© C

opyr

ight

20

03 L

ath

am

& W

atki

ns.

All

Rig

hts

Res

erve

d.

USC Institute for Corporate Counsel

The SEC’s New Part 205 RegulationsBrian G. CartwrightMarch 21, 2003

2

Part 205 Rulemaking

• Effective date: August 5, 2003• Noisy withdrawal proposal in comment

period

3

Who’s Covered?

• Must be “appearing and practicing before the Commission”:

Transacting business with SEC Includes any communicating with SEC

Representing issuer in SEC proceeding or investigation

Advising on securities law in respect of document, if have notice:

Will be filed or Incorporated by reference into filed

document Advising issuer regarding whether filing or

incorporation by reference is required Supervising an attorney “appearing and

practicing”

4

Obligation to Report Evidence of a Material Violation

• Attorney that becomes aware of evidence of a material violation by an issuer (or its officers, directors, employees or agents) must report such evidence to CLO (or to both the CLO and CEO)

A material violation of federal or state securities laws, material breach of fiduciary duty or similar material violation of any federal or state law

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 occurring or is about to occur

5

CLO’s Duty to Investigate

• Must timely initiate such inquiry:• As reasonably believes necessary to

determine whether material violation has, is or is about to occur

• If affirmatively determines no material violation:

• Must advise reporting attorney of basis for determination

• Unless reasonably believes no material violation, must:

• Take all reasonable steps to cause issuer to adopt appropriate response and

• Advise reporting attorney thereof

6

Up the Ladder Reporting

• If reporting attorney doesn’t reasonably believe CLO provided appropriate response within reasonable time, must report evidence to:

Audit committee or If no audit committee, another committee

of board consisting solely of directors not employed by issuer or

Full board of directors• Can bypass CLO/CEO and go directly to

committee or board, if reasonably believes would be futile

7

What is an Appropriate Response?

• Provides basis for attorney reasonably to believe that:

No material violation has, is or is about to occur; or

Issuer has adopted appropriate remedial measures and/or imposed sanctions

That can be expected to stop, prevent, remedy or otherwise appropriately address violation

8

Appropriate Response, if Board Approves Investigating Attorney

• Reporting attorney must only reasonably believe:

Board or proper committee approved retention or direction of an attorney to investigate and

Issuer: Has implemented remedial

recommendations of that attorney, after reasonable investigation, or

Has been advised the investigating attorney may assert a colorable defense on behalf of issuer

9

Evaluating Response of Issuer

• CLO/CEO and/or directors must inform reporting attorney about measures taken in response to report

• If reporting attorney reasonably believes response is appropriate and timely:

Need do nothing more• If reporting attorney reasonably believes

response is not appropriate and timely: Attorney must explain reasons to

CLO/CEO and/or directors to whom reported

10

Alternative QLCC Procedures

• If have previously established Qualified Legal Compliance Committee:

Attorney may report directly to QLCC Reporting attorney is finished

Has no further “up the ladder” obligations Need not assess QLCC’s response Under proposals, no “noisy withdrawal”

obligation CLO may refer report to QLCC

If does so: QLCC then has duty to investigate and

respond CLO must inform reporting attorney of

referral Note: QLCC does not preclude report to CLO or

investigation and response by CLO only

11

What Requirements Must QLCC Satisfy?

• Must consist of: At least one audit committee member,

and Two or more board members not

employed by issuer• Existing committee (e.g., audit

committee) can be QLCC (if properly composed)

• Must adopt written procedures for: Confidential receipt, retention and

consideration of reports

12

QLCC Authority

• Must be established and empowered by board to:

Investigate reports of evidence of material violations

Retain experts Recommend (by majority vote) appropriate

responses Inform the CLO, CEO and board of:

Results of investigations and Appropriate remedial actions

If deemed appropriate (by majority vote), notify the SEC if issuer fails in any material respect to implement an appropriate response

13

What if Hired by CLO to Investigate?

• Exempt from reporting obligations if: Report results of investigation to CLO

and CLO reports results to board,

appropriate committee or QLCC Unless both attorney and CLO

reasonably believe no material violation has, is or is about to occur

14

What if Hired by CLO to Defend?

• Exempt from reporting obligations if: CLO provides reasonable and timely

reports on progress and outcome to board, appropriate committee or QLCC

15

What if Hired by QLCC to Investigate or Defend?

Exempt from reporting obligations No conditions

16

What if You’re a Supervisory Attorney?

• Must make reasonable efforts to ensure subordinate attorneys comply with Part 205

• Must take over compliance when subordinate reports evidence of material violation to you

You may refer to QLCC

17

What if You’re a Subordinate Attorney?

• Still obligated to comply with Part 205• But only requirement is to report

evidence of material violation to supervisory attorney

After that, subordinate attorney is finished

• May (not required) to report to CLO or QLCC if:

Reasonably believe supervisory attorney failed to comply

• Note: Direct reports of CLO are not subordinate attorneys

18

Permissive Disclosure: Self-Defense

• In connection with any investigation or proceeding in which attorney’s compliance with Part 205 is at issue, may disclose:

Any report Any response Any contemporaneous record thereof

19

Permissive Disclosure to SEC

• May disclose confidences to SEC if reasonably believe necessary:

To prevent material violation: That is likely to cause substantial injury to financial

interest or property of issuer or investors To rectify consequences of material violation:

In the furtherance of which attorney’s services were used and

That caused or may cause substantial injury to financial interest or property of issuer or investors

In SEC investigation or proceeding, to prevent perjury or act likely to perpetrate fraud on SEC

20

Sanctions, Discipline and Liability

• Attorney violating Part 205 subject to: Full panoply of civil remedies for

violation of federal securities laws SEC’s authority to censure or bar

attorney from appearing or practicing before the SEC

• SEC has exclusive enforcement authority

21

No Private Right of Action, but …

• Rule expressly states no private right of action based on non-compliance

• But compare, for example: California Rule of Professional Conduct 1-100:

“Nothing in these rules shall be deemed to create, augment, diminish, or eliminate any substantive legal duty of lawyers or the non-disciplinary consequences of violating such a duty.”

Stanley v. Richmond, 35 Cal. App. 4th 1070 (1995):

“The scope of an attorney’s fiduciary duty may be determined as a matter of law based on the Rules of Professional Conduct … ”

22

Mandatory “Noisy Withdrawal” Proposal

• The trigger: No appropriate response within a

reasonable time Reasonably believes material

violation: Is ongoing or about to occur and Is likely to result in substantial injury

to issuer’s financial interest or property or to investors

23

If Trigger Occurs (Outside Lawyer)

Outside attorney would have to: Withdraw forthwith based on

“professional considerations” Within one business day, notify SEC of

withdrawal Disaffirm to SEC any document filed

with SEC That prepared or assisted in

preparing That reasonably believes is or may

be materially false or misleading

24

If Trigger Occurs (Inside Lawyer)

• Would not be required to withdraw• Within one business day, would have to

notify SEC and promptly disaffirm affected documents

25

After Withdrawal

• Issuer’s CLO must inform any replacement attorney of withdrawal based on professional considerations

26

Permissive “Noisy Withdrawal”—Past Violations

• Would be permitted, but not required, to withdraw, notify SEC and disaffirm filings

• Rule would state such SEC notification and disaffirmation would not breach “attorney-client privilege”

27

“Noisy Withdrawal”—Alternative

• Outside attorney would not be required to notify SEC and disaffirm filings

• But issuer would be required to file Form 8-K announcing outside attorney’s withdrawal