SPEECH OF COMMISSIONER NORMAN S. JOHNSON SUITS AGAINST LAWYERS AMERICAN BAR ASSOCIATION FEDERAL SECURITIES LAW COMMITTEE THE MAYFLOWER HOTEL WASHINGTON, D.C. NOVEMBER 8, 1996 * The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its members of employees. The views expressed herein are those of Commissioner Johnson and do not necessarily reflect the views of the Commission or its staff I. Good afternoon. First, I'd like to thank the Committee for inviting me to speak today. Over the years, I've enjoyed attending this gathering and have always been impressed by the high caliber of those who attend. I see a number of friends here -- and I am gratified at that. Of course, my remarks here are strictly my own and do not reflect those of the Commission, other Commissioners, or the Staff. I'd like to talk today about a subject of interest to all of us - Commission suits against lawyers. After accepting this invitation, I attempted to formulate a coherent, consistent methodology by which I would approach this subject. In so doing, I was reminded of the complexity and endless contradictions that are part and parcel of this area of the law. I pledged to myself that I would provide concrete guidance on how I believe the SEC should deal with the issue of suing lawyers -- principles the practitioner could hang a hat on. This has proven to be elusive and bright guidelines are hard to come by. This is an area that I have been interested in for years. In times past, I have been critical of the Commission's policies on suing lawyers and my previous history with this issue has caused me some angst -- knowing I would now have to analyze the issue from the inside looking out. I admit that I came to this job with some reluctance to name lawyers in Commission cases. I don't apologize for that. But now that I have been on the Commission for almost a year, I must concede that the agency hasn't done badly. There is a strong recognition within the agency of the implications of naming lawyers in Commission actions, and I can tell you, a lot of hand wringing goes into each and every matter presented to the Commission. But the fact that the SEC has taken a restrained approach on this issue in years past does not ensure that they will do so in the future. We are all aware that there exists a minority of lawyers whose conduct on behalf of their clients transcends that which is legitimate. Indeed, in certain rare instances, it is hard to differentiate their conduct from that of a principal. But individuals such as these are acting essentially outside of their legal roles, and their cases present fewer difficulties. It is when the lawyer is acting as a lawyer that such easy distinctions are of little assistance. One of the reasons I have always been reluctant to see attorneys sued by the Commission is because, like everyone here, I have some understanding of the unique position the securities lawyer occupies in our regulatory system. It is well recognized that the full disclosure system relies heavily on a cadre of talented, well-trained attorneys. Securities lawyers must navigate through complex statutes, rules and regulations to fulfill obligations to their clients, while at the same time performing an indefinable role in the system. It is also true that the Commission would be overwhelmed by the sheer volume of work it must handle without the assistance and cooperation of a sophisticated securities bar. As Chairman Williams stated, "we recognize the Commission would be unable to administer effectively those laws in an environment in which issuers, underwriters, and others involved in the capital raising process were not routinely served by professionals of the highest integrity and competence. An incompetent or unethical practitioner has the ability to inflict substantial damage to the Commission's processes, and thus the investing public...." Chairman Williams' statement sums up not only the reason behind why the Commission should view cases to sue lawyers carefully, but also, why we must protect the agency's processes. Because the role the attorney plays and the advice offered the client cannot help but be influenced by how the Commission addresses this issue, we must act responsibly. If we fail to achieve the right equilibrium and pursue lawyers too aggressively, we force lawyers to become "legal auditors" of their clients, the result being to drive away those who are already the least likely to seek -- but most need -- legal counsel. Further, it is periodically popular to whip the Bar, citing what are characterized as its special position and privileges. II. The Commission has separate mechanisms by which it may bring actions against a lawyer. First, the Commission may pursue lawyers injunctively in federal district court. Because of the nature of the lawyer's role in preparing and reviewing reports filed with the Commission, cases against lawyers are often brought as aiding and abetting actions in federal district court. Commentators both inside and outside the agency have expressed a preference for having an Article III judge determine whether the attorney has violated the law; the argument being that a federal court's independence affords it a greater ability to separate illegal conduct from ethical advocacy. I recognize, without speaking to them, these perceived fairness concerns. Rule 2(e), now known as Rule 102(e) under the Commission's New Rules of Practice, makes provision for disciplining attorneys who practice before the Commission. Under its provisions the Commission may deny, temporarily or permanently, the privilege of appearing or practicing as an attorney before the Commission, to any person whom it finds, after notice and an opportunity for hearing (i) does not possess the requisite qualifications to represent others, (ii) is lacking in character or integrity or has engaged in unethical or improper professional conduct, or (iii) has willfully violated or willfully aided and abetted the violation of any provision of the federal securities laws. While I believe that any action brought against a lawyer may impact their practice, either through damage to reputation or otherwise, Rule 2(e) allows the Commission to directly prohibit an attorney from practicing before the agency. Over the past 15 years, almost all Rule 2(e) proceedings against lawyers have been derivative, that is, brought to preclude an individual who has already been found to have violated the law from continued practice before the agency. Finally, the Commission can bring administrative cease and desist proceedings against lawyers. In 1990, the Securities Enforcement Remedies and Penny Stock Reform Act added provisions under which the SEC may obtain a cease and desist order against any person who violates, or would be a cause of a violation of the securities laws. The Remedies Act gave the Commission powers to pursue anyone administratively, not just regulated entities. As many of you know, the culpability level of the "causing" standard is an open question. The Commission has yet to address the issue, but several ALJ opinions have equated "causing" with a negligence standard. III. Any discussion of suing lawyers begins with Carter & Johnson, which not only sets forth the standard the Commission should use to analyze improper or unprofessional conduct, but also captured the atmosphere the practitioner should be able to operate in. Carter & Johnson enunciated the standard that the lawyer who is aware that a client is not in compliance with his disclosure obligations has a duty to attempt to effectuate compliance with the law. Moreover, Carter & Johnson incorporated a degree of flexibility into how the lawyer deals with his client, to indulge the attorney so long as he seeks to get results, and if not, he must get out. Carter & Johnson said, and I quote, "If a securities lawyer is to bring his best independent judgment to bear on a disclosure problem, he must have the freedom to make innocent -- or even, in certain cases, careless mistakes without fear of legal liability or loss of the ability to practice before the Commission. Concern about his own liability may alter the balance of his judgment in one direction as surely as an unseemly obeisance to the wishes of his client can do so in the other." My view is that Carter & Johnson viewed the practice of law as to allow even negligence, as necessary to accomplish the Commission's larger purposes. Shortly, after Carter & Johnson, then-SEC General Counsel Edward Greene expressed what later became an enduring touchstone of the Commission's policy toward suing lawyers. He stated a strong preference for pursuing lawyers, where necessary, in federal district court, and then, where applicable, institution of Rule 2(e) proceedings if the court found violations of the law. This approach, he argued, avoided the criticism that the Commission was using its administrative processes to regulate the practice of law. Mr. Greene also believed, as do others, that attorney disciplinary proceedings should be confined to those that possess a close nexus between the attorney's conduct and the Commission's processes. The Commission and the Bar enjoyed a manageable, if uneasy, truce through the '80s & early 90s. More recently, the Central Bank decision unsettled the situation somewhat. As you will recall, Central Bank cast doubt upon the Commission's ability to bring aiding and abetting cases under the antifraud provisions of the federal securities laws. Because most cases against lawyers and accountants were based on the SEC's aiding and abetting authority, it appeared to many that this would force the attorney disciplinary program "in house", entailing more cease and desist and Rule 2(e) proceedings. These fears, however, appear to have been unfounded, and the Commission did not radically change course on this issue. Just 18 months later, with the passage of the Securities Litigation Reform bill, Congress apparently restored the SEC's ability to bring secondary liability cases, including language that allowed the SEC to pursue "knowing" aiding and abetting liability. Exactly how this new authority would operate, and how it would apply to past misconduct was answered, at least partially, by the Ninth Circuit last month in SEC v. Fehn. Fehn involved an attorney who assisted in the preparation and filing of false periodic reports on behalf of an issuer. Fehn was aware that those reports failed to disclose the promoter's historic role in the company as well as potential civil liability stemming from earlier securities law violations. The Commission sued Fehn in federal district court alleging that he aided and abetted the issuer's antifraud and reporting violations. After the district court found for the Commission and granted an injunction against Fehn, Central Bank cast into doubt the agency's aiding and abetting authority. After briefing and oral argument in the Fehn case, Congress authorized the Commission to seek "knowing" aiding and abetting. Reflecting the new law, the Fehn court sustained the lower court's ruling, finding that application of the Supreme Court's retroactivity principles in no way disadvantaged Fehn since his conduct was illegal at the time of the violations, and thus upset no settled expectations. The court also found a "symmetry" between "knowing" aiding and abetting and the Commission's earlier application of that rule, and held the standards to be substantially similar, although it suggested that because of the statutory "knowing" standard, recklessness would no longer suffice. IV. My guess is that with Fehn, we will return to the status quo ante and restore the federal court as the primary forum for litigating against lawyers. I would also presume that cases where the issue of primary versus secondary liability is not clear, or where there is evidence that the attorney may have been deceived or misled in connection with a filing or opinion, will also be litigated, if at all, in federal court. Cases like these, at least to me, teeter on the outer edges of our authority to regulate in this area, and are best left in federal court. Can I tell you with certainty that the agency will not bring cases against lawyers in an administrative context. No - I can't. As I noted earlier, bright line rules are impossible to find here, and many things have changed since Ed Greene's speech of 14 years ago. One of the primary reasons the agency may not believe it has the luxury of confining itself to the federal courts is that the remarkable growth in our capital markets has stretched the agency's capabilities to the limits. In 1981, the year the Commission decided Carter and Johnson, the SEC instituted 191 enforcement actions. Last year, the number was 486. And the cases we pursue are becoming more and more sophisticated, requiring more investigation and more staff hours. Fraud artists and other confidence men have put their imaginations to work to concoct all manners of schemes to swindle unwitting investors eager to participate in the record bull market. The Commission litigates more enforcement cases than it ever has, at least partially because we are seeking sanctions with more bite. As I see things, the cease and desist approach requires the most scrutiny. The Commission should maintain its position, as set forth in Carter and Johnson, not to penalize good faith though negligent conduct -- the instance where the lawyer commits an innocent mistake, or is used to help perpetrate a fraud despite using best efforts to ascertain the truth. For that reason, I cannot be enthusiastic about our use of the cease and desist authority to bring a "causing" case against a lawyer for conduct involving professional practice. Given the nature of the lawyer's role and the Commission's restrained approach to this issue, I would hope that the cease and desist remedy would be limited to those situations where the attorney's conduct was so egregious that he could properly be deemed a principal actor. I believe that the SEC's mandate for determining who may no longer "practice" before the Commission pursuant to Rule 2(e) is a limited one, and one over which we should continue to exercise self-restraint. We have not brought an original Rule 2(e) proceeding since Carter & Johnson and I see no reason to disturb that trend. Where an attorney is found by a court to have violated the federal securities laws, I believe the Commission must make a facts and circumstances determination before it seeks to disqualify that person from continued practice before it. I remain skeptical of our ability to operate in an area traditionally reserved for state bar and other disciplinary authorities. Where we see conduct that raises difficult ethical and professional responsibility concerns, we should refer the matter to the appropriate state disciplinary body. I am aware of the criticism that state bars and other authorities are not reliable and often fail to follow up on complaints. I don't subscribe to these notions and believe that if we are persistent then these matters will be addressed. V. In a perfect world, I'd love to see this issue go away. I'd like to see a day when no lawyer is in the position where the SEC has to interpret what he has done, and what his state of mind was when he did it. In a perfect world, there would be no close calls or questionable clients. Lawyers would be given copious amounts of accurate information to work with and would not be pressed by deadlines and filing dates. This is not a perfect world. So, be practical, engage in risk management; also be the kind of lawyer you admire -- a person of integrity and high moral purpose. Wear a white hat. Represent clients zealously, but be firm with them. Make your word good as gold, when given to the staff, to the courts, or to opposing counsel. In short, be the kind of lawyer that belongs to this Committee. If a lawyer does all of this, then I will be able to enjoy a calm, peaceful tenure on the Commission -- with no dramatic changes, no shocks. I don't want any landmark lawyer cases or PLI special programs. Thank you.