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Why SOX 307 won’t work (again): Corporations waiving the privilege

Sometimes you do the right thing, even when you suspect it won't succeed. Or, at least, that's what I've come to thing about Sarbanes-Oxley section 307 (the legal ethics provision). It was the right thing to do, as I've argued before. Lawyers work for the corporation's board of directors, not its managers. The up-the-ladder reporting requirement thus is a blow against managerialism and a blow for director primacy. Yet, as I argue in my articles Managerialism, Legal Ethics, and Sarbanes-Oxley Section 307 and The Tournament at the Intersection of Business and Legal Ethics, the nature of legal practice, the largely unchanged relationship between lawyers and managers, and the problematic approach taken by the SEC to implementing Section 307 suggest that the new legal regime is unlikely to result in significantly better information flows within the corporate hierarchy.

One of the reasons I advanced in support of that conclusion was my belief that managers will simply bypass their lawyers. Managers who intentionally commit fraud or breaches of fiduciary duty will only rarely consult their legal counsel, of course. Instead, counsel will be consulted by a manager who is pursuing an aggressive course of conduct or one who has inadvertently strayed over the line into illegality. Unfortunately, SOX 307 likely will discourage even those contacts. Even corporate managers not engaged in actual misconduct will not welcome the investigation that an attorney’s “reporting up” would engender, especially where there is a possibility that counsel will go over their heads. Managers therefore may withhold information from counsel, so as to withhold it from the board, especially when the managers are knowingly pursuing an aggressive course of conduct. Indeed, in many of the recent corporate scandals, the misconduct was committed by a small group of senior managers who took considerable pains to conceal their actions from outside advisors such as legal counsel.

In light of this report by the WSJ (sub. req'd), I am even more convinced that managers are going to bypass their lawyers to the maximum extent possible. The Journal reports that a key government wittness at the obstruction of justice trial of former investment banker Frank Quattrone will be David Brodsky who was Credit Suisse First Boston's general counsel when Quattrone allegedly ordered underlings to destroy documents relevant to a pending SEC investigation. Brodsky will testify as to legal advice he gave Quattrone. How can he do that? What about the attorney-client privilege? As the Journal correctly points out:

Attorneys aren't themselves permitted to waive privilege. That is something that only their clients can do. At companies such as CSFB, a general counsel's client is the company itself, rather than individual employees

(It can be a more complicated when counsel has an attorney-client relationship with both the corporation and the manager, but that is relatively rare.) CSFB waived its privilege, so as to allow Brodksy to testify against Quattrone. The Journal reports that this has become something of a trend:

Companies wishing to avoid onerous charges and fines are now quick to waive attorney-client privilege and force lawyers to cooperate with prosecutors. Tyco International Ltd., the former WorldCom Inc. (now MCI) and Adelphia Communications Corp. are among many companies that have waived privilege in a bid to avert fraud charges against them.

So all of this tends to confirm my views about SOX 307. On the one hand, lawyers are potentially valuable sources of information both for boards of directors and prosecutors. On the other hand, as it sinks in with managers that what they say to the lawyers may not only be used against them in the boardroom but also in the courtroom, managers will be even more reluctant to bring their lawyers into any deal that pushes the edge of the regulatory envelope.

UPDATE: Over at Scrivener's Error CE Petit has a very good critique and extension of my post. Well worth reading. Unfortunately, blogspot is being blogspot again (see here) and the archival link isn't working. At the moment, its the top post, so just hop over and, if need be, scroll down.