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Sarbanes-Oxley rules create ethical minefield for lawyers

An apparent conflict between California rules governing attorney-client confidentiality and recently approved Securities and Exchange Commission rules that require lawyers to report possible violations of securities laws is creating an ethical conundrum for the state's lawyers.

Many California lawyers may not even be aware that they are subject to the new SEC rules.

Because of widespread concern and confusion, the State Bar's Committee on Professional Responsibility and Conduct (COPRAC) and the Business Law Section's Corporations Committee have issued an ethics alert that is posted at www.calbar.ca.gov/archive/calbar/pdfs/SEC-ethics-alert.pdf. Warning California lawyers who face a possible conflict between federal and state rules, the two committees urge them to take no action without careful study of "applicable federal and state legal principles" and consultation with experts in the field.

The issue originated with the Sarbanes-Oxley Act of 2002, passed in response to corporate scandals such as the Enron debacle. Congress directed the SEC to adopt rules setting minimum standards for lawyers appearing and practicing before the SEC ("appearing attorneys").

The SEC in turn adopted what became known as the Part 205 Rules that require appearing attorneys to report evidence of a material violation of the securities laws or breach of fiduciary duty to the company's chief financial officer or even the board of directors; and permit attorneys in certain circumstances to disclose confidential information relating the representation to the SEC without consent of the client-company.

The SEC also expressly said the rules pre-empt state law, the key problem for California lawyers. "The new regulations permitting limited disclosure of client confidential information to the SEC have created an ethical dilemma for California lawyers because California law prohibits disclosure," said Steven Lewis, a Sacramento lawyer and a member of COPRAC.

The principal of protecting client confidences, zealously protected in California for more than 130 years, is set forth in the Business & Professions Code and is incorporated in some of the Rules of Professional Conduct. Specifically, the duty of confidentiality requires California lawyers to "maintain inviolate the confidence, and at every peril to himself or herself to preserve the secrets, of his or her client." Last year, the Legislature carved out an exemption that permits disclosure of confidential information if the attorney believes it's necessary to prevent death or substantial bodily harm.

Attorneys also have limited recourse in the event of wrongdoing by an agent of a client corporation: they may take action "in the best lawful interests of the organization." California law recognizes that a lawyer's duties are to the organization rather than its constituents and permits them to report matters of concern up the organizational ladder.

On the other hand, the federal rules permitting disclosure of client confidences to the SEC appear to conflict with California law requiring attorneys to maintain client confidences. The committees note that the pre-emption issue has not been resolved by any court and is the subject of debate. Lewis said he expects the matter eventually to go to the Supreme Court.

Ironically, he said, the rules could create the very situation they are meant to avoid: rather than face the disclosure of confidential information, companies may avoid consulting with attorneys and wind up getting themselves in trouble with federal regulators. "The SEC's rules jeopardize effective counseling and advocacy by imposing conflicting responsibilities on a lawyer" said Keith Paul Bishop, a former Commissioner of Corporations and member of the Corporations Committee.

So far the only state to issue a formal ethics opinion about breaching client confidences is Washington, which said lawyers there must abide by state law that prohibits disclosure.

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