Lawyer for Publicly Traded Company May "Report Out" Pursuant to SEC Regulations
Opinion rules that a lawyer for a publicly traded company does not violate the Rules of Professional Conduct if the lawyer "reports out" confidential information as permitted by SEC regulations.
Note: This proposed opinion relies upon Rule 1.13 as amended by the council on October 21, 2005. The amended rule is waiting for final approval of the North Carolina Supreme Court.
Section 307 of the Sarbanes-Oxley Act of 2002, 15 U.S.C. §7245 ("SOX §307") required the Securities and Exchange Commission (the Commission) to issue rules setting forth minimum standards of professional conduct for attorneys appearing and practicing before the SEC including a rule
(1) requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof, to the chief legal counsel or the chief executive officer of the company (or the equivalent thereof); and
(2) if the counsel or officer does not appropriately respond to the evidence (adopting, as necessary, appropriate remedial measures or sanctions with respect to the violation), requiring the attorney to report the evidence to the audit committee of the board of directors of the issuer or to another committee of the board of directors comprised solely of directors not employed directly or indirectly by the issuer, or to the board of directors.
In response to this directive, the Commission adopted Rule 205, Standards for Professional Conduct for Attorneys Appearing and Practicing Before the Commission in the Representation of an Issuer, which became effective on August 5, 2003, 17 C.F.R. Part 205 ("Rule 205"). Section 205.3 of Rule 205 sets forth the duty of an attorney appearing and practicing before the Commission to report evidence of a material violation of securities law or breach of fiduciary duty to the chief legal officer and chief executive officer of the client company and, if an appropriate response is not forthcoming, to the audit committee of the board of directors or to the board itself (commonly referred to as "reporting up"). Paragraph (d)(2) of section 205.3 contains a provision permitting, but not requiring, what is commonly referred to as "reporting out" as follows:
(2) An attorney appearing and practicing before the Commission in the representation of an issuer may reveal to the Commission, without the issuer's consent, confidential information related to the representation to the extent the attorney reasonably believes necessary:
(i) To prevent the issuer from committing a material violation that is likely to cause substantial injury to the financial interest or property of the issuer or investors;
(ii) To prevent the issuer, in a Commission investigation or administrative proceeding from committing perjury, proscribed in 18 U.S.C. 1621; suborning perjury, proscribed in 18 U.S.C. 1622; or committing any act proscribed in 18 U.S.C. 1001 that is likely to perpetrate a fraud upon the Commission; or
(iii) To rectify the consequences of a material violation by the issuer that caused, or may cause, substantial injury to the financial interest or property of the issuer or investors in the furtherance of which the attorney's services were used.
Section 205.6 of Rule 205 addresses sanctions and discipline. Paragraph (c) provides:
(c) An attorney who complies in good faith with the provisions of this part shall not be subject to discipline or otherwise liable under inconsistent standards imposed by any state or other
Have the duties of a North Carolina attorney under the Rules of Professional Conduct been affected by the regulations promulgated by the Securities and Exchange Commission under Section 307 of the Sarbanes-Oxley Act of 2002, which authorize a lawyer to disclose confidential or privileged information of a publicly traded company under certain circumstances?
The potential conflict between Rule 205 and the NC Rule raises the question of whether the NC Rule is preempted by Rule 205. A federal regulation validly promulgated carries the force of federal law, with no less preemptive effect than federal statutes. Fidelity Federal v. de la Cuesta, 458 U.S. 141 (1982). According to de la Cuesta, the questions upon which resolution of preemptive effect of a regulation rests is whether the agency means to preempt state law, and if so, whether that action is within the scope of the agency's delegated authority. de la Cuesta at 154. The Commission's intention to preempt state ethics rules conflicting with Rule 205 is unambiguous. In its letter discussing the implementation of the final version of Rule 205, the Commission states:
The language we adopt today clarifies that this part does not preempt ethical rules in
In determining whether the regulation is validly promulgated, the courts are directed by the Supreme Court in Chevron USA, Inc. v. Natural Resources Defense Council, Inc., 457 U.S. 837 (1984) to conduct a two-prong inquiry. First, the court must determine whether Congress has directly spoken on the precise question at issue (the "First Prong"). However, if Congress has not addressed the precise issue and the statute is ambiguous, then the question is whether the agency's interpretation of the statute and the regulation promulgated is based on permissible construction of the statute (the "Second Prong"). SOX §307 mandates the Commission to require "reporting up" in its regulations There is no provision in SOX, however, that expressly authorizes the Commission to adopt "reporting out" regulations. Good faith arguments can be made for both propositions, i.e., that SOX does, and does not, implicitly grant such authority to the Commission.
It has been argued that there is no conflict between Rule 205 and the North Carolina Rules. Because Rule 205 is permissive, the argument goes, one can comply with a more stringent state requirement while not offending federal law, i.e. compliance with both regulatory regimes is not a "physical impossibility." Once again, de la Cuesta is instructive. In that case, the court noted that the more stringent state law effectively created an obstacle to the achievement of "the full purposes and objective" of the federal regulation. Following the reasoning in de la Cuesta, the NC Rule undeniably impinges on the flexibility provided by Rule 205, and a reviewing court would likely hold that if Rule 205 was validly promulgated, it preempts the NC Rule.
It is beyond the capacity of an ethics opinion to determine whether or not the "reporting out" provision of Rule 205 was validly promulgated. Therefore, unless and until the Fourth Circuit Court of Appeals or the US Supreme Court determines that Rule 205 was not validly promulgated, (a) there will be a presumption that Rule 205 was promulgated by the Commission pursuant to a valid exercise of authority and (b) a North Carolina attorney may, without violating the North Carolina Rules of Professional Conduct, disclose confidential information as permitted by Rule 205 although such disclosure would not otherwise be permitted by the NC Rule.
1. US Securities & Exchange Commission, Final Rule: Implementation of Standards of Conduct for Attorneys, Release Nos. 33-8185, 34-47276, IC-25929, republished in Practicing Law Institute, Corporate Law and Practice Course Handbook Series 489, 494 (May 2005).