In remarks at PLI’s Corporate Governance webcast last week, SEC Commissioner Allison Herren Lee advocated that, after 20 years, it’s time for the SEC to fulfill the mandate of SOX 307 by adopting rules to set minimum standards of professional conduct for attorneys appearing and practicing before the SEC in the representation of issuers. But didn’t the SEC adopt up-the-ladder attorney reporting provisions under SOX 307 many years ago? Yes, but, she contended, the SEC “did not adopt a broader set of rules as Congress directed, and quite significantly, even this single standard has not been enforced in the nearly 20 years since it was adopted.” Her suggestions for standards are sure to trigger some controversy. Will the SEC up the ante on regulations for attorneys as gatekeepers?
In Lee’s view, the “bottom line is this: when corporate lawyers give bad advice, the consequences befall not just their clients, but the investing public and capital markets more broadly—especially when it comes to disclosure advice. But we do not currently have sufficient standards in place upon which to assess this kind of advice.” In SOX 307, Congress intended to provide accountability for lawyers, Lee observed, because “Congress was concerned…that counsel often acted in the interests of the executives who hired them rather than the company and its shareholders to whom their duty and responsibility is owed.” The policies behind the SOX 307 mandate were designed, she said, to support counsel in their role as gatekeepers.
In her remarks, Lee railed against lawyers’ “bad advice,” which, she said, “arises from a type of ‘can-do’ approach to lawyering that is ill-suited to lawyers in a gatekeeping role. It is born from a desire to give management the answer that it wants,” alluding to several Delaware cases in which the court characterized counsel’s actions as “goal-directed reasoning,” issuing opinions “based on artifice and sleight of hand,” or “‘commit[ing] fraud’ by holding back important information.” Although she acknowledged that these cases did not involve securities disclosure, “they are nevertheless emblematic of a dynamic—a kind of race to the bottom—that can occur when specialized professionals like securities lawyers compete for clients in high stakes matters and are pressured to provide the answers their clients seek.”
When lawyers fail as gatekeepers, Lee contended, by providing “‘goal-directed’ reasoning to public companies on critical issues like materiality,…[i]nvestors and financial markets can be harmed through false or misleading disclosure.” And the involvement of lawyers in disclosure determinations has increased as the SEC has shifted toward principles-based rulemaking focused on materiality. While “reputational harm can offer a powerful incentive,” concerns regarding reputational harm can cut both ways: they can spur “lawyers not to succumb to [management] pressure,” but also, lawyers view themselves as “problem-solvers for their clients, and failing to give management what it wants can actually be what causes reputational harm.”
Lee also argued that “contrived legal advice can actually insulate from liability those individuals within a company who are responsible for false or incomplete disclosure. This turns the role of gatekeeper on its head.” In addition, the absence of “individual accountability greatly undermines the deterrent effect of a potential enforcement action or private litigation.” Why has the SEC been “too often hamstrung” when it sought to charge individuals, especially for disclosure violations? In some cases, it may have been because the misrepresentation was not attributable to a specific person or because it was viewed as unfair to charge a low-level employee. In other cases, however, the SEC knew who was responsible, but faced “significant risks in charging them due to the involvement of lawyers in the disclosure decision that forms the basis of the enforcement action.” While Lee recognized that seeking the advice of counsel is prudent, “if counsel merely contrives to support a pre-determined goal of management, such activity is merely rent-seeking masquerading as legal advice, while providing a shield against liability.” Lee recounted that she has “seen this scenario on a number of occasions—examples of lawyers providing advice that was, in [her] view, reckless, but that provided cover for other executives who weren’t charged. Because we generally lack standards by which to hold such lawyers accountable, the result is no individual accountability of any kind.”
The professional standards that are currently in place, Lee argued, are inadequate. State bars may not have the resources or the requisite expertise in public company disclosure. In addition, cases that the SEC has brought tend to be cases premised on claims of violations by the lawyer of substantive provisions of the securities laws. And the SEC has typically used Rule 102(e) “only to impose follow-on bars after attorneys have been found to violate substantive provisions of the securities laws.” Rule 102(e), which authorizes the SEC to suspend or bar attorneys when their behavior falls below “generally recognized norms of professional conduct,” could be used more broadly, but it was not entirely clear what the “generally recognized norms of professional conduct” are that would be applied to judge lawyers’ conduct.
However, Lee contended, as noted above, SOX 307 authorized the SEC to address this concern by adopting “minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers,” a mandate that Lee believed to be broader than simply up-the-ladder reporting. And in contrast to oversight of accountants and even clawbacks imposed against executives, the SEC has “never brought a single case finding a violation of the up-the-ladder rule under Section 307, a glaring fact of which market observers are well aware.”
According to Lee, the “time is ripe to return to this unfinished business.” What were her suggestions? She had several: the SEC could provide more detailed standards “regarding a lawyer’s obligation to a corporate client, including more specifically how their advice must reflect the interests of the corporation and its shareholders rather than the executives who hire them.” This standard would involve a distinction that she acknowledged “is not always an easy one to make in practice, but at a minimum, might require consideration of the impact of the advice on the corporation and its shareholders, including the impact should the disclosure decision ultimately prove incorrect.”
The standards could also address concepts necessary for an independent and rigorous analysis of questions of “materiality,” making explicit the standards that courts have recognized over time, including that doubts should be construed in favor of requiring disclosure. In this context, she noted the SEC’s discussion of materiality in its 2010 guidance on climate, which “recognized that doubts as to materiality of information would be commonplace, but that, particularly in view of the prophylactic purpose of the securities laws and the fact that disclosure is within management’s control, it is appropriate that these doubts be resolved in favor of those the statute is designed to protect.”
Standards might also address requirements of competence and expertise. For example, lawyers “rendering advice on disclosure issues” should have adequate training and “competence in the relevant area of law.” “Disclosure lawyers,” she suggested, “may opine on materiality without sufficient focus or understanding of the views of ‘reasonable’ investors. They may focus instead on defending non-disclosure.” She offered the possibility that the SEC could impose CLE requirements applicable to securities lawyers advising public companies, as the PCAOB has done for auditors. Another standard might involve a requirement for some level of independence in rendering advice.
An additional topic for minimum standards might be an “obligation to investigate red flags and ensure an accurate factual predicate for legal opinions.” Her extensive notes referred here to Professor John Coffee’s suggestion “that it may be appropriate for attorneys to certify to the accuracy of a client’s disclosures in much the same way that an auditor must certify a client’s financials,” adding his qualification that “the differences in the type and scope of work performed by auditors and attorneys would require a careful calibration of the actual certification required of attorneys.” Another potential topic might be “the retention of sufficient contemporaneous records to support the reasonableness of any legal advice, including whether appropriate expertise was brought to bear.”
The SEC could also “consider some degree of oversight at the firm level. Audit firms for public companies are obligated to have a system of quality control at the firm level; something similar might make sense for securities lawyers.” Alternatively, she noted, Congress could create an oversight board for lawyers, comparable to the PCAOB, that could develop and oversee standards for lawyers practicing before the SEC.
