New Developments in the Interaction of Sarbanes-Oxley's Standards of Professional Conduct for Attorneys and California's Ethics Rules
By Rashida Adams, a senior appellate court attorney for the Second District Court of Appeal, and member of LACBA's Professional Responsibility and Ethics Committee. The opinions expressed are her own.
After Congress passed the Sarbanes-Oxley Act (SOX) in 2002, the Securities and Exchange Commission (SEC) enacted rules imposing mandatory, internal, "up the ladder" reporting requirements on attorneys (Part 205). An attorney representing an issuer of securities must report evidence of the issuer's material violation of securities laws or material breach of fiduciary duty.1 Part 205 also permits an attorney to reveal confidential information related to the representation to the SEC, without the issuer's consent, "to the extent the attorney believes necessary" to prevent an issuer's material violation likely to cause substantial financial injury to the issuer or investors; to prevent the issuer from committing perjury or perpetrating a fraud upon the SEC; or to rectify the consequences of an issuer's material violation that caused or may cause substantial injury to the financial interest or property of the issuer or investors, "in the furtherance of which the attorney's services were used."2 Under the rules, a state may impose additional obligations on attorneys, but Part 205 is to govern in the event of conflicting state standards.3
Portions of Part 205 created an obvious tension with California ethics rules. In 2004, two California State Bar committees jointly issued an "Ethics Alert" to warn lawyers about the potential conflict.4 As the alert explained, under Business and Professions Code section 6068(e)(1), it is an attorney's duty to "maintain inviolate the confidence, and at every peril to himself or herself to preserve the secrets, of his or her client."5 This duty is reflected in Rule 3-100 of the California Rules of Professional Conduct. While Part 205 permits disclosure of confidential information to the SEC, and purports to preempt any conflicting state standards, the Alert noted "the preemption issue has not been resolved by any court and is currently the subject of much debate."
Recently, a federal district court confronted the preemption issue, in the context of a SOX retaliation claim. SOX prohibits retaliation against any employee of a publicly traded company for providing information regarding a securities fraud violation or violation of any SEC rule or regulation.6 Enter Wadler v. Bio-Rad Laboratories, Inc.7 Wadler was the former general counsel for Bio-Rad Laboratories (Bio-Rad). He alleged Bio-Rad terminated him because he was investigating the company's potential violation of the Foreign Corrupt Practices Act and because he reported his concerns "up the ladder." Wadler filed a SOX whistleblower complaint with the U.S. Department of Labor and a subsequent complaint in the federal district court.8
On the eve of trial, Bio-Rad filed a motion seeking exclusion of "virtually all" evidence Wadler might use to prove his claims. Bio-Rad contended dismissal was required because Wadler could not prove his retaliatory discharge claim without revealing the company's privileged and confidential information, in violation of Rule 3-100 and Section 6068(e). Bio-Rad invoked General Dynamics Corporation v. Superior Court9, in which the California Supreme Court held in-house counsel may pursue a retaliatory discharge claim under certain circumstances, but also warned that where such a claim "cannot…be fully established without breaching the attorney-client privilege, the suit must be dismissed in the interest of preserving the privilege."10
The Wadler court concluded neither California law regarding the attorney-client privilege nor California's ethical rules limited Wadler's ability to pursue his claims.11 The court found General Dynamics was inapplicable to a federal SOX claim; federal common law regarding the attorney-client privilege governed. Following several federal appellate decisions and the ABA Model Rules,12the court ruled Wadler could rely on privileged communications and confidential information reasonably necessary to any claim or defense in the case.13
However, in California, the duty of confidentiality is broader than the attorney-client privilege.14 Thus, the Wadler court separately concluded SOX preempts California's ethics rules to the extent they restrict disclosures otherwise authorized by Part 205. The court relied in part on title 17 section 205.1 of the Code of Federal Regulations and the SEC comment to the final rule, which specifically reaffirmed that SEC rules prevail over any conflicting or inconsistent state laws.15 The Wadler court thus reasoned the SEC rule reflects an "unambiguous intent to preempt state ethical rules that prevent attorneys from disclosing privileged information necessary to comply with Sarbanes-Oxley. To the extent that one of the methods Congress chose for achieving that objective was to afford protection from retaliation to those who comply with these reporting requirements, an ethical rule that deprives an attorney of such protection interferes with the methods by which Sarbanes-Oxley was designed to achieve its objective."
Wadler endorses Part 205's preemption of conflicting state ethics rules and highlights the comments accompanying the final SEC rule as a source of authority. Those comments regarding permissive disclosures to the SEC asserted that title 17 section 205.3(d)(2) of the Code of Federal Regulations was consistent with exceptions to the duty of confidentiality many states had adopted; as to the other states, the Commission again reaffirmed that SEC rules are to prevail over any conflicting state standards.16
Still, the 2004 Ethics Alert's recommendation of caution, with respect to an attorney's permissive reporting to the SEC under title 17 section 205.3(d)(2) of the Code of Federal Regulations, remains prudent.17 Unlike many other states, California has not adopted a rule creating an exception to the duty of confidentiality to prevent fraud or crime likely to cause financial injury. The proposed new and amended Rules of Professional Conduct currently under review by the California Supreme Court do not include such an exception.18 Further, while Wadler may be instructive, it did not involve an attorney's disclosure of confidential information to the SEC.19 As the Ethics Alert suggested: "[A]n attorney faced with seemingly conflicting obligations should not take any action without either carefully studying all of the applicable state and federal legal principles, or consulting with other attorneys who have expertise in the Part 205 Rules and California law on the duty of confidentiality."
1 17 C.F.R. §§ 205.2(i), 205.3(b).
2 17 C.F.R. § 205.3(d)(2).
3 17 C.F.R. § 205.1.
4 "The New SEC Attorney Conduct Rules v. California's Duty of Confidentiality," Ethics Hotliner (Spring 2004), available at http://ethics.calbar.ca.gov.
5 Subdivision (e)(2) provides a limited exception to the duty to prevent a criminal act the attorney reasonably believes is likely to result in an individual's death or substantial bodily harm.
6 18 U.S.C. § 1514A(a)(1).
7 Wadler v. Bio-Rad Laboratories, Inc. (N.D. Cal. Dec. 20, 2016) –F.Supp.3d--, 2016 WL 7369246.
8 18 U.S.C. § 1514A(b).
9 (1994) 7 Cal.4th 1164.
10 Id. at p. 1190.
11 Although the court first indicated it would deny Bio-Rad's motion as untimely, it still considered the merits of Bio-Rad's arguments.
12ABA Model Rule 1.6(b)(5) permits a lawyer to reveal information relating to a client representation to the extent the lawyer reasonably believes necessary to "establish a claim or defense on behalf of the lawyer in a controversy between the lawyer and the client, to establish a defense to a…civil claim against the lawyer based upon conduct in which the client was involved, or to respond to allegations in any proceeding concerning the lawyer's representation of the client[.]"
13 The court additionally ruled Bio-Rad had waived the attorney-client privilege as to a large portion of the relevant evidence.
14 See Dietz v. Meisenheimer & Herron, (2009) 177 Cal.App.4th 771, 786.
15 Implementation of Standards of Professional Conduct for Attorneys, 68 Fed. Reg. 6296-01, at p. 6297.
16 68 Fed. Reg. at p. 6311; see ABA Model Rule 1.6(b)(2), (3).
17 The Alert noted that under 17 C.F.R.§ 205.6(c), an attorney complying in good faith with Part 205 is not to be disciplined or held liable under inconsistent state standards. However, the Alert suggested an attorney must take into account the risk that a court could conclude he or she did not satisfy the good faith defense.
18 See http://ethics.calbar.ca.gov/Committees/RulesCommission2014/ProposedRules.aspx.4
19 There are numerous fundamental differences between a SOX retaliation suit and a permissive report to the SEC, including that an attorney's disclosure to the SEC under 17 C.F.R. § 205.3(d)(2) presumably may occur without the issuer's knowledge; the issuer may have no opportunity to object or otherwise be heard before the disclosure occurs. There is also no court oversight or judicial management of the disclosure. (See General Dynamics, supra, 7 Cal.4th at p. 1191.)
LACBA's Professional Responsibility and Ethics Committee welcomes new inquiries from LACBA members regarding ethical issues or concerns about professional responsibilities. The identity of the inquirer is kept confidential within the committee. The committee, however, does not publish formal opinions that are the subject of any pending litigation involving the inquirer. If you have an ethical question that you would like the committee to consider, you can mail your written inquiry to Los Angeles County Bar Association, Professional Responsibility and Ethics Committee, P.O. Box 55020, Los Angeles, CA 90055-2020, or e-mail your inquiry marked “Confidential” to Member Services at firstname.lastname@example.org.