NYC Bar Task Force Urges Strengthening Compliance Role Of In-House Counsel

Monday, January 1, 2007 - 00:00

In a report released last month, the New York City Bar Association has urged strengthening the role of corporate lawyers representing public companies, recognizing that lawyers can play a critical role in preventing corporate scandals.

The 190-page report by the Association's Task Force on The Lawyer's Role in Corporate Governance was issued after a 20-month study, including a review of the public record concerning recent scandals such as Enron and WorldCom.

'Lawyers did not cause any of these recent scandals, and undoubtedly many potential scandals have been prevented by strong legal advice,' said Task Force Chair Thomas Moreland, a partner at Kramer Levin Naftalis & Frankel LLP.'But it does appear that at least some of these scandals might have been avoided had lawyers been more assertive in questioning management and more willing to bring their concerns to boards of directors.'

The task force has called for a 'new determination by the corporate bar to play its proper role as confidential advisor counseling compliance with the law - and conduct exceeding its minimum requirements - in a clear and forthright manner,' and has advanced a series of recommendations to enhance the effectiveness of both in-house and outside corporate lawyers.

The task force has proposed that New York amend its ethical rules for lawyers to permit them to disclose to regulatory authorities, such as the SEC, criminal or fraudulent conduct by a client company's management utilizing the lawyer's services, as well as clearly illegal conduct likely to cause substantial injury to the client.

According to the report, any responsible board can be expected to act whenever a lawyer, as now required by SEC rules under the Sarbanes-Oxley Act, 'reports up' to the board 'evidence of a material violation' of law by corporate managers. But in the task force's view, lawyers should not be ethically prohibited, when confronted with this extraordinary circumstance, from 'reporting out' the wrongdoing to protect the company and its investors.

The task force report opposes, however, imposing on lawyers any mandatory duty to report client wrongdoing to the SEC.It states that such an obligation would undermine 'the confidential nature of a lawyer's relationship with his or her client' and 'represent an overreaction to the recent scandals and a cure worse than the disease.' The task force argues that it is by rendering clear and confidential advice to their clients that 'lawyers can play their most productive role in avoiding future corporate scandals.'

The task force report also advances a series of 'best practice' recommendations for lawyers counseling public companies. The task force views the role of general counsel as critical to maintaining a company's high ethical standards and compliance with the law. The task force points to WorldCom and HealthSouth as examples of companies victimized by management fraud where the general counsel appears to have been blocked by a dominant CEO from effectively advising the board.

To strengthen the general counsel's position, the task force urges that the general counsel have an express mandate from the board to promote a corporate culture of integrity, have ready access to the board whenever needed, have regular meetings with independent directors in the absence of management, and have ultimate authority over the hiring and supervision of both in-house and outside lawyers.

With respect to outside lawyers, the task force notes that today public companies often engage outside lawyers only to provide specialized services. In this context, it urges that lawyers make sure they understand the context in which and the purpose for which their services are requested. If they become seriously concerned about management conduct, the task force advises it is best practice for outside lawyers to report up their concern to the general counsel, or the board if necessary, even if the circumstances do not mandate such reporting under the SEC's rules. The task force also advocates that law firms play an active role in promoting ethical conduct by their attorneys. It recommends model 'reporting up' procedures, and a statement of best practices, to further this mission.

Because most of the recent corporate scandals have involved accounting fraud, the task force recommends that lawyers advising public companies be actively consulted in connection with preparation of their client's financial disclosures, and that lawyers advising on such disclosures be familiar with the accounting concepts impacting those disclosures.

The task force report also offers detailed guidelines and recommendations for law firms conducting internal investigations for companies, an increasingly common mechanism for addressing corporate wrongdoing. The report emphasizes that the investigating firm should maintain unquestioned independence from any accused wrongdoers so that the results of its investigation will have credibility with regulators and the public.

Concern is expressed about the state of due diligence, especially in connection with securities offerings by well-established companies (such as WorldCom). The report notes that the time available for due diligence by underwriters has been severely curtailed by the accelerated offering procedures now permitted companies under SEC regulations.

The task force takes a wait-and-see position with respect to the controversial issue of whether Congress should restore aiding and abetting liability for conduct by lawyers (and other 'secondary' actors) found to have assisted corporate fraud.