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Friday, November 5, 2010

SEC Whistleblower Proposal Makes Lawyers Designated Scapegoats

Beware of Greeks bearing gifts, or a mousetrap holding cheese.

The Securities and Exchange Commission came out Wednesday with a proposal (PDF document) for rules to incentivize "eligible whistleblowers" to come forward with "original information" and report suspected violations of the federal securities laws.  The proposal is prompted by the recently-enacted Dodd-Frank Wall Street Reform and Consumer Protection Act.  Dodd-Frank requires the SEC to reward whistleblowers and penalize companies from retaliating against whistleblowers.
The proposal excludes lawyers, auditors and others in "those groups with established professional obligations that play a critical role in achieving compliance with the federal securities laws." (Go to the introduction on page 5, and the later discussion of proposed Rule 21F-4(b)(4) on page 19.)   The idea is that these people -- particularly lawyers -- would come into contact with information about securities violations through their involvement in a confidential attorney-client relationship.

The proposal -- specifically the proposed Rule 21F-4(b)(4) -- is flawed.  It puts these classes of professionals -- attorneys and auditors in particular -- at risk of ultimately being held liable (civilly or criminally) for the noncompliance or deliberate violations by other people. 

The premise of the 21F-4(b)(4) exclusion is that the attorney's and auditor's job is to ensure compliance with the federal securities laws.  The problem is that the drafters of this rule have not envisioned the scenario of the deliberate miscreant client, who not only is inclined to deceive, defraud and lie to his attorneys and auditors, but also to try to use their services to commit, conceal or continue a securities violation.  

Attorneys and auditors have many responsibilities.  The SEC proposal continues the troubling premise that attorneys and accountants are not just supposed to advise and watch for compliance, but to ensure -- in fact, to guarantee -- compliance. This becomes a problem when there is a client who is incorrigible, or when others "up the ladder" to whom the problem is reported decide to ignore it. In those scenarios, attorneys and auditors are professionally precluded from revealing certain violations. For example, lawyers face disbarment for revealing a client confidence unless they can prove a crime or fraud is ongoing and have the fortitude to wait years for their suspicion to be validated.  Under the SEC's view, such professionals are frozen in place, without the freedoms to report suspected violations which everyone else has, including many nonprofessionals whose motives will be less than pure.  But it get worse.   Attorneys and auditors are the government's designated scapegoats. 

Since the Enron fraud, there have been attorneys and auditors who have been threatened with debarment from SEC practice, and even with civiil lawsuits and criminal prosecution, for allegedly failing to meet a strict liability standard, that is, for failing to prevent their client's alleged violation.  The responsibility of not violating the law should be that of the client -- the actual violator.   The responsibility should never be allowed to be shifted to non-culpable parties tasked with an impossible, thankless job. 

The SEC's proposed Rule 21F-4(b)(4) is the latest demonstration of the SEC's contempt for attorneys and auditors as the designated wrongdoers.  Under this misguided world view, attorneys and auditors are supposed to "do their job" (however that is defined in SEC-land by someone who may well be "making it up as they go along"), keep quiet about client confidences, seek no rewards, and then be willing to be subject to being the designated scapegoats for plaintiffs, regulators and prosecutors who want someone to blame and are looking for the most vulnerable and easiest targets to pursue and pressure.

In such an environment, who would want to be a lawyer or auditor and face this immense downside, while being specifically excluded from any reward -- if there ever is any real reward for being a whistleblower?  The conspiracy theorist might think that this is the exact purpose: to drive out of the legal and auditing professions those people who are precisely the most able, and inclined, to detect, deter and report wrongdoing (subject to the applicable limitations of the attorney-client privilege).  Maybe Jesse Ventura (former Minnesota governor turned TV host of a TruTV network show actually called "Conspiracy Theory" might be interested in this.

Why is the SEC seeking to exclude -- and through such exclusion effect a punishment upon -- members of the two professions whose members may possess the skills, acumen and instincts to detect problems, irregularities, fraud or outright criminality?

Is it the smartest philosophy for our government agencies, tasked with policing our financial markets, to simultaneously (and unjustly) impose virtual strict liability compliance burdens on attorneys and accountants while then expecting these people to continue to be altruistic?  Is this good policy?  Or is it just another mistake by the SEC? 
Eric Dixon is a New York small business lawyer and 1994 graduate of Yale Law School.  Mr. Dixon is the president of Eric Dixon LLC.  Mr. Dixon offers world-class strategic analysis, business and investigative due diligence and negotiation, mediation and settlement services to businesses and individuals and political campaigns.  Mr. Dixon has an extensive background in the American federal securities laws, complex business transactions, compliance and related issues involving government investigations and internal investigations.  Mr. Dixon is available for comment or consultation at 917-696-2442 and by e-mail at

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