© Copyright 2003 Latham & Watkins. All Rights Reserved. USC Institute for Corporate Counsel The SEC’s New Part 205 Regulations Brian G. Cartwright March 21, 2003

2 Part 205 Rulemaking Effective date: August 5, 2003 Noisy withdrawal proposal in comment period

3 Who’s Covered? Must be “appearing and practicing before the Commission”: Transacting business with SEC Includes any communicating with SEC Representing issuer in SEC proceeding or investigation Advising on securities law in respect of document, if have notice: Will be filed or Incorporated by reference into filed document Advising issuer regarding whether filing or incorporation by reference is required Supervising an attorney “appearing and practicing”

4 Obligation to Report Evidence of a Material Violation Attorney that becomes aware of evidence of a material violation by an issuer (or its officers, directors, employees or agents) must report such evidence to CLO (or to both the CLO and CEO) A material violation of federal or state securities laws, material breach of fiduciary duty or similar material violation of any federal or state law Credible evidence based upon which it would be unreasonable, under the circumstances, for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is occurring or is about to occur

5 CLO’s Duty to Investigate Must timely initiate such inquiry: As reasonably believes necessary to determine whether material violation has, is or is about to occur If affirmatively determines no material violation: Must advise reporting attorney of basis for determination Unless reasonably believes no material violation, must: Take all reasonable steps to cause issuer to adopt appropriate response and Advise reporting attorney thereof

6 Up the Ladder Reporting If reporting attorney doesn’t reasonably believe CLO provided appropriate response within reasonable time, must report evidence to: Audit committee or If no audit committee, another committee of board consisting solely of directors not employed by issuer or Full board of directors Can bypass CLO/CEO and go directly to committee or board, if reasonably believes would be futile

7 What is an Appropriate Response? Provides basis for attorney reasonably to believe that: No material violation has, is or is about to occur; or Issuer has adopted appropriate remedial measures and/or imposed sanctions That can be expected to stop, prevent, remedy or otherwise appropriately address violation

8 Appropriate Response, if Board Approves Investigating Attorney Reporting attorney must only reasonably believe: Board or proper committee approved retention or direction of an attorney to investigate and Issuer: Has implemented remedial recommendations of that attorney, after reasonable investigation, or Has been advised the investigating attorney may assert a colorable defense on behalf of issuer

9 Evaluating Response of Issuer CLO/CEO and/or directors must inform reporting attorney about measures taken in response to report If reporting attorney reasonably believes response is appropriate and timely: Need do nothing more If reporting attorney reasonably believes response is not appropriate and timely: Attorney must explain reasons to CLO/CEO and/or directors to whom reported

10 Alternative QLCC Procedures If have previously established Qualified Legal Compliance Committee: Attorney may report directly to QLCC Reporting attorney is finished Has no further “up the ladder” obligations Need not assess QLCC’s response Under proposals, no “noisy withdrawal” obligation CLO may refer report to QLCC If does so: QLCC then has duty to investigate and respond CLO must inform reporting attorney of referral Note: QLCC does not preclude report to CLO or investigation and response by CLO only

11 What Requirements Must QLCC Satisfy? Must consist of: At least one audit committee member, and Two or more board members not employed by issuer Existing committee (e.g., audit committee) can be QLCC (if properly composed) Must adopt written procedures for: Confidential receipt, retention and consideration of reports

12 QLCC Authority Must be established and empowered by board to: Investigate reports of evidence of material violations Retain experts Recommend (by majority vote) appropriate responses Inform the CLO, CEO and board of: Results of investigations and Appropriate remedial actions If deemed appropriate (by majority vote), notify the SEC if issuer fails in any material respect to implement an appropriate response

13 What if Hired by CLO to Investigate? Exempt from reporting obligations if: Report results of investigation to CLO and CLO reports results to board, appropriate committee or QLCC Unless both attorney and CLO reasonably believe no material violation has, is or is about to occur

14 What if Hired by CLO to Defend? Exempt from reporting obligations if: CLO provides reasonable and timely reports on progress and outcome to board, appropriate committee or QLCC

15 What if Hired by QLCC to Investigate or Defend?  Exempt from reporting obligations  No conditions

16 What if You’re a Supervisory Attorney? Must make reasonable efforts to ensure subordinate attorneys comply with Part 205 Must take over compliance when subordinate reports evidence of material violation to you You may refer to QLCC

17 What if You’re a Subordinate Attorney? Still obligated to comply with Part 205 But only requirement is to report evidence of material violation to supervisory attorney After that, subordinate attorney is finished May (not required) to report to CLO or QLCC if: Reasonably believe supervisory attorney failed to comply Note: Direct reports of CLO are not subordinate attorneys

18 Permissive Disclosure: Self-Defense In connection with any investigation or proceeding in which attorney’s compliance with Part 205 is at issue, may disclose: Any report Any response Any contemporaneous record thereof

19 Permissive Disclosure to SEC May disclose confidences to SEC if reasonably believe necessary: To prevent material violation: That is likely to cause substantial injury to financial interest or property of issuer or investors To rectify consequences of material violation: In the furtherance of which attorney’s services were used and That caused or may cause substantial injury to financial interest or property of issuer or investors In SEC investigation or proceeding, to prevent perjury or act likely to perpetrate fraud on SEC

20 Sanctions, Discipline and Liability Attorney violating Part 205 subject to: Full panoply of civil remedies for violation of federal securities laws SEC’s authority to censure or bar attorney from appearing or practicing before the SEC SEC has exclusive enforcement authority

21 No Private Right of Action, but … Rule expressly states no private right of action based on non-compliance But compare, for example: California Rule of Professional Conduct 1-100: “Nothing in these rules shall be deemed to create, augment, diminish, or eliminate any substantive legal duty of lawyers or the non-disciplinary consequences of violating such a duty.” Stanley v. Richmond, 35 Cal. App. 4 th 1070 (1995): “The scope of an attorney’s fiduciary duty may be determined as a matter of law based on the Rules of Professional Conduct … ”

22 Mandatory “Noisy Withdrawal” Proposal The trigger: No appropriate response within a reasonable time Reasonably believes material violation: Is ongoing or about to occur and Is likely to result in substantial injury to issuer’s financial interest or property or to investors

23 If Trigger Occurs (Outside Lawyer) Outside attorney would have to: Withdraw forthwith based on “professional considerations” Within one business day, notify SEC of withdrawal Disaffirm to SEC any document filed with SEC That prepared or assisted in preparing That reasonably believes is or may be materially false or misleading

24 If Trigger Occurs (Inside Lawyer) Would not be required to withdraw Within one business day, would have to notify SEC and promptly disaffirm affected documents

25 After Withdrawal Issuer’s CLO must inform any replacement attorney of withdrawal based on professional considerations

26 Permissive “Noisy Withdrawal”—Past Violations Would be permitted, but not required, to withdraw, notify SEC and disaffirm filings Rule would state such SEC notification and disaffirmation would not breach “attorney-client privilege”

27 “Noisy Withdrawal”—Alternative Outside attorney would not be required to notify SEC and disaffirm filings But issuer would be required to file Form 8-K announcing outside attorney’s withdrawal