Helping Clients Defend Against SEC Actions
In a seminal case presided over by Judge Stanly Sporkin (colloquially known as the “Father of SEC Enforcement” due to his earlier work at the SEC), one of the cases that arose out of the savings and loan debacle of the 1980s and part of the scandal involving Charles Keating, the court noted:
"There are other unanswered questions presented by this case. Keating testified that he was so bent on doing the "right thing" that he surrounded himself with literally scores of accountants and lawyers to make sure all the transactions were legal. The questions that must be asked are:
Where were these professionals, a number of whom are now asserting their rights under the Fifth Amendment, when these clearly improper transactions were being consummated?
Why didn't any of them speak up or disassociate themselves from the transactions?
Where also were the outside accountants and attorneys when these transactions were effectuated?
What is difficult to understand is that with all the professional talent involved (both accounting and legal), why at least one professional would not have blown the whistle to stop the overreaching that took place in this case."
Lincoln Savings & Loan Ass’n v. Wall, 743 F. Supp. 901, 919-20 (D.D.C. 1990) (footnote omitted). Judge Sporkin, whose description of the above comments is often boiled down (including by Judge Sporkin himself) to, “where were the gate-keepers?” asked the pertinent question about where the ethical responsibilities of professionals lie. Known as a strong ethicist and someone possessing great personal integrity, when he spoke about this case in later years, Judge Sporkin often discussed the duties that professional owe to society and to the rule of law. His views as expressed in the Lincoln Savings & Loan opinion continue to impact the SEC and its enforcement investigations.
General Counsel/Corporate Lawyers
In the context of acting as a corporate lawyer, the attorney-client relationship (whether that of the general counsel, other in-house attorneys, or outside counsel) is clear. An attorney representing a company has an ethical responsibility to the corporate entity and not to any individual executive(s) or to the Board. Accordingly, under the Model Rules of Professional Conduct, adopted by most state bars, if an attorney becomes aware that a crime or fraud is being committed by an executive they must notify the Board and, if the Board fails to take appropriate action, the attorney must resign from the representation. If an attorney does not take those steps, they may be disbarred or face other disciplinary action from the state bar where they are licensed and where they practice. In addition, in 2003 the SEC promulgated rules, pursuant to Section 307 of the Sarbanes-Oxley Act, setting "standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers." SEC, Press Release No. 2003-13 (Jan. 23, 2003).
The SEC's rules governing attorney conduct mandated that an attorney representing an issuer:
The Commission had proposed a "noisy withdrawal" requirement in the proposed rule, which would have required the attorney to notify the SEC about their withdrawal and the reason they were obliged to withdraw from representation. Alternatively, the proposed rule laid out a requirement that the issuer itself reveal the attorney's withdrawal and the reasons for it. But, given the implications of a reporting out requirement on the attorney-client relationship between issuers and their counsel, the SEC decided to wait and consider this issue further. The SEC reconsidered the "noisy withdrawal" requirement (disclosure by the attorney or by the issuer) and backed away from having that portion of the proposed rules to go into effect.
Although the SEC eventually decided not to require "noisy withdrawal," in August 2003 the American Bar Association modified Rules 1.6 and 1.13 of the Model Rules of Professional Conduct to expand certain exceptions to the basic confidentiality rule to permit disclosure when the lawyer's services are used by a client to assist a crime or fraud reasonably certain to cause substantial financial injury to a third person and to clarify a lawyer's obligation to report material violations of law by company personnel up the ladder and, under some circumstances, when the board persists in a clear violation of law, to report out to the extent necessary to protect the client organization.
It should be noted as well that the SEC's rules would also apply under certain circumstances when an attorney is not working directly for an issuer. For example, an attorney working for an investment adviser who prepares material for an investment company, knowing the material will be filed with the SEC is "appearing and practicing before the Commission" on behalf of the investment company. Also, an attorney employed by a subsidiary of an issuer may be viewed as representing the parent because the definition of "issuer" includes fully-controlled subsidiaries of the issuer.
In the context of an SEC investigation, the SEC may look to whether the general counsel or in-house attorney complied with the SEC's attorney conduct rules and, in addition, based upon the attorney's role in the company's decision-making structure, the SEC may consider whether or not the attorney may have participated in the underlying fraud--for example, by backing the action or providing justification for something that is objectively in furtherance of a securities fraud.
The above discussion refers to lawyers who are aware, contemporaneously, of a company or company executive’s misdeeds. An attorney or firm who is retained to deal with a government investigation and defend the company (or an individual executive) has no requirement to resign and is free to defend his or her client even if they learn that the client in fact violated the law or committed fraud—they cannot be a party to lying about the issue and must advise their client to abide by legal requirements (such as responding to lawfully issued subpoenas etc.), but they can force the government to prove its case and are under no obligation to make it easy to do so (although they may advise the client that doing so is in the client’s best interest, it that is the attorney’s view).
Again, obtaining independent counsel to represent individual company executives, including the company’s General Counsel or other in-house counsel, can assist the company in handling the fallout of an internal investigation or dealing with a government investigation because these individuals may need separate advice to address the issues unique to them and which may not be consistent with the company’s going-forward strategy. Although it is still relatively rare for the SEC to bring claims against in-house counsel, it has happened and, in our experience, retaining separate counsel is necessary for the sake of both the individuals involved and the corporation.
The outside auditors of a company under investigation should also consider obtaining their own counsel. Even here, it is often necessary to retain separate counsel for individual auditors if and when the government begins investigating an audit. Such an investigation can arise in a myriad of ways, from the fallout of an investigation of the corporate audit client, to the results of a Public Company Accounting Oversight Board (“PCAOB”) inspection or review, to an audit company employee acting as a whistleblower and reporting potential improprieties by the audit firm itself due to violating its own standards or in not reporting frauds by audit clients.
Unlike attorneys, auditors are third parties and there is generally not a (US Constitution-based, protected) requirement to maintain client secrets and confidences. Accordingly, under Section 10A of the Securities Exchange Act, auditors must report to the SEC if they learn, during the course of a financial audit required under the Exchange Act, that there have been illegal acts that have a material impact on the company’s financial statements and appropriate remedial actions are not undertaken by the company’s management or the Board.
In this circumstance, the audit firm will need to provide the SEC with details and follow-up as to what alerted the firm to the issue and the firm will generally cooperate with the SEC’s investigation. This does not mean that the audit firm will escape scrutiny: to the contrary, the SEC will evaluate what the auditors knew and, if any individual auditor knew what was happening at the time, they or the firm may also face potential liability for either failing to adhere to the PCAOB’s audit standards or (more rarely) aiding or abetting the company’s violations.
For this reason, audit firms also must consider engaging counsel to address the investigation and, possibly, retaining separate counsel for individual auditors.