Enron, Etc. Scandals' Impact

NEW HAMPSHIRE MAY be home to only a handful of publicly traded companies, but the state's corporate lawyers are already starting to feel the after-effects of the national corporate scandals.

The Sarbanes-Oxley Act of 2002, passed with lightning speed by Congress on July 25, enacted sweeping changes to prevent a future Enron, Worldcom or Tyco debacle. Barely two months later, in-house counsel at New Hampshire's public companies are already dealing with the Act's ramifications.

Among many other provisions, the legislation increases governmental controls over public company accounting; promulgates rules to ensure auditor independence; requires independent public company audit committees; increases corporate responsibility for financial reports; requires enhanced financial disclosures; and increases both penalties and accountability for corporate fraud. Securities and Exchange Commission (SEC) funding for 2003 was increased to $776 million to implement and enforce the Act.

Michael Tule, vice president and general counsel at the publicly traded Rock of Ages Corporation in Concord, feels that the vast majority of companies have always been very diligent to ensure accurate SEC filings, but that the Sarbanes-Oxley Act has "raised the bar."

"One of the big things that Sarbanes did is require that the CEO and CFO personally certify the accuracy, completeness and veracity of the financial statements and other disclosures," said Tule, whose company owns and operates granite quarries in New Hampshire and Vermont. "This will force CEOs and CFOs to become more deeply involved in the preparation and review of these reports. It will no longer be possible for top executives to say that they had no idea what was going on, as in the Enron case."

Steve Markiewicz, in-house counsel at PC Connection, based in Merrimack, said altered deadlines for financial disclosures are keeping corporate attorneys on their toes. Among other accelerated disclosures, the Act required that a disclosure be filed with the SEC within two days after an officer or director stock transaction. "You just have to be more alert," Markiewitz said.

Markiewicz and Tule are directly feeling the impact of the new legislation, but they are in the minority in New Hampshire. Of the handful of public companies headquartered in New Hampshire, very few actually use New Hampshire attorneys to handle their securities work.

In the long run, however, changes brought about by the Sarbanes-Oxley Act are expected to have a much broader impact. "We're going to see a cascade effect," predicts Steven Burke, chair of the Tax Department at McLane, Graf, Raulerson & Middleton. "First, the legislation will affect SEC clients and then we're going to see private companies that need audits feel the impact."

Burke feels that the heightened concerns about corporate accountability will materialize in more complicated and intense audits imposed by lenders. "Banks may reference the legislation in documents," he said.

Burke cautions that a section buried deep within the Sarbanes-Oxley Act calls for "consideration by appropriate state regulatory authorities." Section 209 of the Act directs state regulatory authorities to "make an independent determination of the proper standards applicable" in supervising non-registered public accounting firms.

"The federal legislation imposes rules on SEC clients, but the act goes one step further to promulgate standards at the state level that will affect private companies," he said. "The real impact on New Hampshire lawyers will come when legislation is enacted at the state level."

New Rules for Attorneys

As president of the NH Society for CPAs, Burke has a front-row seat to witness the accounting profession being turned upside down. The focal point of the Sarbanes-Oxley Act is the establishment of a Public Company Oversight Accounting Board to police auditors. The board is charged with registering auditors; establishing or adopting quality control, ethics, independence and other standards for auditors; conducting inspections, investigations and disciplinary proceedings; and enforcing compliance with the Sarbanes-Oxley Act.

Similar action against lawyers has yet to come, but the legislation does include a requirement that the SEC establish rules "setting forth minimum standards of professional conduct for attorneys appearing and practicing before the (SEC) in any way in the representation of public companies." SEC rules must include a requirement that attorneys report evidence of material misconduct to appropriate corporate officials. If the attorney does not receive an adequate response, counsel must report the concern to the audit committee, another independent board group, or the entire board.

Now that attorneys are charged with reporting transgressions on the part of management, some fear that corporate executives will be loath to divulge necessary information to their attorneys. The ABA opposed the Sarbanes-Oxley reporting requirement on the grounds that it would interfere with the attorney-client relationship.

"Everyone agrees that confidentiality is key. Clients have to trust us. It has been a lively debate within the Ethics Committee to determine when there is an exception to this. Some say that it is not an attorney's duty to report; others say attorneys have a moral obligation," says Rolf Goodwin, a member of the NHBA Ethics Committee who is overseeing the committee's review of the ABA Ethics 2000 overhaul of the Model Ethics Code, and an attorney at the McLane firm.

Within New Hampshire, at least, there does seem to be unanimity that the reporting requirement contained in the Sarbanes-Oxley Act does not jeopardize attorney-client confidentiality. "My client is the company. The company is not the executive officers. If I am protecting the officers, I am not discharging my duty," said Tule.

Calling the legislation a "wake-up call for lawyers," George R. Moore of Devine, Millimet & Branch said it has "heightened awareness of how easy it is to facilitate actions for the good of management and lose sight of what is good for the company."

ABA Seeks to Head off More Attorney Oversight

In a speech at the annual meeting of the Business Law Section of the ABA on Aug. 12, SEC Chair Harvey Pitt chastised attorneys for "giving assistance to corporate wrongdoers by hiding behind their ability to craft a clever phrase to circumvent what they know to be the right answer." However, he made clear that he would not relish the establishment of an Oversight Attorney Board similar to the one set up for accountants.

"One need not oppose federalizing corporate governance standards to recognize there are risks inherent in giving an agency that sometimes faces corporate lawyers as adversaries the ability to regulate whether and how they satisfy our notions of appropriate professional behavior. It's in the profession's interest to work with us to remedy deficiencies in the present system," Pitt said.

The American Bar Association (ABA) has reacted swiftly to head off government regulation. The ABA created the Task Force on Corporate Responsibility on March 28, 2002, to "allow the ABA to contribute its perspectives to the dialogue now occurring among regulators, legislators, major financial markets and other organizations focusing on legislative and regulatory reform to improve corporate responsibility."

In its preliminary report issued on July 16, 2002, the task force recommended standards for the internal corporate governance of public companies and for the boards of directors of public companies. In addition, it called for amendments to the ABA Model Rules of Professional Responsibility and improved communication by general counsel and outside counsel.

A key part of the task force's recommendations liberalizes the permissible disclosure of confidential information to include conduct that "has resulted or is reasonably certain to result in substantial injury to the financial interests or property of another." It also makes disclosure mandatory under Rule 1.6 to prevent felonies or other serious crimes, including violations of federal securities laws.

NH's Conduct Rules Allow Some Disclosure Now

In New Hampshire, these proposed changes are a bit anticlimactic. New Hampshire is one of a minority of states that already includes harm to financial interests among the grounds for permissible disclosure of confidential information. "From New Hampshire's standpoint, that debate went on in the 1980s," said L. Jonathan Ross, a member of the ABA House of Delegates and an attorney at Wiggin & Nourie.

The task force also suggested amendments to Rule 1.13 to require a lawyer to take action to prevent or rectify corporate misconduct, including referring the matter to higher corporate authority. Rule 1.13 in the New Hampshire Rules of Professional Conduct stops short of requiring that an attorney take action against corporate misconduct, stating, instead, that:

Speaking as a member of the Bar's Ethics Committee, Goodwin said "it would be crazy to predict what we're going to do." But he feels that New Hampshire is "fairly uninterested in liberalizing the rules."

There seems to be a consensus among attorneys familiar with New Hampshire's Code of Professional Conduct that many of the new rules promulgated by the ABA task force are not dramatically different from the state's present rules. However, Moore points to two rules proposed by the ABA that he feels will make a difference by providing a more direct line of communication between attorneys and corporate board members.

The first rule calls for general counsel to meet routinely with one or more independent directors to call board attention to potential violations of law by and breaches of duty to the corporation. The second rule states that outside counsel should establish a direct line of communication with general counsel to inform general counsel of violations and potential violations of law.

Corporate counsel routinely report to the CEO, Moore pointed out, and "sometimes you don't know if what you recommend even makes it to the board. There is no platform to use to voice concerns," explained Moore. "The ABA is trying to set up clear lines of communication so that concerns about legalities may be voiced."

A Ripple Effect in the Granite State

While the impact of the Sarbanes-Oxley Act and the ABA proposed rule changes may be indirect, many attorneys practicing corporate law in New Hampshire are preparing for a ripple effect as a reflection of a climate of heightened accountability. "You're going to see businesses that want to get out in front of the issue and be able to say 'that's not us'," predicts Moore.

In a best-case scenario, new codes of ethics, open lines of communication, and more stringent auditing requirements for all businesses are likely byproducts of the corporate scandals. In a worst-case scenario, New Hampshire attorneys fear the political momentum exists to legislate lawyers in the same way that Sarbanes-Oxley now provides government oversight for accountants.

"Attorneys have to recognize problems and take action to make things better before Congress just scratches out 'accountants' and puts in 'lawyers' in legislation," concludes Moore.

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