Corporate lawyers would be forced to report evidence of misconduct to top executives and company boards under a Securities and Exchange Commission proposal that the commission voted yesterday to submit for public comment.
The draft rule would be the first national standard of its kind. It would require that company attorneys report wrongdoing first to the chief executive or chief legal counsel. If the executive's response is inadequate, the lawyers would have to report their concerns to the board of directors, its audit committee or another independent board group.
Lawyers who violate the requirement could be barred from practicing before the SEC under the draft rule, which is required under a new federal accounting law.
"It's a very serious sanction," said Karl Groskaufmanis, a partner at Fried, Frank, Harris, Shriver & Jacobson in Washington. "If you have the kind of practice that requires you to be before the SEC, then it's not just a slap on the wrist. It has potential of significantly impairing your ability to earn a living."
The draft rule is the result of an amendment added by Sen. John Edwards (D-N.C.) to accounting-overhaul legislation signed by President Bush in July. The law is an effort to restore confidence in financial markets shaken by accounting scandals at Enron Corp., WorldCom Inc., Xerox Corp. and other companies.
The law was passed after allegations that Enron's main law firm, Houston-based Vinson & Elkins LLP, should have demanded greater public disclosure about off-the-books partnerships that hid $1 billion in Enron losses.
The proposed rule would require the SEC to issue standards of professional conduct for lawyers who represent public companies before the SEC. A new rule must be adopted by Jan. 26, 2003.
A lawyer would have to report evidence of "material" violations of securities laws. The SEC defines a material violation as one that a reasonable investor would want to know about.
"The whole notion is, if you are the lawyer to the corporation, your loyalty is to the corporation, not to the individuals who may have hired you," said Harvey L. Pitt, the outgoing SEC chairman.
Lawyers said the details of the rule need discussion. "The statute requires attorneys who are presented with evidence of wrongdoing to report it to the general counsel," said Larry S. Gondelman, a partner with Akin Gump Strauss Hauer & Feld LLP. "What constitutes evidence?"
The proposed rule would cover lawyers whether they are employed in-house by a corporation or are retained from an outside law firm. The rule also would cover lawyers licensed or qualified to practice in foreign countries.