Rule is readied on duties of lawyer
Bar groups oppose requirement for `noisy withdrawal'
chicagotribune.com
By Greg Burns
Tribune senior correspondent
February 1, 2004
Corporate lawyer Carter Emerson of Chicago's Kirkland & Ellis knew it was illegal, but after his client went ahead with it, he stuck around anyway.
He told the top executives of Spiegel Inc. they were breaking the law by refusing to file their annual report with the Securities and Exchange Commission.
Spiegel's bosses decided to stall, covering up a warning from their auditor that the company was heading for insolvency.
So Emerson filled out the forms to postpone the required filing and the company kept the public in the dark about the auditor's bombshell.
Ten months went by until Spiegel finally collapsed on its way into bankruptcy last year, according to a 213-page report prepared by the retailer's court-appointed examiner.
Emerson did nothing wrong, his law firm maintains, saying the filing of extensions with the SEC in no way assisted the company in breaking the law. Spiegel has partially settled SEC fraud charges connected to the case without admitting or denying wrongdoing.
Yet Kirkland's conduct is fueling a push for new regulation governing America's corporate lawyers.
Over objections from much of the legal profession, the SEC is preparing to approve a new rule this spring requiring attorneys like Emerson to blow the whistle when confronted with wrongdoing, sources close to the commission say.
The two-part rule, likely to be adopted as soon as March or April, would put the burden on corporate directors to disclose to the SEC when a lawyer withdraws because of illicit activity. If the board fails to act, the lawyer would be required to step away from the client and report the wrongdoing--a measure known as a "noisy withdrawal."
The American Bar Association and other lawyer groups say the regulation is unnecessary and counterproductive. It would undermine the confidential relationships between executives and their counsel needed to police clients from within, said Dennis Archer, ABA president.
"You take away the lawyer's ability to stop in its tracks impermissible activity," he said.
Besides, he said, the standards of conduct already have become more stringent.
As part of the Sarbanes-Oxley legislation spawned by the collapse of Enron Corp., the SEC requires corporate lawyers to report any illegal conduct they encounter up the client's chain of command, to the board of directors if necessary.
In addition, the ABA and most other ethics arbiters have given clearance for lawyers to voluntarily withdraw from representing a company embroiled in ongoing criminal activity.
But critics say lawyers still have too much latitude to aid and abet corporate crime, with dire consequences for the economy, as reflected in Enron and other debacles. Competition for fees has eroded their role as watchdogs, said Ronald Rotunda, law professor at George Mason University.
"A less scrupulous lawyer has a competitive advantage," Rotunda said. "He can get the clients who want the lawyers to do the dirty work."
As the Spiegel matter reflects, any rule that does not require lawyers to blow the whistle falls short, said Charles Murdock, law professor at Loyola University Chicago. "If you don't require them to do it, they're not going to do it."
Emerson, a Kirkland partner described on the firm's Web site as a corporate governance expert, was brought into Spiegel in mid-2001 when the company hired a new general counsel.
Emerson declined to comment for this story, referring questions to Jack Levin, a senior partner at Kirkland who had no involvement in Spiegel's trouble.
The trouble came on fast. The Downers Grove-based retailer had mismanaged its apparel offerings and put credit cards in the hands of customers unable to pay the bills.
By the end of March, 2002, auditor KPMG had determined the company's financial woes were threatening its ability to continue as a "going concern."
So-called going concern qualifications can have serious consequences in the marketplace. Typically, suppliers refuse to ship goods on credit, investors bail out of the stock, employees look for other jobs and customers postpone purchases.
Nevertheless, Spiegel was required to publicly report the warning, along with other bad news, in its 10-K annual report to the SEC, according to the examiner.
Instead, its management directed Kirkland to draft a "notification of late filing," saying the company could not submit the required report. In drafting the notice, Kirkland said Spiegel had violated its loan covenants, but never mentioned the auditor's warning.
"Of course, as Kirkland & Ellis knew, the real reason why Spiegel was not filing its periodic reports was that it did not want to disclose KPMG's going concern qualification and other material bad facts and circumstances threatening Spiegel's survival," examiner Stephen Crimmins wrote in the report, first made public last fall.
While Kirkland's Levin said that citing the auditor's opinion would have been inappropriate in a late-filing notice, the examiner disputed that assertion.
During the weeks that followed, Kirkland advised Spiegel to file its 10-K, which would contain much more detailed disclosures. On May 15, the law firm warned that the failure to file could result in civil action as well as criminal prosecution.
Spiegel's general counsel in the U.S. agreed, and the American managers of the German-controlled company started getting worried, according to the examiner's report.
A meeting between Chief Executive Martin Zaepfel and the Chicago-area management team on May 30 became "very emotional," the report said. One attendee brought a newspaper photo of executives from another public company being paraded in handcuffs on a "perp walk."
Zaepfel decided to recommend filing the 10-K after all, according to the report.
The next day, Spiegel's audit committee met in West Germany, placing a call to Kirkland's Emerson in Chicago. Emerson told the bankruptcy examiner he gave "heated" advice to file the 10-K, saying it was illegal not to file. The Spiegel leaders maintained that Emerson never advised them they could face serious consequences, so they decided against it.
Yet Spiegel leaders also believed Kirkland had exaggerated the seriousness of the matter, the examiner's report said. They were so peeved that they considered finding new lawyers to replace the pessimists at Kirkland, whom they dubbed "black painters," the report said.
That finding suggests Kirkland's warnings were sufficiently strident, said Levin. "We loudly and properly and heatedly stated the gravity of the matter."
But then Kirkland dropped it and moved on to other Spiegel business. In coming months, neither Kirkland nor anyone else at Spiegel "seriously raised the non-filing of the Form 10-K as an issue," and Kirkland continued to prepare and file the extension forms, according to the examiner's report.
"The material information that should have reached investors was kept under wraps," the report said. "None of Spiegel's legal advisors withdrew--noisily or otherwise--from representing Spiegel."
If Kirkland had withdrawn, its efforts to renegotiate Spiegel's bank loans would have ended, too, Levin said.
"If we'd have resigned and walked away from the company after it rejected our advice to file the 10-K, the company and its creditors and its shareholders would all have been worse off," he said.
The examiner's report reaches a different conclusion: "The absence of a noisy withdrawal requirement allowed Spiegel to keep investors and the SEC in the dark."
An SEC spokesman declined to comment on any timetable for renewed consideration of the "noisy withdrawal" rule, though sources at the commission say it is likely a matter of weeks away.
Although he said he is neutral on whether the new regulation is needed, former SEC Chairman David Ruder believes the change is likely to come. That is especially true, he said, since accountants already have a similar obligation under SEC rules.
Commissioners "tend to ask, `Why noisy withdrawal for accountants and not lawyers?"' said Ruder, a law professor at Northwestern University. "It's going to be sooner rather than later."
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