The Sarbanes Oxley Act (SOX), and associated rulemaking redefined the task of corporate governance and brought a new focus on the role of the board of directors.

Director independence from corporate management stopped being an academic debate pressed by institutional investors, and became mandatory. The audit committee emerged from SOX as the uber-committee, with significant powers, responsibilities, and claims on corporate resources.

For the moment, at least, corporate directors are intensely aware of the legal environment in which board-level decisions are made. With SOX, new thorns have grown in the corporate legal thicket.

One still-unresolved question is whether, and in what form, the Securities and Exchange Commission (SEC) will enact the pending portion of its rules regarding attorney conduct. Few boards to date have formed a qualified legal compliance committee (QLCC), but adoption of a “noisy withdrawal” rule should prompt many more to do so.

In such an environment, nominating committees for corporate boards that are tasked with seeking the right blend of skills and experience among directors to advance the company's interests might well want to add legal    skills and experience to that mix, making it worthwhile for companies to consider adding lawyers as directors.

Rule 205, Qualified Legal Compliance Committees, and “Noisy Withdrawal”  

SEC Rule 205 should prompt public company boards to consider adding attorney board members as part of a mechanism for the company to retain control of corporate securities disclosure decisions, rather than leaving those decisions in the hands of counsel (either in-house or outside).

Rule 205 changes the lawyer-client dynamic on that small but important number of public company reporting decisions on whether, and what, to report about a potential violation of securities laws.

Under Rule 205, once an attorney in the course of representing a public company becomes aware of “credible evidence” of a “material violation” of the securities laws by that company or its officers or directors, there are only three possible outcomes: (1) The attorney is satisfied that the company has adopted an “ appropriate response” to the attorney's concerns; (2) the attorney, if the company's response is not appropriate or not timely, resigns, or (3) a qualified legal compliance committee of the company accepts the role of determining the company's ultimate response to the attorney's concerns.

There are no particular experience qualifications for membership on the QLCC under Rule 205. A QLCC must consist of at least three board members, one of whom is an audit committee member and all of whom are independent; have written procedures for confidential receipt of a report of a material violation; and have specific authority from the board to investigate and resolve issues relating to securities law violations.

Logically, if having financial experts as members is good for audit committees (and hence the overall board), QLCCs and boards should benefit from having attorneys as members.

While there is not significant data about the number of companies that have adopted QLCCs, the number appears to be small. One survey in late 2004 put the number at about two percent of the public companies, including those that have made the QLCC function an added responsibility of the Audit Committee. General Motors and Time Warner are the highest-profile companies to have adopted a QLCC.

One revision to Rule 205 proposed by the SEC may be crucial to a company's determination whether to form a QLCC: the SEC's proposal that an attorney who does not believe that the corporate client has delivered an “appropriate response” must resign as counsel and notify the SEC of the resignation (the so-called “noisy withdrawal”). The SEC is also considering a variation on the noisy withdrawal rule under which the company, not the attorney, would be obligated to notify the SEC of the attorney's resignation.

Under either version of noisy withdrawal, a company that does not have a QLCC potentially puts control of the disclosure decision in the hands of counsel. Formation of a QLCC keeps the ultimate decision under the control of the board itself. Even if a QLCC decides in a particular cage that disclosure is warranted, the company still controls the nature of the disclosure, its timing, and the strategies for resolution of a problem.

The SEC's development of the QLCC concept represents a continuation of a securities law trend of recent years, that of making reporting and securities compliance issues matters of individual duty by specified officers or directors of a company, rather than defining compliance as an institutional obligation. Other examples include the CEO and CFO certifications of public company reports, and the specific duties and authority assigned to audit committees, including the obligation that the audit committee include a “financial expert.”

The SEC did not adopt either of the noisy withdrawal elements under Rule 205 during 004. If and when those provisions are adopted, the level of interest in QLCCs should increase.

Boards without QLCCs

Rule 205 is not the only reason that a company might want to adopt a QLCC. Audit committees have significantly increased workloads as a result of SOX, and might need the help, particularly on securities disclosure matters that are not specifically related to finance. The recently adopted changes to Form 8-K require companies to make current reports on a greater number of events, in a shorter period of time, and contain a number of disclosure items that are not strictly financial in nature.

Attorneys provide knowledge of the law but, more importantly, they bring to the oardroom seasoned experience and understanding of how to apply the law's rules to the specific facts at hand. Moreover, experience working in one area of the law, while it does not provide a knowledge of the working principles of all other areas of law, does provide a “feel” for how the law works that can give a lawyer a certain intuitive grasp of when a description of legal issues or legal analysis is flawed or incomplete.

Nominating committees tasked with seeking the right blend of skills and experience among directors to advance the company's interests might well want to add “legal skills and experience” to that mix.

Clearly, not only attorneys can understand legal issues. Many non-attorney board members develop sufficient experience dealing with legal issues to have their own ntuitive grasp of how the law should apply. Boards typically have corporate counsel on hand for meetings to advise on specific legal issues that might arise. It is the job of corporate counsel to ensure that legal issues are explained in terms that a non-attorney client can appreciate and use to take action.

However, by bringing additional perspective and training in legal analysis, and the ability to appreciate the importance of critical facts in a legal setting, an attorney-board member can offer unique understanding in board decision making. An attorney can bring the habit of approaching a problem unemotionally, and seeking a thorough solution.

What makes good attorney-board members?

As with any board members, the right traits are crucial. The style and personality of theattorney-board member is important. While putting a bad lawyer on a board is not worse than having a bad board member from any other profession, those of us who have dealt with bad lawyers can well imagine the havoc that an overbearing and under-talented advocate could create. Also, there are attorneys who consider pessimism to be “risk management,” or who continue debate when others are ready to decide and act, and those characteristics would not play out well in the boardroom.

The requirement for independence also makes it important to ensure that the attorney's role does not extend to representation of the company, or to acting as a “ supervisory attorney,” as those terms are defined in Rule 205.

The requirement that a director-attorney not represent the company would implicate oth the director independence requirements and the attorney conduct rules. Since Rule 205 (including any “noisy withdrawal” provision that the SEC may adopt in its final rules) regulates the activities of attorneys in connection with the representation of companies on securities law matters, neither the company not the attorney-board member would desire to see the regulatory impact of Rule 205 visited on boardroom deliberations.

Judgments offered by a director-attorney must clearly not constitute legal advice, but be viewed as the contribution of one out of many directors.  

Judgments offered by a director-attorney must clearly not constitute legal advice, but be viewed as the contribution of one out of many directors. Discussions involving the director-attorney would be discoverable, not the confidential and privileged communications of a legal practitioner advising a client.

Should an attorney serve on a board?

While there are economic benefits to board membership, directors are not generally overpaid in comparison to the significant responsibilities they assume, and there are issues that a potential attorney-board member should consider.

The independence rules of the stock exchanges and other self-regulatory organizations (SROs) do not preclude an attorney who represents a company from participating on a board, but the emerging theme of SOX and associated rulemaking is that conflicts of nterest are disfavored, regardless of whether there are mechanisms to address the conflicts. Moreover, as noted above, an attorney who represents a company on securities law matters will be subject to the provisions of Rule 205.

In addition, participation on a corporate board by an attorney who is a member of a larger firm could create issues for the firm as well as for the attorney. An attorney serving on a corporate board would also want to be mindful of whether there were conflicts with other clients of the law firm, or the perception, for marketing purposes, of such conflicts.

A company could also find itself on one side of a legal issue while the attorney's firm represented a client on the other. Many law firms might take the view that an attorneyrespected enough to be a board member would generate more profit for the firm by providing services as outside counsel, rather than acting as a director.

Retired counsel and attorneys from academic backgrounds would not face the same economic conflict. Also, attorneys not associated with major firms or who are more accustomed to litigation or crisis counseling may be less concerned with the potential issues while still providing the analytical sense and perspective that make them valuable board members.

It is conceivable that the experience and training that would be of benefit to a board could expose an attorney-director to greater scrutiny in litigation. Depending upon the situation, an attorney on a board, unlike other directors, might for pleading purposes be reated as having a higher standard of care in acting on board matters, a “reasonable lawyer” rather than “reasonable person” standard.

The SEC, in adopting the rules relating to financial experts on audit committees, has taken pains to prevent the creation of a higher standard of care for the possessors of such expertise, so as not to scare them away from participating on boards. To promote the effectiveness of the QLCC concept, the SEC should take the same step for attorney directors.

In all events, any director, whether or not that director is an attorney, should be certain that the company has an officers and directors insurance policy in force, that the protection is adequate, and that the insurance is paid up. Litigation is never brought efore-the-fact. When something goes wrong, even well-informed and well-intentioned decisions can generate litigation that requires the expenditure of time and money to fight before a director's lack of culpability is demonstrated to the satisfaction of plaintiff's counsel.

The right blend of skills

Directors need to discharge their duties with an awareness of corporate, SEC and SRO governance requirements, and with a sense of the potential legal ramifications of disclosure decisions. For the same reasons that audit committees are now required to have at least one member who is financially literate, boards, or QLCCs, would benefit from having a lawyer to help steer the company past potential legal shoals.

Bruce Dravis is a partner specializing in corporate and securities law at Downey Brand LLR David Caplan is a shareholder of Brooks & Raub, PC, a commercial insolvency firm in Silicon Valley. Rich Koppes is Of Counsel at Jones Day and serves on the boards of Apria Healthcare and Valeant Pharmaceuticals.