12.07. Misconduct by an Organizational Constituents — Reporting Up and Out

This section addresses a situation where a lawyer represents an organization and someone within the organization is engaged in conduct that would harm the organization (client).  What should the lawyer do to protect the client’s interest? To understand the current rule, it is helpful to consider how the obligations have changed over time.

Here is a hypothetical to consider: You are a lawyer and one of your clients is Simpson Car Company. Internal tests performed by Car Company have shown that some of the cars they produce have faulty seat belts. You learn that Homer Simpson, the owner of Simpson Car Company, has been falsifying safety records saying that the seat belts meet regulatory requirements.  These false certifications are a crime, and if someone is injured as a result of the faulty seat belts, there could also be civil liability imposed against the company.

We are going to consider this hypothetical under the pre-2003 rules and then under the current rules. Below is the pre-2003 Rule. Read the rule and write down answers to these two questions: (1) when does a lawyer have an obligation to act under Rule 1.13, and (2) what is a lawyer supposed to do when she acts?

[Pre-2003] Rule 1.13: Organization as Client

(a) A lawyer employed or retained by an organization represents the organization acting through its duly authorized constituents.

(b) If a lawyer for an organization knows that an officer, employee or other person associated with the organization is engaged in action, intends to act or refuses to act in a matter related to the representation that is a violation of a legal obligation to the organization, or a violation of law which reasonably might be imputed to the organization, and is likely to result in substantial injury to the organization, the lawyer shall proceed as is reasonably necessary in the best interest of the organization. In determining how to proceed, the lawyer shall give due consideration to the seriousness of the violation and its consequences, the scope and nature of the lawyer’s representation, the responsibility in the organization and the apparent motivation of the person involved, the policies of the organization concerning such matters and any other relevant considerations. Any measures taken shall be designed to minimize disruption of the organization and the risk of revealing information relating to the representation to persons outside the organization. Such measures may include among others:

(1) asking for reconsideration of the matter;

(2) advising that a separate legal opinion on the matter be sought for presentation to appropriate authority in the organization; and

(3) referring the matter to higher authority in the organization, including, if warranted by the seriousness of the matter, referral to the highest authority that can act on behalf of the organization as determined by applicable law.

(c) If, despite the lawyer’s efforts in accordance with paragraph (b), the highest authority that can act on behalf of the organization insists upon action, or a refusal to act, that is clearly a violation of law and is likely to result in substantial injury to the organization, the lawyer may resign in accordance with Rule 1.16.

[2003 Changes to the Rule]

Are you satisfied with the options under the old Rule 1.13? Although there were some misgivings about whether these options really satisfied a lawyer’s obligations to their corporate client when the client was being harmed by a constituent, this rule stayed intact until 2003 when a dramatic change was made to the rule.

To understand the nature of the change, you need to understand what prompted the change. The early 2000s saw a slew of corporations fail because of wrongdoing by those in charge of the organization (including Enron and WorldCom just to mention two). When the smoke started to clear, folks began to wonder: how could this happen? Where were those who were supposed to be exercising independent judgment – lawyers and accountants – and why didn’t they stop their corporate clients from harming the public as well as the corporation itself? Here is what one article from the New York Times said in January, 2002: “Much of the Enron scandal involves complex financial arrangements that teams of lawyers helped to cobble together, and to which law firms gave their professional imprimatur. If any of these arrangements were in fact illegal, the lawyers may have been in the best position to know.”^[1]

There seemed to be a consensus among the public (and among members of Congress), that the established rules and requirements simply did not do enough to hold lawyers accountable. Lawyers could simply say, “I reported my concerns to the individuals I was supposed to report to in the organization – and that’s all I could do because I had to protect client confidentiality.”  Thus, relying on the obligation of confidentiality could deflect responsibility when the consequences became clear. When the ABA considered amendments to the Rules of Professional Conduct that would give lawyers the right to report misconduct out of the organization, there was a great deal of pushback (and in fact the original amendments were defeated). Corporate lawyers were concerned about the responsibility of disclosing confidential client information outside of the corporate structure. They were also concerned that recognizing a right to expose misconduct would be turned into an obligation to disclose misconduct and that civil litigation that could follow when they failed to come forward.

Something happened, however, that changed the direction of the conversation – Congress began to consider a bill that would increase the obligations and responsibilities of lawyers when representing publicly traded companies. The law, called Sarbanes-Oxley, was passed in 2002, and placed stringent disclosure requirements on lawyers who practice before the Securities and Exchange Commission (SEC). Particularly, it requires these lawyers to “report evidence of a material violation of the securities laws or a breach of fiduciary duty or similar violation by the company or any of its agents to the chief legal officer or chief executive officer of the company….”^[2] If the lawyer does not receive an “appropriate response” from the CLO or CEO, the lawyer must then report further up the ladder – to the board of directors or to another appropriate group (such as independent auditors).^[3] The lawyer may also disclose client confidences to the SEC in certain situations – including commission of a violation of securities laws that will cause substantial injury to the client or investors, rectify financial injuries if the lawyer’s services were used, or prevent someone acting on behalf of the client from committing perjury in a securities matter.^[4]

The ABA was not a fan of Congress getting involved in the regulation of the relationship between lawyer and client. This area, the ABA argued, is traditionally regulated at the state level, and it should stay that way. In an attempt to either convince the SEC not to enact onerous rules requiring disclosure or to provide a roadmap for the SEC to follow, the ABA changed its position on lawyers handling corporate employee misconduct. The ABA wanted to be able to go to the SEC and say, “See, we’ve already handled this, no reason for you to get involved.” Of course, the SEC went ahead and adopted its regulations. The ABA rules, however, were finally amended to what we have now.

The current rule provides that if a lawyer “knows” that someone associated with an organizational client “is engaged in action, intends to act or refuses to act in a matter related to the representation that is a violation of a legal obligation to the organization, or a violation of law that reasonably might be imputed to the organization” and the action/inaction “is likely to result in substantial injury to organization,” then the lawyer should report the matter up the corporate chain of the organization, and if the matter is serious enough, report to the highest authority that can act on behalf of the organization.  A lawyer must report up unless the lawyer has a good reason not to do so.[5]

If individuals who the lawyer reports up the chain to refuses to act (or if they insist upon the harmful action), and the lawyer “reasonably believes that the violation is reasonably certain to result in substantial injury to the organization,” then the lawyer “may reveal information relating to the representation [confidential information]” to the extent the lawyer believes necessary “to prevent substantial injury to the organization.”[6]  This means that the lawyer can report the conduct to the relevant authorities so they can take action. 

The only time this report-up (and possibly out) obligation does not attach is if the lawyer is hired by the organization to investigate an alleged violation of law by the corporation or someone in the organization.  In other words, unless the lawyer is hired to represent the organization with regard to the misconduct, the lawyer must take steps to protect the organization.

One thing to note – earlier we discussed several situations under Rule 1.6(b) where a lawyer can disclose client confidential information without client consent.  The right of a lawyer to disclose under Rule 1.13(c) supplements those exceptions to the obligation of confidentiality – it does not supplant them.

Liam Lawyer represents Widgets, Inc.  Lawyer recently learned that the board of directors of Widgets, Inc. falsified corporate documents, and Lawyer filed those documents with the state.  If the false documents are discovered, Widgets, Inc. could face a very large fine.  Can Lawyer contact the state and disclose the fraud? [ABA Rule 1.13, Comment [6]]

Yes.  This hypothetical demonstrates the interaction of Rule 1.6 and Rule 1.13.  In this situation the corporation (through its board of directors) has used the lawyer’s services to commit a fraud.  If the lawyer determines that this fraud is reasonably certain to result in “substantial injury to the financial interests… of another” – such as shareholders, then the lawyer can reveal the information related to the fraud under Rule 1.6(b)(2).  Under Rule 1.13(c), the lawyer can disclose the information if he first reports it up the corporate chain  and the board of directors refuses to withdraw  the documents.  In addition, also remember that Rule 1.2(d) provides that a lawyer cannot assist a client in engaging in a fraud, and under that rule, the lawyer could withdraw from representing Widgets, Inc. and disaffirm the documents if the board of directors fails to act.  One last point to make about this – while the confidentiality exceptions under Rule 1.6(b)(2) and (3) require that the client use the lawyer’s services to commit the fraud, the report-up and out right under Rule 1.13 only requires that the matter be “related to representation” (a broader standard). If a lawyer is fired for reporting up or reporting out or is required to withdraw because of wrongdoing, the lawyer has an ethical duty to “proceed as the lawyer reasonably believes necessary to assure that the organization’s highest authority is informed” that the lawyer had to withdraw or was fired.  The justification for this is to ensure that a lawyer is not fired to prevent the lawyer from revealing misconduct.

[1] Enron and the Lawyers, New York Times (Jan. 28, 2002).

[2] 15 U.S.C. § 7245(1).

[3] 15 U.S.C. § 7245(2).

[4] Regulations Implementing the Sarbanes-Oxley Act, 17 CFR 205.3(d) (2010).

[5] ABA Rule 1.13(b).

[6] ABA Rule 1.13(c).