Whistle-blowers tapped to clean up corporate crimes

Uncle Sam is looking for a few good whistle-blowers.

No, it's not part of the Justice Department's war on terrorism. Rather it is a centerpiece of the government's corporate reforms to prevent the kinds of bookkeeping excesses that led to the downfall of business giants like Enron and WorldCom.

If only someone - an auditor, executive, outside director - had come forward and "blown the whistle" sooner, investors would have been better able to gauge the value of certain corporations. And the market, rather than bankruptcy judges, would sort out the good from the bad.

But how does one break a corporate code of silence that can be as intimidating as one imposed by Mafia dons?

The answer from Congress: lean on the lawyers.

The latest wrinkle in the government's attempt to restore investor confidence in American stocks hinges on the idea that corporate lawyers can - and should - be dragooned into service as whistle-blowers.

Unlike Time Magazine's "Persons of the Year," three whistle-blowers who voluntarily exposed questionable activities at Enron, WorldCom, and the FBI, corporate lawyers would be forced to take action or face professional and other sanctions.

The idea has sparked sharp debate within the legal community.

"This is really a revolutionary innovation - for good or bad - in legal ethics," says Geoffrey Miller, legal ethics professor at New York University. "It puts the attorney in the position of ratting out the client."

The new regulation was approved by the Securities and Exchange Commission (SEC) and is set to take effect on Jan. 26.

It requires corporate lawyers who suspect wrongdoing to report their concerns to senior management and, potentially, to the board of directors. The regulations require that if the firm fails to take sufficient steps to resolve the questionable activity the lawyer must end his legal representation and notify the SEC of any documents containing false or misleading information. The procedure is known as a "noisy withdrawal."

Legal experts say there is nothing new about requiring lawyers to fulfill their ethical obligations to report suspected wrongdoing to senior managers. But what is new is the mandate that lawyers must resign and notify the SEC of their resignation if suspected corporate misdeeds are not rectified.

Although not required to disclose to the SEC precise details, any resignation by a lawyer will serve as a red flag for investigators, legal experts say.

Supporters of the new regulation say it creates a powerful deterrent against corporate wrongdoing by putting executives on notice that they may no longer rely on a lawyer's silence.

Opponents say it undermines the principle behind the attorney-client privilege.

"It could drive a wedge between lawyers and clients," says M. Peter Moser, chairman of an American Bar Association (ABA) task force on the issue. "The system won't work, you will have corporations that won't feel they can consult lawyers."

Stanley Keller, a Boston lawyer on the ABA task force, agrees: "The historical rule that state courts have adopted and recognized is that the public interest is best served if clients are able to freely consult with counsel knowing that whatever is said stays between the client and the lawyer."

"That is the more important principle to protect and preserve than to focus on the few instances when a lawyer notifying the SEC might prevent a specific fraud."

A handful of states, including Florida and New Jersey, have similar resignation and disclosure rules. There has been no avalanche of forced resignations among corporate lawyers in those states, say supporters of the SEC regulation.

"It can't be as bad as the scaremongers are yelling," says Anthony Davis, a New York lawyer who advises law firms on professional responsibility. "It may require very careful consultation with clients before you start engagements and significant advice when problems arise."

Mr. Davis says such rules can play a positive role by making clear that a lawyer's options are limited. In such cases, executives might be angry with the attorney in question, but unseemly conduct gets resolved, he says.

"That is not a bad outcome. I am not terrified by that," Davis says. "It is about knowing how to handle your clients based on the ethics requirements."

Supporters say the SEC measure makes the world a safer place for ethical lawyers, because corrupt managers would blame a lawyer's potential whistle-blowing on SEC regulations rather than on the lawyer's own concept of right and wrong.

The regulation is also based on the principle that even though corporate lawyers are retained and paid by top managers, they must represent the best interests of the entire corporation, including its shareholders. In legal terms, that means the client is the corporation, not individual corporate executives.

Richard Painter, a professor of legal ethics and securities regulation at the University of Illinois College of Law, says much of the debate over the SEC regulation is overblown. "I don't see major corporations complaining about this," he says. "What I see are lawyers complaining about it."

Mr. Painter says SEC rules give corporations an alternative to the noisy withdrawal provision. Corporations may set up a legal compliance committee composed of independent members who should not be beholden to top managers. It would then be the responsibility of the committee, rather than an individual lawyer, to take action within the corporation to resolve any allegations of wrongdoing.

Painter says such committees must be watched closely by the SEC to ensure they are truly independent of top management.