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Article Excerpt
INTRODUCTION
The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) (1) imposes specific requirements on corporate attorneys that have broad implications on corporate governance and corporate organization. With the adoption of Sarbanes-Oxley, Congress and the SEC seek to limit corporate misconduct through two devices. First, they expand the accountability of corporate "gatekeepers," such as accountants, attorneys, and financial analysts. (2) Second, they vigorously promote specialized committees of independent directors within the corporate governance structure. (3)
This article will explore how one of these specialized committees proposed under SEC Rule 205, (4) the Qualified Legal Compliance Committee (QLCC), can serve as a valuable resource for management and corporate counsel when a reasonable belief exists that a material violation of the law may have occurred, is occurring or is about to occur. Part I provides a brief legislative history of the Act, particularly Section 307, and explores the SEC's rationale for involving corporate counsel in its investigation of corporate misconduct. Part II describes the SEC's requirements for establishing a QLCC, including its composition, its procedures, its authority, and its responsibilities. Part III analyzes the strengths and weaknesses of various structural and procedural options available to boards of directors that may be considering establishing a QLCC. Part IV explores the costs, the potential personal liability of directors, and other reasons that may explain a relatively slow rate of adoption of the QLCC by the corporate community. In Part V, the article offers a recommended structure and a set of procedures for the QLCC to ensure its effectiveness as a monitor of corporate behavior and as a valuable resource for management, in-house attorneys and the investment community.
1. PRELUDE TO SARBANES-OXLEY
Throughout its seventy-year history of enforcing federal securities laws, the SEC has assumed the role of the public's "statutory guardian" of honesty in the securities markets. (5) Many of the expanded statutory remedies created in Sarbanes-Oxley can be traced to enforcement proposals of the 1970s, an era known as the "golden age of SEC enforcement." (6) The SEC's vision for expanded regulation of corporate governance was outlined in a 1976 speech entitled, "Restoring Integrity to American Business." (7) In that speech, Stanley Sporkin, Director of the SEC's Enforcement Division, proposed that companies appoint a business practice officer responsible for implementing codes of ethical conduct. (8) Although a seemingly modest proposal in comparison to the regulations imposed by Sarbanes-Oxley, Sporkin, in fact, was looking to expand SEC powers beyond the limited statutory remedies then available to it. The SEC's historic power to seek injunctive relief against corporate violators of securities laws was seen by some commentators both as an inadequate remedy for the losses suffered by investors and as an ineffective deterrent to corporate violators. (9) Although courts have generally supported the SEC's petitions to force corporate management to disgorge ill-gotten gains, those charged with enforcement at the SEC have actively sought additional means to enforce the law. (10)
Access Theory
One strategy conceived by the SEC in the 1970s, when consent decrees were commonly used, was the "access theory" of securities law enforcement. (11) Because lawyers, accountants, and securities industry professionals often participate in, or have access to, management's decision-making process, the SEC reasoned that placing pressure on these key professionals would force a closer monitoring of corporate compliance. (12) This theory of enforcement sought to impose individual sanctions not only upon those professionals who were active participants in a violation, but also upon those who had merely acquiesced or who had failed to detect the illegal activity. (13)
In 1981, the SEC proposed disclosure rules that specifically required corporate counsel to report their client's non-compliance, but the ABA successfully argued against the adoption of such rules. (14) Despite this defeat, the SEC never abandoned the idea of leveraging corporate compliance by mandating reporting by individual attorneys. (15) In 2001 and 2002, a string of corporate accounting scandals, namely Enron, WorldCom, Tyco, and Adelphia, (16) gave the SEC an opportunity to resurrect the "access theory." (17)
Corporate Scandals Circa 2000-2001
Much of the extensive press coverage of the above-noted corporate scandals portrayed a public accounting profession failing miserably in fulfilling its duty of self-regulation and in its public trust as gatekeeper to accounting and corporate integrity. (18) Both the state boards of accountancy and the national standard-setting boards of public accounting were depicted as simply not up to the task of regulating the activities of the mega public accounting firms.(19) Also implicated were attorneys who played important roles in these scandals.(20)
In March 2002, Professor Richard W. Painter and forty other law professors sent a letter to then Chairman of the SEC, Harvey Pitt, suggesting that more stringent rules be promulgated for corporate attorneys. (21) The letter proposed that corporate attorneys should be required to report noncompliance with securities laws to their respective companies' board of directors. (22) The SEC's reply noted that the role of lawyers in securities fraud was "a matter of legitimate concern," but declined to promulgate rules to discipline attorneys because of the history of self-regulation by state bar associations. (23) Nonetheless, in a thinly disguised solicitation for enhanced regulatory power, the SEC suggested that congressional action in the direction of a more federalized system of regulation of corporate attorneys may be needed.(24)
Congress's response to the demand for tighter regulation of attorne ys was incorporated in Section 307 of Sarbanes-Oxley. The Act was resoundingly approved in the United States House of Representatives by 423 votes to 3 and in the United States Senate by 99 votes to 0. (25) When President George W. Bush signed the Act into law, he claimed it was one of "the most far-reaching reforms of American business practices since the time of Franklin Delano Roosevelt." (26) The President added, "[t]he era of low standards and false profits is over; no boardroom in America is above or beyond the law. No more easy money for corporate criminals--just hard time." (27)
Section 307 and Attorney Conduct
Section 307 of Sarbanes-Oxley instructs the SEC to adopt "minimum standards of professional conduct for attorneys." (28) Initially, the ABA expressed concern about this federal intrusion into legal ethics regulation. However, the ABA quickly moved to amend and align its Model Rules of Professional Conduct with Sarbanes-Oxley's shrinking of corporate counsel's duty of confidentiality and expansion of the duty to report illegal conduct. (29)
A month after the passage of Sarbanes-Oxley, SEC Chairman Pitt spoke to the ABA's Business Law Section and made clear the agency's regulatory goal. Pitt commented, "[r]ecent events have refocused our attention on the need for the profession to assist us in ensuring that fundamental tenets of professionalism, ethics, and integrity, work to ensure investor confidence in public companies." (30) Chairman Pitt also noted the generally poor response received by the SEC from state bar licensing agencies when referring matters for possible disciplinary proceedings. (31)
The congressional mandate of Section 307 directed the Commission to adopt rules requiring attorneys to (1) report evidence of corporate misconduct up the corporate ladder to the chief legal officer (CLO) or the chief executive officer (CEO), and (2) in the absence of an appropriate response from senior management, to report the misconduct to the audit committee of the board of directors, or a comparable committee of the board or the board of directors itself. (32) In response to this mandate, the SEC passed Rule 205.3 (b), requiring an attorney who learns of a possible material violation (33) of a securities law, a material breach of fiduciary duty, (34) or a similar material violation to report the evidence to the CLO and, if the attorney wishes, to the CEO as well. (35) Rule 205 then requires the CLO to conduct an appropriate inquiry to determine whether the material violation described in the report has occurred, is ongoing, or is about to occur. (36) Once the inquiry concludes, the CLO has a duty to advise the reporting attorney of the basis of his or her determination and, if there is a material violation, to communicate the response taken or to be taken as a result of the investigation. (37)
II. THE QLCC OPTION
The regulatory language adopted by the SEC in Rule 205 provides an important alternative to the reporting obligations outlined by Congress in Section 307. The SEC Rule encourages issuers to adopt a Qualified Legal Compliance Committee (QLCC) "as a means of effective corporate governance." (38) In its Proposing Release, the SEC received few substantive comments on the language describing the QLCC. (39) In its Adopting Release, the SEC noted, "commenters generally approved of the QLCC in concept, although several proposed changes in how it should work." (40) According to the Adopting Release, "the QLCC institutionalizes the process of reviewing reported evidence of a possible material violation. That would be a welcome development in itself. It may also produce broader synergistic benefits, such as heightening awareness of the importance of early...
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