Congress, in a bold and dramatic move, has placed the SEC for the first time into the uncharted waters of federal regulation of attorneys.

Section 307 of the Sarbanes-Oxley Act, and the attendant SEC rules, firmly remind attorneys appearing and practicing before the SEC in the representation of a company that they owe their professional and ethical duties to the company as an organization and not to the corporate officers, directors, or employees that they work with and advise.

The SEC responded to the statutory mandate with a broad and detailed regulatory reporting regime covering both inside and outside corporate counsel that is designed to improve the accuracy and reliability of corporate disclosures made pursuant to the securities laws and foster investor confidence in the securities markets.

The final SEC rules impose an up-the-ladder reporting requirement when attorneys become aware of evidence of a material violation by the company or any of its officers, directors, employees, or agents. An attorney must initially report such evidence to the company's chief legal officer (CLO) or to both the CLO and chief executive officer. A reporting attorney who receives an appropriate response within a reasonable time has satisfied all obligations under the rules.

But reporting attorneys who do not receive an appropriate response within a reasonable time must report the evidence of a material violation up-the-ladder to the company's audit committee, to another committee of independent directors if the company has no audit committee, or to the full board if the company has no such committee.

QLCC: An Attractive Alternative

The SEC has provided an alternative reporting route for attorneys that companies should seriously consider adopting. It is not mandatory, but may be an attractive alternative to the up-the-ladder approach.

Companies may establish a qualified legal compliance committee (QLCC), consisting of independent board members, for the purpose of investigating reports of material violations made by attorneys. The QLCC would be authorized to recommend to the company that it adopt appropriate remedial measures to prevent ongoing, or to alleviate past, material violations, and empowered to notify the SEC of the material violation if the QLCC decides, by a majority vote, that the company has failed to take any remedial measure that the QLCC has directed the company to take.

Attorneys may satisfy entirely their reporting obligations under the rules by reporting evidence of a material violation to a QLCC. Further, a CLO to whom a report of a material violation has been made may refer the matter to a QLCC.

Obviously, the attorney reporting rules force companies to make a number of crucial decisions. One of the most important initial decisions that companies will face is whether to create a qualified legal compliance committee. The creation of such a committee will signal that the company has created an alternative route to up-the-ladder reporting.

The SEC rules require a QLCC to be composed of at least three independent directors, one of whom must also be a member of the company's audit committee. The rules also provide that the company can designate the audit or another board committee to serve as the QLCC so long as the other committee meets all of the requisite criteria for a QLCC and agrees to function as a QLCC in addition to its separate duties. Thus, the company is not required to form a QLCC as a new corporate structure unless it wishes to.

The SEC encourages companies to form QLCCs as a means of effective corporate governance. The Commission estimates that approximately 20% of public companies will choose to establish a QLCC. But some commenters think the percentage will be much higher, since establishment of a QLCC will institutionalize the process of reviewing reported evidence of a possible material violation and give companies more control over the process. In addition, many companies will utilize a QLCC because reporting evidence of a material violation to a QLCC relieves an attorney of responsibility to assess the company's response.

While the SEC does not intend for service on a QLCC to increase the liability of company directors, and indeed expressly finds that it would be inconsistent with the public interest for a court to so conclude, establishment of a QLCC will impose costs on the company that should not be ignored. For example, a QLCC must adopt written procedures for the confidential receipt, retention and consideration of any report of evidence of a material violation. Costs of a QLCC might also include increased compensation and insurance for QLCC members, and administrative costs to establish the committee.

This column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

 

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