Testimony of Richard W. Painter
May 13, 1998
To: Ethics 2000 Commission
From: Richard W. Painter
I write to recommend that Model Rule 1.13 be amended to require that a lawyer representing an organization report an illegal act that is likely to be committed by the organization or one of its agents to the board or directors, the trustees or other highest authority authorized to act on behalf of the organization, if the appropriate authority within the organization has been informed of the pending illegal act and has failed to take preventative measures.
Specifically, MR 1.13 should be amended to state (proposed new language in italics):
(a) A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents.
(b) If a lawyer for an organization knows that an officer, employee or other person associated with the organization is engaged in action, intends to act or refuses to act in a matter related to the representation that is a violation of a legal obligation to the organization, or a violation of law which reasonably might be imputed to the organization, and is likely to result in substantial injury to the organization, the lawyer shall proceed as is reasonably necessary in the best interest of the organization. In determining how to proceed, the lawyer shall give due consideration to the seriousness of the violation and its consequences, the scope and nature of the lawyer's representation, the responsibility in the organization and the apparent motivation of the person involved, the policies of the organization concerning such matters and any other relevant considerations. Any measures taken shall be designed to minimize disruption of the organization and the risk of revealing information relating to the representation to persons outside the organization. Such measures may include among others:
(1) asking reconsideration of the matter;
(2) advising that a separate legal opinion on the matter be sought for presentation to appropriate authority in the organization; and
(3) referring the matter to higher authority in the organization.
If these and other measures taken by the lawyer fail to prevent an imminent illegal act, or fail to end an ongoing violation of the law, the lawyer shall refer the matter to the highest authority that can act on behalf of the organization with respect to the matter as determined by applicable law and the organization's charter or articles of incorporation.
(c) If, despite the lawyer's efforts in accordance with paragraph (b), the highest authority that can act on behalf of the organization insists upon action, or a refusal to act, that is clearly a violation of law and is likely to result in substantial injury to the organization, the lawyer may resign in accordance with Rule 1.16.
ABA Ethics 2000 Commission
May 14, 1998
A memorandum in support of this proposed amendment is attached. I request an opportunity to testify at the hearing scheduled for Friday, May 29, 1998.
Very truly yours,
Richard W. Painter
Visiting Associate Professor of Law
(Associate Professor, University of Illinois)
(607) 255-1427
Memorandum in Support of Proposal to Amend Model Rule 1.13
The business and affairs of a corporation are managed by or under the board of directors unless otherwise stated in the certificate of incorporation. Del. Gen. Corp. Law, Section 141(a); ABA Revised Model Business Corporation Act, Section 8.01(b). Directors can be held personally liable to the corporation for failing to prevent illegal conduct by the corporation's agents. See In Re Caremark International Inc, Derivatives Litigation, 698 A.2d 959 (Del. Ch. 1996). Furthermore, under the federal sentencing guidelines, the corporation's penalty could be mitigated if the directors and the corporation have taken effective steps to prevent violations of the law. U.S. Sentencing Commission Sentencing Guidelines Manual, Chapter 8, Introductory Commentary (1993). See also Cynthia A. Williams, Corporate Compliance with the Law in the Era of Efficiency, 76 N.C. L. Rev. __ (April 1998).
Given the potential personal liability of directors and officers for a corporation's illegal acts, as well as the harm to the corporation that could be avoided if preventative or remedial measures are taken, a lawyer representing a corporation should inform the corporation's directors or senior officers about any illegal acts for which the corporation could be held responsible. The lawyer furthermore should be required to make such a report to the corporation's full board of directors if the illegal conduct is prospective and the lawyer has informed the appropriate person within the organization, and that person has failed to take appropriate preventative measures. The lawyer's report to the full board should be excused only if the corporation's articles of incorporation, to the extent permitted by state corporate law, have delegated ultimate responsibility for managing the corporation, or specifically for preventing illegal conduct, to a body or person other than the board of directors, in which case the lawyer's report should be made to that person or body. See Del. Gen. Corp. Law Section 141(a) (providing that the certificate of incorporation may opt out of management by or under the board of directors) and Section 351 (providing that the certificate for a close corporation my opt for management by stockholders rather than by directors); ABA Revised Model Business Corporation Act Section 8.01 (providing that the articles of incorporation may opt out of management by or under the board of directors), and Section 7.32 (providing that an agreement among all shareholders may eliminate or restrict the power of the board of directors); Richard W. Painter and Jennifer E. Duggan, Lawyer Disclosure of Corporate Fraud: Establishing a Firm Foundation, 50 SMU L. Rev. 225, 267-68 (1996) (in rare circumstances it might be in a corporation's interest that the full board of directors not be told about illegal acts by the corporation or its agents).
The foregoing course of conduct by a corporation's lawyer arguably is already mandated by principles of corporate law, which make it clear that a corporation's board of directors is the ultimate authority empowered to act on behalf of the corporation, coupled with Model Rule 1.4 (requiring a lawyer to "keep a client reasonably informed about the status of a matter" and requiring a lawyer to explain a matter "to the extent reasonably necessary to permit the client to make informed decisions regarding the representation.") Indeed, informing a client about the client's past or future violations of the law goes to the heart of the purpose of legal representation.
Nonetheless, the ABA Working Group reporting after the Kaye, Scholer matter on the duties of lawyers representing regulated clients took the position that a lawyer need not report illegal acts to a corporate client's board of directors. See Working Group on Lawyers' Representation of Regulated Clients, American Bar Ass'n, Report to the House of Delegates 2 (1993). The Working Group stated that among the Office of Thrift Supervision's "novel theories of professional responsibility" in the Kaye, Scholer case was the notion that lawyers have an obligation to report misconduct to superiors, going "all the way to the client's board of directors." Id. at 6-7. The Working Group's position on this issue is particularly troublesome in view of the Working Group's narrow overall view of a lawyer's responsibilities concerning illegal conduct.
Such a limited role for a corporation's lawyer is not in keeping with the profession's responsibility to uphold the law, and perhaps most important, is not in the interest of the corporate client. Model Rule 1.13 already makes it clear that the lawyer is required to proceed in the best interests of the organization, not the interest of the corporate officers who may be responsible for an illegal act. However, in view of the fact that it is almost never in the corporation's interest that the full board of directors not be informed about illegal conduct, Model Rule 1.13 should be amended to make the lawyer's responsibility in this respect more specific.
Finally, a requirement that a lawyer for a corporation or other organization report illegal acts to the full board of directors should reduce the number of instances in which lawyers are held responsible for clients' illegal acts by federal regulators. See In re Carter & Johnson, Exchange Act Release No. 17,597 [1981 Transfer Binder] Fed. Sec. L. Rep. (CCH) P 82,847, at 84,172 (Feb. 28, 1981). In Carter and Johnson the lawyers for National Telephone failed to inform the corporation's outside directors about ongoing securities violations for over a year. Although remedial steps were taken as soon as the outside directors were so informed, it was too late; the company failed and the Securities Exchange Commission commenced an administrative proceeding against the two lawyers. If Carter and Johnson had been required to report National Telephone's violations of the securities laws to the full board as soon as it became clear that senior management was not going to obey the law, not only might the company had been saved, but the confrontation between the bar and the Commission that followed the Commission's administrative proceeding could have been avoided. Similar cases have arisen in subsequent years, almost all of which involved conduct that could have been avoided or mitigated if a report of illegal acts had been made by a lawyer to his client's full board of directors rather than only to senior management. See In re Gutfreund, Exchange Act Release No. 31,554, [1992 Transfer Binder] Fed. Sec. L. Rep. (CCH) P 85,067, at 83,599 (Dec. 3, 1992); In Re Fishbein, OTS AP-92-19, 1992 WL 560939 (O.T.S.) (Mar. 1, 1992).
Conclusion
Model Rule 1.13 should be amended to require that a lawyer representing an organization report a pending illegal act that is likely to be committed by the organization or one of its agents to the board or directors, the trustees or other highest authority authorized to act on behalf of the organization, once the appropriate authority within the organization has been informed of the illegal act and has failed to take preventative measures. Such a rule would help protect corporate clients from the adverse consequences of illegal conduct and would provide corporate directors with the information they need to protect themselves from personal liability. Such a rule would also make it far less likely that lawyers would be accused by federal regulators of giving assistance to illegal conduct. Perhaps most important, the rule would provide specific guidelines as to how lawyers can, when confronted with pending illegal acts, uphold both the law and their clients' interests at the same time.
Respectfully submitted,
Richard W. Painter
Associate Professor
University of Illinois College of Law