RESEARCH Business Industry
CORPORATE GOVERNANCE
SEC should broaden ethics rules for corporate lawyers, scholar says

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

10/1/02

CHAMPAIGN, Ill. — A review of ethics rules for corporate lawyers should be undertaken by the Securities and Exchange Commission as part of its mandate to reform corporate practice, writes a securities law expert at the University of Illinois at Urbana-Champaign.

Richard W. Painter, a professor of law, urged the agency to take a broad view of "minimum standards governing a wide range of problems that can arise" when it drafts the rules for corporate lawyers that are now required under Section 307 of the Sarbanes-Oxley Corporate Responsibility Act.

Section 307 is based in large part on Painter’s proposal, first made last spring to the SEC and then to Congress, that lawyers be required to report securities law violations to client boards of directors.

In a letter to the SEC, Painter called on the agency to adopt several rules, including:

An evidentiary threshold under which a lawyer’s reporting obligation would kick in when there is "a substantial likelihood" of a securities-law violation.

A definition of the extent to which the reported violation must be corrected by senior executives for the lawyer not to be required to go to the full board of directors, and the extent to which the lawyer is obligated to determine that the violation has been corrected.

A time period within which a lawyer must report a violation not handled properly by senior executives to the board of directors.

Restrictions on senior executives from trying "to game the system" by hiring their own lawyers to do legal work previously done by a company’s law firm or in-house counsel.

Specific rules of professional responsibility for lawyers representing participants in securities transactions besides issuers, such as underwriters, accountants and broker-dealers.

In addition, Painter said the SEC should review contingency fees and other incentive arrangements (such as receipt of company stock) in place of hourly billings for legal work. He cited a case in 2000 in which a prominent New York City firm, Cravath, Swaine & Moore, was reported to have agreed not to bill Time Warner for its partners’ legal work for the company if the proposed Time Warner merger with AOL was not completed, but would get a contingency fee of $35 million if the merger went through.

While not criticizing Cravath in particular, Painter said arrangements of this sort can encourage lawyers to look the other way when a transaction involves improper disclosure or other securities law violations. "A lawyer’s job is to stop a transaction if the securities laws are not being complied
with – for example, if there is not adequate disclosure to shareholders. A contingency fee encourages lawyers to ally themselves with management rather than objectively review a transaction. Accountants are not allowed to be paid on contingency, and, I believe, lawyers should not, either."

The SEC has until January 2003 to draw up new rules for securities lawyers. Painter’s letter was written to Mike Eisenberg, SEC deputy general counsel.