SPEAKERS CONTENTS INSERTS
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THE ROLE OF ATTORNEYS
IN CORPORATE GOVERNANCE
Wednesday, February 4, 2004
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance,
And Government Sponsored Enterprises
Committee on Financial Services,
The subcommittee met, pursuant to call, at 10:01 a.m., in Room 2128, Rayburn House Office Building, Hon. Richard Baker [chairman of the subcommittee] presiding.
Present: Representatives Baker, Ose, Gillmor, Manzullo, Kelly, Shadegg, Ryun, Capito, Kennedy, Kanjorski, Sherman, Inslee, Moore, Lucas of Kentucky, McCarthy, Emanuel and Scott. Mr. Gonzalez was also present.
Chairman BAKER. [Presiding.] I would like to call this meeting of the Capital Markets Subcommittee to order. The committee meets today to consider the role of professional conduct of attorneys and their responsibility toward appropriate corporate governance. Unfortunate events all too public now, from Enron to WorldCom and others, have necessitated the committee's work in review of the role of accountants, corporate officers, board members, credit rating agencies, research analysts and others.
The hearing today is a continuation of that review of all responsible parties and today we will focus on the professional accountability of corporate attorneys in disclosing material violations of securities law. The SEC is now in the process of considering two significant modifications to current standards, one referred to as the ''up the ladder'' responsibility to disclose to the chief legal counsel or the chief executive of the corporation material breaches of professional conduct; secondly, to report the evidence to the company's audit committee and the independent director specifically, or to the board of directors if the counsel does not appropriately respond to the evidence.
Page 2 PREV PAGE TOP OF DOC Another recommendation which has seemed to draw more attention and comment is the obligation of an attorney to file a ''noisy withdrawal'' from representing the company, and simultaneously notifying the SEC as to the reasons for this action. Significant debate continues over the appropriateness of the ''noisy withdrawal'' requirement, and we are here today to receive perspectives as to the appropriate direction the committee should take in regard to the SEC's consideration of this important matter.
I would also point out for the conduct of the hearing that we do expect at 11 o'clock this morning to have a joint session of the Congress, of course requiring us to adjourn the meeting for that purpose. It would be my hope that we could proceed in a timely manner this morning, perhaps limiting opening statements as much as is possible and asking all witnesses to engage their testimony in 5 minutes or less in order to give the committee opportunity for some interchange before the hour comes for adjournment. It is unfortunate, but at the time this was planned, we did not know and were not aware of this development. I suggest that for the witnesses's convenience, because I would not want to keep you here unnecessarily while the joint session was proceeding.
With that statement, I would call on Mr. Kanjorski for his comments.
Mr. KANJORSKI. Thank you, Mr. Chairman.
We adopted the Sarbanes-Oxley Act during the last Congress after a rash of corporate scandals. This statute modified the regulation of auditors, business executives, corporate boards and research analysts. A key section of this law also revised the oversight of attorneys in our capital markets. This part of the law and its related pending regulatory proceedings at the Securities and Exchange Commission are the focus of today's hearing.
The regulatory system for our capital markets depends in large part on the effectiveness of a variety of independent gatekeepers. These skilled professionals include the lawyers and accountants who verify and analyze the disclosures and documents of publicly held companies. These experts, from my perspective, have a special obligation to behave ethically and follow the law. Professionals like lawyers also have a responsibility to police themselves. If, however, such professionals fail to effectively monitor their actions and those of their peers, we have an obligation to protect investors by taking action in Washington.
Page 3 PREV PAGE TOP OF DOC After examining the corporate scandals at Enron, WorldCom and other companies, we ultimately determined that securities lawyers played a role in these debacles and decided to alter the rules governing the profession. One year ago, the Securities and Exchange Commission adopted a regulation to implement the reforms affecting securities attorneys mandated by the Sarbanes-Oxley Act. This rule requires lawyers to report ''up the ladder'' evidence of material wrongdoing to a company's officers and, if necessary, a company's board. This regulation, which I strongly support, became effective last August.
When adopting the rule governing the professional responsibilities of securities lawyers, the Commission also extended the public comment period on a proposal to require a ''noisy withdrawal'' by attorneys who do not receive a satisfactory response from a company to internal reports of wrongdoing. This plan to require the notification by the attorney to the Commission of his or her withdrawal immediately met with strong opposition from many practitioners in the legal community. In response, the Commission put forward for review an alternate plan. This substitute would require the issuer, rather than the attorney, to report the withdrawal of a lawyer for professional reasons.
The two withdrawal-and-notification proposals presently pending before the Securities and Exchange Commission raise important questions that we should carefully examine today. Each one has the potential to alter the attorney-client privilege and could have a chilling effect on communications between management and counsel, making executives less likely to consult and speak frankly with lawyers. These proposals might also unintentionally reward those lawyers with lower ethical standards, who would stretch the law beyond its reasonable interpretations and never withdraw from a client. We should closely examine each of these concerns.
In their observations today, I hope that our distinguished witnesses will answer a question that I have about restoring the ability of victims of securities fraud to sue those who aid and abet issuers in defrauding the public. Prior to a 1994 decision by the Supreme Court, individuals had the right to pursue a private cause of action against lawyers and other professionals who helped public corporations to deceive the public.
Page 4 PREV PAGE TOP OF DOC Although we partially overturned this decision when passing the Private Securities Litigation Reform Act of 1995 to allow the commission under certain circumstances to bring cases against aiders and abettors of securities fraud, we may have failed to do enough to protect investors. After all, past leaders of the Securities and Exchange Commission from both political parties have stressed the integral role of private lawsuits in maintaining investor confidence.
Since 1994, however, the victims of securities fraud have been unable to bring claims against lawyers and other gatekeepers who abuse the public trust by aiding issuers in misleading shareholders. Rather than adopting either one of the pending alternatives for reporting an attorney's withdrawal from representation because of concerns about the client's potential or actual wrongdoing, it may make sense for the Congress to instead restore the right of individuals to pursue their legal claims in our courts.
In closing, Mr. Chairman, I commend you again for your sustained leadership in studying these matters. This timely hearing will help us to better appreciate the decisions facing the commission as it continues its work to bolster investor confidence, restore the integrity of financial statements, and rebuild trust in our securities markets.
[The prepared statement of Hon. Paul E. Kanjorski can be found on page 32 in the appendix.]
Chairman BAKER. I thank the gentleman for his statement. It is my understanding Members on my side do wish to file for the record their opening statements, but do not wish to be recognized at this time. I would ask, are there Members on your side, Mr. Kanjorski, who wish to be recognized for an opening statement? Mr. Gonzalez, did you have a unanimous consent request?
Mr. GONZALEZ. Sir, I will be submitting something for the record, and I appreciate the opportunity to do that, but I do not wish to speak at this time.
Page 5 PREV PAGE TOP OF DOC [The prepared statement of Hon. Charles A. Gonzalez can be found on page 31 in the appendix.]
Chairman BAKER. We welcome your insightful participation, Mr. Gonzalez. Thank you, sir.
If there are no further opening statements at this time, then I will proceed to recognize our first participant this morning, Ms. Linda A. Madrid, managing director, general counsel and corporate secretary, CarrAmerica Realty Corporation, appearing on behalf of the Association of Corporate Counsel. Welcome, Ms. Madrid.
STATEMENT OF LINDA A. MADRID, MANAGING DIRECTOR, GENERAL COUNSEL AND CORPORATE SECRETARY, CARRAMERICA REALTY CORPORATION, ON BEHALF OF THE ASSOCIATION OF CORPORATE COUNSEL
Ms. MADRID. Good morning, Mr. Chairman, Ranking Member Kanjorski, and other Members of the committee.
I am Linda Madrid, and I serve as managing director, general counsel and corporate secretary of CarrAmerica Realty Corporation. CarrAmerica is a commercial office REIT that is traded on the New York Stock Exchange.
I am pleased to appear on behalf of the nearly 16,000 members of the Association of Corporate Counsel, or ACC, and the more than 7,000 private organizational entities that they represent in over 47 countries. Because outside counsel are not eligible for membership, we understand the issues and concerns facing in-house counsel probably better than any other organization.
The comments I offer here today are those of ACC and do not reflect the positions of my employer, CarrAmerica Realty Corporation. My oral testimony summarizes a more detailed statement which I hope you will include as part of the permanent record.
Chairman BAKER. Without objection, all witnesses's testimony will be made part of the official record. Thank you.
Page 6 PREV PAGE TOP OF DOC Ms. MADRID. Thank you.
The passage of the Sarbanes-Oxley Act reflects an understandable response to recent and devastating corporate scandals. ACC strongly supports the law's intention to restore shareholder and investor confidence. Corporate counsel play the key role in helping management and the board enact governance reforms that ensure the company's ethical culture is supported by sound governance systems. Our members embrace their professional and fiduciary duties, which include reporting allegations up the ladder to the highest authority necessary to ensure that the client can and does remedy the legal problems caused by rogue employees or executives.
Lawyers who represent corporations owe their allegiance to the institution, not to any individual within it. It is a basic tenet of all professional rules, not just those of the SEC, that have been promulgated under section 307. Our members fully support section 307 reforms that help in-house lawyers to work closely with managers to instill compliance values and guarantee sound legal systems.
My full statement as to how companies and law departments are ensuring compliance with 307 rules has been included, but I am happy to report today that the majority of law departments that have implemented policies under 307 have gone beyond the SEC's requirements.
I would be happy to respond to any questions you may have regarding the law departments's efforts, as well as the unanticipated problems they have discovered through practical implementation. These include the concern that too much time is spent on process, and it will take away focus from the preventive counseling that is necessary, continuing problems with the definition and scope of many of the important aspects of the Act and its terminology, and the proliferation of conflicting attorney conduct rules by governmental agencies and state bars.
However, ACC strongly opposes mandatory reporting-out requirements, which the SEC has kept on the table for consideration. We believe that they will damage the underlying relationship between in-house lawyers and their clients. Mandatory reporting-out by lawyers inhibits legal compliance efforts because it discourages clients from welcoming lawyers into every aspect of the company's most sensitive of matters.
Page 7 PREV PAGE TOP OF DOC In-house lawyers are only effective if they are integrated and trusted members of corporate management teams. If lawyers are viewed as in-house cops whose regulatory duties to outside enforcement agencies outweighs the client's need for confidential counsel, then the attorney-client relationship will have been undermined in a manner that is both counterproductive to the purpose and intent of the Act, and a disservice to the effective protection of the public and the client.
Thank you for this opportunity. I would be happy to answer any questions.
[The prepared statement of Linda A. Madrid can be found on page 57 in the appendix.]
Chairman BAKER. Thank you very much.
Our next witness is Mr. Stanley Keller, partner in the law firm of Palmer and Dodge. Welcome, Mr. Keller.
STATEMENT OF STANLEY KELLER, PARTNER, LAW FIRM OF PALMER & DODGE, LLP
Mr. KELLER. Thank you, Chairman Baker, Ranking Member Kanjorski and other Members of the committee. I am pleased to have the opportunity to testify before the subcommittee on this important subject.
Because Linda is here speaking for in-house lawyers, I can speak for out-house lawyers, having spent over 40 years in private practice representing corporations, and many public corporations. I have been actively involved in the subject of this hearing, having chaired until last August the American Bar Association's Committee on Federal Regulation of Securities.
I was also actively involved in the ABA's Task Force on Corporate Responsibility, known as the Cheek Commission, as a special adviser. Just to round it out, I was actively involved as liaison to the ABA's Task Force on Implementation of Section 307 of the Sarbanes-Oxley Act. In that capacity, I had a primary role in preparing the comments of the ABA to the SEC.
Page 8 PREV PAGE TOP OF DOC Having said that, I do not appear here as a representative of the ABA, but note that just as background. Rather, I am here in my individual capacity. I refer you to a letter submitted by the ABA, as well as a letter from Peter Moser, who chaired the section 307 task force. I embrace those letters.
I would like to very quickly, given the time constraints, address just two points, and two related points: one, the significant changes that have taken place in corporate governance and lawyer professional responsibility since the enactment of what we fondly refer to as SOX; second, the issues surrounding the need for additional action, namely the SEC's proposed ''noisy withdrawal'' rule.
Let me make clear that when I speak about the ''noisy withdrawal'' rule, I am speaking about either alternative that is still on the table. To me, it makes no difference if the mandate is that the lawyer withdraw, whether it is the lawyer that ends up reporting that withdrawal or it is the company that then is put in the position of having to report that withdrawal. The problems, I think, are the same with either alternative, although one has a cosmetic appeal.
The two issues are related because attorney professional conduct rules are best understood and considered in the context of the enhancements that have already taken place in corporate governance and in lawyer responsibility. My written testimony lists those. I will not dwell on them, but just to check-off a handful, we really have a new corporate governance structure requiring a majority of independent directors and effective committees of the board, notably the audit committee and recommendations that have been embraced widely for improved corporate governance from various groups, including the ABA's task force on corporate responsibility.
The ABA's approval this past summer of revisions to the model rules of professional conduct enhance the lawyer's role in ensuring legal compliance. We have the SEC's ''reporting up'' rules. I would like to say that the SEC did an outstanding job in responding to the mandate from Congress in section 307, to adopt the ''reporting up'' rules.
Page 9 PREV PAGE TOP OF DOC Those rules, while I must admit 307 was not enthusiastically embraced when it was proposed, have had a beneficial impact and have been widely accepted and are being followed or being implemented, because they are consistent with the ethics rules that lawyers have been subject to and, if anything, they have brought renewed attention to the need to comply with professional responsibility requirements.
The SEC's effort to override inconsistent state rules so as to permit lawyers in appropriate circumstances to report out again is consistent with existing state ethics rules. As I said, there have been significant compliance efforts by law firms, by corporate law departments, continuing legal education efforts and the like.
The result of all of these efforts has been the creation of a system in which we can all take confidence. Lawyers who are aware of their responsibility and are vigilant, having had brought, if you will, to their attention what their responsibilities always have been, and who are now paying attention to them reporting up when there is a problem to a board with independent directors who are in a position to receive, consider and act upon those reports. I think this is a system that we should allow to operate, that addresses the problems.
In the face of these circumstances, the ''noisy withdrawal'' proposals bring with them serious risks of adverse consequences, not in the lawyer's interest, if you will, but rather in the interest of the client and access to effective legal representation, to the core values of our legal system, and to principles of corporate governance.
These adverse consequences, put very simply, are erosion of the attorney-client relationship by making the lawyer a potential adversary; two, encouraging or promoting early withdrawal by lawyers who have to be more concerned about their own exposure to a violation of federal law than just hanging in there, seeking corporate compliance by the client, and serving the best interest of the client and the investors of those clients.
Perhaps even worse, because of the serious nature of having to withdraw, we may find lawyers discouraged from looking at the hard issues, the hard questions, so as not to turn over the stone and see the problems which would then put then in the position of having to report and potentially to withdraw. To me, that would be contrary to the best interests of promoting legal compliance.
Page 10 PREV PAGE TOP OF DOC Finally, judgments on critical business decisions, where a mandatory rule would suddenly put the lawyers in the position of making those decisions, rather than boards of directors and independent directors who are charged with that responsibility and expected to fulfill that responsibility.
Let me conclude, and leave the rest to my written testimony, really with my conclusion that we should allow the measures that have been put in place to operate before we embark on these fundamental changes to the lawyer's role, with the potential serious consequences that can result from those changes.
Thank you, and I would be happy to respond to questions at the appropriate time.
[The prepared statement of Stanley Keller can be found on page 52 in the appendix.]
Chairman BAKER. Thank you, Mr. Keller.
Our next witness is Professor Richard Painter from the University of Illinois College of Law. Welcome, professor.
STATEMENT OF PROFESSOR RICHARD PAINTER, UNIVERSITY OF ILLINOIS COLLEGE OF LAW
Mr. PAINTER. Thank you, Mr. Chairman and Members of the committee.
Wherever possible, I believe it is best to leave regulation to the states, rather than to the federal government. There are, however, exceptions, and section 307 is one of them. I pointed out in the early 1990s my frustration that out of dozens of lawyers accused by federal banking regulators of aiding and abetting savings and loan fraud, not one was disciplined by a state bar association, at least that I know of. This was so despite the fact that many of these lawyers settled cases brought by federal regulators for $20 million, $30 million and even over $40 million. The fact is that state bar discipline is virtually meaningless for policing the practice of securities and banking law.
Page 11 PREV PAGE TOP OF DOC It is for this reason that I proposed in a 1996 law review article that Congress enact a statute requiring securities lawyers to report known illegal acts of corporate clients up the ladder to the client's full board of directors. It is also for this reason that I appealed to the ABA in 1998 to amend the model rules of professional conduct to require such ''up the ladder'' reporting, only to have the proposal rejected in favor of the prevailing view at the time that such matters ought to be left to the lawyer.
It is for this reason that I and 40 other law professors wrote SEC Chairman Harvey Pitt in March of 2002 to request that the Commission promulgate rules requiring ''up the ladder'' reporting. Finally, this proposal made its way to Congress and Congress in the summer of 2002 enacted section 307, which requires the SEC to promulgate the ''up the ladder'' reporting rule.
Section 307 and the SEC rules thereunder appear to be working. Just last month, the New York Times reported that because of section 307, outside lawyers for TV Azteca, Mexico's second-largest broadcasting company, reported to its board of directors the fact that the company was probably violating United States securities laws. For the most part, I support the SEC's final rules under section 307 and would be happy to go into detail with respect to that if you would like.
With respect to the SEC's proposed rules, which have not yet become final, the most controversial provision is, of course, the proposal for ''noisy withdrawal.'' I would support a requirement that the lawyer withdraw from representing a client when they have reported to the full board of directors known securities law violations and the full board of directors refuses to obey the law. The amount of noise, however, should perhaps be left to the lawyer. Indeed, most lawyers, who do not want to find themselves in a position where they could be exposed to civil liability for their client's conduct, will take prompt steps once they have resigned to make sure that the fraud does not come to pass.
Page 12 PREV PAGE TOP OF DOC So with respect to that issue, I agree partially with the SEC's position that withdrawal should be required, but the ''noisy withdrawal'' proposal that has been so controversial is perhaps unnecessary.
I would then move on to other issues that I believe deserve our serious attention. One of these is the level of knowledge required to trigger section 307's reporting obligations to begin with. I believe the SEC's definition of ''evidence of material violation'' is exceedingly narrow and does not comply with the broad language of the statute. Second, the SEC needs to consider how easy or difficult it is for issuers to use the opt-out mechanism, which is a qualified legal compliance committee. The SEC should solicit commentary on how this aspect of the rule is working in practice.
Finally, Congress in section 307 gave the SEC quite broad authority beyond ''up the ladder'' reporting requirements. As I mentioned, I would not, if I were the Commission, use this authority and the political capital that the Commission might have on this issue, to fight over ''noisy withdrawal,'' but rather turn to some other areas of concern. One of them that I mention in more detail in my written testimony is contingent fees in connection with corporate transactions. In the AOL-Time Warner merger, Time Warner's counsel, according to press reports, received a contingent fee of $35 million contingent on the deal closing. It would have only been around $5 million if the deal had not closed.
I am not going to imply in any way that Time Warner received anything other than the most competent and loyal representation of counsel, but I am seriously concerned about contingent fees in securities transactions where the lawyer gets paid far more if the deal closes than if it does not, and this is the same lawyer who is supposed to be looking out for problems with the deal where it may not be in the interests of their client.
In sum, while the ''noisy withdrawal'' debate has received much attention, I urge the SEC to consider requiring withdrawal without requiring noise, and then to move on to other more pressing issues in carrying out its congressional mandate.
Page 13 PREV PAGE TOP OF DOC Thank you, Mr. Chairman.
[The prepared statement of Richard Painter can be found on page 85 in the appendix.]
Chairman BAKER. Thank you very much.
Our next witness is Professor George M. Cohen, University of Virginia Law School. Welcome, sir.
STATEMENT OF PROFESSOR GEORGE M. COHEN, UNIVERSITY OF VIRGINIA LAW SCHOOL
Mr. COHEN. Thank you very much. Thank you, Mr. Chairman, and thank you for having me here.
I want to state my conclusions that I give in the testimony first, and then talk about some responses to some of the objections that lawyers have made to the existing and the proposed rules.
First, the rule as it exists I support wholeheartedly. I believe that it needs to be fixed in several respects. One, the ''reporting up'' trigger is a very difficult trigger, I think, for lawyers and anyone else to understand, and very difficult for the SEC to enforce. Let me read to you what the rule actually says. The rule says that you have to report evidence of a material violation, and the definition of ''evidence of a material violation'' is ''credible evidence based upon which it would be unreasonable under the circumstances for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is ongoing, or is about to occur.''
This kind of formulation, with its double negative, makes it very difficult for the SEC to enforce actions against lawyers who engage in wrongdoing. I think that that needs to be changed because if the initial trigger, which is the main purpose of section 307 and the SEC rules, does not work well, then the whole thing does not work well.
Page 14 PREV PAGE TOP OF DOC Secondly, there is a problem with the ''appropriate response'' definition, that is, that if a lawyer reports wrongdoing to the CEO or the chief legal officer of the court, the question is, does the lawyer get an appropriate response, because that determines whether or not the lawyer needs to go up the ladder to the board. The ''appropriate response'' definition contains what you might expect.
That is, if after an investigation it is determined that there is no problem, or if it is determined that there is a problem, but it is being fixed. But there is another possibility that is listed in the SEC rules, and that is, if a lawyer is hired to investigate the alleged wrongdoing and is able to assert or is willing to assert a so-called ''colorable defense,'' then that is deemed to be an appropriate response.
I submit to the committee that that is not an appropriate response. It is an appropriate stance that one might take perhaps in litigation, but there is an important difference between lawyers' role as advocates in litigation and lawyers' roles as counselors in determining whether or not the company is more likely than not engaged in serious wrongdoing.
Finally, I think the rule needs to be changed to apply not only to individual lawyers, but to law firms. Firms are hired generally by corporations, not individual lawyers. The firm as a whole ought to be responsible. If the firm is not made responsible, there is a danger that work will be parceled out in such a way that no individual person, no individual lawyer will have sufficient knowledge of what is going on, what the big picture is.
The imputation of knowledge is a common feature of agency law, partnership law, and exists throughout the law. The SEC itself has used this idea under its former and still continuing authority under Rule 102(e). That should be adopted as part of the new SEC rules as well.
Secondly, I support wholeheartedly the ''noisy withdrawal'' rule that the SEC has proposed. I think that it is consistent with the traditional approach to this problem that has existed in the lawyer rules. In fact, the ''noisy withdrawal'' proposal is a creature not of the SEC, but of the ABA itself, which in its own comments to its own model rules says that there may be times when it is necessary for a lawyer to withdraw and also to disavow any documents or opinions that have proven to be false on further investigation. This is necessary in order for the lawyers to avoid becoming complicit in wrongdoing by corporations.
Page 15 PREV PAGE TOP OF DOC So the question is, if you go up the ladder and you have a board that is a corrupt board and insists on engaging in wrongdoing, how is the lawyer supposed to extricate himself or herself from being an assister, an aider and abettor in the wrongdoing? I think that the only way to do that, and I hope and expect that it would be in very rare circumstances, but I think that past experience suggests that it can happen, is that we ought to take a stance and say that if it does happen, that the board is engaged in wrongdoing and will not stop, that the lawyer ought to be required to make the noisy withdrawal. Whether or not the lawyer does it or the company does it, I do not have strong feelings about.
Third, I think that it is important to go beyond the SEC rules and fixing the SEC rules, to think about other ways to deal with some of the problems of lawyers assisting in corporate wrongdoing, the most important of which, in my view, is to restore private lawsuits, private damage suits for aiding and abetting liability, which were taken away by the Supreme Court decision in Central Bank in the mid-1990s, and were not restored, even though Congress had the chance to do it, in the Private Litigation Securities Reform Act. I think that that needs to happen. In some sense, the potential for liability for aiding and abetting is the most effective deterrent, the most effective regulator for lawyer behavior. I would urge Congress to restore the aiding and abetting cause of action.
Finally, I think that it is important to recognize that although the SEC is an important federal agency that regulates lawyers, it is not the only one. I think it would be wise for Congress to consider extending the SEC's rules to other lawyers who also appear before other federal agencies, both in the name of uniformity and consistency in an approach to the problem of corporate wrongdoing and lawyers' assistance in that wrongdoing.
I see that my time is up. I would be happy to answer questions and to talk about some of the other arguments I make in the testimony later on.
[The prepared statement of George M. Cohen can be found on page 34 in the appendix.]
Page 16 PREV PAGE TOP OF DOC Chairman BAKER. Thank you very much, sir.
Our next witness is Professor Thomas D. Morgan from George Washington University Law School. Welcome.
STATEMENT OF PROFESSOR THOMAS D. MORGAN, GEORGE WASHINGTON UNIVERSITY LAW SCHOOL
Mr. MORGAN. Thank you, Mr. Chairman, Members of the committee. I, too, appreciate the chance to be here with you today. You have heard from all of us, and we all agree that there is no right of any lawyer knowingly to assist a client, corporate or otherwise, to commit a crime or fraud. The problem is that there are a number of serious questions about how a given lawyer should be required to act in any particular concrete situation. But we all agree that the boundaries of appropriate zealous representation of a client end where knowingly assisting a crime or fraud begins.
The testimony that I have submitted to you, and that I will simply stand on, makes three important points. First, a comprehensive body of state and federal regulation already exists that renders doubtful the need for additional regulation. It includes, under some circumstances, a requirement of withdrawal and even permission of noisy withdrawal.
Second, the role of corporate attorneys in actually formulating corporate policy and in some cases even being aware of the intricacies of what the company is doing, very often tends to be much smaller than we sometimes think. Thus, the responsibility for much of the corporate wrongdoing is not likely to be significantly at the feet of attorneys. I leave the statement to develop that.
Third, federally mandated ''noisy withdrawal'' in the face of possible wrongdoing would potentially create more problems than it would solve. In the interest of time, I would like to focus my oral comments on that issue. Under current SEC standards, matters that an attorney is required to report within the client are quite broad. As Professor Painter suggested, the standard of knowledge is really quite low.
Page 17 PREV PAGE TOP OF DOC It includes matters about which the attorney may have very little knowledge, may not have worked on, may not even understand the subject matter area. Indeed, the attorney may not even be well equipped to evaluate the company's response. Yet, the lawyer may very conscientiously conclude that he or she must withdraw or does not want to continue representing the client.
What I suggest in my written testimony is that ''noisy withdrawal'' in those circumstances does not, will not provide investors with direct reliable information. I describe it as the professional equivalent of the parlor game of charades, the game in which people are asked to read content into otherwise ambiguous gestures. The problems of restoring investor confidence and of getting lawyers to give good legal advice and to respond appropriately in tough situations is just too serious for that kind of simplistic response.
I suggest to you that disclosure of ambiguous information to securities markets is not an unvarnished good. Accurate, easily understood information makes markets work better, but confusing, ambiguous information makes markets work less well. If investors are led to believe by the conscientious noisy withdrawal of a lawyer that they know facts about the company that later prove to be less significant than they once thought, real Americans are going to lose real dollars for no good reason.
Today, under existing regulation both of the SEC and of the states, attorneys can make disclosure to regulators, but their disclosures should be based on sound information, and before information goes to the markets, it ought to be confirmed and accurate and not simply be part of a single process.
Finally, Mr. Kanjorski asked us to talk about Central Bank. In response to Professor Cohen, I would simply suggest to you that moving to creating aiding and abetting liability for attorneys would not be a good idea. Under the Newby case, the Enron case in Texas, the judge has moved the law of primary violation of the securities law much more in the direction of saying that if a lawyer is actively involved in reporting inaccurate information to the public, the lawyer may be guilty of a primary violation. Simply creating a rule that ropes into every investor lawsuit every lawyer who might have touched the matter at some point in time, I would suggest to you is a great overreaction to the problem.
Page 18 PREV PAGE TOP OF DOC Thank you very much.
[The prepared statement of Thomas D. Morgan can be found on page 71 in the appendix.]
Chairman BAKER. Thank you, Professor Morgan.
I would like to start with you, and for the sake of the committee's conduct, I will announce that we will try to adhere to the 5-minute rule strictly today to give as many Members the opportunity because of the 11 o'clock joint session.
I think in order to determine the appropriateness of the revisions, one has to first establish the role of the corporate counsel within the structure, much like the committee did in viewing the role of the accountants and their fiduciary duty to shareholders. We had CPAs appear before the committee. When asked, to whom do you feel ultimate responsibility? They made the statement it is a shared responsibility between management and shareholders, which I found disappointing; that their role was to provide a true and accurate picture of financial condition so shareholders could assess the value of that holding.
If we determine that the role of corporate counsel is to ensure that corporate conduct does not engage in unintentional or intentional violations of law for the protection of the shareholder, that seems to create a higher standard of accountability than if we simply view it as an attorney-client relationship working on behalf of that executive to isolate that executive from any statutory or criminal liabilities.
To that end, if in your example it is unclear, uncertain, outside the area of specialization, and he acted, that would be in the shareholders's disinterest, I believe was your conclusion. On the other hand, where there is a three-act play, an opening, an explanation and a conclusion, it is clear. You have gone to the board; you have done all appropriate action. Isn't there some point at which a withdrawal appropriately should be made, when there is clear knowledge that all appropriate responses have been without remedy? Is this a moving target where one standard, as you describe it, does not fit all, but there are cases where such a withdrawal might be advisable?
Page 19 PREV PAGE TOP OF DOC Mr. MORGAN. Yes, Mr. Chairman. I do not think there is any question there are cases where it might be desirable, and where under current regulation it is appropriate and indeed, as Professor Cohen suggested, it is consistent with current state regulations that a lawyer should withdraw. Indeed, any lawyer who puts his or her reputation behind a situation that they know to be dishonest and fraudulent is clearly violating the rules today.
Chairman BAKER. It would appear to me that reestablishing that professional accountability would not be adverse to public interest, wherein you have established, and you are leaving it to the attorney; we are not prescribing the elements, the material facts that must be engaged in order for the step to be taken. We are merely establishing the fiduciary standard for your conduct.
I am not sure that the ''noisy withdrawal'' rule as currently constructed achieves the goal it is intended to achieve. But I have seen circumstances where I think it should have been appropriate and it was not taken, and shareholder interests were dissipated as a result of that failure to act. There has not been a corresponding responsibility for the attorney who did not engage in proper conduct. That really goes to the heart of my concerns about it.
Did anyone just want to jump in? Yes, Professor Painter?
Mr. PAINTER. I believe you are exactly right, Mr. Chairman. The lawyer for the corporation represents the corporation, which is run by its board of directors, not its officers, but its board of directors. That is why the ''up the ladder'' reporting is so critical. Directors have the right and the responsibility to know about violations of the law.
Second, the lawyer is also an officer of the corporation. The lawyer has some public obligation. If the lawyer knows the client refuses to obey the law, and they have exhausted all remedies with the board of directors, the lawyer should be required to resign. I support that part of the SEC's rules. The amount of noise involved can be a debatable question, but the lawyer should get out of there, and any intelligent lawyer will get out of there because they will be sued. We do not really need to overturn Central Bank of Denver to make it possible to sue lawyers in these situations.
Page 20 PREV PAGE TOP OF DOC If the company goes bankrupt, the trustee comes in and sues the lawyers. We saw that in the savings and loan cases. Indeed, the civil liability regime for the past 10 or 15 years has been way ahead of the ethics rules on this point. It was the civil liability regime that was really the sole disciplining factor for the bar until Congress decided in section 307 to step in and mandate SEC ethics rules, which was the right thing to do.
Chairman BAKER. Thank you.
Yes, Mr. Keller?
Mr. KELLER. May I just comment briefly? I think there is no question that there are circumstances when lawyers are well advised to withdraw. But I think the issue is whether you do more harm than good in trying to define any kind of bright-line rules as a matter of federal regulation or federal legislation, given the complexity of situations that we are confronted with.
We know when someone announces they are going to rob a bank that there is a clear violation of law. But very frankly, in the area we deal with, disclosure concerns, breach of fiduciary duties, there are subtle complex issues. That is why the regime that permits lawyers, indeed encourages lawyers, to take those actions helps; a regime that backs up the failure to act reasonably within a range of reasonableness, through being exposed to liability. Aiding and abetting liability exists. It is sanctioned by the SEC. You also can be a primary violator. That provides the kind of incentives, if you will, for proper conduct. I just do not think that this is an area susceptible to a bright-line test.
Chairman BAKER. Thank you sir. My time has expired.
Mr. KANJORSKI. In lieu of section 307, I am curious as to how great a problem the witnesses's feelings are as to how much of a problem exists today as compared to prior to 307. Are we beating a dead horse, that we need additional rules? Or is there any evidence out there that there is a failure to comply with either ethical codes or standards that were implied in section 307?
Page 21 PREV PAGE TOP OF DOC Mr. KELLER. As I indicated in my remarks, I think there has been a dramatic impact as a result of 307. Most every law firm in the country, I assume every in-house legal department, has put in place procedures to implement the SEC rules adopted pursuant to 307. There is a great deal of attention. This is part of what I think has been the overall impact of the Sarbanes-Oxley Act, which is reminding people and getting their attention back to what their fundamental responsibilities were.
Mr. KANJORSKI. Mr. Keller, I am going to direct it to you. We have a little difference between Professor Cohen and Professor Morgan in terms of aiding and abetting, whether we should go back and let the marketplace work out with the legal system on this problem. If you had to make a choice as a private practitioner to go back and reinstate the legal liability of aiding and abetting to investors or other individuals, as opposed to extending the ''noisy withdrawal,'' which would you choose?
Mr. KELLER. I would choose to let the law evolve as it is evolving in the Newby case, because the problem is the disproportionality of the exposure based upon the conduct and the financial interest, and the chilling effect of automatically being named in the proliferation of lawsuits which Congress sought to address in the Private Litigation Securities Reform Act would have on the ability of lawyers to counsel clients zealously and in the best interest of the client, as opposed to protecting their own interest. So I would let the common law evolve, given the anti-fraud rules that are now in place.
Mr. KANJORSKI. Professor Morgan, you indicated that there are instances where lawsuits can be brought by the trustee of a bankrupt estate, but how about in those situations where the fraud is successful?
Mr. MORGAN. Perhaps I do not understand the question.
Mr. KANJORSKI. The lawyer participates in a fraudulent transaction, but the corporation does not fail. There is no lawsuit by those people injured for aiding and abetting.
Page 22 PREV PAGE TOP OF DOC Mr. MORGAN. I was not intending to speak to the question of bankruptcy.
Mr. KANJORSKI. You mentioned in your response that there are in fact lawsuits that can be brought for aiding and abetting. You cite as an example a trustee in bankruptcy of a bankrupt corporation can bring an action. That is true, but what if the corporation does not go bankrupt? What if the fraud actually succeeds and the corporation makes a great deal of benefit, but at someone else's cost where a lawsuit for aiding and abetting in fraud would give that person a chance to recover?
Mr. MORGAN. There are two answers. One, to the extent the lawyer can be shown to have aided and abetted fraud, and there is a suit for fraud, the victim of the fraud can recover today.
Mr. KANJORSKI. That would only be if the attorney is directly involved in fraud, not aiding and abetting, as I understand it.
Mr. MORGAN. At least not under the federal securities laws. The question is, what is going to constitute a primary violation? The point that I was trying to make and that Mr. Keller reiterated was that under the Newby case, the law is moving more in the direction of saying that such a suit is available to a person who is injured by direct activity of the lawyer, as opposed to simply the lawyer having been involved at some point in time in the activities of the company.
What many of us are concerned about is that lawyers will be swept into a large undifferentiated mass of people who will be accused of aiding and abetting, but who have no primary responsibility. That is the concern.
Mr. KANJORSKI. I understand that, but why can't we put a filtering mechanism of the review of peers, and the suit does not have merit to proceed against the lawyer unless the peers decide that it was very clear that he had information, knowledge, and participated? We are doing a black and white situation here. I say why can't we move to a little bit of a gray area to reinforce and restore the aiding and abetting obligation or standard. As I understand it, the objection would be made now if a lawyer is named in a lawsuit as an aider and abettor. It would be stricken under existing law.
Page 23 PREV PAGE TOP OF DOC Mr. MORGAN. What happens today is that they will accuse him of being a primary violator. If the law as stated in the Newby case becomes the law, becomes generally accepted, then we will have moved in the direction that I think you are seeking to move. What some of us are saying is that we think the law is moving in the direction that you prefer, and that a general move toward aiding and abetting liability would not be desirable. Whether there is an interim step is a question about which I guess we would just simply have to look at the language that is selected.
Mr. KANJORSKI. Thank you. If I could take one more second, Mr. Cohen, I think, has something to add to this discussion.
Mr. COHEN. Yes, I do. Let me just say something about aiding and abetting. First of all, it is important to remember, one, aiding and abetting is a crime. It is a federal crime if there is sufficient criminal intent. Now, it is hard to prove criminal intent, but it has always been a crime to aid and abet. It has always been an ethical violation to aid and abet. The SEC currently has the authority to prosecute aiding and abetting. So to me, the idea that lawyers cannot figure out what aiding and abetting is, they have been living with aiding and abetting forever. So I do not find that a valid argument.
As to the Newby (Enron) case, I agree with the result in that case, but I think that, to go back to Professor Morgan's point about making sure that we want to clarify the law, Newby was not predicted by many securities lawyers ahead of time, the result. In fact, Professor John Coffee from Columbia had written a statement before that case was decided saying he did not think there could be a primary violation found.
So yes, you can stretch the law and call things primary violations that used to be called secondary violations, but why should you do that? We had a history under the securities laws, several decades of case law defining what aiding and abetting was. That was overturned in Central Bank. So there is a history. There is an understanding of what that means, and I do not think we should need to resort to subterfuge in expanding what primary violations are in order to have an effective rule.
Page 24 PREV PAGE TOP OF DOC Chairman BAKER. The gentleman's time has expired.
Mrs. KELLY. Thank you, Mr. Chairman.
There is one consideration here. There is an elephant in this room that has not been mentioned, so I am going to mention it. That is the shareholders. Because what any attorney does with regard to a corporation, anything that they do has to be focused on the shareholders. Whether the corporate people are focusing there or not, I believe there is a duty that the attorneys need to focus on what the effect is on the shareholders.
Professor Cohen, I am interested in what you said about making a mandatory corporate waiver statutory. Did I get that right? Would you like to talk about that a little bit? I am interested in what you were saying there.
Mr. COHEN. If you are referring to the ''noisy withdrawal'' proposal, I think what I was referring to there was that the SEC initially came out with a ''noisy withdrawal'' proposal that would require the lawyer who had reported the wrongdoing up to the board and was rebuffed, to make the noisy withdrawal. There was a firestorm about that and a lot of objections about that. So the SEC then came out with a revised proposal whereby rather than the lawyer making the noisy withdrawal, the company would have to make a filing with the SEC that stated that the lawyer, this law firm or lawyer, had resigned and explain the circumstances under which the resignation was made. So that is what I was referring to as the alternative proposal. What I was saying was that I think either proposal is fine, but I think that there should be some kind of noise at that point, whoever makes it.
Mrs. KELLY. No, that is not exactly what I was going after, but let me just continue on in that vein since you brought it up. In essence, that becomes then really a quiet withdrawal, because then it becomes a discussion between the corporation and the SEC, if I understand what you are saying.
Page 25 PREV PAGE TOP OF DOC Mr. COHEN. Yes, the corporation would have to make a disclosure to the SEC. Of course, it is possible that the corporation would not do that or would not say very much, but the theory is that as long as the SEC is alerted to some possibility, then the SEC could make a judgment about whether it is desirable to investigate further and the like. That is the theory behind it.
Mrs. KELLY. In general, inasmuch as most lawyers in corporations are there to help corporations comply with the law, an adjunct of that is to help corporations find where there is a loophole in the law. That is the conundrum we face. So basically, if I understand this panel correctly, most of you are not interested in the SEC pursuing a ''noisy withdrawal.'' Is that correct?
Mr. COHEN. I believe so.
I am not in favor of it. It looks like I am not the only one.
Mr. PAINTER. I have very mixed views on it. I think it is nowhere near as harmful as opponents of the ''noisy withdrawal'' proposal have said. Indeed, it is an opt-out rule. If you do not like it, under the SEC rules you simply set up a qualified legal compliance committee, and then all the reporting goes to the committee and there is no ''noisy withdrawal'' requirement anymore. So the company can opt out. I do not think it is anywhere near as bad as it has been described.
On the other hand, I see a lot of attention being focused on this issue, rather than some other potentially much more serious issues. I mentioned contingent fees in connection with merger deals and so forth. So I think the commission might want to re-phrase the rule in a manner that is somewhat more acceptable to its opponents, if necessary, because it is not that big a deal in the end. People will find out if the lawyer resigns. The Commission will find out. The underwriters will find out and start snooping around. I am not so sure we need a telephone call to the Commission saying, ''I have withdrawn for professional reasons, hint, hint,'' I am not sure that is necessary.
Page 26 PREV PAGE TOP OF DOC Ms. MADRID. If I may, I would have to say that there are a lot of theoretical issues, but the fact of the matter is there are many, many lawyers who are inside of corporations every day trying to figure out how to do this. I think that with a noisy withdrawal, there are very serious consequences that can flow from that. Fundamentally, the trust relationship between the inside counsel and the management team is critical to ensuring that there is sound corporate governance, and that there is legal activity.
To the extent that inside counsel are essentially cops, this is going to discourage management from including lawyers in on the conversations. If we start with the assumption that lawyers are going to help the management work through issues and find legal mechanisms and not loopholes, but really sound corporate decisions, having a ''noisy withdrawal'' we believe would really discourage that type of activity.
Mrs. KELLY. My time is up, but I would like to follow that up with written questions. Will you keep the hearing open?
Chairman BAKER. Certainly.
Mrs. KELLY. Thank you.
Chairman BAKER. I thank the gentlelady.
Mr. SCOTT. Thank you very much, Mr. Chairman.
I think there is certainly an important role that we must have for the attorneys in any of the ethics conflicts of interest, but I would also think that we must not overreach, that there is a balance with the ''noisy withdrawal.''
I have a two-point question. First, Ms. Madrid, there is a requirement in the Sarbanes-Oxley legislation that requires the first attorney, the ''up the ladder'' provision. What is your appraisal of that? How well has that performed and do you have any evidence that it has helped in the governance area?
Page 27 PREV PAGE TOP OF DOC Ms. MADRID. What we know from our membership is that, soon after the enactment of Sarbanes-0xley and the effectiveness of rule 307, the in-house counsel and the in-house law departments very quickly responded to the requirements. There were written requirements that were prepared in many, many law departments across the country. There was training that was delivered.
We understand that while there is still some confusion and ambiguity in terms of what the requirements are in the ''reporting up'' within the legal departments, I think that we find that the lawyers who bring this information or evidence to the chief legal officer, that that is an appropriate mechanism to work through these issues.
Mr. SCOTT. Thank you.
The other part of my question, I believe it was you, Professor Painter, you talked about contingency fees as probably the most serious issues, as opposed to ''noisy withdrawal'' and some of the other things. You used the example of the AOL Time Warner merger, the spread of maybe $30 million, from $5 million to $35 million. How would you restructure that? What recommendations would you offer us to deal with how we can more effectively restrict contingency fees in a way that would be in the best interests of the American shareholder?
Mr. PAINTER. First, it is not a widespread practice at this stage, to charge the contingency fee in that manner on the corporate transaction. That was one of several incidents, but it is not a common practice. But it was an enormous contingency fee for an enormous transaction, which has turned out not to be in the interests of counsel's client.
As I say, I have no evidence that there was inadequate representation there, but I do believe that in a securities transaction where it is the job of the lawyer to look for problems with the deal and to say no when there are problems, that it is not good for the lawyer to be paid several times more if the deal closes than if it does not. Accountants are not put on a contingency fee. Lawyers should not be. Investment bankers are, but investment bankers have a different function.
Page 28 PREV PAGE TOP OF DOC Lawyer contingency fees primarily have been used in the plaintiffs's lawyers area. I have other concerns. That is a different issue about excessive contingency fees in that area. But I think the spreading of contingency fees into corporate transactions is something that ought to be watched very carefully. There are a lot of other ways, whether it is hourly rates or other more traditional methods of billing the client that most law firms adhere to, and we do not need to see more of those types of contingent-fee arrangements.
Mr. SCOTT. Thank you.
Chairman BAKER. Does the gentleman yield back?
Mr. SCOTT. Yes.
Chairman BAKER. Mr. Manzullo?
Mr. MANZULLO. I just have a couple of questions. Do in-house corporate attorneys qualify for key person liability insurance coverage?
Ms. MADRID. Yes. I am sorry. Is the question in terms of D&O liability or another type of policy?
Mr. MANZULLO. Yes, that is correct. Go ahead.
Ms. MADRID. What we know is that today that is in flux. The insurance companies are taking varying positions and are modifying policies currently. It is unclear, at least from the perspective of the insurance companies, whether the attorneys when delivering professional advice to the corporation, they would be included in the D&O coverage.
This is an area that is probably going to, I would imagine, be getting a lot of attention in the near term. Frankly, these issues had not been coming up before, and now with attorneys being named as defendants in these types of cases, the issues are now coming to the forefront.
Mr. MANZULLO. Lawyers always sue anybody available, including other lawyers. In the past when a lawyer has been sued individually in the corporation, isn't there an obligation on the part of the corporation to indemnify, unless there was malfeasance? When I practiced law, if I gave bad advice and it worked to the injury of a client, I was liable for malpractice. Should that be any different in a corporation?
Page 29 PREV PAGE TOP OF DOC Ms. MADRID. As a general counsel, I would hope that we would have coverage. I think that what we are finding, however, is that the insurance companies may be taking a different view. You may have professional liability policies within a company that really are for third-party claims with respect to others that you may have provided professional advice to, as opposed to providing professional advice to the insured itself, that being the company as embodied through either its board of directors or its officers.
Mr. MANZULLO. I don't see any difference in whether you are employed on a retainer, on an hourly, or a member of the corporation as an employee. The obligation is that there has to be responsibility for giving bad advice. That can happen to anybody, and that is why you have insurance. I am just a little bit surprised it may be in flux. Are you telling me that you do not know if corporate attorneys now are covered by malpractice insurance?
Ms. MADRID. What I can tell you is that under D&O policies that have been issued to corporations, we have found that insurance companies are taking the position that in-house counsel may not be a covered insured under certain policies. As you know, many of the policies have different languages; they have different exclusions. Each one would be read individually, but we certainly are finding among the insurance industry a position that attorneys may not be covered under D&O policies. We obviously would hope to find a different opinion on that, but certainly we are seeing it today.
Mr. MANZULLO. So if there is an action that is brought by the shareholders against a member of the board of directors, who is relying up legal advice of the in-house corporate counsel, the member of the board of directors would be eligible for D&O coverage, but not the attorney giving the advice. Is that correct, under some circumstances?
Ms. MADRID. Under some circumstances.
Mr. MANZULLO. But in that circumstance, if the judgment is in excess of D&O coverage against the member of the board of directors, doesn't he have a right to be indemnified by the attorney personally for the excess?
Page 30 PREV PAGE TOP OF DOC Ms. MADRID. No, I do not believe that would be the case.
Mr. MANZULLO. So the member of the board who acts, I am not talking illegally, but acts improperly, based upon the bad advice of the attorney would have no recourse against that attorney. If the attorney were not a member of the corporation, it is obvious that he would. But the fact that the attorney works for the corporation insulates him from a lawsuit by a fellow employee?
Ms. MADRID. No, I do not believe he is insulated, but he may not have insurance. That would be the issue. Today what we are finding is that even when insurance policies are being triggered, they are being triggered only for defense costs, and not indemnification in terms of any liability.
Mr. MANZULLO. Okay. Thank you.
Chairman BAKER. I thank the gentleman.
Mr. EMANUEL. Thank you, Mr. Chairman.
To the professors on the panel and if others want to reply, they can obviously come in. On a slightly different issue in dealing with some of the issues that we on this committee have looked at, as well as in the Senate, in looking at the issue of tax shelters and the role of attorneys in advising on tax shelters. In some of the recent articles, much of the focus has been on the accounting industry. A lot of this would not be allowed to continue if it was not for some of the legal advice and some of the counsel being given by outside attorneys.
Have you conducted any research on the role of attorneys in the tax shelter business? What is the outcome of that research? This is to anybody; don't all jump at once. It is a jump-ball question.
Mr. COHEN. I have not looked at what has been going on with tax opinions. What I have looked at a little bit is the ''advice of counsel'' defense, which tends to be interpreted differently in different areas of the law. That is something that I think one ought to be very skeptical about because one of the problems with the ''advice of counsel'' defense is the more likely that a court is to recognize such a defense, the more likely it is that lawyers are going to have an incentive to give a kind of ''get out of jail free'' card to people who are asking for that advice, and that more clients are going to demand that kind of advice.
Page 31 PREV PAGE TOP OF DOC I think the premise of the ''advice of counsel'' defense is that, well, if people act in good faith and go to see a lawyer and they happen to get bad advice, then they ought not to be penalized as harshly for that. But I think the problem is that once you recognize the defense, you undermine the premise for the defense being given in the first place. That is one area that I think needs to be studied further.
Mr. PAINTER. One other issue with respect to tax opinions is that if an accounting firm provides the tax opinion, and the IRS finds out that the tax opinion is wrong, the IRS can say to the accounting firm, ''I want a list of the people to whom you provided this tax shelter to.'' They go to the law firm and the law firm starts claiming the attorney-client privilege. I do not believe that the mere identity of the clients that you have provided tax advice to should be subject to the privilege; that people ought to be able to take this work, put it in a law firm and claim an attorney-client privilege where the IRS cannot even find out who the law firm has been advising. That has become a serious problem that has been litigated in the courts.
Mr. MORGAN. This is an area, as you know Mr. Emanuel, that the IRS has recently addressed.
Mr. EMANUEL. That was my follow-up question.
Mr. MORGAN. I must admit that I have not prepared any analysis of those regulations. It is an area that clearly needs review because there is a real risk that people will be tempted to give opinions that, as Professor Cohen says, look like they are providing security or reliable information, and in fact turn out to not be reliable. Beyond that, I really do not want to go on the record about something that I have not researched yet.
Mr. EMANUEL. I appreciate that. That has been the main focus, as you know, Mr. Chairman. You and I have talked.
Mr. KELLER. I just wanted to point out that, going back quite a number of years now, the American Bar Association came out with a very strict ethical position imposing very strict rules on lawyers rendering tax shelter opinions. I think it was recognition that it is important, as a professional matter, to hold lawyers to high standards in rendering those opinions.
Page 32 PREV PAGE TOP OF DOC I think there are issues now that need to be reviewed in terms of in fact who is the lawyer representing. Are they representing those who are peddling the tax shelter or are they representing those who are purchasing the tax shelter? We are seeing litigation evolving that will tell us the propriety of the behavior that has taken place.
Mr. EMANUEL. If you go back to Sarbanes-Oxley and some of the reforms given the last 2 years in corporate behavior, a lot of focus has been on the accounting industry and investment banking. But the truth is, the legal profession was equally a participant in some of the, in my own view, flimsy tax shelter advice. They are issuing one opinion, overcharging clients for the same opinion that they were Xeroxing and faxing around. They were a participant.
A number of accounting firms have recently announced that they are going to shut down those departments with that service. I think we need to be as vigilant on the legal profession as we have done in the other financial services sectors in making flimsy or questionable tax shelter advice.
The truth is, besides what the accounting industry has done, you could not go forward if the green light was not provided by the legal firm. So whether they are at the steering wheel or not, they definitely have been sitting in the car seat encouraging people to hit the gas. We need to be vigilant here, because the tax shelter and the tax code, and you talk about the IRS's ability to enforce. I am not against people trying to find if they can pay less in taxes, they can do that, but there has been a question of where the professional ethics stands in issuing this advice in the profession.
Chairman BAKER. The gentleman's time has expired.
I am sorry. Would you want to respond quickly, sir?
Mr. PAINTER. I just want to say that I think the IRS is vigorously pursuing this issue. It is very important for this body to back up the IRS and not to have a scenario where special interests simply run to the Congress to try and get Congress to undermine the IRS.
Page 33 PREV PAGE TOP OF DOC We had similar experiences with the Securities and Exchange Commission a number of years ago that former Chairman Leavitt wrote about in his book. I think it is very important for this Congress to back up regulators, whether it is the SEC or the IRS or other agencies who pursue professionals who are acting irresponsibly.
Mr. EMANUEL. Thank you.
Thank you, Mr. Chairman.
Chairman BAKER. The gentleman's time has expired.
Mr. GONZALEZ. Thank you very much, Mr. Chairman. Again, thanks to you and Ranking Member Kanjorski, as well as to the Chairman and Ranking Member Frank, for allowing me this opportunity.
It really was my question during the hearings that we had in fashioning our own House version of the legislation that addressed the role of attorneys, which was of course taken up by Senator Edwards over in the Senate. So here we find ourselves today.
But for Professor Cohen, what I am hearing, and correct me if I am wrong, is we have the attorneys withdrawing now. Isn't that sufficient? Isn't that wonderful? In my opinion, it is not. The objective is stockholder and shareholder confidence, investor confidence, right?
Then we have to determine how we arrive at that, so we work backwards. That is the SEC. The SEC has to be knowledgeable of what is going on out there in order to impose the rules and regulations so that we have that kind of confidence. So how do they get that information? We are working backwards. How do we get it?
I am going to give you two examples. Let us use Enron and the creation of the SPEs and everything that is out there now, whether it is being litigated in the civil environment or whether it is criminal. One scenario is we have a ''noisy withdrawal.'' The other scenario is we do not have a ''noisy withdrawal.'' Under those two scenarios, you tell me which best serves the interest of the public, and that is to make sure that we have an informed SEC.
Page 34 PREV PAGE TOP OF DOC Anybody, it does not matter in what order.
Mr. KELLER. Can I suggest that when the question is posed that way, it sounds as though the answer is obvious. But that is taking the issue, I think, out of an overall context, because as I tried to note in my remarks, it seems to me we have to keep in mind the role that lawyers play, both as part of the core value of our legal system and the right to independent counsel. Independent counsel, if you will, is the bulwark against oppressive regulation, oppressive government, wrong charges and what have you. That is an important principle I think we would all agree to preserve.
We also have lawyers who indeed every day, and I do this, are the policemen. We are working towards compliance. Our securities law system is very much a self-regulatory system. Yes, we have enforcement and we have civil actions. That keeps people in check, but that is limited, based on the vast array of what is going on. We are the people who are working towards fostering legal compliance. It is important that lawyers be kept in the middle of that process. Yes, held to be accountable; held to professional responsibility.
So I think you need to assess the ''noisy withdrawal'' situation against the broader value. It is part of the total picture. Those who promote it will admit that it is the rare circumstance. There is a distinguished former general counsel of the SEC who said it is a once in a lifetime event. Yes, you can find the one case where it would make a difference, but I would suggest that that one case is far outweighed by the ongoing countless times when lawyers are counseling legal compliance; where the ability to do so would be eroded by the problems that would be created by ''noisy withdrawal.'' So I think it is question of balance.
The ABA professional rules recognize that confidentiality, trust and confidence of clients and their lawyers is a core value. It is not immutable, however. There are exceptions. It is carefully tailored and its balancing those exceptions the way the professional rules have done that is important.
Page 35 PREV PAGE TOP OF DOC Mr. PAINTER. Congressman, in the scenario you describe, I believe that not only is withdrawal required, but a noisy withdrawal is what definitely should take place. A lawyer who does not make a noisy withdrawal in that context is very likely to expose himself to liability and enforcement actions and the like, regardless of what the SEC's rule is under section 307.
That is the reason why I have decided I was going to take the middle position on this. What the SEC must do is require the separation of the lawyer-client relationship in a circumstance where your client refuses to obey the law. You are required to terminate at least the securities side of the representation, if you are advising him on securities law and they won't obey the securities laws. This requires the resignation of the lawyer.
Once you have severed the lawyer-client relationship, I believe the lawyer is highly likely to take the step the lawyer needs to take to prevent the fraud from taking place. They have only downside in this situation, and not up-side if the client goes ahead and perpetrates the fraud.
So it is for that reason I have taken the position that it is not as big a deal either way, the actual SEC ''noisy withdrawal'' requirement as it is being made out to be. I am not opposed to the requirement, and indeed, as I said, it is optional. The client can opt-out simply by setting up a qualified legal compliance committee under these rules. So I do not understand all the fuss.
On the other hand, I am not so sure it is an issue that the SEC should continue to fight over when there are many more important things than the amount of noise in the withdrawal. But the withdrawal absolutely should be required.
Chairman BAKER. The gentleman's time has expired.
I want to insert into the record a statement from Mr. Peter Moser, who was unable to appear today. He is chief counsel to Piper Rudnick, but serves on the ethics committee and the task force of the American Bar Association on compliance with section 307 of Sarbanes-Oxley.
Page 36 PREV PAGE TOP OF DOC [The following information can be found on page 91 in the appendix.]
I also want to express my appreciation to each of you for your courtroom conduct today. You were not only informative, you were more importantly timely. To assure you that no enforcement action or liability will attach because of your participation here today, the committee will maintain the record open for at least 5 days to allow those who have more questions to formally submit those to you for additional response.
This is the beginning of the committee's exploration in this area and we do need to take care that the end result of our efforts is to assure shareholders that corporate governance is meeting the highest possible standard, while at the same time not unreasonably constraining appropriate business decisions for the overall best advantage of that corporate structure.
We do appreciate your participation and look forward to working with you in the days ahead.
Our meeting stands adjourned.
[Whereupon, at 11:22 a.m., the subcommittee was adjourned.]