January/February 2003 • Can The Scandals Teach Us Anything

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January/February 2003

• Can The Scandals Teach Us Anything?
The business world had leaped from the financial section to Page One. The alleged accounting fraud at
Enron was so massive that it brought down one of the nation's largest companies. Then the story
expanded to include allegations of obstruction of justice at Arthur Andersen.
• Transactions Go Global: Can Lawyers Follow?
Do all your clients just do business in your city? No? You say some ask your advice on transactions across a
state line or across an ocean? Hmmm.
• The Text Of The ABA's New Rule
Report 201B: The ABA Commission on Multijurisdictional Practice's Report to the House of Delegates.
• Documents? What Documents?
The trial and conviction of Arthur Andersen on obstruction of justice charges splashed "document
retention" concerns across the front pages of newspapers around the world.
• Squirreling It Away
How much is too much?
• Where Does The Money Come From?
American bank accounts are brimming with the proceeds of illegal narcotics trafficking. The surprising
news is that many of these bank accounts belong to well-respected American corporations that are several
degrees of separation removed from the illegal drug trade, and would never knowingly participate in illicit
activity of any kind.
• What you can do
American corporations can greatly minimize the risks of receiving narcotics proceeds in satisfaction of
legitimate receivables by exercising simple due diligence in the maintenance of their corporate bank
accounts.
• Planting Pearls In Shells
With underwriters licking their wounds and sitting out the down market, quality micro-cap companies are
increasingly taking themselves public through the "back door."
• High Drama And Hindsight
First, Enron. Then Arthur Andersen. We all look for lessons in these spectacular flame-outs.
• Some Call It eLawyering
Your fingers are still doing the walking, only now it's across a keyboard. And it looks like the legal
profession is poised to become the next big beneficiary.
• Go Global. Get Information. Now What?
Online information is big. If you doubt that, consider all of the marketing e-mails that flood your inbox and
the pop-up ads that can inundate you when you visit a Web site.

Departments:

• Snap Judgments
It's a small world-market, after all. That's the tune some e-tailers are singing as they downsize the list of
countries they do business with.
• Meeting Morsels: Wall Street Meets "Wall Street"
We've heard that infamous quote from the movie "Wall Street" a lot lately. You know the one: "Greed is
good." Well, is it? Some stockholders don't seem to think so.
• Focusing on Pro Bono: Business Law Does Pro Bono
At a time when surveys show that 80 percent of the legal needs of the poor are unmet and it appears that
lawyer participation in pro bono may be declining, our Section has a commitment that is robust and
growing..
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Volume 12, Number 3 - January/February 2003
Can The Scandals Teach Us Anything?
Enron, Ethics and Lessons for Lawyers
By Joseph E. Murphy
The business world had leaped from the financial section to Page One. The alleged
accounting fraud at Enron was so massive that it brought down one of the
nation's largest companies. Then the story expanded to include allegations of
obstruction of justice at Arthur Andersen.
Suddenly, there seemed to be an endless succession of corporate scandals:
Adelphia, Tyco, ImClone, Xerox, Rite-Aid, WorldCom.
The trend has been so extensive that it may be undermining the entire capital
market. Instead of a single storm sinking a few ships and passing on out to sea, it
appears the impact is closer to a corporate Watergate — an event that causes
fundamental rethinking of society's assumptions.
Although the cases involve a variety of industries, circumstances and laws, one
striking similarity is the level of the individuals involved. These cases do not
appear to involve the "rogue" employee off on an individual frolic. They are not
about a remote office acting outside of headquarters control, or misguided
employees who went astray because they did not know the rules. Instead, we see
high-profile corporate executives and even corporate lawyers at the center of
these cases.
In this dramatic context, what has been the role of lawyers? Has our profession
been battling misconduct, and taking heroic steps to protect companies and their
investors? For the most part, our profession has not distinguished itself. Even in
the cases where internal voices were raised in protest, usually those voices have
not been lawyers. Indeed, in some of the highest profile cases lawyers have
themselves either been accused of aiding misconduct, or have been the direct
targets of the allegations.
Ironically, this rush of bad news comes in the context of a shift in the expected
role of corporations. Increasingly, corporations and other forms of organization are
being called on to police their own operations to prevent and detect misconduct.
These efforts, called compliance and ethics programs, are becoming part of
organizational life today.
This push for corporate self-policing derives much of its force from government
initiatives. The foremost example is the Organizational Sentencing Guidelines — a
watershed event in 1991 that provided tangible incentives and established
standards for compliance programs. But, in an important sense, there is no real
alternative to this development; society simply must have organizations police
themselves.
No matter how high the penalties for violations may become, they do no good if
the company does not get the word out and take steps to bring the law to life.
Every form of criminal and civil penalty has the same fatal flaw: They only come
into play after an offense has occurred and been detected. But modern
organizations are in positions too critical to the well being of society to accept a
reactive approach.
What we see in the headlines are not just the failings of individual executives.
These cases show organizational failures: failures to assess compliance risks;
failures to reach employees with the compliance message; failures to impose
checks and balances on the exercise of corporate power. In other words, these
disasters could have and should have been prevented, or at least interdicted at a
much earlier stage.
One other common element attaches to all these cases: All of these organizations
had lawyers — both in-house and outside counsel. Within this context, we
examine this question: What ethical standards should guide lawyers who counsel
organizations?
Our starting point for this examination is the context of corporate self- policing. If
compliance programs are to be society's first line of defense against corporate
crime, what must be in these programs? This is no longer a mystery for today's
compliance professional — there are well- established standards to guide these
programs, starting with the Sentencing Guidelines and extending to such sources
as regulatory pronouncements, judicial interpretations (under the Supreme
Court's Kolstad and Ellerth decisions), as well as actual practice in companies.
Not surprisingly, there is also a growing group of people who identify with these
standards and who have adopted organizational compliance as their mission.
These include compliance and ethics officers and their subordinates, auditors,
compliance lawyers, HR managers and others with compliance-related functions.
Given the enormity and sensitivity of this task, it was only a matter of time before
ethical standards for those in the field of organizational compliance began to
emerge. The most comprehensive example was promulgated in 1999 by the
Health Care Compliance Association, an organization of 3,000 members in the
health-care compliance field.
These standards, the Code of Ethics for Health Care Compliance Professionals
(HCCA code), were developed after a review of other professions' standards,
including those of the legal profession, and adopted by HCCA's board in 1999.
The standards adopt three principles: Obligations to the public, obligations to the
employing organization, and obligations to the profession. Within this framework,
the HCCA code provides rules implementing each principle, and commentary
giving guidance on the rules. Although these standards were developed in the
health-care field, they were, in fact, written broadly enough to apply to any type
of compliance work.
We will look at more of the detail in the next section. A broader explanation of the
code is provided in Heller, Murphy and Meaney, Guide to Professional
Development in Compliance (Aspen Pub; 2001).
It is likely that other parts of the compliance world will ultimately follow this
approach. Indeed, in Australia, which has also taken a very sophisticated
approach to compliance, see Dee, "Australia Sets New Standards For Compliance
Programs," 12 ethikos 11 (Marchl/April 1999), their nationwide compliance
professionals group has already published for comment a draft code of ethics.
But even the HCCA standards are still at an early stage. And, unlike lawyers'
ethics, the state provides no enforcement power behind these standards.
Nevertheless, they provide an important perspective on what standards for those
doing compliance work should encompass.
What guidance might these standards and a compliance-oriented approach offer
the legal profession in the current surfeit of organizational misconduct? We
consider here some of the key ethical questions raised by recent cases, and what
difference the HCCA code might have made.
Who is the client? — In the corporate context, for both lawyers and compliance
professionals, the theoretical answer to the question, "who is the client" is
straightforward: It is the organization. But in the real world, those who work with
corporations deal with the individual managers and naturally tend to form
relationships and loyalties. The HCCA code recognized that the compliance role is
more than that of counselor and assistant. The compliance role also contains an
unavoidable "policing" element that calls for a more aggressive role than that of
the traditional legal counselor.
In the Enron case and perhaps in other earnings management cases, one could
fairly question whether counsel were called on to assist managers to conceal the
actual performance of the corporation from the corporation's owners, the
shareholders. Did the lawyers for these companies represent the organization, or
were they acting in reality for the individual executives? Of course, we should not
judge such important matters from press reports, but these cases do spotlight this
ethical issue.
The HCCA code directly addresses this concern, requiring that compliance
professionals "not permit loyalty to individuals in the employing organization . . .
to interfere with or supersede the duty of loyalty to the employing organization"
or the duty to uphold the law. They must also "take such steps as are necessary
to prevent misconduct by their employing organization."
Unlike lawyers' ethical codes, which draw from a history of defending individuals
against the state, compliance standards start with a recognition that large
organizations can be a source of serious harm, and that compliance professionals
are a key line of defense against such misconduct. Managers who engage in
misconduct threaten harm to the organization — and the public.
What standards apply? — While the answer to the question "who is the client"
varies primarily in emphasis between lawyers and compliance professionals, the
answer to the next question, "what standards apply" may mark a major departure
from lawyers' traditional standards.
Compliance professionals deal not just with the letter of the law, but also with a
broader concept of misconduct that includes company codes of conduct. Having a
code is one of the elements of the Sentencing Guidelines standards for compliance
programs, and is one of the most common elements in company programs. Codes
are included in:
the proposed revisions to the NYSE listing rules and similar revisions for
NASDAQ,
the recent Preliminary Report of the ABA Task Force on Corporate Responsibility,
and even, to a limited extent, in the Sarbanes-Oxley Act (required for senior
financial officers).
Yet, for these codes to be effective, they need to be respected and binding
throughout the company — in effect, they need to be treated as the "law of
the company." Should not lawyers who advise a company also respect the
client's direction that these standards bind all employees, including officers?
Can a lawyer act professionally giving advice to an officer that, while
technically legal, violates the company's code of conduct? Or should the code
be considered the highest expression of the client's wishes?
The allegations in Enron highlight this issue. When Enron's outside counsel
examined the special purpose entities that were challenged by the August
2001 Sherron Watkins letter, counsel concluded that the arrangements would
look bad if covered in a Wall Street Journal expose. Yet the advice provided
was that no further investigation was appropriate. If the code of conduct
required that the company act ethically, how could counsel accept conduct
that so blatantly failed the "newspaper test," which is a standard measure for
ethical conduct?
Should there be a duty of compliance diligence? — In general, a lawyer's
ethical duty is reactive. A client asks for legal assistance and the lawyer
responds. The compliance professional, however, must be proactive. Under
the HCCA code, this person has a duty of compliance diligence. The person
must know the applicable compliance program standards and apply them to
prevent and detect misconduct. This duty includes an obligation to report on
the status of these efforts to the highest governing authority in the
organization.
One example illustrates the significance of this standard. Compliance
programs require continuing risk assessment — looking out for potential
compliance, ethical and reputational risks. A compliance professional must be
diligent in this, looking for trends and listening to the voice of the
enforcement community.
Anyone who had been reading the Wall Street Journal well before Enron
imploded would have seen the repeated warnings from the SEC that
accounting fraud was a top priority. Yet there is no indication in such cases as
Enron or Xerox of an aggressive anti-earnings management compliance
initiative. A compliance professional acting under the HCCA standards would
have been obligated to advise senior management and the board of the need
to address this risk.
What if senior management wants to do something wrong? — A central
question in the recent spate of cases is how to deal with senior executives
who want to engage in illegal or unethical conduct. Of course, a lawyer may
not assist in illegal conduct, or advise a client on how to violate the law.
For the compliance professional operating under the HCCA standards, there is
a significant difference in emphasis. They must do much more than not assist
wrongdoing. They must clearly state their objection, and then do everything
in their power to prevent the misconduct. This is, in effect, a duty to resist
the misconduct. And this duty applies not just to criminal conduct, but to
unethical activities as well. It is also a categorical duty, not one allowing room
for interpretation.
What happens if, despite this effort, management persists in an improper
course of action? For a lawyer, there is a duty to "proceed as is reasonably
necessary in the best interest of the organization," and the lawyer "may"
escalate the matter. But even this duty is generally qualified and leaves a fair
amount of room for interpretation (See ABA Model Rule 1.13(b)). For
example, lawyers may take into consideration the scope of their
representation, whether it is likely there will be substantial injury to the
organization, and the motivation of the persons involved in the proposed
activity. Any measures must "minimize disruption of the organization."
The HCCA standards, in contrast, require escalation, and emphasize the
importance of acting to prevent the misconduct. If management persists in
wrongdoing, the compliance professional "shall" escalate the matter to the
highest governing body, as appropriate. Moreover, for more junior staff
members, the issue does not end when one's boss disagrees with the wisdom
of "raising a fuss."
Fear that the communication to the board may someday see the light of day
is not allowed to deter the communication to the board. It is, ultimately, for
the board to decide what to do — and the board can only do this when fully
informed.
Why should legal counsel, who are in position to learn of misconduct, not also
be part of this process, since the information is going to the highest
representative of the client, the board? In the Sarbanes-Oxley Act, it appears
that Congress has endorsed this view, charging the SEC with a duty to
impose through professional standards such an escalation requirement on a
company's securities lawyers.
In the reports on Enron, it appears that one lawyer did take a stand, rejecting
efforts to have him discipline a staff lawyer for resisting management
pressure in a conflict of interest context. That same lawyer even went so far
as to retain separate outside counsel to review the propriety of some of the
questionable transactions. This is the type of principled conduct that could
change the outcome in these cases, if it is also required that information
about such events be communicated up the organizational ladder to the very
top.
What are the obligations in conducting an investigation? — In Enron,
the outside law firm that was asked to conduct an investigation of the
Sherron Watkins allegations was told not to second- guess the accounting,
even though the whistleblower's allegations related to accounting, and was
limited in the transactions the firm could review. The firm did as instructed.
By contrast, the HCCA standards recognize that management is not the
organization itself and does not call all the shots. Under Rule 2.3, the
compliance professional must investigate where there is an issue. Most
striking is that compliance professionals may not accept unprofessional limits
on their investigations. Certainly the investigator must use reasonable
judgment, and must accept the resource constraints of the client. But under
HCCA Rule 3.1, anyone requested to conduct an investigation on the terms
imposed on Enron's outside counsel would be required to decline the
assignment and then explain to the board of directors why it was handled
that way.
Does the duty of confidentiality limit compliance communication? —
When the HCCA code was adopted, one lawyer raised an alarm that the
standards allowed the compliance professional to break the attorney-client
confidentiality requirement, because the HCCA standards require compliance
professionals to "report the decision [by management to violate the law] to
public officials when required by law." Aside from simply misreading the
provision (it requires disclosure only when the law requires it — no ethical
code can override a legal requirement. See ABA Model Rule 1.6(b)(4)
(permitting disclosure by lawyers "to comply with other law or a court
order")), the person also misunderstood ethical requirements for lawyers.
It simply is not correct that all discussions between lawyers and clients are
confidential. If a client asks counsel's advice on how to break the law, that is
not protected communications. Depending on the state jurisdiction and the
gravity of the client's proposed misconduct, various states either permit or
require disclosure by lawyers. If the client proposes a fraud on the court, a
similar review of state ethical standards is required.
The HCCA code respects client confidentiality, but also makes it clear that
compliance professionals cannot be muzzled internally. If the compliance
professional believes management intends to engage in misconduct, and the
professional deems it necessary to resign, the professional must advise the
board of "the precise conditions" that necessitate such drastic action. At that
point, protecting the client (or more accurately, the individual managers) by
not hitting the nail on the head is no longer a consideration; this is the last
chance to get the client to act to prevent misconduct, and that is the highest
duty of the compliance professional.
Yet even at this stage, the professional does not go outside with this
message; the communication is solely internal (unless the law requires
otherwise). Communications up the line need to be clear, they need to cover
the bad news, and the requirement for such communications needs to be free
of any ambiguity.
Congress and regulatory agencies will act. There will be increased fines, with
little thought for the consequences — the shareholders, already victimized by
management misconduct, will now have their investments further decreased
by the payment of enormous fines, followed by the inevitable class actions.
And, as history informs us — despite all the political theater — there will
certainly be new organizational scandals down the road.
There are no easy answers, but I believe we should expect more of ourselves
and our profession. Most important, we need to recognize the emergence of
compliance, or organizational control, as a field of study and practice that
needs to inform our professional standards.
As lawyers, one of our most important contributions would be to reconsider
our professional ethical standards in light of this development. The HCCA
standards offer some insight on a different way of viewing the organizational
client. We, as lawyers, should take the lead in this change, and not wait until
we are forced into changes that miss the mark.
Murphy is vice-chairman of Integrity Interactive Corp. in Haddonfield, N.J.,
and co-editor of ethikos. He was one of the drafters of the Health Care
Compliance Association's Code of Ethics for Health Care Compliance
Professionals. His e-mail is [email protected].
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Volume 12, Number 3 - January/February 2003
Transactions Go Global: Can Lawyers
Follow? Related Article:
An Update On Multijurisdictional Practice And The
The Text of the ABA's New
Unauthorized Practice Of Law
Rule
By Daniel J. McAuliffe and Teresa Voss
Do all your clients just do business in your city? No? You say some ask your
advice on transactions across a state line or across an ocean? Hmmm.
Most lawyers today engage in some form of multijurisdictional practice (MJP)
when they take depositions, document transactions or advise clients in
jurisdictions where they are not admitted.
Whether this is the unauthorized practice of law (UPL) depends on the law of the
state defining and interpreting the actions of out-of-state lawyers. To date, the
focus of the effort to develop rational MJP regulation has been on litigation
practices. But litigators are less likely to run afoul of jurisdictional limitations
because states have systemic protections such as pro hac vice admissions to
practice or requirements for associating with local counsel as a prerequisite to
court appearances.
The areas of practice most likely to be affected by UPL regulation, however, are
the transactional ones. Transactional lawyers have followed the globalization of
their clients' businesses and today's business lawyer must provide legal services
throughout the country. Transactional lawyers face the greatest challenges raised
by MJP because there are no functional equivalents of pro hac vice admissions
under the current system. They are more likely to fall into a UPL trap without so
much as a warning.
The ABA's Model Rule 5.5 of Professional Responsibility (Unauthorized Practice of
Law/Multijurisdictional Practice of Law) as adopted in Aug. 12, 2002, by the ABA
House of Delegates recognizes the current realities of transactional practice but
fails to provide corresponding guideposts for transactional lawyers concerned
about what has become a very murky area.
Historically, states had legitimate interests in regulating the practice of law that,
at best, include protecting the public and, at worst, protecting a monopoly on legal
services for local lawyers. The prior ABA Model Rule of Professional Responsibility
5.5 stated: "A lawyer shall not: (a) practice law in a jurisdiction where doing so
violates the regulation of the legal profession in that jurisdiction; or (b) assist a
person who is not a member of the bar in the performance of activity that
constitutes the unauthorized practice of law."
Most states have adopted similar provisions that require lawyers to obtain and
maintain a license to practice law. See http://www.abanet.org/ cpr/mjp-
uplrules.html, where the Lawyer's Liability Assurance Society Inc. (ALAS) has
compiled a list of unauthorized practice of law statutes and rules from 51 U.S.
jurisdictions, including the District of Columbia.
Protecting the public from unethical lawyers or persons who are illegally holding
themselves out as lawyers remain legitimate purposes in regulating the practice of
law through UPL statutes and rules. But lawyers no longer practice the law of Abe
Lincoln or even the law of Brandeis or Thurgood Marshall and the historical need
for strictly state-based jurisdictional regulation has transformed as well.
Clients are going global and most lawyers, to keep up, provide legal information
and services through e-mail, electronic documents, virtual conferencing and Web
sites available anywhere on the planet. The nature of the legal profession and the
definition of the practice of law are shifting with lightning speed but the monolithic
definitions of UPL remain unaffected by the changing world in which transactional
lawyers must now ply their trade.
Only two states, Michigan and Virginia, recognize exceptions for incidental practice
by lawyers admitted in other jurisdictions. Colorado is considering a version more
liberal in time and scope. Proposed amendments to the Colorado Rules of Civil
Procedure Rule 228 (Unauthorized Practice of Law Rules) will authorize any lawyer
not admitted in Colorado but in good standing in all jurisdictions in which the
lawyer is admitted, to practice law in Colorado unless the lawyer becomes
domiciled or opens an office in Colorado.
In the remaining state jurisdictions, the occasional or incidental transaction
practice by a lawyer admitted in another jurisdiction exposes the lawyer to
sanctions:
In New Jersey — See In the Matter of Opinion 33 of the Committee on the
Unauthorized Practice of Law, 1999 WL 511066 (N.J.) (effectively preventing
bond lawyers who are not admitted in New Jersey from advising local
governments unless representation is "within the public interest" such as where
"bond issues may be so complex, novel or may sufficiently implicate untested
legal theories and techniques that the retention by a New Jersey public entity of
an exceptionally qualified out-of-state law firm may well serve the public
interest.);
In South Carolina — See also South Carolina Appellate Court Rule 418
(Advertising and Solicitation by Unlicensed Lawyers) (Lawyers licensed in other
jurisdictions engage in UPL if they violate the Advertising and Solicitation by
Unlicensed Lawyers rule by contacting in-state residents through the Internet.).
The common and critical factor is that the vast majority of state UPL laws
prohibit lawyers from practicing in jurisdictions in which the lawyer is not
licensed.
Making the issue murkier and more vexing is the definition of MJP. There is
no single definition of an MJP transaction. It is easier to start with what it is
not, that is, where a lawyer admitted in Arizona, for example, advises and
prepares a contract for an Arizona resident from her office in Phoenix. In
other words, the applicable law, the lawyer and the client connect in the
same state.
Now consider the same lawyer with two areas of practice, commercial
contracts and Indian gaming law, to demonstrate some of the different
paradigms of MJP. (These examples are borrowed from a paper by Anthony E.
Davis, "Multijurisdictional Practice by Transactional Lawyers — Why the Sky
Really Is Falling," available at www.abanet.org/cpr/mjp-adavis.html (last
visited Nov. 27, 2002):
1. The lawyer advises an Arizona company on a contract with a California company
governed by California law from her office in Phoenix (in-state client, in-state
lawyer, out-of-state law);
2. The lawyer advises a California company on a contract governed by California
law from her office in Phoenix (out-of-state client, out-of-state law, in-state
lawyer);
3. Same facts as No. 1, but on behalf of the Arizona client, the lawyer travels to
California to negotiate with the California company (out-of-state negotiations, out-
of-state law, in-state client, in-state lawyer);
4. Same facts as No. 3, but the transaction is governed by New York law and the
lawyer conducts negotiations by e-mail and phone with the corporate counsel of the
California-based company who is located in New York (out-of-state client, out-of-
state law, cyberspace negotiations, in-state lawyer);
5. Lawyer receives a request to advise a California Indian tribe on Indian gaming
compacts and the transaction will require the lawyer to give an opinion on federal
Indian Law; as in previous examples, the lawyer can perform all of the work from
her Phoenix office and communicate by e-mail, phone and fax, but the tribe asked
the lawyer to mail copies of the opinion to tribal headquarters in Washington, D.C.
(out-of-state client, federal law, in-state lawyer).
Examples 2-5 are clearly multijurisdiction transactions. It is not clear,
however, whether these transactions implicate any state's UPL laws.
State UPL statutes and rules present problems, not just for the wholly
unlicensed, but also for lawyers licensed in other jurisdictions. Sanctions for
violations of UPL provisions — whether they occur in criminal or civil statutes
or court rules — subject lawyers to potentially serious penalties such as
criminal sanctions (about 40 jurisdictions) or contempt citations (about 26
jurisdictions). See a joint study from the ABA Standing Committee on
Lawyer's Responsibility for Client Protection and the ABA Center for
Professional Responsibility, Survey and Related Material on the Unauthorized
Practice of Law/Nonlawyer Practice (1996).
In California, for example, lawyers engaging in UPL face increased penalties
including up to one year in jail or a $1,000 fine. (On Sept. 6, 2002, the
California legislature approved SB 1459 that amended Section 6126 of the
Business and Professions Code to include UPL by lawyers admitted in other
jurisdictions.)
In addition to direct enforcement, UPL provisions may be used indirectly in
disciplinary proceedings, in disqualification motions and in legal malpractice
actions. Some jurisdictions have more than one enforcement method.
Some UPL statutes may even prevent the lawyer from collecting a fee. In
some cases, the client uses the UPL statutes as a defense to a claim for
unpaid fees. Again, this is not a concern for litigation lawyers admitted pro
hac vice in another jurisdiction, but it is particularly disconcerting for the
transactional lawyer because the states have no formal mechanism for
admitting out-of-state lawyers for legal services that do not involve
courtroom or other tribunal appearances.
In 1998, the California Supreme Court's decision in Birbrower, Montalbano,