The Perplexity and Perversity of the New Lawyer Conduct Rules©†

Sarbanes-Oxley Act (SOx) ß 307 is a fact of life, as are at least the first round of the rules required by itónow codified at Part 205 of Title 17 of the CFR.1 Unfortunately, those rules are unnecessarily perplexing (given their relatively modest goals), far more intricate than they need be, and almost certain to be perverse in at least some of their effects. In some respects, of course, these conclusions may be premature. If what has come to be called the "dirty withdrawal" requirement is ultimately adopted (whether in a clear or thinly disguised format), the stakes are significantly higher, and some of the issues that seem unnecessarily complex now may appear to be more (or, in some instances, even less) reasonable. Nonetheless, we cannot always wait to see if the other shoe drops.

Consider the following:

SOx ß 307 was adopted in response to a Congressionally perceived need to change the manner in which corporate and securities advisors counsel their corporate clients. To the extent the new rules actually affect lawyers' behavior, however, they are far more likely to influence practitioners with legal specialties other than the providing of such advice.

While the new rules probably won't affect the behavior of corporate and securities advisors, as a practical matter they may well result in a reallocation of decision-making authority from clients to lawyers, which is fundamentally counter to normal processes in a capitalist system, and should be highly offensive to corporate clients.

Many argue that "the problem"óassuming (as has not been legitimately established) that there is significant lawyer responsibility for the chain of frauds that led to Sox2óis the result of structural changes in the relative roles of inside and outside counsel to the corporation. Yet the new rules are likely to exacerbate that problem.

While the new rules may not affect behavior, they almost certainly will increase the frequency with which lawyers face disciplinary exposure as a result of the misdeedsóor claimed misdeedsóof their clients.

Most of the perplexing issues inherent in the new rulesóand there are manyóare likely to be "resolved" in proceedings that are settled rather than litigated and adjudicated, even though they affect fundamental issues of the relationship between lawyers and their clients.

These five claims warrantóperhaps demand ójustification. It will follow, but first a somewhat less inflammatory analysis: for the most part, the new rules (absent noisy withdrawal) will probably do little harm, and may even provide some marginal social benefits. While the rules in their entirety are intricate and complex, their fundamental thrust can be easily stated, and for the vast majority of corporate/securities practitioners, in the vast majority of instances, easily applied:

When a lawyer becomes aware of inappropriate behavior on the part of a publicly-held client, he or she should make sure that responsible officials at the client are made aware of the behavior, and should monitor the issuer's response. If the improprieties rise to the level of materiality as to the client, and if the client does not deal with them in a reasonable fashion, the lawyer should press the case further up within the organization even, if necessary, as high as the board or a committee of independent directors.

But there is an unfortunate corollary:

The new rules may be seen not so much as standards to guide lawyer behavior as principles under which lawyers will be the object of SEC enforcement actions. As such, there is an inevitable risk that their application will be premised not on the facts as they were understood and anticipated by the lawyers at the time, but on the facts as they will have historically evolved.

The New Rules Won't Likely Change the Corporate Lawyer's BehaviorÖ

Following the fundamental mandate identified above is unlikely to affect the practice of most corporate advisors for the simple reason that there already are incentives aplenty for lawyers to avoid being present at a scene that they perceive to involve fraudulent conduct. If what happened in the market to Enron (or others) had been anticipated, it could equally have been anticipated that the lawyers representing the involved companies would encounter financial burdens (not to mention potential exposure to liability) well in excess of fees received. The reason such law firms proceeded as they did seems almost certainly to be that they simply did not perceive what now, in retrospect, appears obvious. Put differently, is it conceivable that those firms, now, are pleased that they took on the Enron representation? Is there any particular reason to think that more explicitly identifying an undesirable consequence of having the wrong client in the wrong situation will make lawyers more adept at recognizing those risks? And if the risks are not perceived by the lawyers involved, no amount of rulemaking will likely succeed in affecting their behavior.

In short, it won't be lawyers' imperviousness to consequences that makes the new rules ineffective. Rather, new rules are not likely to provide much additional impetus simply because lawyers are already aware of sufficient adverse consequences. They may affect sensitivity to some of the concerns that generated the rules, but in the post-Enron, post-Anderson, post- WorldCom, post-Adelphia, post-Tyco world, such sensitivities were already on high alert.

ÖBut May Well Change the Conduct of Other LawyersÖ

Curiously, the impact of the new rules may be far greater on those who represent public companies in a capacity other than as corporate or securities counsel. Corporate advisors are to some degree accustomed to thinking about whether their clients pose the sorts of risks that are the subject of the new rules, and are accustomed to thinking (typically in consultation with general counsel) about the kinds of issues that should be brought to the attention of the Board of Directors, Audit Committee, etc. But those who represent corporations in material litigation, the conduct of internal investigations, the design of compensation, and in other capacitiesóall of which may arguably bring them within the definition of "appearing and practicing before the Commission" ómay well, if unsuspectingly, be subject to the mandates of the new rules.

At first blush, even that may not appear troublesome. If I am representing a corporation in litigation, and in the course of depositions I learn that the company's exposure is far greater and far more likely than had been anticipated, there is at least some basis in existing practice to charge me with a responsibility to be aware of the corporation's related disclosure obligations, to raise the issue with the general counsel if necessary, and to appeal to the board (or audit committee) if I am dissatisfied with the corporation's treatment of the issue. But what if the information of which I "become aware" (the language of the rules) during a deposition relates to a violation of law that has nothing whatever to do with the case I am handling? What if, in a case involving a contract dispute, the answer of a corporate officer to a question in a deposition leads meó or should lead any reasonable lawyeróto believe that the company has committed an entirely unrelated violation of the Foreign Corrupt Practices Act? Under the rules, the same standards appear to apply. If the evidence is credible (which seems likely in a deposition) and material (by hypothesis, here) I have a duty to report to the general counsel and to initiate the investigatory and reporting process envisioned by the rules.

Some would no doubt argue that such a result is appropriate. But is it within the litigator's perception of her role? Is it the kind of thing that she will be attentive to when representing the corporation in the contractual litigation? If not, there is at least some risk that occasions will arise in which lawyers become subject to SEC (and possibly even criminal) sanctions as a result of (mis)conduct that may have come to their awareness in some sense, but to which we should not expect them to have sensitivity. The same can be said of the compensation expert drafting a contract that will be an exhibit to the corporation's SEC filings, the labor lawyer drafting a collective bargaining agreement, or any of a number of other legal specialists.3 The SEC would never, of course, bring an action...