Introduction
My topic is the Sarbanes Oxley Act and its significance for the practicing bar, particularly lawyers in corporate practice. The new statute has already acquired the nickname SOX. I believe that SOX will be significant in all branches of business law practice and I am glad to share projections about its effects that seem to me “not unreasonable.”

“Not unreasonable” is a formula used not only by Chairman Greenspan in his financial forecasts but, as some of you recognize, but also employed in new SEC regulations concerning a corporate lawyer’s duty to “report up.”

Before considering SOX as such let me address the issue of whether SOX is Constitutionally valid as applied to lawyers. Some question to that effect was posed here recently. Hence the title of these remarks.

SOX’s Constitutionality
Some segments of the bar have wondered how the Securities and Exchange Commission could presume to regulate lawyers’ conduct. I understand there were murmurs to that effect among the WSBA Board of Governors a year ago when the board was considering an ethics opinion about SOX. There has been similar grumbling down in the California bar.1 Back East, the ABA has strongly criticized some of the proposed SEC regulations, a matter to be considered presently, but as far as I know the ABA has not challenged the Constitution-ality of SOX.

East of the Mississippi the prevailing opinion involves these propositions:

First, Section 307 of SOX authorizes the SEC to promulgate regulations addressing lawyer’s conduct. This is a standard form of delegated regulatory authority they use back there. Accordingly, if SOX itself is Constitutionally valid as applied to lawyers, then the SEC has valid authority to issue implementing regulations.

Second, SOX is a regulation of “Commerce Among the Several States,” to adopt the Constitutional language.

Some lawyers apparently think the range of federal authority is still defined by decisions such as U.S. v. E.C. Knight, decided in 1895 on the theory that “Commerce succeeds to manufacture, and is not part of it.” And some have taken comfort in more recent decisions such as that in U.S. v. Lopez, 514 U.S. 549 (1995).

But E.C. Knight has long since been superseded and Lopez involved legislation having nothing to do with commerce. In contrast, the Supreme Court has repeatedly said, most recently in a unanimous opinion by Justice Thomas, that the Commerce power “Ômay be exercised in individual cases without showing any specific effect upon interstate commerce’ if in the aggregate the economic activity in question would represent Ôa general practiceÉsubject to federal control.’” Citizens Bank v. Alafabco, Inc., 539 U.S. 52 (2003). Perhaps note also should be taken of the Commerce Clause analysis in Pierce County, Wash-ington v. Guillen, 537 U.S. 129 (2003), a case originating in a nearby precinct.

Third, this conclusion is not changed by reason of the facts that the regulations apply to lawyers and that regulation of the bar is traditionally and primarily-- and in my view, appropriately--a matter of state law. Notwithstanding the primacy of state regulation of our profession, federal law now regulates many of our activities, and indeed the activities of state judiciaries. That, after all, is the effect of the Due Process and Equal Protection Clauses of the Fourteenth Amendment.

Accordingly, what might be called the Eastern interpretation of the Com-merce Clause is likely to be given effect not only in Pierce County but in King County as well.

Abandonment of “Reporting Out”
Concerning the terms of SOX and implementing regulations, rather than their Constitutional validity, an important beginning is what the SEC, so far at least, has decided not to do. It is only considering a requirement that a lawyer for a corporation “report out” to the SEC when a company fails or refuses to follow the lawyer’s advice about supposed fraudulent or illegal activity.

In my view the withdrawal of this proposal would be wise. A “reporting out” requirement would make it harder for legal advice to be formulated, conveyed and accepted by a corporation’s management or board. Moreover, a “reporting up” requirement in my opinion will, as a practical matter, equally suffice in obtaining corporate fidelity to law.

What is Not New In SOX
Only a few provisions in SOX directly address the conduct of lawyers. Except for the “reporting up” proposal, these provisions do not involve new concepts of professional conduct. On the contrary, they are drawn from legal and ethical concepts long accepted by the bar. These concepts are embodied in Rule 1.13 of the ABA Model Rules, a decisional law counterpart of which has been adopted in Washington State. The structure and essential provisions of Rule 1.13 were originally proposed by the ABA Section of Business Law.

The concepts are as follows:
First, a lawyer for a corporation (or other organization) represents the company, not the management, not the CEO, and not the board of directors. This is basic corporation law.

Second, the lawyer’s responsibility is to act in the best interests of the corporation. This responsibility becomes active when a corporate operative undertakes or proposes a course of action that is illegal and harmful to the company. The priority of the corporation’s interest follows from the fact that the corporation is the client. See, e.g., FDIC v. O’Melveny & Meyers, 969 F.2d 744 (9th Cir. 1992).

Third, when the course of action threatens substantial injury to the corporation, the lawyer must try to interdict it. The appropriate pathway for the lawyer, if corrective response is not promptly forthcoming, is to “report up” in the company, if necessary to the board of directors, including its independent directors. See Rule 1.13(b) and (c). See also Restatement of the Law Governing Lawyers ¤96 and Comments thereto.

These provisions are essentially reiterated in the SEC regulations. The regulations employ some differences in language and these differences could be basis of legal argument when it comes down to cases. However, in terms of guidance for a lawyer’s conduct in the first instance these differences seem to me immaterial.

What is New About SOX
First, SOX imposes several new specific duties on corporate officers and directors of companies whose shares are publicly traded. Detailing these changes would require a full technical lecture in itself. The most important changes are personal duties imposed on officers concerning the accuracy of financial statements, the requirement that a corporation have an audit committee, and duties imposed on independent directors, particularly the audit committee, that require close monitoring of corporate management.

Second, as my colleague Professor Edward Rock and I predict, because of the new array of SOX legal obligations imposed on independent directors of publicly held corporations, independent directors are almost certainly going to demand legal and accounting advisers independent of the professionals regularly assisting the company. See G. Hazard and E. Rock in The Business Lawyer.

That development in turn is going to require a new dynamic between regular corporate counsel and the officers and the directors and their legal advisers with whom they interact. A further consequence will be that both inside corporate law departments and law firms in corporate practice will have to tighten their internal reporting systems so that “SOX sensitive” information flows promptly through proper channels.

Third, beyond the specific new legal obligations imposed on corporate officials, SOX generally absorbs into federal law the legal standards governing many of the activities of corporate officials and professionals who provide services to publicly traded corporations. Most of the duties imposed by SOX correspond to duties already established in state common law and corporation law.

SOX particularizes some of these duties, for example, requiring personal affirmation by top corporate management of the integrity of corporate SEC filings. This and other requirements are designed primarily as predicates for federal enforcement authority, not as changes in management’s basic responsibilities. After all, as a matter of common law and corporation law, top management is already obligated to provide truthful financial statements to shareholders and the investing public.

It is the provision for federal enforcement that is most significant. There are several possibilities for new enforcement. Most obviously, the SEC can investigate and impose sanctions on corporate legal advisers, including both in-house law department lawyers and lawyers in independent practice. Accordingly, a lawyer who confronts a gross violation of environmental law or employment law, but ignores it, could be subject to SEC administrative sanctions if the violations have material effect on the company’s financial situation.

As a practical matter, up to now it has been unusual for lawyers in corporate practice to be accountable to anyone except their clients. The bar disciplinary authorities and ordinary law enforcement only rarely have investigated or intervened in the corporate law domain. However, if the SEC continues to receive substantial funding for enforcement, there is real prospect that lawyers will be among the targets of attention. Perhaps needless to say, undergoing a federal investigation is a serious professional disaster, even for a lawyer who is ultimately exonerated.

Another enforcement effect is that the obligations imposed by SOX will be absorbed into state corporation law and the law of professional malpractice. State corporation law requires corporate officers and directors to act in good faith and to be reasonably attentive to their responsibilities. See American Law Institute, “Principles of Corporate Governance.”

These duties, in turn, require corporate officers and directors to heed legal obligations of office. SOX prescribes a new set of those obligations. Therefore, disregard of SOX obligations at some level of consciousness is a breach of underlying state law obligations. Judges in the Delaware Chancery Court have already recognized this connection. See G. Hazard and E. Rock, supra. Members of the plaintiff corporate bar no doubt will also recognize this possibility.

There can be a related effect on the law of professional malpractice. It is malpractice for a lawyer to fail to warn a client about serious legal risks that are within the scope of the representation and which the lawyer is aware of. See generally, R. Mallen and J. Smith, Legal Malpractice, (4th ed. 2003). Just as SOX changes the legal basis of the responsibilities of corporate officials, it has corresponding effect on the responsibilities of those who advise corporate officials.

“Migration” of SOX Legal Standards
A still further effect of the SOX legal standards can be reasonably foreseen. This is the absorption of SOX requirements into state corporation law governing corporations that are not publicly traded and hence are outside the purview of the SEC.

Most corporations are medium or small-scale entities, local or family enterprises or essentially incorporated proprietorships. They are not regulated by the SEC and they are not incorporated in Delaware. Under existing state law they are not required to have an audit committee, not required to have independent directors, not required to comply with SOX.

However, legal rules do not necessarily remain confined in the channels into which they were originally introduced. The repudiation in the famous case of McPherson v. Buick of the “privity” rule in products liability, for example, has migrated to the law of liability for professional and informational services. See Greycas, Inc. v. Proud, 826 F.2d 1560 (7th Cir. 1987). By way of another example, the definition of misrepresentation formulated in SEC 10(b)(5) is that misrepresentation includes not only bare falsehoods but statements that are “misleading considered as a whole.” That standard is similarly migrating into the law governing lawyers. See, e.g., Petrillo v. Bachenberg, 655 A.2d 1354 (N.J. 1995).

A similar migration is foreseeable of the legal standards of corporate governance prescribed in SOX. Can we not imagine a disgruntled shareholder in a family corporation demanding that the CEO, his cousin, formally affirm the accuracy of the company’s financial reports? Or that independent directors be appointed to the company board? Of course, there is little or no basis for such demands under the law as it stands. But what if under SOX these become recognized standards of large corporation practice?

“Reporting Up”
One step in the migration from SOX to a broader legal domain has already been taken. In August 2003 the ABA approved amendments in Rule 1.13 to give greater emphasis to the lawyer’s duty to take action, including going “up the ladder,” upon discovery of serious illegal activity inside a corporate client.2 A lawyer’s legal duty to take protective action, including referral to higher corporate authority, is already established law. See FDIC v. Clark, 978 F.2d 1541 (10th Cir. 1992); In re American Continental Corp., 794 F.Supp. 1424 (D. Ariz. 1992). The ethical precept in Rule 1.13 has been accepted in all U.S. jurisdictions for about twenty years.

However, the ABA Task Force responding to Sarbanes Oxley, the so-called Cheek committee, recognized that the original Comments to Rule 1.13 stressed caution against inappropriate response on the lawyer’s part rather than attention and action. The revised comments change the emphasis.

In this connection, I admonish all partner level lawyers in corporate practice to make sure channels are open for younger lawyers to bring up SOX-responsive concerns. Much of the bar’s anxiety about “reporting up” and “reporting out” reflects concern that young lawyers will think they have a personal responsibility to take action directly to the client. In my opinion, if a law department or law firm has functioning internal channels for transmission of SOX concerns, resort to those channels fulfills a junior’s responsibilities. The transmission puts the problem in proper hands, those of the senior level partner. See Rule 5.2

Conclusion
The new emphasis on “reporting up” is probably the most significant effect of the Sarbanes Oxley legislation. “Reporting up” within a company does not breach the lawyer’s duty of confidentiality to the company, because it keeps the information within the company. It does not require a lawyer to “squeal” on a client, because the client is not corporate officialdom but rather the corporation as an entity. It does not make the lawyer into a policeman, except perhaps as a protector of the client’s well-being.

In my observation, “reporting up” rather than “reporting out” does the necessary work. No corporate executive wants to have an argument with a corporate lawyer in front of independent directors on a question of corporate legality.

However, the new emphasis on “reporting up” does require the lawyer to be mindful that corporate operatives can be more interested in their own well-being than that of the company. It may require a lawyer to exercise not only professional judgment but professional courage. At the same time, it emphasizes the responsibility of higher corporate management and the board of directors to be attentive and responsive to advice from company lawyers.

That is the way it should be.