What price, in hard dollars and reputation, does a law firm pay when it becomes entangled with an unethical client? In the aftermath of the collapse of Enron and other companies whose names have become synonymous with corporate scandals, disgruntled investors are searching for deeper pockets to sue than bankrupt corporations and disgraced former executives. Attorneys, with their perceived significant assets and professional liability insurance coverage, have become prime litigation targets for these investors. Former Enron shareholders have already filed suit against two of the company's former law firms, Vinson & Elkins and Kirkland & Ellis.
Sophisticated and aggressive clients with a reputation for "pushing the envelope" in their ethical conduct can spell trouble for lawyers walking the legal tightrope between retaining the client and avoiding liability. Joseph C. Dilg, managing partner of the Houston-based law firm Vinson & Elkins, told the House Energy and Commerce Committee: "We never saw anything at Enron that we considered illegal. . . . There's nothing that I'm aware of that we would change." In the post-Enron legal environment, however, attorneys can no longer set the risk management bar at "legal versus illegal," especially when performing work for publicly traded companies. This article discusses the creation of a profile that can assist attorneys in evaluating whether to take on a public company as a client in this new era of ethical sensitivity.
The Rules Have Changed
In the Sarbanes-Oxley Act of 2002 (which the Securities and Exchange Commission is currently fleshing out and implementing), Congress imposed new whistleblower responsibilities on lawyers. Section 307 of Sarbanes-Oxley requires attorneys who come across evidence of a public company's misconduct to report their findings to the client's top management.
While lawyers are, of course, subject to state ethics requirements, Section 307 of Sarbanes-Oxley expands attorneys' obligations beyond those set forth in the Rules of Professional Conduct. Section 307 requires attorneys to investigate and, if necessary, to take action, if they discover wrongful conduct. The Sarbanes-Oxley reporting requirements are triggered whenever a lawyer becomes aware of credible "evidence of a material violation" by "an officer, director, employee or agent" of a company. For in-house counsel, this means first a report to senior officers of the company and, perhaps, to the board. For outside counsel, this means first a report within the law firm, such as to a supervising attorney. The firm would then report the alleged misconduct to the appropriate persons at the client level.
Determining credible "evidence of a material violation" may be a difficult task for an attorney who is working with a client that tends to "push the envelope." "Evidence of a material violation" is defined as:
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 ongoing, or is about to occur.
The SEC intends the term "material" in this definition to be interpreted in accordance with its well-established meaning under the securities laws. Consistent with that meaning, the SEC describes a "material violation" as one "about which a reasonably prudent investor would want to be informed."
Depending on the circumstances, a lawyer may be required to report the violation further "up the ladder." If the corporation's general counsel, CEO, or other senior officers do not respond to the lawyer's warning, the lawyer must then alert the Board of Directors.
Can/Should Lawyers Teach Their Clients Ethics?
Despite the headlines trumpeting the malfeasance in corporate America, the authors believe that most clients truly want to act ethically, however their conduct is influenced (and, to a large degree, controlled) by their corporate environment. Should lawyers strive to change or influence a client's ethical behavior or should the goal be to merely manage the risk? In fact, lawyers owe a duty (both ethical and legal) to their clients to be the "emergency brake" when the organization begins to act in a questionable manner. Discovering your client's corporate environment is the key to understanding your client's ethical profile. Behavior is predictable to some degree, especially when the top-down leadership models an end-justifies-the-means approach to decision-making. If the bar of improper corporate behavior is misconduct (not only illegal acts), and attorneys have an affirmative duty as whistle-blower, then perhaps it is time to evaluate a new client risk profile.
What Is An Ethical Profile?
Unethical behavior is predictable. We can learn valuable lessons from the recent fiascos at troubled companies such as Arthur Andersen, Enron, Qwest, WorldCom, Rite-Aid, Waste Management, Adelphia, Tyco, and ImClone. The authors of this article believe that "ethically challenged clients" typically share a management style and attitude that can be identified by truthfully answering certain objective and subjective questions about the client.
The aforementioned companies actually share many of the same strengths and weaknesses and can provide excellent insight as to "red flag" leadership styles, corporate structures, and arrogant personality traits. An "ethical profile" is intended to give the practicing attorney or in-house counsel a framework objectively to identify clients who are likely to present potential ethical problems.
THE ETHICAL PROFILE
The authors realize that many of these questions trigger other questions. The profile is not a standard, but is intended to initiate a dialogue between attorney and client, as well as between partners within the attorney's firm. A high score could indicate a potential risk because answers to key questions are still unknown. Is a score of 15 acceptable or too high? Each firm must determine their own risk threshold.
Answer the following questions and score either a 1 or 5 with No=1, Yes=5, Not sure=5
1. Senior Management Reward System (Is it heavily weighted towards short-term stock options or bonuses?)
2. Client Ownership (Is an inordinate amount of stock owned or controlled by the CEO, upper management, or the Board of Directors?)
3. Leadership Reputation (Does the CEO or other upper management have a reputation of arrogance, egotism, or self importance?)
4. Board of Directors (Is there lack of racial, gender, or professional diversity among the outside board members? Do executives of the company sit on boards of companies with few independent directors?)
5. Whistle Blowing (Does the company have a meaningful, formalized "whistle blower system"?)
6. Nature of the Proposed Matter (Will the proposed matter require a statement of opinion?)
7. Importance of Client to the Firm (Will the fees be substantial to the firm?)
8. Importance of Client to the Originating Attorney (Will the fees be substantial to the Originating Attorney?)
9. Financial Statement (Are the client's financial statements confusing? Does the client willingly disclose all material information?)
10. Light of Day (Would the firm be embarrassed if the details of the proposed engagement were reported in the Wall Street Journal?)
HOW TO MANAGE AN ETHICALLY CHALLENGED CLIENT
What if your potential client scores high on the risk profile, but you nonetheless believe that the rewards of representing the client outweigh the risks? Consider the following tactics.
Don't Try To Manage This Client Alone
Managing an ethically challenged client is like a horse race between fear and greed. You want credit for the revenue, but you also want to avoid taking the hit if something goes wrong. One day you think you have the situation under control and the next day you are not so sure. Don't go it alone. Share the client oversight responsibility with one or more senior partners whom you trust and elect someone to take the lead role.
Scorekeeping should not be the driving factor. Set up law firm revenue credit in such a way that allows you to rotate the lead role among the attorneys managing the risky client relationship.
Sweat the Small Stuff
From "Day 1," impress your client that you are very interested in details; that you never compromise your obligations to your firm, their board of directors, or shareholders; and that you take your Sarbanes-Oxley obligations seriously.
Communicate With Your Partners
Your fellow partners do not want surprises. Over-communicate with them about a client that may make them nervous. Invite participation and peer review and avoid any appearance of secrecy or special treatment.
Published January 1, 2004.