SEC Commissioner Signals Need To Fulfill Mandate Of Sarbanes-Oxley Act And Develop "Minimum Standards" For Lawyers Practicing Before The Commission

• Published date: 03 June 2022
• Subject Matter: Corporate/Commercial Law, Corporate and Company Law, Securities, Privilege
• Law Firm: Cadwalader, Wickersham & Taft LLP
• Author: Mr Jason Halper, William P. Mills, III, Erica Hogan, Adam Magid, James Orth and Jayshree Balakrishnan

In remarks on March 5, 2022 on PLI's Corporate Governance webcast, Commissioner Allison Herren Lee of the Securities and Exchange Commission stated that, 20 years after its enactment, it is time to revisit the "unfulfilled mandate" of Section 307 of the Sarbanes-Oxley Act of 2002 and establish minimum standards for lawyers practicing before the Commission.¹ Commissioner Lee, who announced that she will not seek a second term when her current one ends this month, took issue with what she called the "goal-directed reasoning" of some securities lawyers'that is, focusing primarily on the outcome sought by executives, rather than the impact on investors and the market as a whole. Such lawyering, Commissioner Lee observed, has a host of negative consequences, including encouraging non-disclosure of material information, harming investors and market integrity, and stymying deterrence. The solution, Commissioner Lee opined, is to fulfill the mandate of Section 307, which empowered the Commission to "issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers."²

Over the last 20 years, the Commission has declined to adopt enhanced rules of professional conduct for lawyers appearing before the Commission. There are good reasons for the Commission's inaction, including the attorney-client privilege, the goal of zealous advocacy, the fact-specific nature of materiality determinations, and the traditionally state-law basis for the regulation of attorney conduct. Commissioner Lee, moreover, did not propose specific new rules, and recognized that the task was difficult and should be informed by the views of the securities bar and other stakeholders. Nor did she say that action by the Commission was imminent; it is unclear whether the Commission has authority to promulgate new rules under Section 307 given a 180-day sunset under the statute that occurred in 2003. Indeed, neither Commissioner Lee nor any of the other SEC commissioners have issued statements on this topic since the PLI webcast. SEC Enforcement Director Gurbir Grewal has, however, indicated an increased emphasis on gatekeeper accountability in order to restore public trust in the market.³ Nonetheless, given the Commission's existing authority to impose discipline under its Rules of Practice, practitioners should be mindful of the potential for increased scrutiny moving forward.

Background

In the wake of corporate accounting scandals involving Enron, Worldcom, and other companies, Congress enacted the Sarbanes-Oxley Act in 2002 "[t]o safeguard investors in public companies and restore trust in the financial markets."⁴ The Act was aimed at "combating fraud, improving the reliability of financial reporting, and restoring investor confidence,"⁵ including by empowering the SEC with increased regulatory authority and enforcement power.⁶ To that end, the Act includes provisions to fortify auditor independence, promote corporate responsibility, enhance financial disclosures, and enhance corporate fraud accountability.⁷

The Sarbanes-Oxley Act was passed just six months after the collapse of Enron in December 2001, and neither the House nor Senate bills originally contained professional responsibility language.⁸ Hours before the Senate passed its version of the Act, however, the Senate amended the bill to include language that would eventually become Section 307.⁹ Around the same time, 40 law professors sent a letter to the SEC requesting inclusion of a professional conduct rule governing corporate lawyers practicing before the Commission.¹⁰ The letter picked up on a 1996 article by Professor Richard Painter, then of the University of Illinois College of Law, which recommended corporate fraud disclosure obligations for attorneys similar to those imposed on accountants by the Private Securities Litigation Reform Act of 1995.¹¹ Senator John Edwards, one of the sponsors of the Senate floor amendment of the bill, emphasized the importance of including professional conduct rules for attorneys in such a significant piece of legislation, stating that "[o]ne of the problems we have seen occurring with this sort of crisis in corporate misconduct is that some lawyers have forgotten their responsibility" is to the companies and shareholders they represent, not corporate executives.¹²

In its final form, Section 307 imposed a professional responsibility requirement for attorneys that represent issuers appearing before the Commission. Specifically, Section 307 directed the Commission, within 180 days of enactment of the law, to "issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers,"¹³ and, at minimum, promulgate "a rule requiring an attorney to report evidence of a material violation of securities laws or breach of fiduciary duty or similar violation by the issuer or any agent thereof to appropriate officers within the issuer and, thereafter, to the highest authority within the issuer, if the initial report does not result in an appropriate response."¹⁴

Since enactment of Section 307, however, the Commission has promulgated only one rule pursuant to its authority, commonly known as the "up-the-ladder" rule.¹⁵ The up-the-ladder rule imposes a duty on attorneys representing an issuer before the Commission to report evidence of material violations of the securities laws. When an attorney learns of evidence of a material violation, the attorney has a duty to report it to the issuer's chief legal officer ("CLO") and/or the CEO.¹⁶ If the attorney believes...