another attorney which he or she 
knowingly ratifies or which he or she fails to prevent when able to do 
so.
    Paragraphs 205.4(a) and (b) of the proposed rule are similar in 
concept in that they define who is a supervisory attorney, and obligate 
a supervisory attorney to make reasonable efforts to ensure compliance 
with the rule by subordinate attorneys. However, these paragraphs 
broaden the formulation from Rule 5.1 beyond attorneys who are actually 
supervising other attorneys to include attorneys ``directing or having 
supervisory authority over another attorney''. This expansion was 
intended to clarify that individuals who may exercise authority over 
subordinate attorneys for a particular matter, but who do not routinely 
supervise that attorney, are supervisory attorneys under the proposed 
rule. Paragraph 205.4(a) also states that an issuer's chief legal 
officer is a supervisory attorney, and cannot avoid responsibility 
under the rule by claiming a lack of knowledge of, or supervision over, 
the actions of subordinate attorneys.
    Paragraph 205.4(b) obligates a supervisory attorney to take 
affirmative steps to ensure that subordinates comply with the proposed 
rule. While the rule imposes an obligation on the supervisory attorney 
to take affirmative steps, it leaves to the professional judgment of 
the supervisory attorney how best to accomplish that goal. Particularly 
in a large organization, the Commission would expect that these steps 
would include the creation of procedures for subordinate attorneys to 
report evidence of material misconduct they learn about and, perhaps, 
periodic meetings for the purpose of discussing how to address such 
matters. In addition, the provision affirms that the supervisory 
attorney of a subordinate attorney who appears and practices before the 
Commission also appears and practices before the Commission. Sections 
205.4 and 205.5 place the burden of compliance with Section 205.3's 
reporting requirement on the supervisory attorney once he or she has 
received a report of a material violation from a subordinate.
    Paragraph 205.4(c) affirmatively states that a supervisory attorney 
assumes the responsibility for compliance with section 205.3's 
reporting requirement when a subordinate attorney reports evidence of a 
possible material violation. The Commission believes that this 
provision is consistent with common practice. A supervisory attorney is 
expected to be in a better position (as a result of a presumed higher 
level of experience and/or expertise) than a subordinate attorney to 
evaluate whether the evidence of potential wrongdoing obtained by the 
subordinate needs to be reported. Moreover, the issuer (either a client 
or the employer of the supervisory attorney) is likely to assume (and, 
indeed, may reasonably expect) that a subordinate attorney will discuss 
the evidence of potential wrongdoing with the supervisor before 
reporting it to the issuer. Finally, an issuer is probably more likely 
to respond diligently to a report of potential wrongdoing under section 
205.3 received from a supervisory attorney than from a subordinate 
attorney.
    Finally, paragraph 205.4(d) obligates a supervisory attorney who 
believes that evidence of potential wrongdoing presented by a 
subordinate does not need to be reported under Section 205.3 to take 
reasonable steps to document the basis for that belief. The reporting 
requirement under section 205.3 will be weakened, if not entirely 
undermined, unless a supervisory attorney is required to memorialize a 
unilaterally arrived at conclusion that evidence of purported 
wrongdoing does not need to be reported to an issuer. Moreover, a 
supervisory attorney to whom a subordinate attorney presents evidence 
of potential wrongdoing will as a matter of good practice typically 
memorialize his or her conclusion that the evidence does not need to be 
reported, and the bases for that conclusion. Accordingly, as with the 
prior paragraph, this requirement is consistent with how responsible 
attorneys will conduct themselves.
    Interested persons are invited to comment on any aspect of this 
section of the proposed rule including: (1) Whether the definition of a 
``supervisory attorney'' in 205.4(a) is too broad and should be 
curtailed, or whether it is too narrow and should be expanded, and, if 
so, how; (2) whether the rule imposes too much responsibility upon 
supervisory attorneys for the actions of subordinate attorneys and, if 
so, how the rule should be revised; (3) whether

[[Page 71696]]

the responsibility for complying with the rule's reporting obligation 
should be placed upon supervisory attorneys at all and, if not, why 
imposing that responsibility upon supervisory attorneys is 
inappropriate, and how the rule should be amended to insure that the 
reporting obligation is satisfied; (4) whether the Commission's premise 
that supervisory attorneys are in a better position to report evidence 
of material violations ``up the ladder'' with the issuer than 
subordinate attorneys is correct; and (5) whether supervisory attorneys 
should be required to document their conclusion that evidence presented 
by a subordinate does not need to be reported.

Section 205.5 Responsibilities of a Subordinate Attorney

Section 205.5 would provide:

    (a) An attorney under the supervision, direction, or supervisory 
authority of another attorney is a subordinate attorney.
    (b) A subordinate attorney is bound by this rule notwithstanding 
that the subordinate attorney acted at the direction of or under the 
supervision of another person.
    (c) A subordinate attorney complies with Sec.  205.3 of this 
rule if the subordinate attorney reports to his or her supervising 
attorney under paragraph (3)(b) of that section evidence of a 
material violation that the subordinate attorney becomes aware of in 
the course of appearing and practicing before the Commission.
    (d) A subordinate attorney may take the steps permitted or 
required by Sec.  205.3(b), (c), and (d) if the subordinate attorney 
reasonably believes that a supervisory attorney to whom he or she 
has reported evidence of a material violation under Sec.  205.3(b) 
has failed to comply with Sec.  205.3.

    Paragraphs 205.5 (a) and (b) of the proposed rule are based on Rule 
5.2 of the ABA's Model Rules (which provides that subordinate attorneys 
remain bound by the Model Rules notwithstanding the fact that they 
acted at the direction of another person). These proposed paragraphs 
define who is a subordinate attorney, and confirm that subordinate 
attorneys are responsible for complying with section 205.3. The 
Commission believes that subordinate attorneys should not be exempted 
from the application of the rule merely because they operate under the 
supervision or at the direction of another person (who may or may not 
be an attorney), and that creation of such an exemption would seriously 
undermine Congress' intent to provide for the reporting of evidence of 
material violations to issuers. Indeed, because subordinate attorneys 
frequently perform a significant amount of work on behalf of issuers, 
the Commission believes that subordinate attorneys are at least as 
likely (indeed, potentially more likely) to learn about evidence of 
material violations as supervisory attorneys.
    Paragraph 205.5(c), which obligates subordinate attorneys to report 
evidence indicating a material violation to their supervisor, is 
related to paragraph 205.4(c), which provides that a supervisory 
attorney is charged with the responsibility for compliance with Section 
205.3(b)'s reporting requirement when a subordinate attorney reports 
evidence of a material violation. As with paragraph 205.4(c), paragraph 
205.5(c) is premised upon the concept that supervisory attorneys are in 
a better position than subordinate attorneys to report instances of 
possible material violations to appropriate individuals in the issuer.
    A subordinate attorney is obligated under Section 205.3(b)(2) to 
maintain a record of a report made to the supervisory attorney, as 
supervisory attorneys are by paragraph 205.4(d). The Commission 
believes that the requirement imposed by this provision simply 
replicates the practice which responsible attorneys would adopt in any 
event.
    Paragraph 205.5(d) provides that a subordinate attorney who 
reasonably believes that a supervisory attorney to whom he or she has 
reported evidence of a possible material violation has failed to comply 
with the reporting requirements of section 205.3 may report the 
evidence to appropriate officers and directors of the issuer pursuant 
to paragraph 205.3(b) or to the issuer's QLCC, if the issuer has 
established such a committee, and may carry out a ``noisy withdrawal'' 
under the circumstances specified in paragraph 205.3(d). The Commission 
is confident that supervisory attorneys will satisfy their reporting 
obligations under the rule, and that instances when a subordinate 
attorney disagrees with the supervisory attorney's actions will be 
exceedingly rare. The Commission also notes that this paragraph is 
permissive rather than mandatory. Nevertheless, the Commission believes 
that inclusion of such a provision is both appropriate and necessary to 
address those situations where it is clear that a supervisory attorney 
has neither made the report permitted by paragraph 205.3(c) nor 
complied with the reporting obligations imposed by paragraphs 205.3(b) 
and (d), and the subordinate attorney believes he or she must act to 
prevent harm to the issuer and its shareholders.
    Interested persons are invited to comment on any aspect of this 
section of the proposed rule, including whether: (1) The definition of 
who is a subordinate attorney in 205.5(a) is too broad (or too narrow) 
and should be curtailed (or expanded); (2) the rule should distinguish 
between supervisory attorneys and subordinate attorneys at all or 
should do so in some other ways and, if so, what those other ways 
should be; (3) both subordinate and supervisory attorneys should be 
held to the same obligation to report evidence of material violations 
``up the ladder'' within the issuer, and if so, why; (4) subordinate 
attorneys should have any obligations under the rule; (5) the rule 
should permit subordinate attorneys to report evidence of material 
violations if they reasonably believe that a supervisory attorney has 
failed to comply with the rule.

Section 205.6 Sanctions

Section 205.6 would provide:

    (a) A violation of this part by any attorney appearing and 
practicing before the Commission in the representation of an issuer 
shall be treated for all purposes in the same manner as a violation 
of the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.), and 
any such attorney shall be subject to the same penalties and 
remedies, and to the same extent, as for a violation of that Act.
    (b) With respect to attorneys appearing and practicing before 
the Commission on behalf of an issuer, ``improper professional 
conduct'' under section 4C(a) of the Securities Exchange Act of 1934 
(15 U.S.C. 78d-3(a)) includes:
    (1) Intentional or knowing conduct, including reckless conduct, 
that results in a violation of any provision of this part; and
    (2) Negligent conduct in the form of:
    (i) A single instance of highly unreasonable conduct that 
results in a violation of any provision of this part; or
    (ii) Repeated instances of unreasonable conduct, each resulting 
in a violation of a provision of this part.
    (c) An attorney appearing and practicing before the Commission 
who violates any provision of this part is subject to the 
disciplinary authority of the Commission, regardless of whether the 
attorney may also be subject to discipline for the same conduct in a 
jurisdiction where the attorney is admitted or practices.

    Part 205 sets forth minimum standards of professional conduct for 
attorneys appearing and practicing before the Commission in the 
representation of issuers. As discussed above, some of the provisions 
of the proposed rule are permissive; others are mandatory. When an 
attorney fails to comply with a mandatory provision of the proposed 
rule, that failure will be treated as a violation of a substantive rule 
and will subject the attorney to enforcement and/or disciplinary action 
by the Commission.
    Proposed paragraph 205.6(a), which tracks the language of Section 
3(b) of the

[[Page 71697]]

Act, expressly states that a violation of the proposed rule shall be 
treated as a violation of the Exchange Act, subjecting any person 
committing such a violation to the same penalties as are prescribed for 
violations of the Exchange Act. Thus, if an attorney violates the 
proposed rule, the Commission may commence a civil action seeking 
injunctive and other appropriate equitable relief, as well as civil 
money penalties, pursuant to Section 21(d) of the Exchange Act. 
Alternatively, the Commission may commence a cease-and-desist 
proceeding against the violator, and any other person who was a cause 
of the violation, pursuant to Section 21C of the Exchange Act.
    The Commission does not believe, however, that violations of the 
proposed rule would, without more, meet the standard prescribed in 
Section 32(a) of the Exchange Act (15 U.S.C. 78ff), which provides for 
the imposition of criminal penalties.
    In the event that an injunction is entered against an attorney for 
violating this rule, the Commission may initiate administrative 
proceedings to determine an appropriate disciplinary sanction. Even 
when no injunctive action is brought against an attorney under this 
rule, the Commission may bring an original administrative proceeding 
for a cease-and-desist order and/or seeking an appropriate disciplinary 
sanction for a violation of this rule.
    The Commission notes that nothing in Section 307 creates a private 
right of action against an attorney. Indeed, statements by the sponsors 
of the provision unequivocally demonstrate that there was never an 
intention to create a right of action by third parties for violation of 
the rule. \81\ Similarly, the Commission does not intend that the 
provisions of Part 205 create any private right of action against an 
attorney based on his or her compliance or non-compliance with its 
provisions.
---------------------------------------------------------------------------

    \81\ See statement by Senator Edwards, 148 Cong. Rec. S6552 
(``Nothing in this bill gives anybody a right to file a private 
lawsuit against anybody. The only people who can enforce this 
amendment are the people at the SEC.''); see also statement by 
Senator Enzi, id. at S6555 (``[T]his amendment creates a duty of 
professional conduct and does not create a right of action by third 
parties.'').
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    Paragraph (b) of this section reflects the fact that Section 602 of 
the Act amends the Exchange Act by adding Section 4C(a), which 
incorporates that portion of the text of Rule 102(e) which provides 
that the Commission may discipline professionals for improper 
professional conduct. Accordingly, an attorney who violates any 
provision of Part 205 engages in improper professional conduct. The 
Commission may proceed against such an attorney in the manner described 
above.
    Paragraph (b) of this section incorporates the state-of-mind 
requirements prescribed in Section 4C(b)(2). The ``[i]ntentional or 
knowing conduct, including reckless conduct'' standard articulated in 
205.6(b)(1) is the standard which has been applied by the Commission in 
Rule 102(e) cases brought against accountants since the amendment to 
the rule in 1998. The ``negligent conduct'' standard prescribed in 
205.6(b)(2) is similar to the standard adopted by the Commission in the 
1998 amendment to Rule 102(e).\82\ Accordingly, a single, highly 
unreasonable instance of attorney misconduct, or repeated instances of 
unreasonable attorney misconduct which result in violation of the rule 
will constitute improper professional conduct. Paragraph 205.6(b) 
evidences that the Commission will not proceed against attorneys when 
conduct that amounts to no more than simple negligence results in a 
failure to comply with a provision of Rule 205.
---------------------------------------------------------------------------

    \82\ Exchange Act Section 4C(b)(2) defines the term ``improper 
professional conduct'' to include negligent conduct by an accountant 
in the form either of a single instance of highly unreasonable 
behavior or repeated instances of unreasonable conduct which results 
in a violation of applicable professional standards and indicates a 
lack of competence.
---------------------------------------------------------------------------

    In proposing Part 205, the Commission does not intend to rescind 
Rule 102(e). While the Commission has employed Rule 102(e) as a 
disciplinary tool to protect the Commission's processes from improper 
professional conduct, Part 205 may serve both an enforcement and a 
disciplinary function. As noted, the Commission intends to proceed 
against individuals violating Part 205 as it would against other 
violators of the Exchange Act. In addition, when appropriate, the 
Commission may initiate proceedings under this rule seeking the 
imposition of an appropriate disciplinary sanction. At present, the 
Commission intends to limit its use of Part 205 to address only 
misconduct arising under that rule. Rule 102(e) will continue to be 
used to address the same types of misconduct it has been traditionally 
relied upon for, except those that would now fall under Part 205. The 
Commission intends to revisit this issue at such time as it determines 
whether to promulgate more comprehensive standards of professional 
conduct. In the event it does implement such rules, it may be necessary 
to reconsider whether it is appropriate to continue prosecuting 
disciplinary actions under Rule 102(e).
    Interested persons are invited to comment on (1) the interaction 
between Part 205 and Rule 102(e), and (2) whether (and if so, how) the 
Commission should amend Rule 102(e) in light of the adoption of Part 
205.
    Paragraph (c) of the Act recognizes that the Commission may 
discipline attorneys who violate the rule, regardless whether the 
attorney is subject to prosecution or discipline for violation of a 
state ethical rule which applies to the same conduct. Accordingly, in 
the event that an attorney's conduct violates Part 205 as well a state 
ethical rule, the Commission may bring proceedings against the attorney 
regardless of whether the state proceeds against the attorney.
    The prospect of simultaneous Commission and state disciplinary 
proceedings for the same misconduct raises the question of the impact 
of the rule upon state ethical rules and regulations. Due to the 
breadth and specificity of the Congressional mandate to the Commission 
to implement an ``up the ladder'' reporting system applicable to 
attorneys representing issuers, the Commission is considering whether 
Congress intended for the agency's rule to ``occupy the field'' on this 
issue, and whether Part 205 would preempt any state rules governing the 
reporting of evidence of a material violation by attorneys representing 
issuers before the Commission. Commission preemption of any state 
ethical rules as topics covered by Part 205 would have the salutary 
benefit of creating a single uniform standard which attorneys in all 
jurisdictions must satisfy; and it would also resolve the dilemma faced 
by attorneys who practice in multiple jurisdictions, and thereby 
subject themselves to different (and potentially conflicting) standards 
prescribed in the ethical rules adopted by those jurisdictions. 
Alternatively, the Commission is considering whether those provisions 
of the rule which are necessary to effectively implement an ``up the 
ladder'' reporting system may preempt conflicting state ethical rules 
which impose a lower obligation upon the attorney (or impose no 
obligation at all).\83\ In those limited circumstances in which a state 
rule actually imposes a higher obligation than Part 205 (e.g., by 
requiring an attorney to take some step

[[Page 71698]]

which Part 205 does not mandate), the attorney would remain free to 
comply with the state rule.
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    \83\ See Crosby v. National Foreign Trade Council, 530 U.S. 363, 
372 (2000) (Court will find preemption ``when it is impossible for a 
private party to comply with both state and federal law, and where 
under the circumstances of a particular case, the challenged state 
law stands as an obstacle to the accomplishment and execution of the 
full purpose and objectives of Congress''); City of New York v. FCC, 
486 U.S. 57, 64 (1989) (agency regulations can preempt state laws).
---------------------------------------------------------------------------

    Interested persons are invited to comment on any aspect of this 
section of the rule. With respect to state-of-mind requirements, 
parties are invited to comment on the following issues: (1) What the 
state-of-mind requirement for violations of the rule should be; (2) 
what the required mental state should be in an injunctive action for 
violation of the rule; (3) whether attorneys who violate the rule 
should also be subject to disciplinary proceedings under Rule 102(e) 
for improper professional conduct; (4) whether the state-of-mind 
requirements for disciplinary proceedings set forth in paragraph 
205.6(b) provide adequate guidance to attorneys, and whether they are 
appropriate; (5) whether the same state of mind requirements for 
accountants should also apply to attorneys and, if not, why.
    With respect to the issue of preemption, interested persons are 
invited to comment on: (1) whether the internal reporting requirements 
within the issuer proposed by Section 307 and Part 205 should be 
interpreted to ``occupy the field'' so as to preempt all state 
regulation of an attorney's internal reporting evidence of a material 
violation; and (2) whether the reporting requirements preempt only 
conflicting state ethical rules.
    The Commission has not established a ``safe harbor'' provision 
within the rule similar to Section 10A(3)(c) of the Exchange Act (15 
U.S.C. 78j-1(3)(c)), which proscribes private suits against auditor's 
for statements or conclusions expressed in notices to the Commission 
mandated by Section 10A(b)(3). Interested persons are invited to 
comment on whether the Commission should include a similar provision 
within the proposed rule prohibiting private actions challenging an 
attorney's decision to take, or not to take, action under the proposed 
rule, when taken in good faith. Would inclusion of such a provision 
promote effective operation of the proposed rule by protecting 
attorneys who make a good faith effort to comply with the rule, and 
preventing ancillary litigation for alleged violations of the rule? Why 
or why not?

VI. Paperwork Reduction Act

    The proposed rule contains a ``collection of information'' 
requirement within the meaning of the Paperwork Reduction Act of 1995 
(``PRA'').\84\ The title for this collection of information is 
``Reports of Evidence of Material Violations.'' We have submitted the 
collection of information to the Office of Management and Budget 
(``OMB'') for review in accordance with 44 U.S.C. 3507(d) and 5 CFR 
1320.11.
---------------------------------------------------------------------------

    \84\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

    The proposed rule would impose an ``up the ladder'' reporting 
requirement when attorneys appearing and practicing before the 
Commission become aware of evidence of a material violation by the 
issuer or any officer, director, employee, or agent of the issuer. As 
discussed in greater detail elsewhere in this release, an attorney must 
report such evidence to the issuer's chief legal officer (``CLO'') or 
to both the chief legal officer and chief executive officer (``CEO''), 
and must take reasonable steps to document his or her report and the 
response received, and retain this documentation for a reasonable time. 
A subordinate attorney complies with the proposed rule if he or she 
reports evidence of a material violation to his or her supervisory 
attorney (who is then responsible for complying with the proposed 
rule's requirements). A subordinate attorney may also take the other 
steps described in the proposed rule if the supervisor fails to comply. 
Additionally, when a supervisory attorney believes that information 
reported to him or her by a subordinate attorney is not evidence of a 
material violation, the supervisory attorney must take reasonable steps 
to document the basis for his or her belief.
    If the CLO, after investigation, reasonably believes that there is 
no violation, he or she must so advise the reporting attorney. If the 
CLO reasonably believes that there is a violation, he or she must 
ensure that the issuer adopts remedial measures and/or imposes 
sanctions appropriate to stop, prevent or rectify any violation. The 
CLO must also promptly report on the remedial measures or sanctions to 
the CEO, the audit committee or the board of directors, and the 
reporting attorney. The CLO must take reasonable steps to document his 
or her inquiry and to retain such documentation for a reasonable time.
    As described in detail elsewhere in this release, the proposed rule 
also requires attorneys to take certain steps if the CLO or CEO does 
not provide an appropriate response to a report of evidence of a 
violation. These steps include reporting the evidence ``up the ladder'' 
to the audit committee, another committee consisting solely of outside 
directors if there is no audit committee, or to the board of directors 
if there is no such committee, and taking reasonable steps to document 
the report and response and to retain the documentation for a 
reasonable time. If the attorney believes that the issuer has not made 
an appropriate response to the report, the attorney must explain the 
reasons for his or her belief to the CEO, CLO or directors to whom the 
report was made, and take reasonable steps to document the response, or 
absence thereof, and retain the documentation for a reasonable time. In 
addition, outside counsel must, if the violation is ongoing or about to 
occur and is likely to result in substantial injury to the financial 
interest or property of the issuer or investors (or may, if the 
violation is not ongoing and is likely to have resulted in substantial 
injury to the financial interest or property of the issuer or 
investors): (1) Withdraw from the representation and notify the issuer 
that the withdrawal is based on professional considerations, (2) notify 
the Commission in writing of the withdrawal indicating that the 
withdrawal was based on professional considerations, and (3) disaffirm 
in writing any tainted documents filed with the Commission. In these 
circumstances, in-house attorneys must or may, depending on whether the 
violation is ongoing or not, notify the Commission in writing that they 
intend to make a disaffirmation and make the disaffirmation. The 
issuer's CLO must also inform any attorney retained or employed to 
replace an attorney who withdrew under these circumstances that the 
withdrawal was based on professional considerations. An attorney who 
reasonably believes that he or she has been discharged for making a 
report covered by the proposed rule may notify the Commission of this 
belief and may also disaffirm in writing any tainted documents.
    Alternatively, if an attorney other than a CLO reports the evidence 
to a qualified legal compliance committee (``QLCC''), he or she need 
take no further action under the proposed rule. The QLCC would have 
written procedures for the receipt, retention, and consideration of 
reports of material violations, and would be authorized and responsible 
to notify the CLO and CEO of the report, determine whether an 
investigation is necessary and, if so, to notify the audit committee or 
the board of directors. The QLCC would also initiate an investigation 
to be conducted by the CLO or outside attorneys, and retain any 
necessary additional expert personnel. At the conclusion of the 
investigation, the QLCC would direct the issuer to adopt appropriate 
remedial measures and/or impose sanctions, and would notify the CLO, 
CEO, and board of directors of the results of the inquiry and 
appropriate remedial measures to

[[Page 71699]]

be adopted. Where an issuer failed to take the remedial measures 
directed by the QLCC, each member of the QLCC, along with the CEO and 
CLO, would have the authority and responsibility to notify the 
Commission of the material violation and disaffirm in writing any false 
or misleading documents. A CLO may also refer a report of evidence of a 
material violation to a QLCC, which then would have responsibility for 
taking the steps required by the rule. In the case of such a referral 
from the CLO, if the issuer fails to take any remedial measures 
directed by the QLCC, the CLO must notify the Commission of the 
violation and disaffirm in writing any tainted documents.
    The information collection is necessary to implement the Standards 
of Professional Conduct for Attorneys prescribed by the proposed rule 
and required by Section 307 of the Sarbanes-Oxley Act of 2002. 
Specifically, the collection of information is intended to ensure that 
evidence of violations is communicated to appropriate officers and/or 
directors of issuers, so that they can adopt appropriate remedies and/
or impose appropriate sanctions. In the rare cases in which issuers do 
not act appropriately, the information would be communicated to the 
Commission, so that the Commission could take appropriate action. The 
collection of information is, therefore, an important component of the 
Commission's program to discourage violations of the federal securities 
laws and promote ethical behavior of attorneys appearing and practicing 
before the Commission.
    We believe that the burden imposed by the proposed collection of 
information would be minimal. The respondents to this proposed 
collection of information would be attorneys who appear and practice 
before the Commission and, in certain cases, the issuer, and/or 
officers, directors and committees of the issuer. For the most part, 
and except as described below, we believe that these respondents are 
already making the types of reports and retaining the records 
contemplated by the proposed rule. In providing quality representation 
to issuers, attorneys already report evidence of violations to others 
within the issuer, including the CLO, the CEO, and, where necessary, 
the directors. We believe that attorneys also generally document their 
advice to clients and the responses to that advice that they receive. 
In addition, officers and directors already investigate evidence of 
violations and report within the issuer the results of the 
investigation and the remedial steps they have taken or sanctions they 
have imposed. Officers and directors generally also document these 
actions. Except as discussed below, we therefore believe that the 
reporting and recordkeeping requirements imposed by the proposed rule 
are ``usual and customary'' activities that do not add to the burden 
that would be imposed by the collection of information.\85\
    Certain aspects of the collection of information would, however, 
impose a new burden. As described above, if an issuer chooses to 
establish a QLCC, the QLCC would have to establish written procedures 
for the confidential receipt, retention, and consideration of any 
report of evidence of a material violation. Additionally, outside 
attorneys might, in certain cases, notify the Commission and the issuer 
that their withdrawal from representation is based on professional 
considerations, and disaffirm any tainted filings. Similarly, in-house 
attorneys might, in certain cases, notify the Commission that they must 
make a disaffirmation and make a disaffirmation. CEOs, CLOs and QLCCs, 
as well as attorneys who believe that they were discharged for making a 
report under the proposed rule, might, depending on the circumstances, 
notify the Commission of a violation and make a disaffirmation. 
Finally, in cases of an ongoing violation, a CLO would notify any 
successor attorneys retained or employed to replace an attorney who 
withdrew that the withdrawal was based on professional considerations.
---------------------------------------------------------------------------

    \85\ See 5 CFR 1320.3(b)(2).
---------------------------------------------------------------------------

    We estimate for purposes of the PRA that there are approximately 
18,200 issuers that would be subject to the proposed rule.\86\ Of 
these, we estimate that approximately one quarter, or 4,550 will choose 
to establish a QLCC. Establishing the written procedures required by 
the proposed rule should not impose a significant burden. We assume 
that an issuer would incur a greater burden in the year that it first 
establishes the procedures than in subsequent years, in which the 
burden would be incurred in updating, reviewing, or modifying the 
procedures. For purposes of the PRA, we assume that an issuer would 
spend 6 hours every three-year period on the procedures. This would 
result in an average burden of 2 hours per year. Thus, we estimate for 
purposes of the PRA that the total annual burden imposed by this aspect 
of the collection of information would be 9,100 hours.
---------------------------------------------------------------------------

    \86\ This estimate is based, in part, on the total number of 
operating companies that filed annual reports on Form 10-K (8,484), 
Form 10-KSB (3,820), Form 20-F (1,194) or Form 40-F (134) during the 
2001 fiscal year, and an estimate of the average number of issuers 
that may have a registration statement filed under the Securities 
Act pending with the Commission at any time (100). In addition, we 
estimate that approximately 4,500 investment companies currently 
file periodic reports on Form N-SAR.
---------------------------------------------------------------------------

    We cannot estimate with precision how many attorneys will be 
subject to the rule's requirements or how frequently they will be 
required to make the ``up the ladder'' reports required by the proposed 
rule. There are approximately 18,200 issuers that may employ or retain 
attorneys that would be subject to the rule. These issuers may employ 
in-house attorneys, outside counsel, or a combination of both. We 
believe, however, that it will be the rare occasion when, as a last 
resort, a disclosure will be made to the Commission. In the vast 
majority of cases, we expect that problems will be resolved at the 
corporate level, and the Commission will not be notified. We therefore 
estimate for the purposes of the PRA that approximately 10 attorneys, 
CLOs, CEOs, or QLCCs per year will make one disclosure to the 
Commission per year. Depending on the circumstances, the disclosure 
could consist of a notice of withdrawal (and a similar notice to the 
issuer and a CLO's notice to successor attorneys), a notice of material 
violations, a notice of discharge, a notice of disaffirmation, a 
disaffirmation, or some combination thereof. The burden hours for the 
disclosure will obviously vary depending on the circumstances. None of 
the components of the disclosure would, however, require a significant 
amount of time to compile. We therefore estimate, for purposes of the 
PRA that, on average, each disclosure would require 10 burden hours. 
Under these assumptions, this aspect of the collection of information 
would impose approximately 100 annual burden hours.
    The total annual burden hours imposed by the collection of 
information would therefore be 9,200. Assuming half of the burden hours 
will be incurred by outside counsel at a rate of $300 per hour would 
result in a cost of $1,380,000.
    Pursuant to 44 U.S.C. 3506(c)(2)(B), the Commission solicits 
comments to: (i) Evaluate whether the proposed collection of 
information is necessary for the proper performance of the functions of 
the agency, including whether the information will have practical 
utility; (ii) evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collection of information; (iii) determine 
whether there are ways to enhance the quality, utility, and clarity of 
the information to be collected; and (iv) evaluate whether there are 
ways to minimize the burden of the collection of information on those

[[Page 71700]]

who are to respond, including through the use of automated collection 
techniques or other forms of information technology.
    Persons submitting comments on the collection of information 
requirement should direct the comments to the Office of Management and 
Budget, Attention: Desk Officer for the Securities and Exchange 
Commission, Office of Information and Regulatory Affairs, Washington, 
DC 20503, and should send a copy to Jonathan G. Katz, Secretary, 
Securities and Exchange Commission, 450 Fifth Street, NW., Washington, 
DC 20549-0609, with reference to File No. 33-8150.wp. Requests for 
materials submitted to OMB by the Commission with regard to this 
collection of information should be in writing, refer to File No. 33-
8150.wp, and be submitted to the Securities and Exchange Commission, 
Records Management, Office of Filings and Information Services. OMB is 
required to make a decision concerning its review of the collection of 
information between 30 and 60 days after publication of this release. 
Consequently, a comment to OMB is assured of having its full effect if 
OMB receives it within 30 days of publication.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless it displays a 
currently valid control number. Compliance with the collection of 
information requirements is, as described above, in some cases 
mandatory and in some cases voluntary depending upon the circumstances. 
As described above, in certain cases, records must be retained for a 
reasonable time; in other cases, there is no mandatory retention 
period. Responses to the requirements to make disclosures to the 
Commission will not be kept confidential.

VII. Costs and Benefits

    We are proposing Part 205 to implement Section 307 of the Sarbanes-
Oxley Act. Part 205 will affect all attorneys who appear and practice 
before the Commission in the representation of an issuer and who learn 
of evidence that tends to show that a material violation of the federal 
securities laws, a material breach of fiduciary duty, or a similar 
material violation by the issuer or an officer, director, agent, or 
employee of the issuer has or may have occurred or may occur. The rule 
that we are proposing today implements a Congressional mandate. We 
recognize that any implementation of the Sarbanes-Oxley Act will likely 
result in costs as well as benefits and have an effect on the economy. 
We are sensitive to the costs and benefits of our proposal. We discuss 
these costs and benefits below.
    Part 205 would implement an ``up the ladder'' reporting requirement 
upon attorneys representing an issuer before the Commission who become 
aware of potential misconduct of which a reasonably prudent investor in 
the issuer would want to be informed. It is expected that, in the vast 
majority of instances of such reports, the situation will be addressed 
and remedied before it causes significant harm to investors. Where the 
potential impropriety is ongoing and not taken care of internally 
following a report mandated by the rule, Part 205 mandates that the 
covered attorney, if retained by the issuer, effectuate a ``noisy 
withdrawal'' from representation of the issuer and disaffirm to the 
Commission any tainted documents, which will alert the Commission to 
investigate the issuer. In the same circumstance, if the attorney is 
employed by the issuer, the attorney must disaffirm to the Commission 
any tainted documents.
    In addition to these requirements, the rule would authorize a 
covered attorney to reveal to the Commission confidences or secrets 
relating to the attorney's representation of an issuer before the 
Commission to the extent the attorney reasonably believes it necessary 
to: (i) Prevent the issuer from committing an illegal act likely to 
cause substantial financial harm to the issuer or investors; (ii) 
prevent the issuer from perpetrating a fraud upon the Commission; or 
(iii) rectify the consequences of the issuer's illegal act that the 
attorney's services had furthered.

A. Benefits

    Part 205 is designed to improve the accuracy and reliability of 
corporate disclosures made pursuant to the securities laws and foster 
investor confidence in the securities markets. This may lower the cost 
of capital. In addition, Part 205 should, in some instances, prevent or 
mitigate illegal conduct and hasten the apprehension of wrongdoers 
whose misconduct injures investors and others. These benefits are 
difficult to quantify.
    Interested persons are invited to comment upon this benefits 
analysis. Are there other foreseeable benefits? What is the likely 
economic impact of these benefits? Can the benefits be quantified in 
any meaningful way? If so, how and what conclusions should be drawn?

B. Costs

    Part 205 will impose costs on issuers and law firms representing 
them. For issuers, the proposed rule will require the chief legal 
officer of an issuer to investigate and, where necessary, cause 
remedial actions and/or sanctions to be taken and/or imposed. It also 
will cause the chief executive officer, qualified legal compliance 
committee, and board of directors of the issuer to review evidence of 
possible impropriety. For the most part, we believe that most issuers 
already have procedures for reviewing evidence of reports of 
misconduct. Similarly, we expect that most issuers already incur costs 
with investigating and documenting such reports.
    Those companies that choose to form a qualified legal compliance 
committee to implement this provision will incur a cost. These might 
include increased compensation for QLCC members, and administrative 
costs to establish the committee. Additionally, for purposes of the 
PRA, we assume that one-quarter of issuers will form such a committee 
and incur an annualized paperwork cost of 2 hours for a total annual 
burden of 9,100 hours. Assuming outside counsel accounts for half of 
these hours at a cost of $300 per hour, and inside counsel accounts for 
the other half at $110 per hour would result in a cost of $1,865,500.
    For lawyers, the proposal could have an effect upon malpractice 
insurance premiums, which could, in turn, increase the cost of attorney 
services to issuers. It may also encourage issuers to handle more legal 
matters in-house to avoid the possibility of a noisy withdrawal. The 
proposal will also impose some costs to make and document required 
reports and responses. For purposes of the Paperwork Reduction Act, we 
assume that attorneys already document most important legal advice 
given to corporate clients. We also assume that the number of times an 
attorney, CEO, CLO or QLCC will report potential illegal conduct 
outside the issuer will be rare--for purposes of that analysis we 
estimate a total of ten times a year (although we cannot, of course 
predict how many will actually be submitted). Further, we estimate in 
that analysis that preparing the various notices and disaffirmations 
will on average take 10 hours to prepare. We assume for the purposes of 
the PRA that half of these hours would be incurred by in-house counsel, 
QLCCs, CEOs and CLOs, and half would be incurred by outside counsel. 
Assuming an outside attorney charges $300 an hour, and the cost of in-

[[Page 71701]]

house personnel is $110 an hour, these reporting requirements would 
impose a cost of $20,500.
    There may also be some additional costs of the proposal imposed on 
the market that are exceedingly difficult to predict or quantify. To 
the extent the obligation to report some illegal conduct outside the 
issuer creates an incentive on issuers not to share confidences with a 
lawyer, the lawyer may not be able to avoid, remedy or report illegal 
conduct. While we recognize that such an effect would decrease the 
rule's effectiveness, we have no data to suggest that the rule would 
create such an incentive. We request data on this issue. In addition, 
there may also be some incentives to maximize use of inside counsel 
rather than retained attorneys, or small firms rather than large firms, 
or the reverse, for issuers that presently have no attorney employees 
to hire at least one attorney, and for issuers to reduce or eliminate 
reliance upon attorneys in some circumstances. Additionally, there may 
be economic consequences of ``noisy withdrawals'' that may occur under 
the rule.
    Interested persons are invited to comment upon this costs analysis. 
Are there other foreseeable costs? What is the likely economic impact 
of these costs? Can the costs be quantified in any meaningful way? If 
so, how and what conclusions should be drawn? Interested persons are 
invited to address all aspects of costs and benefits attributable to 
proposed Part 205. The Commission requests data to quantify the 
expected costs and the value of the anticipated benefits.

VIII. Effect on Efficiency, Competition and Capital Formation

    Section 23(a)(2) of the Exchange Act (15 U.S.C. 78w(a)(2)) requires 
us, when adopting rules under the Exchange Act, to consider the impact 
that any new rule would have on competition. Section 23(a)(2) prohibits 
us from adopting any rule that would impose a burden on competition not 
necessary or appropriate in furtherance of the purposes of the Exchange 
Act. In addition, Section 2(b) of the Securities Act, Section 3(f) of 
the Exchange Act, and Section 2(c) of the Investment Company Act 
require us when engaging in rulemaking where we are required to 
consider or determine whether an action is necessary or appropriate in 
the public interest, to consider, in addition to the protection of 
investors, whether the action will promote efficiency, competition and 
capital formation.
    Part 205 is intended to assure that attorneys representing issuers 
before the Commission are governed by standards of conduct that 
increase disclosure of potential impropriety within an issuer so that 
prompt intervention and remediation can take place. Doing so should 
boost investor confidence in the financial markets. We anticipate that 
these proposals would enhance the proper functioning of the capital 
markets and promote efficiency by reducing the likelihood that illegal 
behavior would remain undetected and unremedied for long periods of 
time. Part 205 would apply to all issuers and attorneys appearing 
before the Commission and is therefore unlikely to affect competition.
    Interested persons are invited to comment upon any aspect of this 
analysis. We request comment on whether Part 205, if adopted, would 
impose a burden on competition. Commenters are requested to provide 
empirical data and other factual support for their views if possible.

IX. Initial Regulatory Flexibility Analysis

    This Initial Regulatory Flexibility Analysis has been prepared in 
accordance with 5 U.S.C. 603.

A. Reasons for the Proposed Action

    We are proposing Part 205 to comply with Section 307 of the 
Sarbanes-Oxley Act of 2002 (15 U.S.C. 7201 et seq.)(``the Act'').

B. Objectives

    Section 307 of the Act requires the Commission to prescribe 
``minimum standards of professional conduct for attorneys appearing and 
practicing before the Commission in any way in the representation of 
issuers.'' The standards must include a rule requiring an 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.

C. Legal Basis

    We are proposing Part 205 under the authority set forth in Section 
19 of the Securities Act of 1933, Sections 3(b), 4C, 13, and 23(a) of 
the Securities Exchange Act of 1934, Sections 38 and 39 of the 
Investment Company Act of 1940, Section 211 of the Investment Advisers 
Act of 1940, and Sections 3(a), 307 and 404 of the Sarbanes-Oxley Act 
of 2002.

D. Small Entities Subject to Proposed Part 205

    Proposed Part 205 would affect issuers and law firms that are small 
entities. Exchange Act Rule 0-10(a) (17 CFR 240.0-10(a)) defines an 
issuer, other than an investment company, to be a ``small business'' or 
``small organization'' if it had total assets of $5 million or less on 
the last day of its most recent fiscal year. As of October 23, 2002, we 
estimated that there were approximately 2,500 issuers, other than 
investment companies, that may be considered small entities. For 
purposes of the Regulatory Flexibility Act, an investment company is a 
small entity if it, together with other investment companies in the 
same group of related investment companies, has net assets of $50 
million or less as of the end of its most recent fiscal year.\87\ We 
estimate that there are 211 small investment companies that would be 
subject to the proposed rule. The proposed revisions would apply to any 
small entity that is subject to Exchange Act reporting requirements.
---------------------------------------------------------------------------

    \87\ 17 CFR 270.0-10.
---------------------------------------------------------------------------

    Proposed Part 205 also would affect law firms that are small 
entities. The Small Business Administration has defined small business 
for purposes of ``offices of lawyers'' as those with under $6 million 
in annual revenue.\88\ Because we do not directly regulate law firms 
appearing before the Commission, we do not have data to estimate the 
number of small law firms that practice before the Commission or, of 
those, how many have revenue of less than $6 million. We request data 
on that issue.
---------------------------------------------------------------------------

    \88\ 13 CFR 121.201.
---------------------------------------------------------------------------

E. Reporting, Recordkeeping, and Other Compliance Requirements

    Paragraph 205.3(b) of proposed Part 205 prescribes the duty of an 
attorney who appears or practices before the Commission in the 
representation of an issuer to report evidence of a material violation 
that has or may have occurred, or may occur. The attorney is initially 
directed to make this report to the issuer's chief legal officer 
(``CLO''), or to the issuer's CLO and chief executive officer 
(``CEO''). Absent exigent circumstances, the attorney is also obligated 
to take reasonable steps to make and retain a contemporaneous written 
record of his or her reports, as well as any response received from the 
CLO or CEO. Requiring the attorney to keep a contemporaneous written 
record will protect the attorney in the event his or her compliance 
with the proposed rule is put in issue at some future proceeding.

[[Page 71702]]

    When presented with a report of a possible material violation, the 
rule obligates the issuer's CLO to conduct a reasonable inquiry to 
determine whether the reported material violation has occurred, is 
occurring or may occur. A CLO who reasonably concludes that there has 
been no material violation must advise the reporting attorney of this 
conclusion, and must also preserve all relevant documentary evidence 
that supports that 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 and/or sanctions--including appropriate disclosures. 
Furthermore, the CLO is required to report ``up the ladder'' within the 
issuer and to the reporting attorney what remedial measures have been 
adopted. A reporting attorney who receives an appropriate response 
within a reasonable time has satisfied all obligations under the rule. 
In the event a reporting attorney does not receive an appropriate 
response within a reasonable time, he or she must report the evidence 
of a material violation to the issuer's audit committee, to another 
committee of independent directors if the issuer has no audit 
committee, or to the full board if the issuer has no such committee. 
Similarly, if the attorney reasonably believes that it would be futile 
to report evidence of a material violation to the CLO and CEO, the 
attorney may report directly to the issuer's audit committee, another 
committee of independent directors, or to the full board. A reporting 
attorney who has reported a matter all the way ``up the ladder'' within 
the issuer and who reasonably believes that the issuer has not 
responded appropriately must take reasonable steps to document and 
retain the response or lack thereof.
    Alternatively, issuers may (but are not required to) establish a 
QLCC, consisting of at least one member of the issuer's audit 
committee, and two or more independent members of the issuer's board 
for the purpose of investigating reports of material violations made by 
attorneys. Such a QLCC would be authorized to require the issuer to 
adopt appropriate remedial measures to prevent ongoing, or alleviate 
past, material violations, and empowered to notify the Commission of 
the material violation and disaffirm any document submitted to the 
Commission which has been tainted by the material violation. The QLCC 
would be required to notify the board of the results of any inquiry. An 
attorney other than a CLO may satisfy entirely his reporting obligation 
under the rule by reporting evidence of a material violation to a QLCC. 
Further, a chief legal officer to whom a report of a material violation 
has been made may refer the matter to a QLCC.
    Paragraph 205.3(d) discusses the obligation of an attorney who has 
not received an appropriate response from the issuer and, in certain 
instances, requires or permits a ``noisy withdrawal.'' The provision 
distinguishes between outside attorneys retained by the issuer and 
attorneys employed by the issuer. A provision which obligates a 
reporting attorney under certain circumstances to disaffirm a 
submission to the Commission which the attorney believes has been 
tainted by a material violation (and permits the attorney to disaffirm 
under other circumstances) is also important to the effective operation 
of the reporting obligation in those instances where an issuer does not 
respond appropriately. The provision imposes an affirmative obligation 
on attorneys to disaffirm a document or filing where they believe a 
violation is ongoing or prospective because of the greater potential of 
harm to investors inherent in such violations. Pursuant to this 
provision, outside attorneys who have reported a material violation 
which they believe has occurred, is ongoing or is about to occur that 
is likely to result in substantial injury to the financial interest or 
property of the issuer or investors, and who have not received an 
appropriate response, are required to withdraw from representation, 
notify the Commission and the issuer that their withdrawal is based on 
professional considerations, and disaffirm any submission to the 
Commission which is tainted by the violation (unless, as noted above, 
they have reported the information to a QLCC). Attorneys employed by an 
issuer who have reported a material violation which they believe is 
ongoing or about to occur that is likely to result in substantial 
injury to the financial interest or property of the issuer or investors 
and have not received an appropriate response are required to disaffirm 
any tainted submission, but are not required to resign. Attorneys are 
permitted, but not required, to take these steps in the event they 
believe that the violation has already occurred and has no ongoing 
effect and is likely to have resulted in substantial injury to the 
financial interest or property of the issuer or investors. Issuers must 
also, in certain cases, notify an attorney who is employed or retained 
to replace an attorney who withdrew, that the withdrawal was based on 
professional considerations. Finally, an attorney formerly employed or 
retained by an issuer who reasonably believes that he or she has been 
discharged because he or she fulfilled the reporting obligation imposed 
by the rule may, but is not required to, notify the Commission of his 
or her belief and disaffirm in writing any submission to the Commission 
which is tainted by the violation.
    Paragraph 205.3(e) sets forth the specific circumstances under 
which an attorney is authorized to disclose confidential information 
related to his or her appearance and practice before the Commission in 
the representation of an issuer. Pursuant to this provision, an 
attorney may use the contemporaneous records he or she is required to 
create by the rule to defend against charges of attorney misconduct. 
Paragraph 205.3(e)(2) also allows an attorney to reveal confidential 
information to the extent necessary to prevent the commission of an 
illegal act which the attorney reasonably believes will result either 
in perpetration of fraud upon the Commission or in substantial injury 
to the financial or property interests of the issuer or investors. 
Similarly, the attorney may disclose confidential information to 
rectify an issuer's illegal actions when such actions have been 
advanced by the issuer's use of the attorney's services.
    We expect that the various reporting and recordkeeping requirements 
required by proposed Part 205 would, at least to a limited extent, 
increase costs incurred by both small issuers and law firms. We believe 
that many of these reports are, however, already being made and 
retained by those affected by the proposed rule. We are unable to 
estimate the frequency with which reports would have to be prepared and 
retained by small entities. The time required for the actual 
preparation of a report would vary, but should not be extensive. Small 
issuers and law firms may bolster, and in some instances, institute, 
internal procedures to ensure compliance--although the rule does not 
dictate how these procedures should be implemented.

F. Duplicative, Overlapping, or Conflicting Federal Rules

    Proposed Part 205 would not duplicate, overlap, or conflict with 
other federal rules. There are no other statutory federal requirements 
that small entities make similar reports or provide similar 
information.

G. Agency Action To Minimize Effect on Small Entities

    The Regulatory Flexibility Act directs the Commission to consider 
significant

[[Page 71703]]

alternatives that would accomplish the stated objective, while 
minimizing any significant adverse impact on small entities. In 
connection with the proposed rule, we considered the following 
alternatives: (a) The establishment of differing compliance or 
reporting requirements that take into account the resources available 
to small entities; (b) the clarification, consolidation, or 
simplification of the reporting requirements for small entities; (c) an 
exemption from coverage of the requirements, or any part thereof, for 
small entities; and (d) the use of performance rather than design 
standards. As discussed above, the Sarbanes-Oxley Act directs the 
Commission to implement rules requiring ``up the ladder'' reporting. 
The Act does not contain any exemption or other limitation for small 
entities. Small business issuers may have some difficulty staffing a 
QLCC, as we presume that they may have fewer independent directors. We 
note that issuers are not required to have a QLCC under the proposal, 
but we nevertheless seek comment on whether the QLCC should be modified 
for small issuers or if another committee or procedure could accomplish 
the same regulatory purpose. We do not believe that the rule will 
impose any significant increased costs on small law firms.
    The proposed rule uses some performance standards and some design 
standards. While the rule establishes a framework for reporting 
evidence of material violations ``up the ladder,'' it does not set 
specific standards for how to comply with the rule's requirements. For 
the most part, rather than requiring reports to contain specific, 
detailed disclosures, the proposed rule prescribes general requirements 
for reporting and recordkeeping. It does not dictate the time period 
that records need to be kept, but directs only that they be retained 
for a reasonable time. This should give small entities flexibility in 
complying with the proposed rule.
    We believe that utilizing different reporting or other compliance 
requirements for small entities would seriously undermine the effective 
functioning of the proposed reporting regime. The proposed rule is 
designed to restore investor confidence in the reliability of the 
financial statements of the companies they invest in--if small entities 
were not subject to such requirements, investors might shun their 
securities. Further, we see no valid justification for imposing 
different standards of conduct upon small law firms than would apply to 
others who choose to appear and practice before the Commission. We also 
believe that the proposed reporting and recordkeeping requirements will 
be at least as well understood by small entities as would be any 
alternate formulation we might formulate to apply to them. Therefore, 
it does not seem necessary or appropriate to develop separate 
requirements for small entities. We solicit comment on whether small 
entities should be subject to different requirements.

H. Solicitation of Comments

    Interested persons are invited to comment upon any aspect of this 
Initial Regulatory Flexibility Analysis. In particular, we request 
comments concerning: (i) The number of law practices that constitute 
small entities; (ii) the number of small entities that may be affected 
by proposed Part 205; (iii) the existence or nature of the potential 
impact of the proposed rule on small entities; and (iv) how to quantify 
the impact of the proposed revisions. Commenters are asked to describe 
the nature of any impact and provide empirical data supporting the 
extent of the impact. Such comments will be considered in the 
preparation of the Final Regulatory Flexibility Analysis, if the 
proposed rule is adopted, and will be placed in the same public file as 
comments on the proposed rule itself.

X. Small Business Regulatory Enforcement Fairness Act

    For purposes of the Small Business Regulatory Enforcement Fairness 
Act of 1996 (``SBREFA''), we must advise the OMB as to whether the 
proposed rule constitutes a ``major'' rule. Under SBREFA, a rule is 
considered ``major'' where, if adopted, it results or is likely to 
result in:

--An annual effect on the economy of $ 100 million or more (either in 
the form of an increase or a decrease);
--A major increase in costs or prices for consumers or individual 
industries; or
--Significant adverse effects on competition, investment, or 
innovation. Where a rule is ``major,'' its effectiveness will generally 
be delayed for 60 days pending Congressional review. We request comment 
on the potential impact of the proposed rule on the economy on an 
annual basis. Commenters are requested to provide empirical data and 
other factual support for their views to the extent possible.

XI. Statutory Basis and Text of Proposed Part 205

    We propose to add a new Part 205 to Title 17, Chapter II, of the 
Code of Federal Regulations under the authority in Sections 3, 307, and 
404 of the Sarbanes-Oxley Act of 2002,\89\ Section 19 of the Securities 
Act of 1933,\90\ Sections 3(b), 4C, 13, and 23 of the Securities 
Exchange Act of 1934,\91\ Sections 38 and 39 of the Investment Company 
Act of 1940,\92\ and Section 211 of the Investment Advisers Act of 
1940.\93\
---------------------------------------------------------------------------

    \89\ 15 U.S.C. 7202, 7245, 7262.
    \90\ 15 U.S.C. 77S.
    \91\ 15 U.S.C. 78c(b), 78d-3, 78m, 78w.
    \92\ 15 U.S.C. 80a-37, 80a-38.
    \93\ 15 U.S.C. 80b-11.
---------------------------------------------------------------------------

List of Subjects in 17 CFR Part 205

    Standards of conduct for attorneys.

    For the reasons set out in the preamble, the Commission proposes to 
amend Title 17, Chapter II, of the Code of Federal Regulations by 
adding Part 205 to read as follows:

PART 205--STANDARDS OF PROFESSIONAL CONDUCT FOR ATTORNEYS APPEARING 
AND PRACTICING BEFORE THE COMMISSION IN THE REPRESENTATION OF AN 
ISSUER

Sec.
205.1 Purpose and scope.
205.2 Definitions.
205.3 Issuer as client.
205.4 Responsibilities of supervisory attorneys.
205.5 Responsibilities of a subordinate attorney.
205.6 Sanctions.

    Authority: 15 U.S.C. 77s, 78d-3, 78w, 80a-37, 80a-38, 80b-11, 
7202, 7245, and 7262.


Sec.  205.1  Purpose and scope.

    Consistent with Section 307 of the Sarbanes-Oxley Act of 2002, 15 
U.S.C. 7245, the Commission is adopting rules setting forth minimum 
standards of professional conduct for attorneys appearing and 
practicing before it in any way in the representation of an issuer. 
Where the standards of a state where an attorney is admitted or 
practices conflict with this part, this part shall govern.


Sec.  205.2  Definitions.

    For purposes of this part, the following definitions apply:
    (a) Appearing and practicing before the Commission includes, but is 
not limited to, an attorney's:
    (1) Transacting any business with the Commission, including 
communication with Commissioners, the Commission, or its staff;
    (2) Representing any party to, or the subject of, or a witness in a 
Commission administrative proceeding;
    (3) Representing any person in connection with any Commission 
investigation, inquiry, information request, or subpoena;

[[Page 71704]]

    (4) Preparing, or participating in the process of preparing, any 
statement, opinion, or other writing which the attorney has reason to 
believe will be filed with or incorporated into any registration 
statement, notification, application, report, communication or other 
document filed with or submitted to the Commissioners, the Commission, 
or its staff; or
    (5) Advising any party that:
    (i) A statement, opinion, or other writing need not or should not 
be filed with or incorporated into any registration statement, 
notification, application, report, communication or other document 
filed with or submitted to the Commissioners, the Commission, or its 
staff; or
    (ii) The party is not obligated to submit or file a registration 
statement, notification, application, report, communication or other 
document with the Commission or its staff.
    (b) Appropriate response means a response to evidence of a material 
violation reported to appropriate officers or directors of an issuer 
that provides a basis for an attorney reasonably to believe:
    (1) That no material violation, as defined in paragraph (i) of this 
section, is occurring, has occurred, or is about to occur; or
    (2) That the issuer has, as necessary, adopted remedial measures, 
including appropriate disclosures, and/or imposed sanctions that can be 
expected to stop any material violation that is occurring, prevent any 
material violation that has yet to occur, and/or rectify any material 
violation that has already occurred.
    (c) Attorney refers to any person who is admitted, licensed, or 
otherwise qualified to practice law in any jurisdiction, domestic or 
foreign, or who holds himself or herself out as admitted, licensed, or 
otherwise qualified to practice law.
    (d) Breach of fiduciary duty refers to any breach of fiduciary duty 
recognized at common law, including, but not limited to, misfeasance, 
nonfeasance, abdication of duty, abuse of trust, and approval of 
unlawful transactions.
    (e) Evidence of a material violation means information that would 
lead an attorney reasonably to believe that a material violation has 
occurred, is occurring, or is about to occur.
    (f) In the representation of an issuer 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.
    (g) Issuer means an issuer (as defined in Section 3 of the 
Securities Exchange Act of 1934 (15 U.S.C. 78c)), the securities of 
which are registered under Section 12 of that Act (15 U.S.C. 78l), or 
that is required to file reports under Section 15(d) of that Act (15 
U.S.C. 78o(d)), or that files or has filed a registration statement 
that has not yet become effective under the Securities Act of 1933 (15 
U.S.C. 77a et seq.), and that it has not withdrawn.
    (h) Material refers to conduct or information about which a 
reasonable investor would want to be informed before making an 
investment decision.
    (i) Material violation means a material violation of the securities 
laws, a material breach of fiduciary duty, or a similar material 
violation.
    (j) Qualified legal compliance committee means a committee of an 
issuer that:
    (1) Consists of at least one member of the issuer's audit committee 
and two or more members of the issuer's board of directors who are not 
employed, directly or indirectly, by the issuer and who are not, in the 
case of a registered investment company, ``interested persons'' as 
defined in Section 2(a)(19) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(19));
    (2) Has been duly established by the issuer's board of directors 
and authorized to investigate any report of evidence of a material 
violation by the issuer, its officers, directors, employees or agents;
    (3) Has established written procedures for the confidential 
receipt, retention, and consideration of any report of evidence of a 
material violation under Sec.  205.3(c);
    (4) Has the authority and responsibility:
    (i) To inform the issuer's chief legal officer and chief executive 
officer (or the equivalents thereof) of any report of evidence of a 
material violation (except in the circumstances described in Sec.  
205.3(b)(5));
    (ii) To decide whether an investigation is necessary to determine 
whether the material violation described in the report has occurred, is 
occurring, or is about to occur and, if so, to:
    (A) Notify the audit committee or the full board of directors;
    (B) Initiate an investigation, which may be conducted either by the 
chief legal officer (or the equivalent thereof) or by outside 
attorneys; and
    (C) Retain such additional expert personnel as the committee deems 
necessary; and
    (iii) At the conclusion of any such investigation under paragraph 
(j)(4)(ii) of this section, to:
    (A) Direct the issuer to adopt appropriate remedial measures, 
including appropriate disclosures, and/or to impose 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; and
    (B) Inform the chief legal officer and the chief executive officer 
(or the equivalents thereof) and the board of directors of the results 
of any such investigation under paragraph (j)(4)(ii) of this section 
and the appropriate remedial measures to be adopted; and
    (5) Each member of which individually, together with the issuer's 
chief legal officer and chief executive officer (or the equivalents 
thereof) individually, has the authority and responsibility, in the 
event the issuer fails in any material respect to take any of the 
remedial measures that the qualified legal compliance committee has 
directed the issuer to take, to notify the Commission that a material 
violation has occurred, is occurring or is about to occur and to 
disaffirm in writing any document submitted to or filed with the 
Commission by the issuer that the individual member of the qualified 
legal compliance committee or the chief legal officer or the chief 
executive officer reasonably believes is false or materially 
misleading.
    (k) Reasonable or reasonably denotes the conduct of a reasonably 
prudent and competent attorney.
    (l) Reasonably believes means that an attorney, acting reasonably, 
would believe the matter in question.
    (m) Report means to make known to directly, either in person, by 
telephone, by e-mail, electronically, or in writing.


Sec.  205.3  Issuer as client.

    (a) Representing an issuer. An attorney appearing and practicing 
before the Commission in the representation of an issuer represents the 
issuer as an organization and shall act in the best interest of the 
issuer and its shareholders. That the attorney may work with and advise 
the issuer's officers, directors, or employees in the course of 
representing the issuer does not make such individuals the attorney's 
clients.
    (b) Duty to report evidence of a material violation. (1) If, in 
appearing and practicing before the Commission in the representation of 
an issuer, an attorney becomes aware of evidence of a material 
violation by the issuer or by any officer, director, employee, or agent 
of the issuer, the attorney shall report any evidence of a material 
violation to the issuer's chief legal officer (or the equivalent 
thereof) or to both the issuer's chief legal officer and its chief 
executive officer (or to the equivalents thereof) forthwith (unless the 
issuer has

[[Page 71705]]

a qualified legal compliance committee and the attorney chooses instead 
to report the evidence of a material violation to that committee under 
paragraph (c) of this section). An attorney does not reveal client 
confidences or secrets or privileged or otherwise protected information 
by communicating such information related to the attorney's 
representation of an issuer to the issuer's officers or directors.
    (2) The attorney reporting evidence of a material violation shall 
take steps reasonable under the circumstances to document the report 
and the response thereto and shall retain such documentation for a 
reasonable time.
    (3) The chief legal officer (or the equivalent thereof) shall cause 
such inquiry into the evidence of a material violation as he or she 
reasonably believes is necessary to determine whether the material 
violation described in the report has occurred, is occurring, or is 
about to occur. If the chief legal officer reasonably believes no 
material violation has occurred, is occurring, or is about to occur, he 
or she shall so advise the reporting attorney. If the chief legal 
officer reasonably believes that a material violation has occurred, is 
occurring, or is about to occur, he or she shall take any necessary 
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 chief legal officer shall 
promptly report the remedial measures adopted and/or sanctions imposed 
to the chief executive officer, to the audit committee of the issuer's 
board of directors, or to the issuer's board of directors, and to the 
reporting attorney. The chief legal officer shall take reasonable steps 
to document his or her inquiry and to retain such documentation for a 
reasonable time. In lieu of causing an inquiry under this paragraph 
(b), a chief legal officer (or the equivalent thereof) may refer a 
report of evidence of a material violation to a qualified legal 
compliance committee under paragraph (c)(2) of this section. If the 
issuer fails in any material respect to take any remedial measure that 
the qualified legal compliance committee directs the issuer to take in 
order 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 chief legal officer 
shall notify the Commission that a material violation has occurred, is 
occurring or is about to occur and shall disaffirm in writing any 
documents submitted to or filed with the Commission by the issuer that 
the chief legal officer reasonably believes are false or materially 
misleading.
    (4) If an attorney who has made a report under paragraph (b)(1) of 
this section reasonably believes that the chief legal officer or the 
chief executive officer of the issuer (or the equivalent thereof) has 
not provided an appropriate response, or has not responded within a 
reasonable time, the attorney shall report the evidence of a material 
violation to:
    (i) The audit committee of the issuer's board of directors;
    (ii) Another committee of the issuer's board of directors 
consisting solely of directors who are not employed, directly or 
indirectly, by the issuer and are not, in the case of a registered 
investment company, ``interested persons'' as defined in section 
2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19)) 
(if the issuer's board of directors has no audit committee); or
    (iii) The issuer's board of directors (if the issuer's board of 
directors has no committee consisting solely of directors who are not 
employed, directly or indirectly, by the issuer and are not, in the 
case of a registered investment company, ``interested persons'' as 
defined in section 2(a)(19) of the Investment Company Act of 1940 (15 
U.S.C. 80a-2(a)(19))).
    (5) If an attorney reasonably believes that it would be futile to 
report evidence of a material violation to the issuer's chief legal 
officer and chief executive officer (or the equivalents thereof) under 
paragraph (b)(1) of this section, the attorney may report the evidence 
of a material violation as provided under paragraph (b)(4) of this 
section.
    (6) An attorney retained or directed by an issuer to investigate 
evidence of a material violation reported under paragraph (b)(1), 
(b)(4), or (b)(5) of this section shall be deemed to be appearing and 
practicing before the Commission. Directing or retaining an attorney to 
investigate reported evidence of a material violation does not relieve 
the officers or directors of the issuer to whom the evidence of a 
material violation has been reported under paragraph (b)(1), (b)(4), or 
(b)(5) of this section of the duty to respond to the reporting 
attorney.
    (7) An attorney who receives what he or she reasonably believes is 
an appropriate and timely response to a report he or she has made 
pursuant to paragraph (b)(1), (b)(4), or (b)(5) of this section and who 
has taken reasonable steps to document his or her report and the 
response thereto under paragraph (b)(2) of this section need do nothing 
more under this section regarding the evidence of a material violation.
    (8) If the attorney reasonably believes that the issuer has not 
made an appropriate response to the report or reports made pursuant to 
paragraph (b)(1), (b)(4), or (b)(5) of this section, or the attorney 
has not received a response in a reasonable time, the attorney shall:
    (i) Explain his or her reasons for so believing to the chief legal 
officer, chief executive officer, or directors to whom the attorney 
reported the evidence of a material violation pursuant to paragraph 
(b)(1), (b)(4), or (b)(5) of this section; and
    (ii) Take reasonable steps to document the response, or absence 
thereof, and to retain such documentation for a reasonable time.
    (c) Alternative reporting procedures for attorneys retained or 
employed by an issuer with a qualified legal compliance committee. (1) 
If, in appearing and practicing before the Commission in the 
representation of an issuer, an attorney becomes aware of evidence of a 
material violation by the issuer or by any officer, director, employee, 
or agent of the issuer, the attorney may, as an alternative to the 
reporting requirements of paragraph (b) of this section, report such 
evidence of a material violation to a qualified legal compliance 
committee, if the issuer has duly formed such a committee. Except as 
provided in paragraph (b)(3) of this section, an attorney who reports 
evidence of a material violation to a qualified legal compliance 
committee has satisfied his or her obligation to report evidence of a 
material violation within the issuer, is not required to assess the 
issuer's response to the reported evidence of a material violation, and 
is not required to take any action under paragraph (d) of this section 
regarding the evidence of a material violation.
    (2) A chief legal officer (or the equivalent thereof) may refer a 
report of evidence of a material violation to a qualified legal 
compliance committee in lieu of causing an inquiry to be conducted 
under paragraph (b)(3) of this section. Thereafter, pursuant to the 
requirements under Sec.  205.2(j), the qualified legal compliance 
committee shall be responsible for responding to the evidence of a 
material violation reported to it under this paragraph (c) of this 
section.
    (d) Notice to the Commission where there is no appropriate response 
within a reasonable time. (1) Where an attorney who has reported 
evidence of a material violation under paragraph 3(b) of this

[[Page 71706]]

section rather than paragraph 3(c) of this section does not receive an 
appropriate response, or has not received a response in a reasonable 
time, to his or her report, and the attorney reasonably 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:
    (i) An attorney retained by the issuer shall:
    (A) Withdraw forthwith from representing the issuer, indicating 
that the withdrawal is based on professional considerations;
    (B) Within one business day of withdrawing, give written notice to 
the Commission of the attorney's withdrawal, indicating that the 
withdrawal was based on professional considerations; and
    (C) Promptly disaffirm to the Commission any opinion, document, 
affirmation, representation, characterization, or the like in a 
document filed with or submitted to the Commission, or incorporated 
into such a document, that the attorney has prepared or assisted in 
preparing and that the attorney reasonably believes is or may be 
materially false or misleading;
    (ii) An attorney employed by the issuer shall:
    (A) Within one business day, notify the Commission in writing that 
he or she intends to disaffirm some opinion, document, affirmation, 
representation, characterization, or the like in a document filed with 
or submitted to the Commission, or incorporated into such a document, 
that the attorney has prepared or assisted in preparing and that the 
attorney reasonably believes is or may be materially false or 
misleading; and
    (B) Promptly disaffirm to the Commission, in writing, any such 
opinion, document, affirmation, representation, characterization, or 
the like; and
    (iii) The issuer's chief legal officer (or the equivalent) shall 
inform any attorney retained or employed to replace the attorney who 
has so withdrawn that the previous attorney's withdrawal was based on 
professional considerations.
    (2) Where an attorney who has reported evidence of a material 
violation under paragraph (b) rather than paragraph (c) of this section 
does not receive an appropriate response, or has not received a 
response in a reasonable time, to his or her report under paragraph (b) 
of this section, and the attorney 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 
investors but is not ongoing:
    (i) An attorney retained by the issuer may:
    (A) Withdraw forthwith from representing the issuer, indicating 
that the withdrawal is based on professional considerations;
    (B) Give written notice to the Commission of the attorney's 
withdrawal, indicating that the withdrawal was based on professional 
considerations; and
    (C) Disaffirm to the Commission, in writing, any opinion, document, 
affirmation, representation, characterization, or the like in a 
document filed with or submitted to the Commission, or incorporated 
into such a document, that the attorney has prepared or assisted in 
preparing and that the attorney reasonably believes is or may be 
materially false or misleading;
    (ii) An attorney employed by the issuer may:
    (A) Notify the Commission in writing that he or she intends to 
disaffirm some opinion, document, affirmation, representation, 
characterization, or the like in a document filed with or submitted to 
the Commission, or incorporated into such a document, that the attorney 
has prepared or assisted in preparing and that the attorney reasonably 
believes is or may be materially false or misleading; and
    (B) Disaffirm to the Commission, in writing, any such opinion, 
document, affirmation, representation, characterization, or the like; 
and
    (iii) The issuer's chief legal officer (or the equivalent) shall 
inform any attorney retained or employed to replace the attorney who 
has so withdrawn that the previous attorney's withdrawal was based on 
professional considerations.
    (3) The notification to the Commission prescribed by this paragraph 
(d) does not breach the attorney-client privilege.
    (4) An attorney formerly employed or retained by an issuer who has 
reported evidence of a material violation under this section and 
reasonably believes that he or she has been discharged for so doing may 
notify the Commission that he or she believes that he or she has been 
discharged for reporting evidence of a material violation under this 
section and may disaffirm in writing to the Commission any opinion, 
document, affirmation, representation, characterization, or the like in 
a document filed with or submitted to the Commission, or incorporated 
into such a document, that the attorney has prepared or assisted in 
preparing and that the attorney reasonably believes is or may be 
materially false or misleading.
    (e) Issuer confidences. (1) Any report under this section (or the 
contemporaneous record thereof) or any response thereto (or the 
contemporaneous record thereof), may be used by an attorney in 
connection with any investigation, proceeding, or litigation in which 
the attorney's compliance with this part is in issue.
    (2) An attorney appearing and practicing before the Commission in 
the representation of an issuer may reveal to the Commission, without 
the issuer's consent, confidential information related to the 
representation to the extent the attorney reasonably believes 
necessary:
    (i) To prevent the issuer from committing an illegal act that the 
attorney reasonably believes is likely to result in substantial injury 
to the financial interest or property of the issuer or investors;
    (ii) To prevent the issuer from committing an illegal act that the 
attorney reasonably believes is likely to perpetrate a fraud upon the 
Commission; or
    (iii) To rectify the consequences of the issuer's illegal act in 
the furtherance of which the attorney's services had been used.
    (3) Where an issuer, through its attorney, shares with the 
Commission information related to a material violation, pursuant to a 
confidentiality agreement, such sharing of information shall not 
constitute a waiver of any otherwise applicable privilege or protection 
as to other persons.


Sec.  205.4  Responsibilities of supervisory attorneys.

    (a) An attorney supervising, directing, or having supervisory 
authority over another attorney is a supervisory attorney. An issuer's 
chief legal officer (or the equivalent) is a supervisory attorney under 
this section.
    (b) A supervisory attorney shall make reasonable efforts to ensure 
that a subordinate attorney, as defined in Sec.  205.5(a), that he or 
she supervises, directs, or has supervisory authority over is appearing 
and practicing before the Commission conforms to this part and complies 
with the statutes and other rules administered by the Commission. To 
the extent a subordinate attorney appears and practices before the 
Commission on behalf of an issuer, that subordinate attorney's 
supervisory attorneys also appear and practice before the Commission.
    (c) A supervisory attorney is responsible for complying with the 
reporting requirements in Sec.  205.3 when a subordinate attorney has 
reported to

[[Page 71707]]

the supervisory attorney evidence of a material violation.
    (d) A supervisory attorney who reasonably believes that information 
reported to him or her by a subordinate attorney under Sec.  205.5(c) 
is not evidence of a material violation shall take reasonable steps to 
document the basis for the supervisory attorney's belief.


Sec.  205.5  Responsibilities of a subordinate attorney.

    (a) An attorney under the supervision, direction, or supervisory 
authority of another attorney is a subordinate attorney.
    (b) A subordinate attorney is bound by this part notwithstanding 
that the subordinate attorney acted at the direction of or under the 
supervision of another person.
    (c) A subordinate attorney complies with Sec.  205.3 if the 
subordinate attorney reports to his or her supervising attorney under 
Sec.  205.3(b) evidence of a material violation that the subordinate 
attorney becomes aware of in the course of appearing and practicing 
before the Commission.
    (d) A subordinate attorney may take the steps permitted or required 
by Sec.  205.3(b), (c), and (d) if the subordinate attorney reasonably 
believes that a supervisory attorney to whom he or she has reported 
evidence of a material violation under Sec.  205.3(b) has failed to 
comply with Sec.  205.3.


Sec.  205.6  Sanctions.

    (a) A violation of this part by any attorney appearing and 
practicing before the Commission in the representation of an issuer 
shall be treated for all purposes in the same manner as a violation of 
the Securities Exchange Act of 1934 (15 U.S.C. 78a et seq.), and any 
such attorney shall be subject to the same penalties and remedies, and 
to the same extent, as for a violation of that Act.
    (b) With respect to attorneys appearing and practicing before the 
Commission on behalf of an issuer, ``improper professional conduct'' 
under section 4C(a) of the Securities Exchange Act of 1934 (15 U.S.C. 
78d--3(a)) includes:
    (1) Intentional or knowing conduct, including reckless conduct, 
that results in a violation of any provision of this part; and
    (2) Negligent conduct in the form of:
    (i) A single instance of highly unreasonable conduct that results 
in a violation of any provision of this part; or
    (ii) Repeated instances of unreasonable conduct, each resulting in 
a violation of a provision of this part.
    (c) An attorney appearing and practicing before the Commission who 
violates any provision of this part is subject to the disciplinary 
authority of the Commission, regardless of whether the attorney may 
also be subject to discipline for the same conduct in a jurisdiction 
where the attorney is admitted or practices.

    Dated: November 21, 2002.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-30035 Filed 11-29-02; 8:45 am]
BILLING CODE 8010-01-P