Proposed Rule:
Implementation of Standards of Professional Conduct for Attorneys

17 CFR Part 205

[Release Nos. 33-8150; 34-46868; IC-25829; File No. S7-45-02]

RIN 3235-AI72

Implementation of Standards of Professional Conduct for Attorneys

Agency: Securities and Exchange Commission

Action: Proposed rule

Summary: The Securities and Exchange Commission ("Commission") is soliciting comments on a proposed rule that would establish standards of professional conduct for attorneys who appear and practice before the Commission on behalf of issuers. Section 307 of the Sarbanes-Oxley Act of 2002 requires the Commission to prescribe minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers. The standards must include a rule requiring an attorney to report evidence of a material violation of securities laws 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); and, if they do not respond appropriately to the evidence, requiring the attorney to report the evidence to the audit committee, another committee of independent directors, or the full board of directors. Proposed Part 205 responds to this directive and is intended to protect investors and increase their confidence in public companies by ensuring that attorneys who work for those companies do not ignore evidence of material misconduct.

Dates: Comments should be received on or before December 18, 2002.

Addresses: To help us process and review your comments efficiently, comments should be sent by hard copy or by e-mail, but not by both methods.

Comments sent by hard copy should be submitted in triplicate to Jonathan G. Katz, Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Alternatively, comments may be submitted electronically to the following e-mail address: rule-comments@sec.gov. All comment letters should refer to File No. S7-45-02; this file number should be included on the subject line if e-mail is used. All comment letters received will be available for public inspection and copying in the Commission's Public Reference Room at the same address. Electronically submitted comments will be posted on the Commission's internet web site (http://www.sec.gov.) ¹

For Further Information Contact: Timothy N. McGarey or Edward C. Schweitzer at 202-942-0835.

Supplementary Information: The Commission is proposing to add a new Part 205 to Title 17, Chapter II, of the Code of Federal Regulations² establishing standards of professional conduct for attorneys who appear and practice before the Commission in the representation of issuers, under the Securities Act of 1933, the Securities Exchange Act of 1934, the Investment Company Act of 1940, the Investment Advisers Act of 1940, and the Sarbanes-Oxley Act of 2002.

Table of Contents

1. Purpose of this Rule Proposal
    
2. Commission Initiatives to Establish Professional Standards for Attorneys Appearing And Practicing before the Commission
    
1. The Role of Attorneys Who Appear before the Commission
    
2. The Commission's Ability to Discipline Attorneys under Rule 102(e)
    
3. Prior Commission Consideration of an Attorney's Obligation to Report Corporate Misconduct to Management
    
3. Section 307 of the Sarbanes-Oxley Act
    
4. Proposed Part 205
    
1. General Overview
    
2. Summary of Part 205
    
5. Section-by-Section Discussion of the Proposed Rule and Request for Comments
    
6. Paperwork Reduction Act
    
7. Costs and Benefits
    
8. Effect on Efficiency, Competition and Capital Formation
    
9. Initial Regulatory Flexibility Analysis
    
10. Small Business Regulatory Enforcement Fairness Act
     
11. Statutory Basis and Text of Proposed Part 205

I. Purpose of this Rule Proposal

The purpose of this release is to solicit comments on proposed Part 205,³ which prescribes Standards of Professional Conduct for Attorneys who appear and practice before the Commission in any way in the representation of issuers.

Section 307 of the Sarbanes-Oxley Act of 2002 (the "Act") (15 U.S.C. 7201 et seq.) mandates that the Commission

shall issue rules, in the public interest and for the protection of investors, setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers, 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.

The proposed rule responds to this directive.⁴

II. Commission Initiatives to Establish Professional Standards for Attorneys Appearing and Practicing before the Commission

A. The Role of Attorneys Who Appear before the Commission.

Attorneys play a varied and crucial role in the Commission's processes. Attorneys prepare, or assist in the preparation of, materials that are filed with or submitted to the Commission by, or on behalf of, issuers. These materials are relied upon by public investors in making their investment decisions. Thus, the Commission, and the investing public, must be able to rely upon the integrity of in-house and retained lawyers who represent issuers.

Attorneys also play an important and expanding role in the internal processes and governance of issuers, ensuring compliance with applicable reporting and disclosure requirements (including, inter alia, requirements mandated by the federal securities laws). During the floor debate on the amendment that was subsequently adopted and enacted as Section 307 of the Act, Senator John Edwards emphasized the important function attorneys play at public companies. "This amendment is about making sure those lawyers, in addition to the accountants and executives in the company, don't violate the law and, in fact, more importantly, ensure that the law is being followed."⁵ Unfortunately, the actions of some attorneys have drawn increasing scrutiny and criticism in light of recent events demonstrating that at least "some lawyers have forgotten their responsibility."⁶ Moreover, existing state ethical rules have not proven to be an effective deterrent to attorney misconduct.⁷ The July 16, 2002 Preliminary Report of the American Bar Association Task Force on Corporate Responsibility (hereinafter the "Cheek Report") noted that "a disturbing series of recent lapses in corporations involving false or misleading financial statements and alleged misconduct by executive officers" has compromised investors' confidence in both the "quality and the integrity"of the governance of publiccompanies.⁸ Indeed, the Task Force concluded that "the system of corporate governance at many public companies has failed dramatically." Moreover, the Task Force's preliminary report acknowledges that attorneys representing and advising corporate clients bear some share of the blame for this failure.⁹

Moreover, foreign attorneys are playing an ever greater role in connection with their representation of issuers making Commission filings. With the globalization of the U.S. capital markets, there has been a marked increase in the number of companies from non-U.S. jurisdictions registering securities with the Commission.¹⁰ At present, there are over 1,300 foreign private issuers from 59 countries that are filing reports with the Commission under the Exchange Act, as compared with approximately 400 issuers from less than 30 countries in 1990. As a result, it is important to address how the proposed rule would apply to these foreign attorneys.

B. The Commission's Ability to Discipline Attorneys under Rule 102(e).

Rule 102(e) of the Commission's Rules of Practice has been the primary vehicle available to the Commission to protect its processes and ensure the competence of professionals (including attorneys) who appear and practice before it.¹¹ The Commission adopted Rule 102(e) as a "means to ensure that those professionals, on whom the Commission relies heavily in the performance of its statutory duties, perform their tasks diligently and with a reasonable degree of competence."¹² The rule permits the Commission to initiate disciplinary proceedings against attorneys who lack integrity or competence, engage in improper professional conduct,¹³ or who are determined to have violated provisions of the federal securities laws. The sanctions available in those proceedings include censure, temporary suspension, and permanent bar.

Professionals against whom the Commission has instituted Rule 102(e) proceedings (particularly accountants) have challenged the Commission's authority to promulgate the rule. Every court that has ever considered the issue has concluded that the Commission possessed the authority to promulgate Rule 102(e), and the courts have recognized that it is appropriate for theCommission to use a disciplinary mechanism like Rule 102(e) to protect the integrity of its processes and to encourage professionals to adhere to minimum standards of competence.¹⁴ Nevertheless, as noted below, the Commission's use of Rule 102(e) has proven to be controversial,¹⁵ and until enactment of the Act, the Commission has never had express statutory authority to promulgate a rule establishing standards of conduct for attorneys representing issuers.¹⁶

C. Prior Commission Consideration of an Attorney's Obligation to Report Corporate Misconduct to Management.

Even before enactment of the Act, the Commission had addressed the responsibility of attorneys appearing and practicing before the Commission to report to management evidence of misconduct of which they become aware during the course of their representation of a publiccompany.

In a 1981 decision, In the Matter of William R. Carter, Charles J. Johnson, Jr., 22 S.E.C. Docket No. 292, 1981 WL 384414, the Commission reversed an initial decision by a Commission Administrative Law Judge that concluded that two attorneys who failed to correct misstatements contained in a client's press releases and Commission filings concerning earnings had aided and abetted their client's violation of the federal securities laws. The Commission concluded that existing ethical standards governing the conduct of attorneys did not unambiguously proscribe the behavior in question, and the Commission therefore did not sanction the attorneys. Nevertheless, the Commission announced that in the future it would interpret Rule 102(e) to require an attorney who learns that a client is "engaged in a substantial and continuing failure to satisfy" disclosure requirements prescribed by the federal securities laws to "take[] prompt steps to end the client's noncompliance" in order to avoid violating professional standards. 1981 WL 384414 at *29-*31.¹⁷ The Commission indicated that the attorney can initially simply "counsel[] accurate disclosure" by the client. However, in the event the client does not cure the deficiency, the Commission stated that an attorney must take additional "more affirmative steps" including possibly a "direct approach to the board of directors or one or more individuals or officers" or an attempt "to enlist the aid of other members of the firm's management" to correct the deficiency. Id. at *31. "What is required, in short, issome prompt action that leads to the conclusion that the lawyer is engaged in efforts to correct the underlying problem, rather than having capitulated to the desires of a strong-willed, but misguided client." Id. at *31.

The Commission announced in its decision in Carter and Johnson that it would solicit comments from the public regarding whether the newly articulated interpretation of "unethical or improper professional conduct" should be expanded or modified. Id. at *28. The release doing so stated that, based on the comments received, the Commission might or might not expand or modify its interpretation of the phrase "unethical or improper professional conduct" in Rule 102(e). "Until that time, the present interpretation will govern all similar circumstances for purposes of proceedings pursuant to Rule [102](e) if the conduct occurred after February 28, 1981" - the date on which the Commission announced its interpretation in Carter and Johnson.¹⁸ The Commission's announcement in Carter and Johnson of the standard to be applied to similar cases in the future and its request for written comments engendered strong opposition from the private bar. The Commission, however, never amended the interpretation of "unethical or improper professional conduct" articulated in Carter and Johnson.¹⁹

Subsequently, the Commission's then-General Counsel expressed concern in a speech regarding the Commission's lack of either "the time or expertise" to fashion a code of professional conduct for attorneys appearing and practicing before it.²⁰ He further suggested that the Commission should focus its attention on bringing Rule 102(e) proceedings against attorneys when the alleged misconduct represents "a violation of established state law ethical or professional misconduct rules and has a direct impact on the Commission's internal processes," and indicated that the Commission generally should not institute Rule 102(e) proceedings against attorneys absent a judicial determination that the lawyer has violated the federal securities laws.²¹ In 1988, the Commission issued a release announcing adoption of an amendment to Rule 102(e) to provide for public proceedings initiated under the rule. See Disciplinary Proceedings Involving Professionals Appearing or Practicing Before the Commission, 1988 SEC LEXIS 1365 (July 7, 1988). The majority of the release discussed the basis for the Commission's conclusion that the benefit of conducting such proceedings in public outweighed the competing privacy concerns. The Commission noted in the release that it "has generally utilized Rule [102(e)]proceedings against attorneys only where the attorney's conduct has already provided the basis for a judicial or administrative order finding a securities law violation in a non-rule [102(e)] proceeding" and that it would continue to follow this policy. Id. at *22.

Nevertheless, the Commission has continued to assess the actions of attorneys who learn of misconduct by public company clients outside of the context of Rule 102(e). In a subsequent case, In the Matter of George C. Kern, Jr., 50 S.E.C. 596, 1991 SEC LEXIS 1222 (June 21, 1991), a Commission Administrative Law Judge concluded that an attorney serving both as outside counsel and as a director of a company caused his client to violate the Exchange Act by failing to amend his client's prior filing with the Commission to reflect more recent developments during the course of a tender offer. The ALJ nevertheless concluded that he lacked authority to enter an order directing future compliance pursuant to Section 15(c)(4) of the Exchange Act, and discontinued the proceedings. The Commission affirmed the order discontinuing proceedings.

In another case, In the Matter of John H. Gutfreund, Thomas W. Strauss and John W. Meriwether, 51 S.E.C. 93 (Dec. 3, 1992), the Commission issued a report of investigation pursuant to its authority under Section 21(a) of the Exchange Act (15 U.S.C. 78u(a)) concerning the actions of the chief legal officer at a broker-dealer who was apprised of criminal wrongdoing by a corporate officer. While the chief legal officer was not named as a respondent, the Commission issued the report to emphasize its views on the supervisory responsibilities of legal and compliance officers who learn of misconduct by their employer or by a co-worker. The Commission concluded that such individuals are "obligated to take affirmative steps to ensure that appropriate action is taken to address the misconduct," including "disclosure of the matter tothe entity's board of directors, resignation from the firm, or disclosure to regulatory authorities." Id. at 113-114.²²

In sum, while the Commission has opined on a case-by-case basis that lawyers appearing and practicing before the Commission have an obligation to report corporate misconduct to appropriate officers and directors, it has not adopted comprehensive standards directing attorneys to report instances of misconduct.

III. Section 307 of the Sarbanes-Oxley Act

In the wake of sensational revelations concerning Enron and other public companies, a group of legal academics forwarded a letter to Chairman Pitt urging the Commission to impose an "up the ladder" reporting requirement on attorneys that would oblige attorneys who learn of misconduct at public companies to report this information to the management of the company.²³ In a March 28, 2002 response, the Commission's then-General Counsel did not take issue withthe academics' proposals but noted that there are good reasons why "a significant change in established practice should be undertaken in the context of Congressional legislation, as opposed to agency rulemaking."²⁴ Senator John Edwards, the sponsor of Section 307, learned of this exchange of letters and concluded that it was time for Congress to act to provide a context of Congressional legislation for Commission rules imposing an "up the ladder" reporting requirement on attorneys representing public companies. ²⁵

Section 307 of the Act requires the Commission to promulgate minimum ethical standards for attorneys representing issuers, including an "up the ladder" reporting requirement on attorneys as originally proposed by the Commission in Carter and Johnson²⁶ as a means of addressing the same types of concerns regarding attorney behavior and shareholder protection as were described in the Cheek Report. The provision directs the Commission to issue rules applicable to all attorneys appearing and practicing before the Commission in the representation of issuers that require attorneys initially to report evidence of a material violation to appropriate officers within the issuer and, thereafter, to the highest authority within the issuer if the initial report does not result in an appropriate response.²⁷

IV. Proposed Part 205

A. General Overview

Proposed Part 205 responds to Congress' mandate that the Commission adopt an effective "up the ladder" reporting system, and evidences the Commission's intention to implement a robust system in this regard. As set forth in greater detail in the discussion below, the proposed rule would adopt an expansive view of who is appearing and practicing before the Commission. This approach recognizes that attorneys interact with the Commission on behalf of issuer clients in a number of ways, and protects investors by reaching attorney conduct that may threaten the Commission's processes and harm shareholders.

In addition to a rigorous "up the ladder" reporting requirement, the proposed rule incorporates several corollary provisions that are not explicitly required by Section 307, but which the Commission believes are important components of an effective "up the ladder" reporting system. Under certain circumstances, these provisions permit or require attorneys toeffect a so-called "noisy withdrawal" and to notify the Commission that they have done so and permit attorneys to report evidence of material violations to the Commission. These provisions embody ethical principles that legal commentators and the ABA have been considering for years,²⁸ and are similar in important respects to ethical rules that have already been enacted in a number of jurisdictions. At the same time, the proposed rule does not attempt to articulate a comprehensive set of standards regulating all aspects of the conduct of attorneys who appear and practice before the Commission. The Commission does not intend to supplant state ethics laws unnecessarily, particularly in areas (e.g., safeguarding of client assets, escrow procedures, advertising) where the Commission lacks expertise. The Commission believes that the proposed rule will deter instances of attorney and issuer misconduct and where misconduct has occurred, minimize its impact upon issuers and their shareholders.

At the same time, the Commission does not want the rule to impair zealous advocacy, which is essential to the Commission's processes. The Commission also does not want the rule to discourage issuers from seeking and obtaining effective and creative legal advice. Finally, the Commission is cognizant of the ongoing efforts by the ABA and other organizations to address many of the same issues that are covered by the rule, and will continue to monitor those efforts and review the content and operation of the rule, particularly insofar as any measure adopted by the ABA or some other organization or entity extends beyond the scope of Section 307.

B. Summary of Part 205

Section 205.3(b) of proposed Part 205 prescribes the duty of an attorney who appears orpractices before the Commission in the representation of an issuer to report evidence of a "material violation." The rule's reporting obligation is triggered only when an attorney becomes aware of information that would lead a reasonable attorney to believe a material violation has occurred, is occurring, or is about to occur, thus limiting the instances in which the reporting duty prescribed by the rule will arise to those where it is appropriate to protect investors. The attorney is initially directed to make this report to the issuer's chief legal officer ("CLO"), or to the issuer's CLO and chief executive officer ("CEO"). Absent exigent circumstances, the attorney is also obligated to take reasonable steps to document his or her reports, as well as any response received from the CLO or CEO and retain the documentation for a reasonable time. Keeping such documentation will protect the attorney in the event his or her compliance with the proposed rule is put in issue in some future proceeding.

When presented with a report of a possible material violation, the rule obligates the issuer's CLO to conduct a reasonable inquiry to determine whether the reported material violation has occurred, is occurring, or is about to occur. A CLO who reasonably concludes that there has been no material violation must notify the reporting attorney of this conclusion. A CLO who concludes that a material violation has occurred, is occurring, or is about to occur must take reasonable steps to ensure that the issuer adopts appropriate remedial measures and/or sanctions, including appropriate disclosures. Furthermore, the CLO is required to report "up the ladder" within the issuer what remedial measures have been adopted or sanctions imposed and to advise the reporting attorney of his or her conclusions.

A reporting attorney who receives an appropriate response within a reasonable time and has taken reasonable steps to document his or her report and the response to it has satisfied his orher obligations under the rule. In the event a reporting attorney does not receive an appropriate response within a reasonable time, he or she must report the evidence of a material violation to the issuer's audit committee, or (if the issuer does not have an audit committee) to another committee of independent directors, or (if the issuer does not have another committee of independent directors) to the full board. If the attorney reasonably believes that it would be futile to report evidence of a material violation to the CLO and CEO, the attorney may report directly to the issuer's audit committee, or (if the issuer does not have an audit committee) to another committee of independent directors, or (if the issuer does not have another committee of independent directors) to the full board. A reporting attorney who has reported a matter all the way "up the ladder" within the issuer and who reasonably believes that the issuer has not responded appropriately must take reasonable steps to document the response, or absence thereof.

The proposed rule would also provide an alternative system for reporting evidence of material violations. See Section 205.3(c). Issuers may, but are not required to, establish a qualified legal compliance committee ("QLCC") composed of at least one member of the issuer's audit committee, and two or more independent members of the issuer's board for the purpose of investigating reports of material violations made by attorneys. A QLCC must have the authority and the responsibility to conduct any necessary inquiry into the reported evidence, to require the issuer to adopt appropriate remedial measures to prevent an ongoing, or alleviate a past, material violation, and to notify the Commission of the material violation and disaffirm any tainted document submitted to the Commission. The QLCC would be required to notify the board, the CLO, and the CEO of the results of any inquiry and the remedial measures the QLCC decided were appropriate. In the event the issuer fails to take remedial measures as directed by theQLCC, each member of the QLCC, the CLO, and the CEO would each be individually responsible for notifying the Commission of the material violation and for disaffirming any tainted submission to the Commission. An attorney would satisfy his reporting obligation under the rule by reporting evidence of a material violation to a QLCC. Additionally, a CLO who receives a report of a material violation may refer the report to a QLCC in lieu of conducting his or her own inquiry.

Paragraph 205.3(d) discusses the obligations of an attorney who has not received an appropriate response from the issuer. The provision distinguishes between outside attorneys retained by the issuer and attorneys employed by the issuer. Outside attorneys who have made a report and have not received an appropriate response and who reasonably believe that the reported material violation is ongoing or is about to occur and is likely to result in substantial injury to the financial interest of the issuer or of investors are required to withdraw from the representation, notify the Commission of their withdrawal, and disaffirm any submission to the Commission that they have participated in preparing which is tainted by the violation. In-house attorneys employed by an issuer who reasonably believe that the reported violation is ongoing or is about to occur and is likely to result in substantial injury to the financial interest of the issuer or of investors are required to disaffirm any tainted submission they have participated in preparing, but are not required to resign. In the event an attorney reasonably believes that a material violation has already occurred and has no ongoing effect, the attorney is permitted, but not required, to take these steps, so long as he or she also reasonably believes that the reported material violation is likely to have caused substantial injury to the financial interest of the issuer or of investors. Finally, an attorney formerly employed or retained by an issuer who reasonablybelieves that he or she has been discharged because he or she fulfilled the reporting obligation imposed by the rule may, but is not required to, notify the Commission of his or her belief that he or she was discharged for reporting evidence of a material violation and also disaffirm in writing any submission to the Commission that he or she participated in preparing which is tainted by the violation. A notification to the Commission under this section does not breach the attorney-client privilege.

Paragraph 205.3(e) sets forth the specific circumstances under which an attorney is authorized to disclose confidential information related to his or her appearance and practice before the Commission in the representation of an issuer. Pursuant to this provision, an attorney may use the documentation he or she has prepared under the rule to defend against charges of attorney misconduct. Paragraph 205.3(e)(2) also allows an attorney to reveal confidential information to the extent necessary to prevent the commission of an illegal act which the attorney reasonably believes will result either in perpetration of a fraud upon the Commission or in substantial injury to the financial or property interests of the issuer or investors. Similarly, the attorney may disclose confidential information to rectify an issuer's illegal actions when such actions have been advanced by the issuer's use of the attorney's services.

Sections 205.4 and 205.5 detail the respective responsibilities of supervisory and subordinate attorneys, both those employed in-house by the issuer and those serving as outside counsel retained by the issuer. Collectively, these provisions broadly define who is serving as a supervisory attorney, specifically providing that an individual serving as the CLO of an issuer (or who serves in an equivalent role) is a supervisory attorney under the rule. The provision also places the responsibility for compliance with the rule's reporting requirements anddocumentation obligations upon the supervisory attorney after he or she has been informed of evidence of a material violation by a subordinate. Subordinate attorneys are not exempt from the rule, though they will have complied with it where they report evidence of material violations they learn about to their supervisory attorney. In addition, a subordinate attorney who has reported evidence of a material violation to a supervisory attorney, and who believes that the supervisory attorney has failed to comply with the reporting requirement under the rule is permitted, but not obligated, to report the evidence "up the ladder" within the issuer.

Section 205.6 describes the manner in which violations of the rule will be addressed by the Commission. Violation of the proposed rule will subject the violator to all the remedies and sanctions available under the Exchange Act, including injunctions, and cease and desist orders. An attorney who violates a provision of Part 205 will have engaged in improper professional conduct and may also be subject to administrative disciplinary proceedings that can result in a censure, or a suspension or bar from practicing before the agency. Paragraph 205.6(b) incorporates the same state of mind requirements that were adopted for accountants by the Commission in the 1998 amendment to Rule 102(e). Specifically, an attorney is subject to discipline for (1) intentional, including reckless, violations of the Part, and (2) negligent conduct in the form of a single instance of highly unreasonable conduct that results in a violation, or repeated instances of unreasonable conduct resulting in a violation of the Part. The rule provides that the Commission may impose discipline and sanction an attorney who violates the rule, even when the attorney is subject to discipline in the state where he or she practices or is admitted.

V. Section-by-Section Discussion of the Proposed Rule and Request for Comments

The proposing release invites interested persons to submit comments on a large number of specific issues. However, the Commission invites any interested person to submit comments on any aspect of the proposed rule, whether or not comments have been specifically solicited.

Section 205.1 Purpose and Scope

Section 307 of the Act expressly directs the Commission to adopt a rule imposing a reporting requirement upon attorneys "appearing and practicing before the Commission in any way in the representation of issuers". Section 307 mandates that the Commission "shall issue rules . . . setting forth minimum standards of professional conduct . . . including a rule" imposing an "up the ladder" reporting requirement. At the very least, this language directs the Commission to issue a rule requiring attorneys to report material misconduct within an issuer. The Commission may at some future date supplement or amend this rule to expand its scope and address additional ethical issues that are relevant to practice before the Commission.²⁹ Interested persons are invited to comment on whether the Commission should promulgate additional rules, the issues those rules should address, how, in what form, and why.

Section 205.2 Definitions

Proposed Part 205 includes a section defining a number of terms that appear in the statute and are used throughout the rule. Section 307 of the Act does not define any of its terms. The Act itself defines the term "issuer," and that definition is incorporated into the rule. For several of the terms in the rule, the Commission has adopted the definitions contained in the ABA's Model Rules of Professional Conduct or a variation thereof. For others, the Commission has relied upon statutory definitions or adopted definitions from other sources, including the Restatement (Third) of the Law Governing Lawyers.

For those terms in Section 307 that are included in the proposed rule but not specifically defined in the proposed rule (e.g., "in any way" and "similar violations"), the Commission's intention is that their meaning shall be determined or interpreted according to Commission decisions. Interested persons are invited to comment on whether the Commission should leave these or other terms undefined in the rule or, alternatively, to propose definitions for these or other terms.

(a) Appearing and practicing before the Commission includes, but is not limited to, an attorney's:

(1) Transacting any business with the Commission, including communication with Commissioners, the Commission, or its staff;

(2) Representing any party to, or the subject of, or a witness in a Commission administrative proceeding;

(3) Representing any person in connection with any Commission investigation, inquiry, information request, or subpoena;

(4) Preparing, or participating in the process of preparing, any statement, opinion, or other writing which the attorney has reason to believe will be filed with or incorporated into any registration statement, notification, application, report, communication or other document filed with or submitted to the Commissioners, the Commission, or its staff; or

(5) Advising any party that:

(i) A statement, opinion, or other writing need not or should not be filed with or incorporated into any registration statement, notification, application, report,communication or other document filed with or submitted to the Commissioners, the Commission, or its staff; or

(ii) The party is not obligated to submit or file a registration statement, notification, application, report, communication or other document with the Commission or its staff.

The definition of the term "appearing and practicing before" the Commission is based upon Rule 102(f).³⁰ The wording of that definition has been modified to clarify and confirm that (as under existing Rule 102(f)) the term includes, among other things, representation of an issuer during the course of an investigation or inquiry conducted by the Commission and that an attorney appears and practices before the Commission if he or she advises an issuer either (1) that a statement, opinion, or other writing does not need to be filed with or incorporated into any type of submission to the Commission or its staff, or (2) that the issuer is not required to submit or file any registration statement, notification, application, report, communication or other document with the Commission or its staff.

Moreover, the definition of the term has also been drafted to make clear that it covers all communications (oral or written) with the Commission or its staff on behalf of an issuer, as well as conduct involving the preparation of any statement, opinion, or other writing which is submitted to Commissioners, the Commission, or its staff which is incorporated into materials submitted to the Commission - or participation in the process of preparing such a statement, opinion, or other writing. Participation in that process covers both adding and excluding information or a particular characterization of information. The definition also makes clear that an attorney who advises an issuer not to make a filing or submission to the Commission is alsoappearing and practicing before the Commission.

This broad definition is consistent with the position the Commission has taken as amicus curiae in cases involving liability under Section 10(b) of the Exchange Act (15 U.S.C. 78j(b)) in which the Commission has argued that attorneys should be held responsible for materials which they have drafted, or participated in drafting, that they knew would be included in a document to be filed with the Commission but which have been submitted without attribution or under another individual's signature.³¹ The modification also reflects the reality that materials filed with the Commission frequently contain information contributed, edited or prepared by individuals who are not necessarily responsible for the actual filing of the materials.

An attorney ordinarily does not appear and practice before the Commission if his or her representation of an issuer involves no business or communication with the Commission, no participation in any way in a Commission process, and no assistance in the preparation of at least a portion of a document filed with or submitted to the Commission. The conduct of attorneys in practice specialties other than securities law will be covered by the proposed rule where their representation of an issuer involves contact with the Commission or where they have reason to believe they are assisting in the preparation of a document transmitted to the Commission, or where they supervise an attorney who does appear and practice before the Commission.

The proposed definition of "appearing and practicing" is broad enough to include attorneys who do not serve in the legal department of an issuer or do not act in their capacities asattorneys, but who either transact business with the Commission or assist in the preparation of documents filed with or submitted to the Commission.

Interested persons are invited to comment on any aspect of this definition, including its appropriate scope and whether the Commission should exclude any persons from the definition of "appearing and practicing" (e.g., in-house corporate attorneys working outside of a legal department who assist in preparing a document to be filed with the Commission). Interested persons are specifically invited to comment on whether, and how, the definition of "appearing and practicing" will impact upon attorneys representing issuers during the course of Commission investigations, inquiries, administrative proceedings or civil litigation, and whether and how the definition should be modified in those contexts. Does the definition need to be modified to make clear that an attorney defending an issuer in a civil injunctive action by the Commission in a district court is not appearing and practicing before the Commission, because the issuer is not transacting business with the Commission, even though the defense attorney is in contact with the Commission's staff who are representing the Commission in that litigation? In the event an attorney representing an issuer in an administrative proceeding fails to receive an appropriate response to evidence of a material violation that the attorney has reported, should the attorney's response be governed by the proposed rule or by the Commission's Rules of Practice? Why? Comment is also particularly invited on the breadth of "participating in the process of preparing" in paragraph (a)(4) and whether the "has reason to believe" standard in that paragraph is too high or too low (e.g., whether an attorney must have actual knowledge or give express consent for a document to be sent to the Commission in order to be appearing and practicing before the Commission).

The concept of "appearing and practicing" also raises issues regarding foreign attorneys employed or retained by foreign issuers. Such attorneys may, for example, be involved in the preparation of documents for use in a foreign jurisdiction that might subsequently be used as the basis for other documents prepared by others for filing with the Commission, with or without the knowledge of the foreign attorneys who prepared the original documents. Interested persons are invited to comment on whether such foreign attorneys are "appearing and practicing" before the Commission; if not, how the proposed definition might be modified to make that clear; whether an express exclusion for such foreign attorneys is necessary and, if so, how it might be crafted.

(b) Appropriate response means a response to evidence of a material violation reported to appropriate officers or directors of an issuer that provides a basis for an attorney reasonably to believe:

(1) That no material violation, as defined in paragraph (i) of this section, is occurring, has occurred, or is about to occur; or 

(2) That the issuer has, as necessary, adopted remedial measures, including appropriate disclosures, and/or imposed sanctions that can be expected to stop any material violation that is occurring, prevent any material violation that has yet to occur, and/or rectify any material violation that has already occurred.

The definition of the term "appropriate response" emphasizes that the actions of attorneys in evaluating possible instances of material violations and the appropriateness of the response made by an issuer apprised of possible instances of material violations will be evaluated against an objective reasonableness standard. The Commission's intent is to permit attorneys to exercise their judgment as to whether a response to a report is appropriate, so long as their determination of what is an "appropriate response" is objectively reasonable.

For example, if an issuer responds to an attorney's report regarding the legality of a particular transaction by informing the attorney that a reputable law firm has reviewed the transaction and concluded that there has been no violation, and if the issuer provides a copy ofthe opinion to the attorney, the attorney could reasonably believe that the issuer's response was appropriate so long as the opinion satisfactorily addresses all of the reporting attorney's reasonable legal and factual concerns and is otherwise reasonable. Similarly, if an issuer responds to an attorney's report concerning another employee's potentially illegal conduct by, for example, disciplining or terminating the employee, and remedying any impact of the employee's misconduct, the attorney could reasonably believe that the issuer's response was appropriate. If, however, the issuer responds to the attorney's report by peremptorily informing the attorney that the reported matter is not cause for concern, and fails to provide any factual or legal basis for the reporting attorney to conclude there was no violation, such a response may not reasonably be viewed as appropriate by the attorney.

An appropriate response where there has been a disclosure violation would include disclosure of the material information or the correction of any material misstatement. Further, it could include an express directive forbidding the unlawful conduct at issue or, if it has already commenced, ordering that it cease at once. The definition also clarifies that past instances of misconduct may not need to be reported further where that misconduct has been addressed, for example, through the imposition of sanctions or other means. A past instance of misconduct that nevertheless may have an ongoing impact (e.g., a misstatement contained in a prior Commission filing that investors may continue to rely upon) will need to be rectified.

Interested persons are invited to comment on any aspect of what is an appropriate response. Should an attorney's reasonable belief determine whether a response is appropriate? What circumstances would permit an attorney reasonably to believe either that no violation has occurred or that any violation has been rectified? Is there a better objective test to measurewhether a response is appropriate and, if so, what is it?

(c) Attorney refers to any person who is admitted, licensed, or otherwise qualified to practice law in any jurisdiction, domestic or foreign, or who holds himself or herself out as admitted, licensed, or otherwise qualified to practice law.

The term "attorney" is defined broadly so that the proposed rule applies equally to lawyers employed in-house by an issuer and attorneys retained to perform legal work on behalf of an issuer, and covers persons who hold themselves out as attorneys, even if they are not in fact admitted, licensed, or otherwise qualified to practice law. Interested persons are invited to comment on the impact this definition will have upon attorneys in particular positions, or performing particular functions, and to identify situations in which the definition may reach too broadly. In particular, the Commission requests comment on whether the definition should require, with respect to in-house counsel, that the attorney actually provide legal services to the issuer such that an attorney-client relationship exists, so as to exclude attorneys employed by issuers in non-legal capacities, even if they prepare portions of documents submitted to or filed with the Commission.

The proposed definition of "attorney" also covers lawyers licensed in foreign jurisdictions, whether or not they are also admitted to practice in the United States. Under the proposed definition, foreign attorneys who prepare filings or other materials that are submitted to the Commission would be covered by the rule to the extent they are appearing and practicing before the Commission within the meaning of the rule. Potential difficulties related to applying the term "appearing and practicing" to foreign attorneys have been discussed above. The Commission also recognizes that significant issues would be raised by application of the proposed rule to foreign attorneys, or attorneys representing or employed by multijurisdictionalfirms, who may be subject to statutes, rules, and ethical standards in these foreign jurisdictions that are different from, and potentially incompatible with, the requirements of this rule. As noted above, over 1,300 foreign private issuers from 59 countries are registered and reporting with the Commission. These foreign companies are represented by a wide-range of legal counsel. While U.S. lawyers at U.S. law firms often play the principal role in the preparation of disclosure documents filed with the Commission by foreign companies, foreign lawyers can also undertake significant roles in these filings. For example, foreign counsel is often called upon to file a legal or tax opinion as an exhibit to a registration statement filed by a foreign company. In addition, a number of non-U.S.-based law firms (principally firms based in the United Kingdom) have established significant legal practices under the U.S. federal securities laws, and may be the sole law firms representing a particular issuer before the Commission. Generally, such firms have attorneys who are licensed in the United States. Likewise, many U.S. law firms have expanded globally and now employ as partners, counsel and associates lawyers who are admitted to practice solely in jurisdictions outside the United States. These non-U.S. lawyers may play significant roles in connection with Commission filings by both foreign and U.S. issuers. Further, some non-U.S. registrants have employed U.S. or non-U.S. lawyers to serve as their in-house counsel with respect to federal securities law questions.

As proposed, Part 205 would cover lawyers who are licensed in foreign jurisdictions, although only to the extent they "appear and practice" before the Commission in the representation of issuers. The Commission recognizes that the application of Part 205 to foreign law firms, multijurisdictional law firms and foreign lawyers raises significant and difficult issues. Because of these issues, the Commission seeks comment on the application of Part 205 to theseentities. In particular:

Are there statutes, rules and ethical standards in foreign jurisdictions that govern the conduct of foreign attorneys that are different from, and potentially incompatible with, the requirements of Part 205 and, if so, what foreign authority conflicts with what specific provisions of Part 205?

Are there provisions in Part 205 that could not be given effect (or would be nullified) under statutes, rules, or ethical standards in some foreign jurisdictions? If so, which provisions are affected, and how would this situation affect implementation of Part 205?

How would the "up the ladder" rule apply to in-house and retained attorneys in jurisdictions where issuers use different internal corporate structures not contemplated by Part 205?

What difficulties are likely to arise in applying the QLCC alternative to foreign issuers, and how, specifically, could the QLCC alternative be adapted to foreign private issuers?

What are the difficulties in applying Part 205 to law firms that operate in multiple jurisdictions or that have partners, counsel and associates who are admitted to practice law in a foreign jurisdiction but not admitted to practice law in the United States and who participate in the preparation of documents filed with the Commission (or documents that form the basis for documents filed with the Commission)? Are there different considerations in the application of Part 205 in this circumstance depending on whether the law firm in question is principally based in the United States or outside the United States?

What are the difficulties in applying Part 205 to an issuer's in-house attorneys who are admitted to practice law in a foreign jurisdiction but are not admitted to practice law in theUnited States and who participate in the preparation of documents filed with the Commission (or documents that form the basis for documents filed with the Commission)? Are there different considerations in the application of Part 205 in this circumstance whether the issuer is incorporated in the United States or in a foreign jurisdiction? Any such special difficulties and considerations should be discussed with specificity.

Are there mechanisms that satisfy the objectives of Part 205 that would apply the rule to a narrower category of foreign-licensed attorneys - for example, by employing a variation of the proposed definitions of supervisory and subordinate attorneys or by identifying attorneys in the United States who would have responsibility for compliance with U.S. securities laws? How, specifically, would such mechanisms work?

With respect to disciplinary proceedings, do foreign jurisdictions maintain procedures for disciplining attorneys for violations of statutes, rules or standards relating to ethical conduct and, if so, how do these procedures operate? Is a Commission proceeding against an attorney that violated Part 205 reconcilable with a disciplinary proceeding in the home jurisdiction?

Should foreign attorneys be exempted in whole or in part from the application of Part 205, and if so, why? Are there protections under foreign statutes, rules and standards relating to ethical conduct that serve as an adequate substitute for the various provisions of Part 205? Should the Commission establish a process under which foreign attorneys may apply for exemptions on a case-by-case basis, and if so, what should this process be (for example, the submission of a legal opinion as to the incompatibility of some or all of Part 205 with foreign statutes, rules and standards, and whether those statutes, rules and standards serve as an adequate substitute for the various provisions of Part 205)?

(d) Breach of fiduciary duty refers to any breach of fiduciary duty recognized at common law, including, but not limited to, misfeasance, nonfeasance, abdication of duty, abuse of trust, and approval of unlawful transactions.

This definition is intended to identify typical common-law breaches of fiduciary duty. It is not intended to change the law.

Interested persons are invited to comment on any aspect of the definition of "breach of fiduciary duty," including whether the examples given should be expanded or narrowed, and, if so, how.

(e) Evidence of a material violation means information that would lead an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur.

This objective standard is intended to preclude reports based on mere suspicion of a material violation while providing reasonable flexibility to attorneys when evaluating their reporting obligations under the proposed rule. An individual attorney is not excused from reporting evidence of a material violation on the grounds that he or she does not personally believe that a material violation has occurred, is occurring, or is about to occur. Under the definition of "reasonably believes" in paragraph (l) of Section 205.2, any information that would lead an attorney, acting reasonably, to believe that a material violation has occurred, is occurring, or is about to occur must be reported - whether or not the reporting attorney subjectively believes it. An individual attorney is not, however, required to report within the issuer evidence of a material violation that the attorney thinks is insufficient to lead an attorney, acting reasonably, to believe that a material violation has occurred, is occurring, or is about to occur. The definition does not prescribe a process by which an attorney must evaluate evidence he or she learns about.

Interested persons are invited to comment on any aspect of the definition of "evidence of a material violation." Should a different standard be adopted than that proposed by the Commission and, if so, what should that different standard be? Should the test be subjective rather than objective? Where along the spectrum from actual knowledge to mere suspicion should the line be drawn? Is the correct measure "beyond a reasonable doubt," "knows or should know," "substantial credible information," a "prima facie case," "more likely than not," "at least as likely as not," "reason to believe," "some credible information," "a mere scintilla of information sufficient to raise suspicion," or another test and, if so, what? If reasonable belief is the appropriate standard, what should be reasonably believed: that a material violation has occurred, is occurring, or is about to occur or that a material violation may have occurred, may be occurring, or may be about to occur, or something else? Should the definition be revised to make clearer that the standard is objective rather than subjective and, if so, how?

(f) In the representation of an issuer means acting in any way on behalf, at the behest, or for the benefit of an issuer, whether or not employed or retained by the issuer.

The proposed rule includes a broad definition of what constitutes "in the representation of an issuer." A broad definition is essential to protect investors. Accordingly, the term is defined to cover attorneys providing any legal services at the request of, or for the benefit of, an issuer.

For example, an attorney employed or retained by a non-public subsidiary of a public parent issuer is appearing and practicing before the Commission in the representation of an issuer when the subsidiary is covered by an umbrella representation agreement or understanding, whether explicit or implicit, under which the attorney represents the parent company and its subsidiaries, and can invoke privilege claims with respect to all communications involving theparent and its subsidiaries. Similarly, an attorney at a non-public subsidiary appears and practices before the Commission in the representation of an issuer when he or she is assigned work by the parent (e.g., preparation of a portion of a disclosure document) which will be consolidated into material submitted to the Commission by the parent, or if he or she is performing work at the direction of the parent and discovers evidence of misconduct which is material to the parent. The definition of the term is also intended to reflect the duty of an attorney retained by an issuer to report to the issuer evidence of misconduct by an agent of the issuer (e.g., an underwriter) if the misconduct would have a material impact upon the issuer.

An attorney employed by a privately-held investment adviser who prepares, or assists in preparing, materials that the attorney has reason to believe will be submitted to or filed with the Commission by or on behalf of a registered investment company, or will be incorporated into any document filed with or submitted to the Commission, is appearing and practicing before the Commission. Such an attorney, though employed by a privately-held investment adviser, is representing the investment company before the Commission. Where such an attorney discovers evidence of a material violation by an officer of the investment adviser that is related to the investment company, the attorney is obliged to report that evidence to the CLO of the investment company under 205.3(b). The investment adviser is an agent of the investment company and owes the investment company a fiduciary duty under common law and under Section 36 of the Investment Company Act of 1940.³² Section 307 of the Act requires an attorney to report evidence of a material violation by any agent of an issuer to the issuer's CLOor CEO.

This reporting obligation does no violence to the attorney-client privilege. Because the attorney is providing legal services for the registered investment company, the attorney is reporting to his or her client evidence of a material violation that is related to his or her representation of the client.³³ In effect, an attorney employed by the investment adviser and representing the investment company before the Commission has joint clients. Fairness and candor between co-clients regarding matters of common interest normally preclude any expectation of confidentiality regarding communications with their attorney, even regarding a communication of which one co-client was unaware at the time it was made.³⁴ That analysis must apply with special force where the co-clients are both organizations, with the investment adviser owing a fiduciary duty to the investment company, and where the attorney employed by the investment adviser, like any attorney employed by an organization, represents the investment adviser as an organization, not officers or employees who may have engaged in misconduct injuring the investment company.

Interested persons are invited to comment on the appropriate scope of the term, and itsimpact upon attorneys. Does the definition provide sufficient clarity and, if not, how could it be improved? Are there factual circumstances the definition would bring in that might better be excluded? Does the definition go far enough to protect investors?

(g) Issuer means an issuer (as defined in Section 3 of the Securities Exchange Act of 1934 (15 U.S.C. 78c)), the securities of which are registered under Section 12 of that Act (15 U.S.C. 78l), or that is required to file reports under Section 15(d) of that Act (15 U.S.C. 78o(d)), or that files or has filed a registration statement that has not yet become effective under the Securities Act of 1933 (15 U.S.C. 77a et seq.), and that it has not withdrawn.

The definition for the term "issuer" adopts the definition set forth in Section 2(a)(7) of the Act, which in turn incorporates the definition contained in the Exchange Act. This definition raises a question regarding whether the rule should also apply to attorneys who represent various entities that are subject to comprehensive Commission regulation and oversight, and who regularly appear before the agency, but whose clients are not "issuers." For example, many broker-dealers, investment advisers, self-regulatory organizations, transfer and clearing agents are, by law, required to register with the Commission. Attorneys for these entities prepare documents that are filed with the Commission and interact regularly with the Commission. As a regulated entity that is not an issuer presumably does not have a board of directors or an audit committee, and perhaps not even a chief legal officer, imposing the proposed rule on such entities may be inappropriate.

Certain foreign governments have listed debt securities that are registered under Section 12(b) of the Exchange Act. These foreign governments are thus issuers under the Act's definition. These foreign governments, however, may not have the organizational structure contemplated by the proposed rule in that the foreign governments may not have reasonableequivalents to a CEO, an audit committee, independent directors, or a board of directors. Thus, it may be difficult or inappropriate to apply the new Part 205 to such foreign issuers. It may be necessary for the Commission to create an exception or exemption for foreign governments that are issuers of listed debt securities.

The Commission invites interested persons to comment on any aspect of this definition, including: whether some form of "up the ladder" reporting should be implemented for attorneys employed by regulated entities that are not issuers; whether there is good reason or a legal basis to alter the definition in Section 2(7) of the Act; and whether the Commission should create an exemption for foreign issuers - providing, for example, that "Part 205 shall not apply to foreign governments that are eligible to register [or "that register"] securities under Schedule B of the Securities Act of 1933" - or should modify the definition of "issuer" to exclude foreign issuers -and, if so, how.

(h) Material refers to conduct or information about which a reasonable investor would want to be informed before making an investment decision.

The definition for the term "material" is derived from Supreme Court precedent, and is consistent with the remarks of Senator John Edwards, the sponsor of Section 307, who stated that "the obligation to report is triggered only by violations that are material - violations that a reasonable investor would want to know about."³⁵

Interested persons are invited to comment on this definition, particularly whether it provides sufficient clarity or, alternatively, whether another formulation would be preferable.

(i) Material violation means a material violation of the securities laws, a material breach of fiduciary duty, or a similar material violation.

The rule defines the term "material violation" to clarify that the term "material" in Section 307(b) modifies all three succeeding references to violations (i.e., "violation of securities law," "breach of fiduciary duty," and "similar violation"), and that only evidence of material misconduct triggers the rule's reporting obligation.

The rule does not define what constitutes a "violation of securities law" since the term is well-understood. The Commission believes that the term covers violations of the federal securities laws, as defined in Section 2(a)(15) of the Act, as well as violations of state securities laws. The rule separately defines "breach of fiduciary duty" to cover those forms of breach of fiduciary duty recognized at common law, including misfeasance, nonfeasance, abdication of duty, abuse of trust and the approval of unlawful transactions.

The rule does not define the term "similar violation." However, it appears from the context in which it is used in Section 307 that the term is intended to extend beyond a breach of fiduciary duty or a violation of the securities laws.

Interested persons are invited to comment on any aspect of the definition. Is there good reason to exempt violations of state securities laws from the definition? Should the term "similar violation" be defined and, if so, how? Does the definition encompass conduct about which the Commission should not be concerned? Would an alternate test be better? What test, and why?

(j) Qualified legal compliance committee means a committee of an issuer that:

(1) Consists of at least one member of the issuer's audit committee and two or more members of the issuer's board of directors who are not employed, directly or indirectly, by the issuer and who are not, in the case of a registered investment company, "interested persons" as defined in Section 2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19));

(2) Has been duly established by the issuer's board of directors and authorized to investigate any report of evidence of a material violation by the issuer, its officers, directors, employees or agents;

(3) Has established written procedures for the confidential receipt, retention, and consideration of any report of evidence of a material violation under §205.3(c);

(4) Has the authority and responsibility:

(i) To inform the issuer's chief legal officer and chief executive officer (or the equivalents thereof) of any report of evidence of a material violation (except in the circumstances described in §205.3(b)(5));

(ii) To decide whether an investigation is necessary to determine whether the material violation described in the report has occurred, is occurring, or is about to occur and, if so, to:

(A) Notify the audit committee or the full board of directors;

(B) Initiate an investigation, which may be conducted either by the chief legal officer (or the equivalent thereof) or by outside attorneys; and

(C) Retain such additional expert personnel as the committee deems necessary; and

(iii)  At the conclusion of any such investigation under paragraph (j)(4)(ii) of this section, to:

(A) Direct the issuer to adopt appropriate remedial measures, including appropriate disclosures, and/or to impose appropriate sanctions to stop any material violation that is occurring, prevent any material violation that is about to occur, and/or to rectify any material violation that has already occurred; and

(B) Inform the chief legal officer and the chief executive officer (or the equivalents thereof) and the board of directors of the results of any such investigation under paragraph (j)(4)(ii) of this section and the appropriate remedial measures to be adopted; and

(5) Each member of which individually, together with the issuer's chief legal officer and chief executive officer (or the equivalents thereof) individually, has the authority and responsibility, in the event the issuer fails in any material respect to take any of the remedial measures that the qualified legal compliance committee has directed the issuer to take, to notify the Commission that a material violation has occurred, is occurring or is about to occur and to disaffirm in writing any document submitted to or filed with the Commission by the issuer that the individual member of the qualified legal compliance committee or the chief legal officer or the chief executive officer reasonably believes is false or materially misleading.

A "qualified legal compliance committee" ("QLCC"), as here defined, is part of an alternative procedure for reporting evidence of a material violation. That alternative procedure is set out in Section 205.3(c) of the proposed rule and is discussed below. Excluding "interestedpersons" of a registered investment company from the investment company's QLCC is intended to ensure that the members of such a QLCC will be truly independent, as explained further in the discussion of Section 205.3(b)(4) below.

Interested persons are invited to comment on any aspect of the definition of a QLCC, considered in light of Section 205.3(c), specifically including whether any changes should be made to the definition, either in light of Section 205.3(c) as proposed or in light of changes that the interested persons believe should be made to that section. Should the written procedures for the retention of reports, which a QLCC must establish pursuant to paragraph 205.2(j)(3), require the QLCC to retain paper or electronic copies of all reports submitted by attorneys? Should this requirement be expanded to obligate the QLCC to retain paper or electronic copies of responses to attorney reports?

(k) Reasonable or reasonably denotes the conduct of a reasonably prudent and competent attorney.

The definition of "reasonable" or "reasonably" is taken from Rule 1.0(h) of the ABA's Model Rules of Professional Conduct. Interested persons are invited to comment on whether this definition is sufficiently clear and whether alternative language would be an improvement.

(l) Reasonably believes means that an attorney, acting reasonably, would believe the matter in question.

This definition is based on the definition of "reasonable belief" or "reasonably believes" in Rule 1.0(i) of the ABA's Model Rules of Professional Conduct, modified to eliminate any implied subjective element. It is intended to define when belief is objectively reasonable. Interested persons are invited to comment on whether this definition is sufficiently clear andwhether alternative language would be an improvement and, if so, what alternative language interested persons would propose. Would the definition of "reasonable belief" by New Jersey's Supreme Court, for example, be clearer: "Reasonable belief for purposes of R[ule of ]P[rofessional ]C[onduct] 1.6 is the belief or conclusion of a reasonable lawyer that is based upon information that has some foundation in fact and constitutes prima facie evidence of the matters referred to in paragraphs (b) or (c)"?

(m) Report means to make known to directly, either in person, by telephone, by e-mail, electronically, or in writing.

This definition emphasizes that an attorney who is obligated to report evidence of a material violation must do so directly rather than indirectly. Although the attorney is not required to communicate in person with the appropriate individual, the Commission believes that it is essential for any report to be made directly rather than through a third party to ensure clarity. In light of the report's importance, most attorneys would want to report directly in any event.

Interested persons are invited to comment on any aspect of this definition. Should the attorney be required to make a written report, or to memorialize the substance of the report in writing shortly after making it? Should the attorney be required to keep a record of the report, including all supporting documentation? Should the Commission require that the report be made in person? Should the Commission prescribe a format for the report? Should the Commission require that a witness be present for each report? Should an attorney be permitted to delegate his or her reporting requirement to another and, if so, under what circumstances?

Section 205.3 Issuer as Client

Section 205.3 is at the core of the Commission's proposed "Standards of Professional Conduct for Attorneys." It sets out the rule on reporting "evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof," as required by the Act. It also sets out related provisions addressing an attorney's obligations to the issuer.

Representing an Issuer

Section 205.3(a) provides:

(a) Representing an issuer. An attorney appearing and practicing before the Commission in the representation of an issuer represents the issuer as an organization and shall act in the best interest of the issuer and its shareholders. That the attorney may work with and advise the issuer's officers, directors, or employees in the course of representing the issuer does not make such individuals the attorney's clients.

This paragraph of the proposed rule makes explicit that the client of an attorney representing an issuer before the Commission, in any way, is the issuer as an entity, not the issuer's individual officers or employees that the attorney regularly interacts with and advises on the issuer's behalf. Those officers and other employees, like the attorney, have a fiduciary duty to act in the best interests of the issuer and its shareholders.

This paragraph is grounded in a lawyer's well-established duty to act with reasonable competence and diligence in representing a client and to take steps to prevent reasonably foreseeable harm to the client - including harm from persons who work for the client.³⁶ As theCheek Report explains (at 27), the premise of the ABA's equivalent rule (Model Rule 1.13) is that, when a lawyer represents an organization (such as an issuer),

the organization is the lawyer's client and . . . the lawyer owes that client an obligation of protection from harm. Harm can result when an officer breaches a duty to the corporation (e.g. wastes or misappropriates corporate assets), when the corporation will be caused to injure a third party who will then have a claim against the corporation or when the corporation will be exposed to a fine or penalty. In any such case the lawyer's duty to protect the corporate client from harm requires the lawyer to serve the interest of the corporation and its shareholders rather than the interests of the individual officers or employees who are acting for the corporation.

The attorney representing an issuer does not represent the issuer's officers and employees simply because the attorney necessarily interacts with them in representing the issuer, and the attorney should make that clear to those officers and employees. Any attorney-client privilege for information related to the issuer's affairs that the officers and employees communicate to the attorney belongs to the issuer.³⁷

Interested persons are invited to comment on any aspect of this paragraph, including whether it should be expanded to address under what circumstances an attorney for the issuer may also represent officers, directors and employees, and, if an attorney does so, the related questions of : (1) the responsibilities of an attorney when there is a potential for a conflict of interest; (2) obtaining waivers from clients when there is a conflict of interest; and (3) terminating representation when an actual conflict arises.

Reporting within the Issuer Evidence of a Material Violation

Section 205.3(b) of the proposed rule clarifies and codifies an attorney's duty to protect the interests of the issuer the attorney represents by reporting within the issuer evidence of a material violation by any officer, director, employee, or agent of the issuer.

Paragraph (b)(1) provides:

(b) Duty to report evidence of a material violation. (1) If, in appearing and practicing before the Commission in the representation of an issuer, an attorney becomes aware of evidence of a material violation by the issuer or by any officer, director, employee, or agent of the issuer, the attorney shall report any evidence of a material violation to the issuer's chief legal officer (or the equivalent thereof) or to both the issuer's chief legal officer and its chief executive officer (or to the equivalents thereof) forthwith (unless the issuer has a qualified legal compliance committee and the attorney chooses instead to report the evidence of a material violation to that committee under paragraph (c) of this section). An attorney does not reveal client confidences or secrets by communicating information related to the attorney's representation of an issuer to the issuer's officers or directors.

Paragraph (b)(1) describes the first step that an attorney representing an issuer is required to take after he or she becomes aware of information that would lead an attorney reasonably to believe that a material violation by an issuer or by any of the issuer's officers, directors, employees, or agents has occurred, is occurring, or is about to occur (unless the issuer has a qualified legal compliance committee, and the attorney chooses to report to it).³⁸ In utilizing thisstandard, the rule seeks to balance the likelihood of increased compliance with the law as a result of having an appropriate triggering standard that prompts the bringing of potentially illegal conduct to the attention of the issuer's management against the likelihood of decreased compliance resulting from reduced consultation with an issuer's attorneys through adoption of too high a standard.

As paragraph (b)(1) itself expressly states, an attorney does not reveal client confidences or secrets (or breach the attorney-client privilege) by communicating to the issuer's officers or directors information related to the attorney's representation of the issuer. This legal principle is not controversial.³⁹ The Cheek Report, however, recommends incorporating into the ABA's Model Rule 1.13 a clear statement that Model Rule 1.6 does not prohibit communicating client confidences or secrets "to higher authority within the corporation."⁴⁰ The consensus of theCheek Task Force was that the existing language of Model Rule 1.13(b) "tends to discourage action by the lawyer to prevent or rectify corporate misconduct" generally and to "discourage[] a lawyer from seeking review by higher corporate authority," even though the lawyer's goal ought to be to "minimiz[e] harm resulting from the misconduct." Id. The Commission has incorporated such an explicit statement of the legal principle into paragraph (b)(1) of this section.

The report required in Section 205.3(b) to prevent or minimize the harm to an issuer resulting from a material violation is internal. It involves no disclosure of confidential information outside the issuer.⁴¹ The report, moreover, is intended to prevent, if possible, misconduct that would injure the issuer and its shareholders, or at least to limit the injury. Accordingly, awareness of information leading an attorney reasonably to believe that a material violation has occurred, is occurring, or is about to occur appears to be the appropriate trigger for the obligation to make an internal report of the evidence of a material violation.

As the reporter for the ABA's Commission of Evaluation of Professional Standards ("Kutak Commission") wrote in 1984, explaining why he considered the ABA's present Model Rule 1.6 (on disclosure of confidential information to outsiders) inadequate,

there is an unavoidable tension between the proposition that the lawyer shouldact early, to prevent the fraud, and the requirement that he should act only on the basis of solid information. The longer the wait, the more solid the information, but also the greater the likelihood of the client's deeper inculpation.⁴²

Requiring more than "a reasonable basis" for believing that a client intends to commit, or has committed, fraud before allowing the lawyer to reveal confidential client information to outsiders "would virtually preclude the possibility of the lawyer's action except in most egregious situations." Id. at 285-86. That analysis would appear to apply with even greater force where the disclosure is within an issuer, as required by Section 205.3(b).

Proposed Section 205.3(b) would require an attorney representing an issuer to report within the issuer evidence of "a material violation by the issuer or by any officer, director, employee, or agent of the issuer." The internal report of evidence of a material violation is not comparable to a judicial determination that a material violation actually occurred. There must, however, be some factual basis that would lead an attorney to reasonably believe that a material violation has occurred, is occurring, or is about to occur. The internal report then allows responsible officers of an issuer to consider the reported evidence, investigate where appropriate, and take actions necessary to prevent or minimize any threatened harm to the issuer.⁴³

The ABA's Model Rule 1.13 includes a similar but narrower reporting requirement for attorneys representing an organization, applicable only when the attorney knows that a violation is occurring or going to occur that is likely to result in substantial injury to the organization:

If a lawyer for an organization knows that an officer, employee or other person associated with the organization is engaged in action, intends to act or refuses to act in a matter related to the representation that is a violation of a legal obligation to the organization, or a violation of law which reasonably might be imputed to the organization, and is likely to result in substantial injury to the organization, the lawyer shall proceed as is reasonably necessary in the best interest of the organization.

Even though a securities lawyer "may be taken as knowing what an alert lawyer would know upon looking with a professional eye at the totality of circumstances there to be seen,"⁴⁴ the ABA's Model Rule appears to set too high a standard for reporting within an issuer evidence of a material violation, both in requiring an attorney to know that an officer, employee or other person associated with the issuer organization is engaged in or intends a material violation and in requiring that material violation to result in substantial injury to the issuer. Such a high threshold for internal reporting would be inconsistent with Section 307's emphasis on the public interest and protecting investors.

The proposed rule obligates an attorney to report information he or she has become aware of that would lead an attorney, acting reasonably, to believe that a material violation has occurred, is occurring or is about to occur. In the Commission's decision in Carter and Johnson and the order entered in Keating, Muething & Klekamp, the Commission addressed the responsibilities of an attorney who "knows" of a violation of law by the issuer or its officers. Because those cases dealt with situations where the attorneys knew, or should have known, about their client's misconduct, the Commission's discussion in both cases focused upon an attorney's obligation in that situation. Neither case, however, established actual knowledge of a client'smisconduct as a minimum threshold for triggering an attorney's duty to report such misconduct. A rule which obligates an attorney to report only a material violation of which he or she "knows" could be interpreted as imposing an initial investigative obligation upon the attorney which he or she may be poorly situated to perform, and which section 307 indicates should be borne by appropriate personnel within the issuer after an attorney has made a report.

When an attorney "becomes aware" of information that would lead an attorney reasonably to believe in the existence of a material violation would turn, at least in part, on the attorney's training, experience, position and seniority. Attorneys are not necessarily expected to identify issues they are not equipped to see. What the reasonable, experienced securities lawyer might regard as a clear violation of the law may appear different - or not appear at all - to an unseasoned attorney with a different level of expertise.⁴⁵

The evidence of a material violation that an attorney first becomes aware of may be the tip of an iceberg and, may, on its face, appear unlikely to result in substantial injury to the issuer. For example, evidence indicating that an issuer controls one or two of many special-purpose entities, which individually do not qualify for the off-balance-sheet treatment they have been given, might indicate a material misstatement in the issuer's financial statements, and a material violation of securities law, but not, without more, a material violation likely to result in substantial injury to the issuer.⁴⁶

The proposed rule, however, is not intended to impose upon an attorney, whether employed or retained by the issuer, a duty to investigate evidence of a material violation or to determine whether in fact there is a material violation. Of course, nothing in the proposed rule is intended to discourage any such inquiry. On the other hand, the attorney cannot ignore evidence of a material violation of which he or she is aware.

In proposing this rule, the Commission does not intend to inhibit the consultative process between an issuer and its attorney. The duty to report "up the ladder" under section 205.3(b)(2) does not arise from a consultation in which an attorney advises an officer or employee of an issuer that the law regarding a proposed course of action is unsettled and there is some possibility that a court might hold in the future that the action violated the securities laws. Nor does it arise where an officer actually pursues a course of action despite being advised by the attorney that the course of action has been held illegal by courts in three states, in none of which the issuer does business, even if the attorney thinks there is a reasonable argument that other courts would also be likely to find it illegal. The course of action is not clearly illegal, because its legality has not been addressed by courts in any state where the issuer does business. The duty to report does not even arise where the officer tells the attorney that he or she intends to pursue a course of action that the attorney thinks is clearly illegal where the issuer does business, because the officer mightreconsider and not do what he or she said he or she would do. The attorney's reporting obligation is not triggered until the attorney can be sure that the officer or employee will actually pursue an illegal course of action.

Interested persons are invited to comment on: whether the "reasonably believes" standard is an appropriate standard to trigger the requirement that an attorney make a report or whether the requirement should be triggered only in instances where the attorney "knows" or "reasonably should know" of a material violation; and whether the standard should also address the quantity and/or quality of evidence required to trigger a report.

The Commission also does not intend the proposed rule to chill zealous advocacy by an issuer's defense counsel. Under certain circumstances, however, the proposed rule would require an attorney defending an issuer to report "up the ladder" to the issuer's CLO evidence of any material violation that the attorney becomes aware of while defending the issuer. That reporting obligation exists whether or not the evidence of a material violation is directly related to a matter under inquiry or investigation by the Commission. Evidence of a material violation that an attorney learns about while defending an issuer does not pose any less a threat to the issuer and to investors than does evidence of a material violation that an attorney becomes aware of under other circumstances, and requiring defense counsel to report such evidence to the issuer-client's CLO - or even, under extraordinary circumstances, to appropriate directors of the issuer - should not chill an attorney's ability to provide effective representation to the issuer. Indeed, the intended deterrent effect of the proposed rule would be significantly compromised if the rule did not apply when an attorney appears and practices during Commission inquiries, investigations and administrative proceedings. (As a rule of reason, the proposed rule should not be construedto require defense counsel to report to the CLO evidence of a material violation that the CLO has made the defense counsel aware of.)⁴⁷

Moreover, the rule's reporting obligation is consistent with defense counsel's ethical obligations to the issuer-client. ABA Model Rule 1.4 requires an attorney to "keep a client reasonably informed about the status of a matter" as "reasonably necessary to permit the client to make informed decisions regarding the representation."⁴⁸ In the context of a Commission inquiry, investigation, or administrative proceeding, the issuer cannot make informed decisions without knowing about evidence that its officers or employees are responsible for a material violation and, if so, what steps would be required to rectify it. In such a context, the issuer's CLO needs to be aware of information indicating that a material violation has occurred, is occurring, or is about to occur in order to participate intelligently with defense counsel in making decisions about the objectives of the representation and how to pursue them. In the context of aninquiry, investigation, or administrative proceeding by the Commission, one of the affected issuer's objectives should be to determine whether there has been any violation and, if so, to decide how best to rectify it. Accordingly, it should be important to ensure that the issuer's CLO knows about any evidence of a material violation.

In an administrative proceeding, even where the Commission's staff asserts it has evidence of a material violation by an issuer, an attorney defending an issuer may assert any relevant and colorable affirmative defense on the issuer's behalf, and may require the Commission staff to prove its case against his or her client. It would not be an inappropriate response to reported evidence of a material violation for an issuer's CLO to direct defense counsel to assert either a colorable defense or a colorable basis for contending that the staff should not prevail. Such directions from the CLO, therefore, would not require defense counsel to report any evidence of a material violation to the issuer's directors under section 205.3(b)(4) of the proposed rule. On the other hand, if the CLO's sole response to reported evidence of a material violation from defense counsel is to direct defense counsel to argue in the proceeding that no violation has occurred and the CLO is conducting no internal inquiry and considering no remedial steps, defense counsel, acting reasonably, would probably believe that the CLO's response to the evidence of a material violation is inadequate and would be obligated to report the evidence of a material violation to the issuer's CEO under section 205.3(b)(1) or to appropriate directors under Section 205.3(b)(4) of the proposed rule.⁴⁹ Such reporting "up theladder," however, would constitute - not chill - zealous representation of the issuer's best interest. Responsible defense counsel should probably make such a report under those circumstances in any event.⁵⁰ The attorney's client is the issuer, not the issuer's CLO. A prudent defense counsel should report "up the ladder" in this situation to ensure that upper management is aware of the evidence and has an opportunity to take appropriate action. As the rule makes clear, reporting potential violations to officers and directors of the issuer does not reveal any client confidences.

If the attorney defending an issuer reports the matter all the way "up the ladder" withinthe issuer and does not receive an appropriate response even from the issuer's directors, and if the material violation is ongoing or about to occur and is likely to result in substantial injury to the financial interest or property of the issuer or of investor, section 205.3(d)(1)(i) obligates an attorney retained by an issuer, even as an advocate, to withdraw from representation and notify the Commission that such withdrawal was for "professional considerations." Section 205.3(d)(2)(i) permits, but does not require, an attorney retained by the issuer to take these steps if he or she reasonably believes the material violation has occurred and is not ongoing and is likely to have resulted in substantial injury to the financial interest or property of the issuer or of investors. The ABA's Model Rule 1.16 requires even an advocate in a criminal case to withdraw, unless ordered not to by a court, where continuing the representation "will result in violation of the rules of professional conduct," as asserting frivolous defenses would, under Model Rule 3.4.

An attorney defending an issuer in a civil injunctive action by the Commission in a district court would not be appearing and practicing before the Commission, because the issuer would not be transacting business with the Commission, even though the attorney may be interacting with Commission staff assigned to the litigation. However, if that attorney is also appearing and practicing before the Commission by defending the issuer in a Commission inquiry or investigation and becomes aware of evidence of a material violation by the issuer, the attorney will have the reporting responsibilities under the proposed rule discussed above, whether or not the evidence is related to the subject matter of the litigation. If the evidence of a material violation relates to the subject of the litigation, the attorney should also observe his or her duty of candor to the court.

The Commission invites interested persons to comment on whether there is a potential chilling effect inherent in requiring an attorney to report within the issuer evidence of a material violation or make a "noisy withdrawal" while representing an issuer in an inquiry, investigation, or administrative proceeding by the Commission, and invites interested persons to suggest how to address this situation. Should the definition of the term "appropriate response" in 205.2(b) be modified to explicitly recognize an attorney's obligation to continue to defend an issuer client in a Commission administrative proceeding, even if the attorney does not believe the client has a meritorious defense? Should the definition be modified to state that an issuer's decision to require the Commission to establish its claims against the issuer in an administrative proceeding constitutes an "appropriate response" by an issuer, notwithstanding the fact that an attorney learns of evidence during the proceeding which indicates that the Commission's claims are valid? Should paragraphs 205.3(d)(1)(i) and 205.3(d)(2)(i) be revised to explicitly state that an attorney is not required, or even permitted, to effect a "noisy withdrawal" under these circumstances?

Maintaining a Contemporaneous Record

Paragraph (b)(2) of the proposed rule provides:

(2) The attorney reporting evidence of a material violation shall take steps reasonable under the circumstances to document the report and the response thereto and shall retain such documentation for a reasonable time.

Absent exigent circumstances, the attorney retained or employed by an issuer who reports "up the ladder" within the issuer evidence of a material violation is required to take reasonable steps to make and retain a contemporaneous record of his or her report and the response itreceives.⁵¹ A subordinate attorney who reports evidence of a material violation to his or her supervising attorney is also required to take such steps. Such contemporaneous records would typically include the date, time, location, manner, and substance of the report and the response and the identity of witnesses to either. Much or all of this information would likely be included in the report or the response itself, if the report or the response is in written form. Requiring such a contemporaneous record of the report may protect the attorney in any proceeding in which his or her compliance with this rule is at issue by demonstrating that the attorney acted properly under the circumstances.⁵² The rule does not establish any requirement for documentation of an attorney's determination that information does not constitute evidence of a material violation (except where a supervisory attorney believes the information reported to the supervisory attorney by a subordinate attorney is not evidence of a material violation). In close cases, it would be prudent for an attorney to do so.

In certain limited circumstances it may not be practicable or reasonable for the attorney to prepare a written record at the time. The attorney, for example, may learn of possible misconduct in the course of a fast-moving corporate deal. In this situation, it may appear more important to bring the evidence to the CLO's attention immediately than to memorialize it. Other exigent or extenuating circumstances also may result in the lack of a contemporaneous record, although the Commission believes that such cases will be rare. In some cases, the CLO's or management's written response may provide adequate documentation of the report as well as the response. Where it does provide adequate documentation, retaining a copy of the CLO's report would satisfy the requirements of (b)(2) and (7). Where it does not, the reporting attorney should endeavor to make a record of his or her report as soon as possible.

Where a report is directed to an issuer's audit committee, to some other committee of the issuer's board of directors, or to the full board - either because the reporting attorney considered it necessary to bypass the CLO and CEO or because the response from the CLO or CEO was inappropriate or was unreasonably delayed - those circumstances may make it important for the reporting attorney to make and retain a contemporaneous record of his or her report.

In the extreme and unlikely event that the issuer's audit committee, some other committee of the issuer's board of directors, or the full board of directors does not provide an appropriate response within a reasonable time, it may be essential for the reporting attorney to prepare and retain a contemporaneous written record documenting those circumstances. Accordingly, in that unlikely event, paragraph (b)(8) of the proposed rule would require the reporting attorney to take reasonable steps to document the response - typically preserving a copy of a written response - the attorney believes inappropriate, and to retain that documentation for a reasonable time. Whatis a reasonable time will depend on the circumstances but would probably not be shorter than the statute of limitations applicable to the material violation at issue.

A prudent attorney is likely to make such a contemporaneous record whether or not the Commission requires it, and all attorneys should do so under the circumstances covered by Sections 205.3 (b)(1), (4), and (5) and 205.5(c). Section 205.3(d)(1) expressly authorizes an attorney who has made and retained such contemporaneous records under the proposed rule to use them in self-defense in the event his or her conduct is called into question.

Interested persons are invited to comment on: (1) whether the rule should require the attorney making a report to maintain a written record of that report; (2) whether the rule should prescribe in detail the form and content of the report, and if so, what form and content should or should not be prescribed; and (3) whether the rule should prescribe specific time deadlines for the preparation of the report, and if so, what time deadlines would or would not be appropriate.

Chief Legal Officer's Duty to Investigate

Paragraph (b)(3) of the proposed rule would provide:

(3) The chief legal officer (or the equivalent thereof) shall cause such inquiry into the evidence of a material violation as he or she reasonably believes is necessary to determine whether the material violation described in the report has occurred, is occurring, or is about to occur. If the chief legal officer reasonably believes no material violation has occurred, is occurring, or is about to occur, he or she shall so advise the reporting attorney. If the chief legal officer reasonably believes that a material violation has occurred, is occurring, or is about to occur, he or she shall take any necessary steps to ensure that the issuer adopts appropriate remedial measures, including appropriate disclosures, and/or imposes appropriate sanctions to stop any material violation that is occurring, prevent any material violation that is about to occur, and/or to rectify any material violation that has already occurred. The chief legal officer shall promptly report the remedial measures adopted and/or sanctions imposed to the chief executive officer, to the audit committee of the issuer's board of directors, or to the issuer's board of directors, and to the reporting attorney. The chief legal officer shall take reasonable steps to document his or her inquiry and to retain such documentation for a reasonable time. Inlieu of causing an inquiry under this paragraph (b), a chief legal officer (or the equivalent thereof) may refer a report of evidence of a material violation to a qualified legal compliance committee under paragraph (c)(2) of this section. If the issuer fails in any material respect to take any remedial measure that the qualified legal compliance committee directs the issuer to take in order to stop any material violation that is occurring, prevent any material violation that is about to occur, and/or to rectify any material violation that has already occurred, the chief legal officer shall notify the Commission that a material violation has occurred, is occurring or is about to occur and shall disaffirm in writing any documents submitted to or filed with the Commission by the issuer that the chief legal officer reasonably believes are false or materially misleading.

Paragraph (b)(3) would clarify the obligations of the issuer's CLO (or equivalent) under the proposed rule. The Commission has not imposed on attorneys making reports under Section 205.3(b) a duty to investigate independently the evidence before making their reports. Attorneys employed by the issuer or retained as outside counsel are often not in a position to conduct such an inquiry. In many cases, attorneys may lack the experience, resources, and access to records and other employees necessary to conduct an appropriate inquiry. Such an inquiry may be beyond the scope of outside counsel's representation. The issuer's CLO, however, is in a position to conduct an internal inquiry when appropriate. Moreover, a CLO has a clear duty to protect the issuer - as opposed to its other officers and employees - in every possible way.⁵³ The proposed rule, accordingly, would expressly make the CLO responsible for having an inquiry conducted in response to a report under paragraph (b), unless the CLO makes a reasonable determination that it is not necessary to do so.

Where an issuer has no general counsel or chief legal officer, the "equivalent" would be the chief executive officer, who would, under the proposed rule, be responsible for having aninquiry conducted in response to a report under 205.3(b), unless he or she makes a reasonable determination that it is not necessary to do so. In most such cases, the CEO would probably authorize whatever attorneys the issuer normally uses for its legal work to conduct the inquiry or retain another law firm to do so.

Interested persons are invited to comment on whether: (1) the chief legal officer should have an obligation to conduct an inquiry in response to a report and, if so, whether he or she should be permitted to retain or assign other counsel to conduct the inquiry; (2) the "reasonably believes" standard is appropriate for determining whether the chief legal officer must cause an inquiry to be conducted; (3) the "reasonably believes" standard is an appropriate guide for the chief legal officer's determination regarding whether a material violation has occurred: (4) the rule should further address when it is necessary for the issuer to take "necessary steps" in response to a material violation; (5) the rule should further address when remedial measures and/or sanctions are appropriate and the kinds of sanctions and remedial measures that are acceptable under different circumstances; and (6) the rule should address what steps by an issuer are sufficient to "stop," "prevent" or "rectify" a material violation.

Reporting a Material Violation to the Issuer's Directors

Paragraph (b)(4) of the proposed rule would provide:

(4) If an attorney who has made a report under paragraph (b)(1) of this section reasonably believes that the chief legal officer or the chief executive officer of the issuer (or the equivalent thereof) has not provided an appropriate response, or has not responded within a reasonable time, the attorney shall report the evidence of a material violation to:

(i) The audit committee of the issuer's board of directors;

(ii) Another committee of the issuer's board of directors consisting solely of directors who are not employed, directly or indirectly, by the issuer and are not, in the case of a registered investment company, "interested persons" as defined in section 2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19)) (if the issuer'sboard of directors has no audit committee); or

(iii) The issuer's board of directors (if the issuer's board of directors has no committee consisting solely of directors who are not employed, directly or indirectly, by the issuer and are not, in the case of a registered investment company, "interested persons" as defined in section 2(a)(19) of the Investment Company Act of 1940 (15 U.S.C. 80a-2(a)(19))).

This paragraph applies where the issuer's CLO and/or CEO fail to respond appropriately to the reported evidence of a material violation, requiring the reporting attorney to report the evidence to the issuer's audit committee, another committee of independent directors, or to the full board of directors. The term "appropriate response" is defined in Section 205.2(b) and identifies the steps a CLO or CEO must take in responding to a report of evidence of a material violation, including making appropriate disclosures when the reported evidence demonstrates the existence of a disclosure violation.

The statutory language refers to situations in which a CLO or CEO "does not appropriately respond to the evidence (adopting, as necessary, appropriate remedial measures or sanctions with respect to the violation)." The proposed rule makes clear that providing no response at all within a reasonable time may be equivalent to not providing an appropriate response and no response may, under certain circumstances, require the attorney to report to a higher level of authority within the issuer - when, for example, a filing or submission that the attorney reasonably believes contains a misstatement of material fact is to be made the next day.

The direction that the attorney must report "up the ladder" to the audit committee of the issuer's board of directors, if there is one; if there is no audit committee, then to another committee of the issuer's board of directors consisting solely of independent directors, if there is one; and if there is no committee of independent directors, then to the full board of directors isintended to implement the statutory language on reporting "up the ladder"⁵⁴ while avoiding a situation in which one attorney might report some evidence of a material violation to one committee of directors while another attorney might report other evidence of a material violation to a second committee, obscuring the full, cumulative significance of reported evidence.

Requiring that the committee of a registered investment company's board of directors to which an attorney is allowed to report evidence of a material violation - here and in paragraph (b)(5) of this section - must exclude "interested persons" is intended to assure that the report will go to independent directors. That exclusion has the same rationale here as does excluding "interested persons" from an investment company's QLCC, as defined in Section 205.2(j). Usually, a director who is not "employed directly or indirectly by the issuer" is an independent director of the issuer. However, registered investment companies (including mutual funds) constitute an important group of issuers that typically are managed externally. As a result, a director of a registered investment who is "not employed directly or indirectly" by the investment company but is employed by the investment company's investment advisor may well not be independent. Independent directors of a registered investment company thus cannot include any "interested person" of the investment company as defined in Section 2(a)(19) of the Investment Company Act of 1940.

The Commission solicits comment on any aspect of this section, including whether: (1) the "reasonably believes" standard is appropriate for the reporting attorney to determinewhether he or she has received an "appropriate response" and, if not, what alternative standard should be used; (2) the "reasonable time" standard is appropriate or whether the rule should contain a more specific deadline (or deadlines) or one that is linked to the complexity of the issues presented by the report; and (3) the rule should specifically prescribe the form and content of any report to the audit committee or the board of directors and, if so, what form and content would or would not be appropriate.

Paragraph (b)(5) of the proposed rule would provide for circumstances under which it may be appropriate to bypass the CLO and CEO:

(5) If an attorney reasonably believes that it would be futile to report evidence of a material violation to the issuer's chief legal officer and chief executive officer (or the equivalents thereof) under paragraph (b)(1) of this section, the attorney may report the evidence of a material violation as provided under paragraph (b)(4) of this section.

In the interest of expediting any required corrective action within the issuer, paragraph (b)(5) permits, but does not require, an attorney to bypass the CLO or CEO of an issuer and report evidence of a material violation directly to appropriate directors of an issuer - to the audit committee of the issuer's board of directors, if there is one; if there is no audit committee, then to another committee of the issuer's board of directors consisting solely of independent directors, if there is one; and if there is no committee of independent directors, then to the full board of directors - where the attorney reasonably believes that it is likely to be futile to report the evidence to the CLO or CEO. It provides a shortcut under the circumstances implicit in paragraph (b)(4), where the inappropriate response of a CLO and/or CEO can reasonably be anticipated. Reporting to the CLO or CEO might appear futile where those officers appear to be involved in the wrongdoing to be reported. Indeed, a report to participants in the wrongdoingmight enable them to destroy relevant evidence. This is an amendment that the Cheek Report (at 29-30) recommends to Model Rule 1.13.

Interested persons are invited to comment on any aspect of this section, including whether: (1) the rule should contain a bypass provision, such as this, allowing a reporting attorney to forego reporting evidence to the chief legal officer and, if so, what its advantages and disadvantages would be; (2) a reporting attorney's ability to bypass the chief legal officer should be limited to instances where it is "futile" or whether it should be expanded to other situations, what those other situations should be, and why; (3) the "reasonably believes" standard is appropriate and, if not, what standard or standards would be appropriate; and (4) the rule should provide that the reporting attorney "may" bypass the chief legal officer or should it require that he or she do so under certain circumstances.

Attorneys Retained or Directed to Investigate a Reported Material Violation

Paragraph (b)(6) of the proposed rule would address circumstances in which those to whom evidence of a material violation is reported direct others, either in-house attorneys or outside attorneys retained for that purpose, to investigate the possible violation:

(6) An attorney retained or directed by an issuer to investigate evidence of a material violation reported under paragraph (b)(1), (b)(4), or (b)(5) of this section shall be deemed to be appearing and practicing before the Commission. Directing or retaining an attorney to investigate reported evidence of a material violation does not relieve the officers or directors of the issuer to whom the evidence of a material violation has been reported under paragraph (b)(1), (b)(4), or (b)(5) of this section of the duty to respond to the reporting attorney

Paragraph (b)(6) makes two points. First, the investigating attorneys would themselves be appearing and practicing before the Commission. They would therefore be bound by the requirements of the proposed rule. Second, the officer or directors who caused them toinvestigate remain obligated to respond to the attorney who initially reported the evidence of a material violation. Either the issuer's officer or directors or, under the officer's or directors' instructions, the investigating attorneys would make the reporting attorney aware of the inquiry, to keep the reporting attorney from concluding mistakenly that the required response was unreasonably delayed.

Interested persons are invited to comment on all aspects of this section, including: (1) whether it is appropriate for an attorney retained or directed to investigate a report to be deemed to be appearing and practicing before the Commission; and (2) to what extent, if any, the rule should permit the retained or directed attorney to fulfill the issuer's obligation to respond to the reporting attorney.

Assessment of the Issuer's Response to the Reported Evidence of a Material Violation

Paragraph (b)(7) of the proposed rule would provide for circumstances in which the attorney receives an appropriate and timely response to the evidence he has reported:

(7) An attorney who receives what he or she reasonably believes is an appropriate and timely response to a report he or she has made pursuant to paragraph (b)(1), (b)(4), or (b)(5) of this section from the issuer's chief legal officer, chief executive officer, audit committee, another committee of the issuer's board of directors consisting solely of directors not employed, directly or indirectly, by the issuer, or the issuer's board of directors and who has taken reasonable steps to document his or her report and the response thereto under paragraph (b)(2) of this section need do nothing more under this section regarding the evidence of a material violation.

This paragraph confirms that the attorney would fully comply with proposed Section 205.3 once the attorney has reported evidence of a material violation and reasonably believes that the issuer's response to that reported evidence is appropriate, so long as there is a record of the report and the response.

Interested persons are invited to comment on any aspect of this section, including whether the rule should have such a "safe harbor" and, if so, its scope.

Paragraph (b)(8) of the proposed rule would provide for circumstances in which the attorney does not receive an appropriate response to the evidence he has reported or does not receive any response in a reasonable time:

(8) If the attorney reasonably believes that the issuer has not made an appropriate response to the report or reports made pursuant to paragraph (b)(1), (b)(4), or (b)(5) of this section, or the attorney has not received a response in a reasonable time, the attorney shall:

(i) Explain his or her reasons for so believing to the chief legal officer, chief executive officer, or directors to whom the attorney reported the evidence of a material violation pursuant to paragraph (b)(1), (b)(4), or (b)(5); and

(ii) Take reasonable steps to document the response, or absence thereof, and to retain such documentation for a reasonable time.

It should be truly extraordinary for an attorney reporting evidence of a material violation to receive an inappropriate response - one, for example, that simply asserted that the reported evidence is no cause for concern without any hint of evaluation or inquiry - or to receive no response at all within a reasonable time. Any attorney who believes that the response to evidence of a material violation is not appropriate or is unreasonably delayed is obligated to the client-issuer to explain to the responsible officers or directors why he or she so believes. Where the attorney's explanation is unavailing and the attorney continues to believe that the issuer's response is not appropriate, that extraordinary event should be documented, and the attorney should retain that documentation for a reasonable time.⁵⁵

Interested persons are invited to comment on any aspect of the rule, including: (1)  whether the "reasonably believes" standard is appropriate and, if not, what is an appropriate standard; (2) whether the rule should prescribe what is a "reasonable time" to permit the issuer to respond to a report; and (3) whether it is important to provide a "safe harbor" from civil suits for the attorney who reports evidence of a material violation under paragraph (b) or paragraph (c).

Section 205.3(c) of the proposed rule would provide an alternative to the reporting requirements of paragraphs 205.3(b) and to requirements under 205.3(d) that become applicable where an attorney reporting evidence of a material violation under 205.3(b) does not receive an appropriate response:

(c) Alternative reporting procedures for attorneys retained or employed by an issuer with a qualified legal compliance committee. (1) If, in appearing and practicing before the Commission in the representation of an issuer, an attorney becomes aware of evidence of a material violation by the issuer or by any officer, director, employee, or agent of the issuer, the attorney may, as an alternative to the reporting requirements of paragraph (b) of this section, report such evidence of a material violation to a qualified legal compliance committee, if the issuer has duly formed such a committee. Except as provided in paragraph (b)(3) of this section, an attorney who reports evidence of a material violation to a qualified legal compliance committee has satisfied his or her obligation to report evidence of a material violation within the issuer, is not required to assess the issuer's response to the reported evidence of a material violation, and is not required to take any action under paragraph (d) of this section regarding the evidence of a material violation.

(2) A chief legal officer (or the equivalent thereof) may refer a report of evidence of a material violation to a qualified legal compliance committee