Should SEC hold securities lawyers accountable for bad advice?

Allison Herren Lee, in a speech delivered Friday to the Practicing Law Institute, said numerous recent professional lapses by corporate lawyers conducting business before the SEC has convinced her existing oversight is inadequate. How and when the agency pursues enforcement actions against chief compliance officers (CCOs) could be a model for how new standards for securities lawyers might be established and enforced.

“The bottom line is this: When corporate lawyers give bad advice, the consequences befall not just their clients but the investing public and capital markets more broadly—especially when it comes to disclosure advice,” she said.

Lee said her particular issue is with so-called “can-do” legal advice, in which a corporate attorney withholds or even distorts available facts to provide management the answers it wants. Under Sarbanes-Oxley (SOX), securities lawyers are obligated to act as gatekeepers, she argued. Their first responsibility in dispensing legal advice should be to the company and its shareholders, not the executives who hired them.

The Sarbanes-Oxley Act, in Section 307, ordered the SEC to establish rules for lawyers who practice before the Commission. The section also mandated the agency to prescribe “minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of issuers.”

But the SEC has not yet established minimum standards for professional conduct. It has only put forward one rule in response to SOX Section 307: The so-called “up-the-ladder rule” that requires lawyers to report certain violations up the chain of management inside a corporate client.

“We did not adopt a broader set of rules as Congress directed, and quite significantly, even this single standard has not been enforced in the nearly 20 years since it was adopted,” Lee said.

She went on to argue, “It’s time to revisit this unfulfilled mandate and consider whether the SEC should adopt (and enforce) a minimum set of standards for lawyers who practice before the Commission to better protect investors and markets.”

Lee suggested the SEC do so by enforcing an existing rule within its own rules of practice. Rule 102(e) allows the Commission to “suspend or bar attorneys when their behavior falls below ‘generally recognized norms of professional conduct.’” In practice, the SEC has applied this law as an added-on punishment for lawyers whose conduct violates securities law, Lee said.

“The time is ripe to return to this unfinished business,” she said.

Elevation or disruption?

When SOX became law in 2002, the American Bar Association (ABA) argued vehemently against the establishment of a set of standards like Lee described in her speech.

“[S]ubjecting lawyers to discipline by the SEC for negligence would have a chilling effect on the ability of lawyers to represent their client’s interests zealously and independently,” wrote then-ABA President Alfred Carlton Jr. in a 2002 letter to the agency.

Lee said she understands the “complexity and sensitivity inherent in this area” but used the example of how the SEC disciplines CCOs to demonstrate how the agency could balance the ability of professionals to do their jobs with its desire to hold accountable those who violate securities law.

“I am confident that, with the benefit of robust public engagement, the Commission is well-situated to craft rules designed to elevate—not disrupt—attorney conduct as it relates to the representation of issuers,” she wrote in a footnote to the speech.

Organizations representing the compliance profession have argued vigorously the SEC’s enforcement actions against CCOs could force practitioners to leave the profession and discourage new recruits.

In June, the New York City Bar Association created a framework for the SEC that set a so-called recklessness standard for the agency to consider when determining whether to charge a CCO for securities law violations that occur at his or her financial services firm. The framework homed in on charging decisions made for actions that do not result from fraud or obstruction on the part of the CCO.

The National Society of Compliance Professionals (NSCP), a nonprofit group representing more than 2,000 compliance professionals in the financial services industry, said in January many of its members are worried a firm’s lack of resources and weak compliance culture can undercut a CCO’s effectiveness. Those factors shouldn’t make a CCO liable for the wrongdoing of others, the NSCP members believe.

The NSCP issued a framework of its own urging regulators to consider CCO liability more holistically, in the context of the compliance culture within a CCO’s firm.

Lee argued in her speech standards for securities lawyers should include greater detail regarding a lawyer’s obligation to a corporate client, advice on materiality, and requirements of competence and expertise.

Once the standards are set, the SEC could apply continuing education requirements for securities lawyers, much like the Public Company Accounting Oversight Board has done for auditors, she said. The SEC could also require law firms that work in securities law have a system of quality control at the firm level, which again would be similar to those used by audit firms at public companies.

“Other topics that could be addressed in a set of minimum standards could include the need for independence in rendering advice, the obligation to investigate red flags and ensure an accurate factual predicate for legal opinions, and the retention of sufficient contemporaneous records to support the reasonableness of any legal advice, including whether appropriate expertise was brought to bear,” she said.