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The QLCC: a chance to get things right; boards should assess the safeguard features of having a qualified legal compliance committee. (Legal Brief).

This is the second in a series of articles examining the Sarbanes-Oxley Act's impact on boards. In the previous article [Fall 2002], we described how the Act has increased the responsibilities of board audit committees. In this article, we discuss rules recently proposed by the SEC to report suspected misconduct.

FOR DECADES, the Securities and Exchange Commission has admonished attorneys representing public companies to report any suspected corporate wrongdoings. However, it was not until the signing of Sarbanes-Oxley that Congress granted the Commission express authority to impose such reporting obligations on attorneys. Recently, the SEC has proposed rules to implement this authority.

The proposed rules impose an up-the-ladder reporting obligation on attorneys who become aware of information that would lead an attorney "reasonably to believe" that a material violation by the company or by any company officer, director, employee, or agent has occurred, is occurring, or is about to occur. When the reporting obligation is triggered, the attorney must report this information to the issuer's chief legal officer or to both the CLO and CEO. If a reporting attorney does not receive an appropriate response within a reasonable time, he is required to report evidence of the material violation up the ladder to the company's audit committee or full board of directors.

The proposed rules go beyond the mandate of Sarbanes-Oxley by creating an additional reporting obligation for outside counsel when climbing the ladder fails to produce a satisfactory result. Under the proposed rules, under certain circumstances attorneys would be obligated to signal their concerns externally to a higher authority: the SEC. Specifically, where outside counsel believes that the material violation is occurring or is about to occur that is likely to result in substantial injury to the financial interest or property of the company or its shareholders and that the company's directors have not responded "appropriately" to evidence of that material violation, the attorney is required to do three things: (1) withdraw from rep resenting the company "forthwith"; (2) within one business day of the withdrawal, notify the SEC of the withdrawal and state that it was based on "professional considerations"; and (3) promptly disaffirm to the SEC any submission that the attorney prepared or helped to prepare th at the attorney reasonably believes is or may be materially misleading.

No doubt anticipating sharp criticism from bar associations that it has exceeded Congress's mandate and is playing fast and loose with the sanctity of privileged attorney-client communications, the SEC also has proposed an "alternative system" to noisy withdrawals. The option exists only if the client's board of directors has elected to form a Qualified Legal Compliance Committee, which should consist of at least one member of the audit committee and two or more independent members of the board.

Under the proposed rules, where evidence of a material violation has been reported to the QLCC, it is specially responsible for taking the following steps: (1) notifying the CLO of the report; (2) conducting any necessary investigation into reported evidence of material violations; (3) determining what remedial measures are required to prevent a material violation that is ongoing or is about to occur, or to alleviate a past material violation; and (4) reporting the results of the investigation to the CLO, CEO, and full board of directors. If the company fails to take the remedial measures directed by the QLCC, each member of the committee is individually responsible for notifying the SEC of any material violation and for disaffirming any tainted submission to the SEC.

As proposed, if an attorney raises her concerns with the QLCC, she has satisfied all her obligations under the rules and is freed from the noisy withdrawal requirement. Thus, no need to embarrass a client, no risk of alienating other clients, and no pressure to decide what constitutes an "appropriate response." Accordingly, attorneys most likely will develop a preference for QLCC-equipped clients.

We expect that boards, too, will come to recognize advantages associated with forming and duly authorizing QLCCs. The QLCC can mitigate the risk of noisy withdrawals and their attendant dangers of damaging investor confidence and sparking the interest of law enforcement officials.

In essence, QLCCs might afford a company one last chance to get things right and avert scandal. Boards should assess whether instituting such a safeguard is in the best interest of the company and its investors.

Ralph Ferrara is a former SEC general counsel. He is now a partner at the law firm of Debevoise & Plimpton and head of its Washington, D.C., office. Ellen Marcus is an associate with the firm and is also based in Washington.
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Author:Ferrara, Ralph C.; Marcus, Ellen D.
Publication:Directors & Boards
Geographic Code:1USA
Date:Jan 1, 2003
Words:766
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