Attorney is required to respond when attorney knows a corporate client has clearly violated an obligation which is likely to result in substantial injury to the company by proceeding as reasonably necessary in the best interest of the company
Requires Actual Knowledge
Clear Violation which is likely to result in substantial injury
No Specific Action Required
Enforced by State’s Ethics Enforcement Authority (usually State Bar Association, not the SEC)
A Deputy General Counsel (the “DGC”) of a public company, retains Ralph Bader, the Managing Partner of a major law firm, to a handle a variety of legal matters, including patent and software licensing, litigation, corporate and employment matters for a recently acquired non-public subsidiary. The DGC reports to the CLO of the public company.
Mr. Bader asks a number of his partners to handle these matters. An associate, together with an assistant general counsel (the “AGC”) and a VP of Business Development (who is a licensed attorney), while conducting diligence in conjunction with negotiating a key software license, discover a file regarding alleged infringement by the company’s key products of third party patents.
What are the duties of the AGC, DGC, VP of Business Development, and the CLO?
What are the duties of the associate, partners and Mr. Bader?
An attorney “ appearing and practicing ” before the SEC “ in the representation of an issuer ” is required to report “ forthwith ” to the issuer’s CLO, or to the CLO and CEO, “ evidence of a material violation ” (or “ EMV”) by the issuer, or by any officer, director, employee or agent of the issuer.
An Attorney’s Duty to Report Up the Ladder (continued)
Unless the reporting attorney reasonably believes that the CLO or CEO has provided an “ appropriate response ” within a reasonable time, the attorney must report the EMV to the issuer’s audit committee, another board committee consisting solely of independent directors or the full board of directors.
Key Elements of the Up the Ladder Reporting Requirements
Attorney Must Be“Appearing and Practicing” Before the SEC
“In the Representation of an Issuer”
Have “Evidence of a Material Violation”
Report Forthwith (promptly) to the CLO, CLO and CEO, or QLCC (if futile to report to CLO, then attorney may report to Audit Committee or Board directly)
If no “Appropriate Response” from the CLO or CEO within a reasonable period of time, report to the Audit Committee, another independent committee or the Board of Directors
When Is An Attorney “Appearing And Practicing” Before the SEC?
“ Appearing and practicing” before the SEC includes attorneys who:
Transact any business with the SEC, including communications in any form;
Represent an issuer in a SEC administrative proceeding or in any SEC investigation, inquiry, information request or subpoena;
When Is An Attorney “Appearing And Practicing” Before the SEC? (cont.)
When an attorney:
Provides advice in respect of the U.S. securities laws regarding any document that the attorney has notice will be filed with or incorporated into any document that will be filed with the SEC, including the provision of such advice when preparing any document; or
Advises an issuer as to whether information or a written document is required to be filed with or incorporated into any document that will be filed with the SEC.
Examples Of Attorneys Appearing and Practicing Before the SEC
Non-Securities Lawyer Who Reviews Portions of an SEC Filing
Contract Attorney Who Knows Contract Will Be Filed As An Exhibit To An SEC Filing
Supervisory Attorney of a Subordinate Attorney Who is “Appearing and Practicing”
CLO (even if CLO delegates SEC duties)
Issue: The scope of the definition of covered attorneys is uncertain.
Rules indicate an attorney must be rendering advice relating to “securities laws.”
SEC staffers indicate the intention to interpret the definition broadly.
Covered attorney is required to report an EMV even if EMV is unrelated to representation.
Hypothetical: Associate (or AGC) may be a covered attorney if he or she (i) knew the software license would be filed with the SEC or (ii) is asked to review SEC disclosure describing the license.
An attorney licensed outside the U.S. is excluded if such attorney does not hold himself out as practicing, and does not give advice on, U.S. securities law (except as provided below) or other laws if such attorney either:
Conducts covered activities only incidentally to, and in the ordinary course of, his or her practice of law outside the U.S.; or
Conducts covered activities only in consultation with a U.S. licensed attorney.
An “Issuer” is defined to Include Reporting Companies and Securities Act Filers
An issuer is defined to include companies:
Which have securities registered under Section 12 of the ’ 34 Act or are required to file reports under Section 15(d) of the ’ 34 Act; or
Which have filed a registration statement that has not yet become effective under the ’ 33 Act which has not been withdrawn.
Does not include a foreign government issuer.
When Does An Attorney Have “Evidence of A Material Violation” or “EMV”?
An attorney must report an EMV forthwith if the attorney has:
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.
“Evidence of A Material Violation” - Key Elements of Test
Objective, Not Subjective Test.
Actual knowledge of the violation is not required to trigger a duty to report. SEC states “actual knowledge” standard is too high.
Attorney has no duty to conduct an investigation of the material violation.
Adopting release refers to definition as provided by federal courts.
“ Materiality” commonly defined by courts in terms of information or facts which a reasonable investor would consider material in making an investment decision with respect to the issuer. See Basic v. Levinson , 485 U.S. 224 (1988).
Unless the CLO reports the violation to a QLCC, CLO is required to take the following action:
The CLO is required to conduct an inquiry;
If the CLO reasonably determines there is no material violation, then the CLO must notify and advise the reporting attorney of the basis for the CLO’s determination;
If the CLO is unable to determine that there is no material violation, the CLO must take “ all reasonable steps to cause the issuer to adopt an appropriate response ” and must advise the reporting attorney thereof.
If an attorney believes that he or she was discharged because he or she fulfilled the reporting obligations, he or she may (but is not required to) notify the issuer’s board of directors, audit committee or other independent committee of the board .
Formation of a Qualified Legal Compliance Committee (a “QLCC”)
QLCC serves as an Alternative to Up the Ladder Reporting.
Board must duly establish the QLCC prior to any report of a material violation.
QLCC must have written procedures for the confidential receipt, retention and consideration of any report of evidence of a material violation under the new rules.
QLCC must have the power and responsibility to do the following:
Inform the CLO and CEO of any report of evidence of a material violation;
Retain independent experts; and
Recommend an “appropriate response” to the Board and take all other appropriate action, acting by majority vote, including the right to notify the SEC in the event the Board does not make an appropriate response.
Rule states that reporting attorney’s duty is satisfied if attorney reports EMV to the QLCC, not if the CLO reports the EMV to the QLCC. (Issue: What is an attorney’s duty if the CLO reports the EMV to a QLCC?)
Rule requires QLCC charter to provide procedures on the reporting and retention of a report of an EMV. What if the report is oral?
Disclosure of Attorney-Client Privileged Information
An attorney is permitted, but not required, to reveal to the SEC, without the issuer’s consent , confidential information to the extent the attorney reasonably believes such disclosure is necessary to:
Prevent the issuer from committing a material violation likely to cause substantial financial injury to the financial interests or property of the issuer or investors;
Disclosure of Attorney-Client Privilege Information (cont.)
Prevent the issuer in a proceeding from committing perjury, suborning perjury or committing any act that is likely to perpetuate a fraud upon the SEC; or
Rectify the consequences of a material violation that caused, or may cause, substantial injury to the financial interest or property of the issuer or investors in which the attorney's services have been used.
Rules do not require any form of documentation when an attorney makes a report or when the CLO or QLCC makes a response.
Rules do not address whether an investigation report provided to the SEC will be covered by the presumptive protection of attorney-client privilege.
Waiver: Criminal defendants such as company officers and directors may seek production of internal reports disclosed to the government.
Disclosure to “adversary”: Effectiveness of confidentiality agreements with the SEC, DOJ and other government entities concerning the sharing of internal report results with them is uncertain.
Common interest/joint defense exception to waiver rule.
Work Product privilege may afford protection.
Written internal reports may provide “road map” for plaintiff’s attorneys and help show “ scienter ” required under PSLRA.
Supervisory and Subordinate Attorneys - Who are they? What are their responsibilities?
A Supervisory Attorney is defined as:
An attorney supervising or directing another attorney who is appearing and practicing before the SEC in the representation of an issuer.
the CLO; and
To the extent a subordinate attorney appears and practices before the SEC, the supervisory attorney is also deemed to appear and practice before the SEC.
Subordinate Attorneys A subordinate attorney is defined as an attorney who appears and practices before the SEC in the representation of an issuer on a matter under the supervision or direction of another attorney (other than under the direct supervision or direction of the CLO).
Subordinate attorneys are subject to the reporting rules, but
Subordinate attorneys can satisfy their reporting obligations by reporting the violation to the supervisory attorney.
A subordinate attorney is permitted (but not obligated) to report the evidence up the ladder within the issuer if the subordinate attorney reasonably believes that the supervisory attorney has failed to comply with the up the ladder reporting requirements.
SEC could seek all remedies and sanctions available under the ’34 Act, including injunctions, cease and desist orders and officer and director bars.
SEC could subject an attorney to administrative disciplinary proceedings that can result in a censure, or a suspension or bar from practicing before the SEC, even if the attorney is subject to discipline by the applicable state bar.
When issuer has not made an “appropriate response” within a reasonable period of time and the material violation is ongoing or about to occur and is likely to result in substantial financial injury to the issuer or investors, then:
Outside Attorneys must:
Withdraw from representing the issuer;
Notify the SEC within 1 business day; and
Disavow any tainted opinion, document or rep filed with the SEC
In-house Attorneys must:
notify the SEC within 1 business day that he or she intends to disaffirm an opinion, document or rep which such attorney has prepared in a document filed (or incorporated in a filing) with the SEC.
When the issuer has not made an “appropriate response” within a reasonable period of time and the attorney reasonable believe that a material violation may have resulted in substantial financial injury to the issuer or investors, but is not ongoing , both inside and outside counsel may but are not required to follow the foregoing procedures.
attorney must still withdraw (outside attorneys) or disaffirm (in-house attorneys) if the attorney reasonably concludes that there is substantial evidence that a material violation is ongoing or about to occur and is likely to cause substantial financial injury to the issuer or its investors, but
the attorney is not required to withdraw or disaffirm in a matter if it would be prohibited by any order or rule of any court or administrative body; provided, however, that the attorney must notify the issuer that, but for such prohibition, he or she would have withdrawn.
issuer must publicly disclose the attorney's withdrawal or foregoing notice within two days.
Recommendations for Companies and In-house Counsel
Educate all attorneys (rules may apply to any attorney working with a public company, including attorneys for affiliates).
Establish Legal Department Procedures.
Develop Formal Procedures on documenting reports and responses (avoid situation where it is not clear that a communication is an EMV Report under the Rules).
Identify the CLO, Supervisory Attorneys and Subordinate Attorneys formally.
Consider procedures on how to conduct an investigation, including:
When to retain independent counsel and accountants.
How to protect the report under the attorney-client and work-product privileges.
Educate In-House and Outside Counsel as to the Company’s Procedures.
Recommendations for Companies and In-house Counsel (continued)
Consider establishing a QLCC.
Adopt a practice whereby the CLO meets routinely and privately with independent directors to facilitate Board attention to potential violations of law and breaches of duty.
Establish a direct line of communication between each outside counsel and the CLO.