Lawyers who represent large corporations are with increasing frequency targets in the cross-hairs of nonclients who are seeking to shift the blame for financial problems and looking for deep pockets to recoup investment losses, according to panelists at the 2003 Annual Conference on Legal Malpractice and Risk Management, held here March 13-14.

Speakers on several panels sounded a common theme: In the post-Enron world, attorneys who represent corporations — both outside legal counsel and those who work as in-house lawyers — face changing responsibilities and expanding liabilities.

Lawyers are being sued more often — and for huge amounts of money — in connection with corporate failures and pension losses, panelists said. Perhaps most notably, Enron's former lead outside counsel, Vinson & Elkins, is caught up as a defendant in a massive securities fraud lawsuit in Texas federal court.

Panelists also asserted that corporate lawyers have new and different obligations under Section 307 of the Sarbanes-Oxley Act of 2002, which mandates up-the-ladder internal reporting of corporate misconduct. Moreover, under another section of Sarbanes-Oxley and proposed regulations, lawyers are subject to action by the Securities and Exchange Commission if they provide an inaccurate or misleading legal analysis to a corporate client's auditors.

The conference was presented by the Hinshaw & Culbertson law firm and was co-sponsored by BNA, the Association of Professional Responsibility Lawyers, Law Bulletin Publishing Co., and Thomson-West.

Blame for Failed Investments
Conference chairman Ronald E. Mallen of Hinshaw & Culbertson's San Francisco office described a disturbing trend in which plaintiffs' lawyers try to pin the blame on attorneys for their clients' failed investments. Mallen is one of the authors of the leading treatise, Legal Malpractice, now in its fifth edition.

As a prime example of this trend to blame corporate counsel, Mallen cited Chem-Age Industries Inc. v. Glover, 652 N.W.2d 756, 18 Law. Man. Prof. Conduct 633 (S.D. 2002), which examined theories under which a promoter's lawyer can be held liable to investors. The court ruled that a lawyer who helped a client with a problematic track record to set up a company and who held himself out as the corporation's lawyer may be accountable to the investors as well as to the company for any funds the promoter misappropriated, to the extent the lawyer knowingly helped the client breach a fiduciary duty to the investors and the company.

Especially troublesome, in Mallen's view, are recent cases against lawyers in which the plaintiffs use expert testimony to establish a lost investment opportunity, such as suits accusing lawyers of bungling patent applications. These "scary" cases tend to involve huge, highly speculative claims that are built on a series of assumptions akin to a house of cards, he said.

Due Diligence
Concerning plaintiffs' attempts to hold lawyers responsible for investment losses, Mallen pointed to recent litigation by the Kansas Public Employees Retirement System (KPERS) against law firms and other professionals in connection with a series of bad investments made on behalf of the pension system.

The KPERS case was discussed at a panel on recent developments in corporate practice. Panelist Robert F. Coleman of Chicago, one of the attorneys who represented KPERS in that litigation, told the audience that law firms were brought in as defendants on the theory that they represented a public entity, KPERS, that was bound by a Kansas statute to exercise the care of a "prudent man" in its investment decisions. The law firms defended, Coleman said, on the argument that they represented only the investment manager and that the scope of their representation did not extend to interpretation of the "prudent man" investment standard. As damages, Coleman noted, KPERS sought not only the principal lost in the bad investments but also the loss of income that could have been earned on that principal.

One phase of the KPERS litigation went to the Kansas Supreme Court. In Kansas Public Employees Retirement System v. Kutak Rock, 44 P.3d 407, 18 Law. Man. Prof. Conduct 269 (Kan. 2002), the court held that a law firm retained by an investment manager to perform "due diligence" in helping the manager make an investment for KPERS did not thereby undertake an obligation to ensure that KPERS was making a prudent financial decision.

Coleman expressed disagreement with that decision and predicted that other courts will not follow it. Emphasizing that settlements totaling $80 million were negotiated in the KPERS litigation, he warned that law firms will face more of these types of claims.

In the conference materials, Terrence P. McAvoy of Hinshaw & Culbertson's Chicago office said that the KPERS case illustrates the importance of drafting engagement agreements with enough specificity to avoid claims arising from a duty that the law firm does not intend to assume. The engagement letter in question specified that the firm would perform "due diligence" as required by investors without clarifying whether "due diligence" included financial advice, McAvoy noted.

Law Firm Sued for Enron Losses
Perhaps the most high-profile recent decision involving an attempt to hold attorneys accountable for investment losses is In re Enron Corp. Securities, Derivative & ERISA Litigation, 235 F. Supp.2d 549, 19 Law. Man. Prof. Conduct 4 (S.D. Tex. 2002), in which U.S. District Judge Melinda Harmon ruled that the Vinson & Elkins law firm must defend against securities fraud charges filed by Enron investors who claim that as Enron's outside general counsel, V&E assisted the corporation in mounting an elaborate Ponzi scheme and then undertook an investigation allegedly intended as a whitewash of the fraud.

In a panel called "Walking the Tightrope — Enron Issues," T. David Ackerman of Kemper Professional, Berkley Heights, N.J., pointed out that Harmon allowed the case against Vinson & Elkins to go forward despite the Supreme Court's holding in Central Bank of Denver NA v. First Interstate Bank of Denver, 511 U.S. 164 (1994), that federal law does not permit a private plaintiff to bring a claim for aiding and abetting a securities violation under Section 10b of the 1934 Securities Exchange Act and SEC Rule 10b-5.

Ackerman recounted that the SEC's views heavily influenced Harmon's decision to let the plaintiffs proceed against Vinson & Elkins. In an amicus brief, the SEC argued that a law firm or other advisor may be sued as a "primary violator" under federal securities fraud laws if the firm creates a material misrepresentation with the intent to deceive, even if it does not sign the document containing the alleged misrepresentation or otherwise identify itself to investors. Harmon accepted that view, Ackerman explained.

Ackerman also noted that the examiner in Enron's bankruptcy proceeding has subpoenaed records from numerous law firms that represented Enron and has issued subpoenas to depose lawyers in many of these firms for information about Enron's efforts to keep debt off its financial statements. The examiner apparently intends to seek confidential information from these firms, he said.

Lessons from Enron

Panelist Peter R. Jarvis of Stoel Rives, Portland, Ore., suggested that the case against Vinson & Elkins teaches this lesson: "Conflicts of interest do matter." A law firm has no business investigating people with whom it is in cahoots, he declared.

On another Enron-related issue, Jarvis said that he disagrees with those who see no problem with lawyer Nancy Temple's e-mailed advice to her client Arthur Andersen about an internal memo that lead Enron auditor David Duncan was writing for Andersen's files in which he recounted his advice to Enron--which the company ultimately rejected — that a forthcoming Enron press release should not describe certain losses as "nonrecurring."

In the e-mail, Temple advised "deleting some language that might suggest we have concluded the release is misleading." The e-mail reportedly influenced jurors to convict the accounting firm of obstruction of justice. Jarvis charged that under the circumstances--that is, with the government breathing down Enron's neck--Temple's advice signaled an intent to conceal. Instead, Jarvis suggested, Temple could have advised Duncan to include in his internal memo some additional explanation.

Shortly before that e-mail, Temple had sent an e-mail to an Andersen partner advising that the Enron audit team be reminded of Andersen's document retention and destruction policy. Jarvis found fault with that advice as well. Lawyers can advise clients to follow a document policy in the ordinary course of business, but the SEC was investigating Enron when Temple gave that advice, Jarvis noted. He urged that lawyers who review drafts of a document to consider creating a better document rather than destroying one.

Section 307: New Standard of Care?
With respect to Section 307 of the Sarbanes-Oxley Act, Jarvis said that the statute significantly changes the responsibilities of corporate lawyers who learn of wrongdoing.

Jarvis pointed out that ABA Model Rule of Professional Conduct 1.13(b) requires corporate counsel who "knows" that someone intends to act in an impermissible way to "proceed as is reasonably necessary in the best interest of the organization" but with measures designed to "minimize disruption of the organization." In contrast, he noted, Section 307 requires a lawyer to report up the corporate chain of command when faced with credible evidence that there has been or will be a material violation of federal or state securities laws, fiduciary obligations, or other similar common-law duties.

Even though Section 307 does not create a private right of action against lawyers, Jarvis predicted that it will become the standard of care for lawyer conduct, even for representation of companies whose stock is not publicly traded. Plaintiffs will present expert testimony that the reasonably prudent lawyer would have acted in accordance with Section 307, he said.

The SEC's proposed "noisy withdrawal" rule under Section 307 has been pulled off the table for the time being, Jarvis noted. He said he accepts the idea of permissive "noisy withdrawal" because that step may be necessary for self-protection to guard against liability once the lawyer learns of a serious problem.

Jarvis also urged corporate lawyers to be aware that as part of making a deal with the government, a company accused of wrongdoing may decide to waive the attorney-client privilege. "Everything needs to be written and kept with the possibility of losing the privilege in mind," he said. Write down whatever you may reasonably want to rely on at some later time, such as "No, don't do it," he suggested.

Watch Out for Section 303
Mallen's co-author, Jeffrey Smith of Greenberg Traurig in Atlanta, warned corporate lawyers to expect more federal legislation along the lines of the Sarbanes-Oxley Act, as well as more far-reaching regulations from the SEC.

Although Section 307 of the Sarbanes-Oxley Act has received the most attention, Smith explained that lawyers are also at risk of being subject to SEC enforcement actions under Section 303(a), which makes it unlawful for an officer or director of issuers of financial statements that are being audited--or anyone acting under their direction--to "fraudulently influence, coerce, manipulate or mislead" an auditor. Section 303 gives the SEC exclusive authority to enforce this section and any regulations issued under it.

Smith complained that the SEC's proposed rules under Section 303(a), which were released in October 2002, go far beyond the statutory language and significantly lengthen the statute's reach. He noted, for example, that the proposed regulations expand the impact of the "fraudulently influence, coerce, manipulate or mislead" phrase by adding the words "directly or indirectly."

Because of other aspects of the Sarbanes-Oxley Act, Smith commented, lawyers are likely to interact with auditors for public companies more than they have in the past. And as audit committees retain lawyers directly, those lawyers will frequently deal with auditors, he noted. Section 303(a) and the SEC's proposed rules under that section will inhibit communications between lawyers and auditors and will expose lawyers to extra risk of SEC action, he predicted.

From the audience, Smith was asked whether, if the proposed regulations are adopted, lawyers are going to face SEC sanctions for giving "name, rank, and serial number" responses when auditors ask about litigation involving the corporate client.

Smith responded that the SEC release announcing its proposed regulations specifically identifies providing an auditor with inaccurate or misleading legal analysis as an example of conduct that might constitute improper influence under Section 303(a).

With respect to corporate lawyers' civil liability to nonclients, Smith predicted that more complaints alleging negligent misrepresentation will be filed against attorneys who represent corporations, because they are easier to bring against lawyers than securities fraud lawsuits.

ERISA Liability
Sometimes lawyers are sued for investment losses when they represent private pension plans, said David P. Hartnett of Hinshaw & Culbertson's Miami office during a panel addressing developments in statutory liability.

Recent case law appears to have expanded lawyers' potential liability under the Employee Retirement Income Security Act of 1974, Hartnett said.

Hartnett explained that ERISA provides for recovery against those who meet the definition of a "fiduciary" — that is, someone who is named in the plan documents, who exercises discretionary authority or control over plan management, administration, or disposition of plan assets, or who renders investment advice for a fee. Under case law, lawyers usually are not deemed to be fiduciaries within the meaning of ERISA simply because they represent an ERISA-covered plan, Hartnett noted.

On the other hand, he said that lawyers may be held liable under ERISA's "party in interest" provisions for their role in certain prohibited transactions even if they are not ERISA fiduciaries. ERISA defines a "party in interest" as "a person providing services" to a covered plan, and prohibits transactions in which the fiduciary causes the plan to lend money to a party in interest, or to pay excessive compensation or transfer plan assets to such a party.

Until recently, Hartnett noted, the remedies available to plaintiffs against a party in interest were limited to equitable remedies such as injunctive relief and restitution. But in Harris Trust & Savings Bank v. Salomon Smith Barney Inc., 530 U.S. 238 (2000), the Supreme Court held that a nonfiduciary (a broker-dealer in that case) could be liable under an ERISA provision, 29 U.S.C. §1132, that authorizes a civil monetary penalty against a fiduciary "or other person."

"This holding exposes lawyers to a new level of liability," Hartnett said in materials prepared for the conference. As an example, he cited Great-West Life & Annuity Ins. Co. v. Smith, 180 F. Supp.2d 1311 (M.D. Fla. 2002), which denied a law firm's motion to dismiss a claim for equitable relief brought by an assignee of the pension plan. The court stated that "[w]hile the law firm is correct that it cannot be considered an ERISA fiduciary ... a cause of action pursuant to Section 1132(a)(3) can be stated against a non-fiduciary."

The reasoning in Smith was rejected, Hartnett noted, in another case brought by the same plaintiff, Great-West Life & Annuity Ins. Co. v. Bullock, 202 F.Supp.2d 461 (E.D.N.C. 2002).

Conflicts Among Affiliated Entities
A session on key risk-management issues highlighted the problem of avoiding and resolving conflicts when representing entities, their parents, subsidiaries, and affiliates.

According to William T. Barker, Sonnenschein, Nath & Rosenthal, Chicago, lawyers used to assume that because a parent and subsidiary are distinct legal entities, they are also distinct for conflicts purposes. But courts take different approaches, he explained, when evaluating whether a firm is permitted to handle a case against an affiliate of a company that the firm represents in an unrelated matter.

One line of authority emphasizes corporate separateness, Barker said, while another focuses on whether the affiliated entities share a unity of interests. Affiliated corporations' use of the same in-house counsel seems to be a key factor in analyzing conflicts under the unity of interest approach, he noted.

Uncertainty can be reduced, Barker suggested, if the retainer agreement expressly speaks to the question of client identity. Corporate counsel can avoid "separateness" by specifying at the time of representation that all affiliated entities must be treated as clients, while law firms can overcome "unity of interests" by stating that they represent only particular corporations.

As a halfway step, Barker remarked that firms can specify whom they represent, not whom they don't. Partners who bring in clients usually aren't eager to wave red flags and therefore tend to prefer this middle approach, he stated.

Continuing on this subject, speaker Sarah Diane McShea, New York, noted that law firms tend to deal with this issue too late due to the fact that lawyers find it awkward to talk with clients up front about the possibility of later handling a matter against an affiliate.

McShea urged firms to "bite the bullet" and address this conflict problem at the outset when taking on a corporate client. If the law firm broaches the idea of being able to sue affiliated companies and the client says no, the firm has to decide at that early point whether it can live with the restriction, she said.

As for whether screening mechanisms can be used to deal with these conflicts, McShea noted that about a dozen jurisdictions now authorize the use of screens; however, she explained, they tend to permit screening only for lawyers changing firms who do not possess significant information that could be used against the former client.

States definitely are not moving in the direction of allowing screens to be used without client consent to permit a firm to sue a current client, McShea said. She suggested advance waivers as a potential tool for addressing this conflicts issue.

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Insurance Professional Highlights Several Areas Where Corporate Counsel Increase Their Liability Risks
At a panel on using self-audits to identify risks in legal practice, Julianne Splain, of Chubb & Son in Simsbury, Conn., discussed several risk-management issues for lawyers who represent corporate clients, either as outside counsel or in the client's legal department.

Beyond lawsuits by disappointed investors, Splain identified these key areas where claims can arise:

Reproduced with permission from ABA/BNA's Lawyers' Manual on Professional Conduct, Vol. 9, No. 7, pp. 176-181 (March 26, 2003). Copyright 2003 by the American Bar Association/The Bureau of National Affairs, Inc. (800-372-1033).

This publication has been prepared by Hinshaw & Culbertson LLP to provide information on recent legal developments of interest to our readers. It is not intended to provide legal advice for a specific situation or to create an attorney-client relationship.