RESEARCH Business Industry
EXECUTIVE FRAUD
Lawyer's campaign pays off in new rules to fight corporate misdeeds

Mark Reutter, Business Editor
(217) 333-0568; mreutter@uiuc.edu

9/1/02

CHAMPAIGN, Ill. — A six-year campaign by a law professor at the University of Illinois at Urbana-Champaign to hold lawyers accountable for preventing executive wrongdoing has ended in tough new federal requirements.

"It's a whole new ballgame," said Richard W. Painter of the Sarbanes-Oxley Act passed in July. Painter cites three changes in attorney relations with corporate clients as a result of the legislation.

"Before this bill, federal securities law did not require a lawyer to report corporate wrongdoing to anybody or to do anything about corporate fraud," Painter said. "Now a report must be made to senior management and, if senior management won’t do anything, to the board of directors."

Second, the law requires a lawyer to report not only material evidence of a securities law violation, but any breach of fiduciary duty. "The latter requirement extends beyond violation of criminal statues to such issues as officers being careless in making acquisitions and other breaches of duty to their stockholders," Painter said. "It opens up the potential of litigation directed at lawyers."

Finally, the law brings the profession under nationwide regulation by the Securities and Exchange Commission (SEC). Previously, attorneys have been governed by the laws of the states where they practice, which in turn were based on the model rules set by the American Bar Association.

Painter has long been critical of the ABA’s model rules because they did not require a lawyer to take any specific course of action when fraud or misconduct by a corporate client was discovered.

In a 1996 law review article, he called for "a clear set of rules stating exactly what lawyers must do about client fraud." He said he had been alarmed by the savings and loans scandals, which revealed improper acts and conflicts of interest by lawyers representing S&Ls.

In 1998, he proposed a change to the model rules calling on lawyers to report any evidence of misconduct to senior executives at the company they represented. If the executives did not respond properly, lawyers were obligated to take the matter to the board of directors.

The ABA rejected the proposal. "They were circling the wagons," he said. After the Enron debacle, which again implicated lawyers in suspect transactions, Painter wrote Harvey Pitt, the SEC chairman. He asked Pitt to impose stricter regulatory rules on lawyers. His letter was signed by 40 other law professors.

The ABA objected to the proposal, and the SEC's general counsel argued that "changes to the rules governing lawyers should be the result of congressional changes to the securities laws." The correspondence was then passed on to legislators on Capitol Hill, the result being the sweeping version of lawyer accountability incorporated in the new law.

"Sarbanes-Oxley shows what little clout the ABA currently has on Capitol Hill," Painter said. While he would have preferred a system that fell within the current state codes of ethical conduct, the Illinois professor said the new bill is well-crafted and should help safeguard stockholders.