potential effects of SEC regulation of attorney conduct under the Sarbanes-Oxley Act, The

INTRODUCTION

Under section 307 of the Sarbanes-Oxley Act, the Securities and Exchange Commission ("SEC") issued rules establishing "minimum standards of professional conduct for attorneys appearing and practicing before" the SEC on January 29, 2003.1 Section 307 only required an internal reporting rule, giving the SEC discretion to establish other rules governing the minimum conduct of attorneys.2 The SEC rules include the reporting requirement expressly required by Sarbanes-Oxley that attorneys must "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."3 If the chief legal officer ("CLO") or chief executive officer ("CEO") fails to "appropriately" respond to the evidence submitted, the rules require attorneys to report the evidence to the audit committee, another committee comprised of members not employed by the corporation, or the board of directors.4 In addition to the internal reporting rule, the SEC also issued rules for disclosure of confidential information, supervisory and subordinate lawyers, sanctions, and proposed rules for "noisy withdrawal."5

Two weeks before Sarbanes-Oxley was enacted, the American Bar Association Task Force on Corporate Responsibility ("Task Force") released a preliminary report proposing changes to the Model Rules of Professional Conduct ("Model Rules") and recommending the creation of communication channels between counsel and independent directors.6 The Task Force also recommended that the American Bar Association ("ABA") develop best practices for law firms.7 In remarks before the ABA Business Law Section in August 2002, former SEC Chairman Harvey Pitt communicated his support and agreement with various aspects of the Task Force's recommendations.8 The SEC regulations reflect the sentiments of both Pitt and the Task Force that the attorney's "true" client is the corporation and its shareholders, not senior management or general counsel.9

This note addresses preemption issues and the effects of SEC regulation of attorney conduct as governed by the rules promulgated subsequent to section 307 of the Sarbanes-Oxley Act. In examining the preemption issues, Section I reviews the historic interplay between the SEC and the ABA, focusing on the question of whether or not ethics rules should be federalized. Additionally, Section I summarizes the reactions within the legal community to the Sarbanes-Oxley Act which codified the SEC's authority to regulate attorney conduct. In examining the effects of the Act, Section II provides an overview of the SEC regulations and commentary within the legal profession by the Task Force, law professors, and practicing securities attorneys. Section II then addresses how the proposed SEC regulation may affect the Model Rules, securities practice within firms, and in-house practice within corporations. Finally, Section II addresses attorney compliance and SEC enforcement and discipline.

I. SHOULD ETHICS RULES BE FEDERALIZED?

In passing the Sarbanes-Oxley Act, Congress mandated that the SEC promulgate rules for attorneys appearing before it.10 While many significant issues arose with this Act, "the main bone of contention is the question of who should be regulating the conduct of attorneys. Until now, it has been the province of [the states] and of the [ABA] whose previous ethical rules have been widely adopted by the states."11 Part A of this section analyzes the historic dialogue about ethics rules between federal and state levels. The historical background illustrates that SEC regulation of attorney conduct has been an underlying theme for many years. Part B of this section compiles the various reactions within the legal community to the regulatory power finally codified by the SEC.

A. HISTORY OF ETHICS RULES

Beginning to recognize the potential for attorney misconduct, the SEC first attempted to clamp down on attorney conduct in SEC v. National Student Marketing Corp12 National Student Marketing Corporation merged with Interstate National Corporation, an insurance holding company.13 The lawyers approved a deal that eventually led to financial downfall for the shareholders.14 Not long after the merger, the value of the stock drastically decreased.15 The SEC argued that

the attorneys should have refused to issue the opinions in view of the adjustments revealed by the unsigned comfort letter, and after receipt of the signed version, they should have withdrawn their opinion with regard to the merger and demanded resolicitation of the Interstate shareholders.16

The SEC tried to tighten its reigns over attorney conduct by charging them for their failure to take any action against the fraud, for issuing an opinion with respect to the merger, for failure to withdraw that opinion and disclose proper information, and for issuance of a letter confirming stock validity.17 Concluding that those actions did not facilitate the merger, the court did not impose liability on the attorneys.18 Though injunctive relief was not granted, the SEC publicly argued for the first time that there was an obligation to the agency itself.19

In 1978, the Institute for Public Interest Representation, an affiliate of Georgetown University Law Center, proposed that the SEC should have an absolute rule that required, rather than allowed, lawyers appearing before them to report evidence of fraud or lawlessness.20 In part because this proposal was met with such strong opposition by the ABA,21 the SEC rejected the proposal.22

In response to the proposals to the SEC, the ABA amended the Model Rules. Before 1983, lawyers were required to withhold client confidences and were only permitted to disclose those confidences if the client intended to commit a crime.23 During the late 1970's, the Kutak Commission of the ABA proposed the Model Rules.24 The proposal would allow lawyers to reveal confidences if needed to prevent the client from committing a criminal or fraudulent act that was likely to cause "substantial bodily harm or injury to the financial interest or property of another."25 In hindsight, this adoption may have served as a preventive measure against corporate fraud. However, the ABA House of Delegates rejected the proposal, instead adopting a different amendment to Rule 1.6:26 "[l]awyers were not permitted to reveal the intention of a client to commit criminal or fraudulent acts likely to result in substantial financial injury or property damage."27

An example of discord between federal and state perspectives is evidenced by In re Kaye Schaler.28 The Office of Thrift Supervision had charged lawyers at Kaye Scholer with misconduct in their representation of Charles Keating, who controlled Lincoln Savings & Loan.29 In essence, the lawyers approved and transmitted misleading documents about the financial soundness of Lincoln Savings & Loan to the investigating Bank Board.30 The conflict centered on the different perspectives of the Office of Thrift Supervision (a federal agency) and state codes.31 "Virtually all state codes envision lawyers as advocates allied with their clients and forbidden to disclose client secrets."32 On the other side, however, the Office of Thrift Supervision perceived lawyers as agents rather than advocates and "argued that lawyers must make all disclosures that their client would be required to make to the regulator, even when disclosure conflicts with professional confidentiality rules."33 The dichotomy between the lawyer as a zealous advocate and as an objective agent emphasizes the tension that will arise when lawyers are forced to be whistleblowers. Though this case settled, it foreshadowed that when "lawyers begin to inform on clients . . . the traditional view of lawyer partisanship will be transformed."34 Additionally, this case highlighted "the ambiguity about the relevant standards of professional responsibility and fueled doubts about its capacity for self-regulation."35

There has long been a current of thought focusing on the federalization of legal ethics. In his article highlighting some of the advantages and disadvantages of federalization of legal ethics, commentator Fred C. Zacharias outlines the recent history of the legal profession.36 He suggests that lawyers have increasingly become more specialized in areas of federal law (such as securities) which inherently requires a broad, interstate client base.37 He then dissects both the advantages and disadvantages of federalization, ultimately calling for a broader reform than even the Sarbanes-Oxley Act entails.38 Such reform would federalize all ethic codes - not just those concerning attorneys appearing before the SEC.39

Zacharias offers practical arguments for unifying legal ethics. First, lawyers in today's society have client bases that span many states.40 Second, splintered rules hurt the legal profession because clients do not have accurate perceptions of what lawyers may or may not do for them.41 Additionally, federal decisions and administrative regulation already undermine the force of state rules.42 For instance, the SEC has always had the power to disbar attorneys appearing before it.43

Zacharias then analyzes arguments against federalism. One argument is that by leaving states to develop their own codes, there is more room for experimentation.44 Another relevant argument to the present situation is that codes traditionally tell lawyers how they should act, not how they must act.45 Federalizing the code "suggests that professional codes are more like 'law' than we have always assumed."46 Overall, his conclusion is one in favor of federalization:

Viewing the arguments fairly, one can draw these conclusions: First, strong justifications militate in favor of federalizing standards, but the precise effect of federalization and the time frame required to achieve its benefits are difficult to estimate. Second, as nationalization of legal practice spreads and the influence of federal rules and judicial decisions expands, some form of standardized national regulation seems inevitable. Self-regulation through ABA leadership is unlikely to bring about an end to splintered codes.47

If one accepts this view of federalizing the whole ethics code, it seems fairly reasonable for Congress to authorize the SEC to promulgate minimum rules for attorneys appearing before it.

Additionally, Robert A. Desilets asserts that the ABA rules are ineffective for attorneys appearing before the SEC.48 Ultimately, he stresses that "the rules offer little guidance to attorneys when representing an organizational entity such as a corporation; therefore, these rules require the securities attorney to try to discern the proper course of conduct despite this lack of direction."49 The first problem he points out is that the Model Rules require securities attorneys to represent the client (the corporation).50 However, within that corporation are a myriad of incompatible, if not directly conflicting, interests.51 "The dilemma for the securities attorney thus becomes determining just exactly who or what the client is while balancing the competing interest of the great numbers of actors comprising the 'client.' "52 Desilets also proposes that another problem with the Model Rules is that although a securities attorney acts as an advisor, the rules are targeted towards the adversarial role of lawyers rather than their role as advocates.53 Additionally, he points out that the Model Rules are not binding on the SEC, which he believes can cause attorneys confusion in their practice.54

Overall, Desilets argues that the "securities attorney needs a code designed specifically to address the unique ethical issues he confronts during the course of his representation of a corporation in a securities transaction."55 His article insightfully foreshadows the economic downfall that instigated the SarbanesOxley Act.56 Perhaps the SEC's new powers, even though not exactly what Desilets had in mind, will provide some guiding principle for attorneys.

The history of ethics rules thus reflects an ensuing tug of war not only between federal and state levels generally, but between the SEC and the ABA specifically. Dialogue among scholars also indicates that critics have long considered federalization of ethics as a potential solution to the discrepancies within the system. Therefore, what perhaps seems a drastic and "unprecedented step of etching an ethical rule into federal law"57 has actually been a part of the dialogue of the legal profession for the last several decades.

B. THE LEGAL COMMUNITY'S REACTIONS TO SARBANES-OXLEY

Passage of Sarbanes-Oxley has raised much speculation within the legal community. Indeed, "[l]egal experts on both sides of the bill said it represents an unprecedented incursion by a legislative body into the governance of the profession, which has historically been the domain of the high courts in each state."58 There is much insight to be gained from the current perspectives of the ABA, legal experts, and the SEC.

1. POSITION OF THE ABA

The ABA, as it stands to lose its authority as the leading regulatory power for lawyers, must find a balance between denning its own role in ethics and cooperating with the larger system. The ABA was concerned that state bar rules would be conscripted:

The ABA also opposes the creation of new federal standards by the oversight board and the SEC because these standards will likely conflict with existing state bar ethical rules, resulting in unnecessary confusion regarding the attorney's ethical duties and obligations. Under the ABA Model Rules of Professional Conduct - and the specific rules that are ultimately adopted by the individual state court systems - a lawyer is expected to serve as both an officer of the court and a zealous advocate for the client, and these rules provide clear instructions for reconciling these duties. Allowing the oversight board or the SEC to superimpose a new set of national ethical rules on the well-established state court rules will likely cause unnecessary confusion regarding the duties and obligations of lawyers who represent accounting firms or who practice before the SEC.59

The ABA thus opposed any Congressional grant of authority that not only allowed, but mandated, the federalization of ethics rules.

With the passage of Sarbanes-Oxley, the ABA issued a preliminary report as its own effort to modify the Model Rules.60 These proposals reflect the sentiment expressed by ABA President Robert E. Hirshon that "[t]he ABA is in a better position to consider rules for lawyers."61 Hirshon stipulated that "the organization supports much of the bill and shares a desire to restore investor confidence . . .; [however] some provisions open 'a Pandora's box.' "62 Through his comparison of the Sarbanes-Oxley Act to Pandora's box, Hirshon articulated the wariness expressed towards federalization of ethics rules.

2. POSITION OF LEGAL EXPERTS

Stephen Gillers, Vice Dean of New York University Law School and a legal ethics expert, offered an objective perspective of both the bill and the ABA's reaction in the same article as Hirshon's piece.63 He stated that many people wonder what will occur now that the ABA is not "the only player on the block."64 He too recognized the import of this bill: "I don't know if it's a first, but it's a significant effort by Congress to assume some responsibility for the regulation of lawyers, who are traditionally licensed at the state level. I worry about how wide that door will swing."65

On the other hand, Gillers has also suggested that the AB A undermined its own authority by not assuming the responsibility or the desire to modify the rules at an earlier point.66 Thus, while he "has some misgivings about bringing new players into the ethics realm," Gillers believes "that the ABA all but invited trespassers into its domain when it declined to endorse whistleblower provisions pioneered by the states or mandatory reporting."67

Gillers is not alone in the opinion that the ABA failed to address the issues underlying Congress's decision to pass Sarbanes-Oxley. Professor Richard Painter "has long been critical of the ABA's model rules because they did not require a lawyer to take any specific course of action when fraud or misconduct by a corporate client was discovered."68 Though "he would have preferred a system that fell within the current state codes of ethical conduct,"69 he and forty other law professors wrote to Former SEC Chairman Harvey Pitt asking him to enforce more stringent regulatory rules on attorneys.70 Many people do not feel that preemption issues are a legitimate concern as only a few states forbid disclosure and the SEC can avoid the conflict by allowing report or resignation.71

3. POSITION OF THE SEC

The SEC also recognized the importance of its new role and commented on the ABA's lack of action:

Rule 102(e) of the Commission's Rules of practice reflects our long-standing recognition of the key role corporate counsel has on the effectiveness of the SEC. By and large, the Commission has been circumspect about using its self-created ability to review and sanction the conduct of lawyers, preferring to leave this task to professional organizations, like the various state bar committees. But, I'm not impressed, or pleased, by the generally low level of effective responses we receive from state bar committees when we refer possible disciplinary proceedings to them.72

Harvey Pitt, as past SEC chairman, thus seemed to accept his new authority as a needed step. At the same time, he also acknowledged the inherent risks of federalization of ethics rales:

One need not oppose federalizing corporate governance standards to recognize there are risks inherent in giving an agency that sometimes faces corporate lawyers as adversaries the ability to regulate whether and how they satisfy our notions of appropriate professional behavior.73

Ultimately, the fact remains that "[TJawyers need to be regulated."74 It appears that the power given to the SEC is not the first or ideal choice for anyone - but perhaps the only one left on the playing field. Harvey Pitt hopes that all sectors, both federal and state, will collaborate in a united front:

If all institutions play their proper role, Congress will articulate broad standards, the SEC will define legal requirements under those standards, and the private sector will augment those legal requirements with additional ethical and moral prescriptions and proscriptions.75

II. EFFECTS OF SEC REGULATION OF ATTORNEY CONDUCT

This section first provides an overview of the SEC regulation of attorney conduct under Sarbanes-Oxley and commentary within the legal community. It then addresses how the proposed SEC regulation may effect the Model Rules, securities practice within firms, and in-house practice within corporations.76 The concerns raised within the legal community are the usual concerns of confidentiality, zealous advocacy, and autonomy raised when regulation of the profession is proposed.77 Until the attorney's practical identification of his client (corporate management) aligns itself with the official identification of an attorney's client (the corporation and shareholders), the regulation will likely encourage attorneys to remain ignorant of certain evidence rather than uncover or identify violations or breaches.78 Finally, this section addresses attorney compliance and SEC enforcement and discipline.

A. OVERVIEW OF THE SEC RULES AND ALTERNATIVE PROPOSALS

1. SEC RULES

In January 2003, the SEC released final rules pursuant to section 307 of the Sarbanes-Oxley Act setting "minimum standards of professional conduct for attorneys appearing and practicing before" the SEC.79 The rules have two main components: (1) an internal reporting requirement expressly mandated under section 307; and (2) proposed external reporting or "noisy withdrawal" provisions.80 In response to requests from the legal community, the SEC deferred the effective date of the rules to August 5, 2003, 180 days after publication in the Federal Register.81

a. 205.2(c) "Attorney"

The SEC adopted an expansive view of who is subject to the rule as an "attorney" to effectuate Congressional intent to protect investors through imposing internal reporting requirements on all attorneys appearing or practicing before the SEC.82 An "attorney" is any person actually "admitted, licensed, or otherwise qualified to practice law in any jurisdiction, domestic or foreign, or who holds himself . . . out as admitted."83 "Attorney" also includes both in-house and outside counsel.84

b. 205.3(a) Issuer as Client

Section 205.3(a) affirmatively defines the attorney's client as the organization, not corporate officers or other individuals with whom the attorney interacts.85 This final rule removes the proposal's requirement that the attorney is obligated to "act in the best interests of the issuer and its shareholders."86

c. 205.3(b) Reporting Requirement

An attorney appearing or practicing before the SEC must report "evidence of a material violation" when the attorney "becomes aware" of the evidence.87 The awareness standard sets a lower threshold of evidence to trigger the reporting requirement than the "knowledge" standard of Model Rule 1.13, which requires that the attorney "know" that a violation has been or will be committed.88 After the reporting requirement is triggered, the attorney has three options: default, bypass, or alternative. Under the default option the attorney must initially report the evidence to the issuer's CLO - or - the CLO and CEO.89 Under the bypass option the attorney may bypass reporting to the CLO or CLO and CEO if the attorney "reasonably believes" reporting to the CLO/CEO would be "futile," and can report directly to the issuer's audit committee, another committee of independent directors, or full board of directors.90 Under the alternative option the attorney may report the evidence of the material violation to a "qualified legal compliance committee" ("QLCC"), only if the QLCC was established before the report.91

After receiving a report of a possible material violation, the CLO has two options: (1) conduct an inquiry to determine if in fact a violation occurred, is occurring, or will occur; or (2) refer the report to the QLCC, only if the QLCC was established before the report.92 The CLO must advise the reporting attorney of the CLO's inquiry conclusions or decision to refer the report to a QLCC.93 Unless the CLO reasonably believes that no material violation occurred, is occurring, or will occur, the CLO must take "all reasonable steps" to ensure that the issuer adopts an appropriate response.94

A reporting attorney can satisfy all obligations under the SEC rule in three ways. First, if the attorney receives what he "reasonably believes" is an "appropriate and timely response,"95 he satisfies all obligations under the SEC rule.96 Second, if the attorney does not receive an appropriate response from the CLO or CEO within a reasonable time, the attorney must (1) report the evidence of the material violation to the issuer's audit committee, another committee of independent directors, or to the full board of directors; and (2) explain why he believes an appropriate response was not made to the CLO, CEO, and directors.97 The attorney's duties after this so-called "up the ladder" reporting will depend on the final noisy withdrawal provisions.98 Third, the attorney can report evidence of the material violation to the pre-established QLCC.99

d. Proposed 205.3(d) Noisy Withdrawal

The proposed provision requires or permits, depending on the circumstances, that an attorney who has not received an adequate response from the issuer to noisily withdraw.100 Mandatory withdrawal is required when the attorney believes a material violation is ongoing or is about to occur, while permissive withdrawal is allowed when the attorney believes a material violation has occurred and likely resulted in "substantial injury" to the issuer or investors.101 The attorney must notify the SEC of his withdrawal in writing and disaffirm all submissions which he believes are a material violation.102 While withdrawal is not explicitly mandated by section 307, it is arguably essential to make reporting obligations effective when the issuer fails to act.103 Noisy withdrawal does not violate the attorney-client privilege.104

e. 205.4 Supervisory Attorneys and 205.5 Subordinate Attorneys

These provisions detail the responsibilities of supervisory and subordinate attorneys and apply to attorneys employed both in-house by the issuer and those retained as outside counsel by the issuer.105 The SEC's failure to define "supervisory" or "subordinate" has been criticized as one of the practical obstacles for attorney compliance.106

f. 205.6 Sanctions and Discipline and 205.7 Private Action

A violation of the SEC rule subjects an attorney to civil penalties, but only the SEC may bring an action for a violation: the rules expressly rule out the possibility of private actions.107 A violating attorney is also subject to disciplinary action by the SEC, regardless of possible discipline by another jurisdiction for the same misconduct.108 An attorney complying with the SEC rule in good faith, however, is not subject to such discipline.109 The rules provide an exception for attorneys practicing outside the country: they are not required to comply with the rules if that compliance is prohibited by foreign law.110

2. ABA TASK FORCE PROPOSAL

Because the broad, aspirational nature of the Model Rules fails to provide sufficient guidance for corporate attorneys, the Task Force recommends changes to rules 1.13 ("Organization as Client"), 1.6 ("Confidentiality"), 1.2 ("Scope of Representation"), and 4.1 ("Truthfulness in Statements").111 In addition to changes to the Model Rules, the Task Force recommends the creation of direct lines of communication for outside and general counsel to report violations to independent directors.112 The underlying rationale of the Task Force's proposals is to ensure that attorneys protect the corporation, rather than an individual manager.113

B. POTENTIAL EFFECTS OF THE SEC REGULATION

Sarbanes-Oxley's emphasis on independence is pervasive, touching upon auditors, the board of directors, audit committees, investors, and attorneys.114 The SEC regulation establishes internal reporting which progresses "up the ladder" to the audit committee, another committee, or the full board, all of which are comprised solely of independent directors.115 As a result, corporations may be pressured to hire independent outside counsel (those law firms which do not already handle the corporation's litigation and transactional matters) to avoid similar improper influences by management.116

Counsel's interaction with the board of directors will probably increase. Under the Task Force's proposal, regular meetings outside of the presence of senior management between in-house counsel and the audit committee should be established.117 Outside legal counsel may also regularly attend board meetings again.118 In addition to hiring criteria of outside counsel and interaction with the board, other potential effects of the SEC regulation may include changes to the Model Rules, securities practice within firms, and in-house practice within corporations.119

1. WILL THE MODEL RULES BE AMENDED TO MIRROR THE SEC REGULATIONS?

The ABA Task Force's Preliminary Report serves to provide guidance to both the ABA and SEC post-Enron. The Task Force recommended that the ABA make concrete changes in the Model Rules.120 The SEC rules incorporate some of the Task Force's recommendations such as emphasizing the client as the organization and allowing an attorney to bypass reporting to the CLO/CEO if deemed futile.121 The SEC rules give proponents of changing the Model Rules additional support and may result in a greater likelihood that the ABA will indeed amend the Model Rules.122 However, similar proposals to amend the Model Rules have been successfully defeated in the past, most recently and notably in the Ethics 2000 proposal to add three exceptions to disclosing confidentiality to third parties.123

2. SECURITIES PRACTICE WITHIN FIRMS

Most firms with a healthy securities practice have been providing guidance for clients in preparing for and interpreting Sarbanes-Oxley.124 Since the role of attorneys in the Enron scandal was revealed and Sarbanes-Oxley was passed, law firms have also been re-evaluating their own practices.125 For example, Sullivan & Cromwell is compiling its advice on Sarbanes-Oxley in a book written by partner John T. Bostelman.126 Cravath, Swaine & Moore's homepage has a separate section dedicated to Sarbanes-Oxley developments and has posted its memorandum on the SEC rules regulating attorney conduct.127 And Kaye Scholer has posted an article written by partner Gregory Wallace providing guidance on internal investigations and document destruction policies.128 Law firms and corporate legal departments will need to draft and implement careful procedures and guidelines to ensure compliance and avoid potential liability.

The SEC regulation may affect the practice of securities by shifting the balance of power to the attorney, because the attorney now has an obligation to take matters "upstairs."129 Richard Hall, a partner at Cravath, Swaine & Moore, predicts that the most significant effect of the SEC regulation "will be on the process through which difficult questions of legal judgment are resolved with the client."130 If the SEC does not implement the proposed external whistle-blowing provision requiring the attorney to report possible violations outside of the corporation to the SEC, Hall expects that attorneys "will continue to be involved in guiding clients in the gray areas of the law."131 Hall suggests that with the internal reporting requirement, the balance of power would shift to the attorney during the "back and forth" discussions with the client concerning situations where it is uncertain whether there is a violation of the law.132

The SEC regulation will force outside counsel to develop professional relationships with the CLO, or general counsel, by requiring the attorney to report to the CLO in most situations when evidence of a material violation arises.133 Depending on the corporation, outside counsel currently reports to either general counsel or senior management.134 If outside counsel has no relationship with the CLO, reporting possible violations to the CLO would be difficult for it.135

Some fear that the SEC regulation may reduce the number of corporate clients who consult attorneys because they fear attorneys are compiling an SEC "investigation file."136 In addition, corporate officers will actually hire their own personal attorneys as a result of other provisions within Sarbanes-Oxley to prevent potential liability.137 The resulting issues are: how much work will be transferred from corporate attorneys to the attorneys for individual officers, and who will pay for these individual attorneys, the officer or the corporation?138 Professor Painter suggests that if the corporation pays for an attorney for an individual officer, this attorney should be subject to the SEC regulations.139

Some predict that the SEC regulations, without an external whistle-blowing requirement, will not have a significant effect on the practice of law, because many states, such as New York, already require internal reporting similar to Model Rule 1.13(b).140 While the SEC regulation differs from current rules, the differences are minor in terms of the actual effect on the practice of law.141

3. EFFECT ON IN-HOUSE COUNSEL

The effects of the SEC regulation on in-house counsel are closely tied to perceived changes in the role of in-house counsel and the SEC's definition of "attorney" subject to the regulation.142 If the role of the CLO is to prevent or avoid trouble, an attorney's obligation to report others, either internally to the board or externally to the SEC, could limit the attorney's inclusion in and exposure to sensitive corporate matters.143 Like law firms, in-house legal departments and interested associations have been providing guidance for compliance with the new SEC regulations.144

Would in-house counsel surrender their admission to practice to avoid being subject to the SEC rule? Does the SEC rule extend to non-lawyer CLOs?145 The answer to both questions depends on how "otherwise qualified to practice" is interpreted. If a non-lawyer CLO is "otherwise qualified to practice," in-house counsel would probably not surrender their admission to practice and the rule would extend to non-lawyer in-house counsel. Even without this interpretation, the potential for unauthorized practice of law ("UPL") actions would probably discourage the surrendering of admission.146

More importantly, the SEC regulation places obligations upon the CLO after a report is made. The CLO must come to a conclusion based on his reasonable belief or further investigation as to whether an actual violation occurred, is occurring, or will occur.147 The CLO must communicate this conclusion to the reporting attorney.148 If the CLO determines that an actual violation did occur, the CLO, not the reporting attorney, must report the violation "up the ladder" to the directors.149 The CLO also must take "all reasonable steps" to ensure that the issuer adopts an appropriate response.150

It has been suggested that in-house counsel may overlook or deny misconduct by outside counsel to avoid the appearance of failing to supervise the work of outside counsel.151 As the Enron situation indicates, in-house counsel might also turn a blind eye to the work of outside counsel because in-house counsel is involved in management's violations. The Powers Report found that both Enron's in-house and outside counsel approved financial disclosures, which if clear and accurate, would have revealed Enron's questionable transactions.152 In addition, an in-house attorney was found to have improperly accepted interest in violation of Enron's own code of conduct.153

C. COMPLIANCE, ENFORCEMENT, AND DISCIPLINE

1. IS ATTORNEY COMPLIANCE REALISTIC?

Attorney compliance will depend on the interpretation of the sec regulation and how the regulation is enforced. Without vigilant enforcement, it appears that the regulation will probably fail to fulfill Sarbanes-Oxley's mission of furthering the public interest and protecting investors because little will change in the practice of securities law.

If history, as told by SEC v. National Student Marketing,154 Charles Keatings' Lincoln Savings & Loan,155 In re OPM Leasing Services,156 and most recently, Enron, is truly a reliable predictor, corporate scandals which cheat hard working citizens and damage the trust in business and the accounting and legal professions, will unfortunately occur again. Hopefully the SEC regulation of attorney conduct will prevent the participation and implication of attorneys in these scandals to avoid repeating a Kaye Scholer or Vinson & Elkins scenario.

2. SEC ENFORCEMENT AND DISCIPLINE OF NON-COMPLIANCE

The SEC may sanction attorneys through Rule 2(e) disciplinary proceedings, cease and desist orders, or the prosecution of aiders and abetters.157 Under Rule 2(e), the SEC may "deny, temporarily or permanently, the privilege of appearing or practicing before it in any way" for unethical conduct or securities law violation.158 According to Professor Painter, "SEC Rule 2(e) proceedings are more common than proceedings against professionals by other administrative agencies."159

While the SEC tools for sanctioning attorneys are extensive, the SEC has generally been reluctant to sanction attorney conduct, leaving the regulation of professional conduct to the state bars.160 However, with the introduction of Sarbanes-Oxley's requirement that the SEC regulate the professional conduct of attorneys appearing before it, the SEC may retreat from its laissez faire approach in In re Carter & Johnson161 and enforce section 307 regulations through Rule 2(e) proceedings.162

CONCLUSION

The SEC regulation of attorney conduct under section 307 of the Sarbanes-Oxley Act raises concerns of preemption with state law and the potential effects of the regulation on the practice of securities and in-house law. The legal profession has resisted attempts in the past to require reporting client financial misconduct. The effects of a legislatively mandated regulation could create a shift towards greater self-regulation as various sectors within society remain critical of the profession's ability to self-regulate in the wake of Enron. Without enforcement through SEC disciplinary proceedings and a change in the way lawyers practically identify their clients, the SEC regulation may not have the intended effect on the actual practice of attorneys.

CHI SOO KIM* & ELIZABETH LAFFITTE** ***

* JD Georgetown University Law Center (expected May 2004). I would like to dedicate this note to my parents, brothers, Yimo, and Eugene. I owe all my past and future achievements to my parents and could not ask for more loving and supportive brothers. Loml- thank you for your unwavering love and patience.

** JD Georgetown University Law Center (expected May 2004).

*** We would like to thank Professors Bauman, Drinan, Luban, and Menkel-Meadow from Georgetown University Law Center for their guidance. Additionally, we would like to thank Brian Altman, James Eastman, Susan Hackett, Richard Hall, Frisby Larson, Margaret Love, Richard Painter, Chris Sabis, and Becky Stretch for their innut and leads.

Copyright Georgetown University Law Center Summer 2003
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