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                                                                                                   HRO Alert

Jennifer A. D’Alessandro     INCREASED SCRUTINY OF ATTORNEYS
Senior Counsel
jennifer.d’alessandro        BY THE SECURITIES AND EXCHANGE COMMISSION
@hro.com
                             On September 20, 2004, Stephen M. Cutler, the Director of the Division of Enforcement of
Courtney C. Kanouff          the Securities and Exchange Commission (the “SEC”), delivered a speech before the UCLA
Associate
courtney.kanouff@hro.com
                             School of Law titled, “The Themes of Sarbanes-Oxley as Reflected in the Commission’s
                                                     1
                             Enforcement Program.” In his speech, Mr. Cutler discussed his views of how the SEC’s
Charles D. Maguire, Jr.      enforcement program mirrors certain principal tenets of the Sarbanes-Oxley Act of 2002
Partner
charles.maguire@hro.com
                             (the “Sarbanes-Oxley Act”). One particular theme outlined in his speech focused directly
                             on attorneys and the role they play as “gatekeepers in maintaining fair and honest mar-
Gino A. Maurelli                   2
                             kets.” As a prelude to this discussion, Mr. Cutler alluded to the following advice of
Associate
gino.maurelli@hro.com
                             lawyer and statesman Elihu Root: “about half the practice of a decent lawyer is telling his
                             clients that they are damned fools and should stop.” To those lawyers who fail to take such
W. Dean Salter               advice seriously, Mr. Cutler had the following to say:
Partner
dean.salter@hro.com                         Consistent with Sarbanes-Oxley’s focus on the important role of lawyers as
                                            gatekeepers, we have stepped up our scrutiny of the role of lawyers in the
                                            corporate frauds we investigate. We have named lawyers as respondents or
                                            defendants in more than 30 of our enforcement actions in the past two
                                            years.

                                            Many of those we charged could have avoided problems if they had heeded
                                            Elihu Root’s advice. We have seen too many examples of lawyers who twisted
                                            themselves into pretzels to accommodate the wishes of company manage-
                                            ment, and failed in their responsibility to insist that the company comply
                                            with the law.

                             As a means of illustrating the type of conduct that Mr. Cutler was referring to, this article
                             summarizes some of the SEC’s enforcement actions against attorneys during the past two
                             years, particularly general counsel of public reporting companies under the Securities
                                                                                          3
                             Exchange Act of 1934, as amended (the “Exchange Act”). While most of these actions
                             involve conduct that occurred prior to the adoption of the Sarbanes-Oxley Act, they exem-
                             plify situations where attorneys appear to have failed to fulfill their role as gatekeepers in
                             preventing corporate misconduct.




                              1
                                  The full text of this speech is available at http://www.sec.gov/news/speech/spch092004smc.htm.

                              2
                                  Mr. Cutler also identified other “gatekeepers” being scrutinized by the SEC: auditors, research analysts
                                  and independent directors.

                              3
                                  While the focus of this article is on enforcement actions against in-house counsel, readers should note
                                  that in his speech, Mr. Cutler pointed out that of the 30 enforcement actions against attorneys that he
                                  alluded to, half were brought against outside counsel.
 January 11, 2005
HRO Alert                                                SEC Increases Scrutiny of Attorneys
              RECENT SEC ENFORCEMENT ACTIONS AGAINST ATTORNEYS: 4

              In the Matter of John E. Isselmann, Jr., Exchange Act Release No. 50428 (September 23, 2004).

              In this action, the SEC made the following findings: John E. Isselmann, Jr., the former General
              Counsel of Electro Scientific Industries, Inc. (“ESI”), was a cause of ESI reporting materially false
              financial reports in its Form 10-Q for the fiscal quarter ended August 31, 2002. According to the
              SEC’s findings, the former Chief Financial Officer (“CFO”) of ESI decided to fraudulently eliminate cer-
              tain vested retirement and severance benefits for ESI’s Asian employees in order to increase ESI’s
              financial results for the quarter. While elimination of the benefits was not Mr. Isselmann’s decision,
              prior to the filing of the Form 10-Q, Mr. Isselmann received written legal advice from Japanese counsel
              that relevant law prohibited such elimination of benefits. Despite having this knowledge, Mr. Isselmann
              failed to advise ESI’s Audit Committee, Board of Directors or auditors. Moreover, Mr. Isselmann was
              present during a Disclosure Committee meeting where the Form 10-Q was reviewed. While Mr.
              Isselmann attempted to raise the issue of the elimination of benefits, the CFO objected and Mr.
              Isselmann did not press the issue any further. After the meeting, Mr. Isselmann met with the CFO and
              provided him with a copy of the written legal advice. Despite receiving such information, the CFO sub-
              sequently signed the Form 10-Q. Prior to the filing of the Form 10-Q, however, an Audit Committee
              member questioned Mr. Isselmann about the elimination of benefits, but Mr. Isselmann failed to convey
              the legal advice he had received about the transaction being illegal.

              Consistent with the theme described in Mr. Cutler’s speech, the SEC found that Mr. Isselmann’s “fail-
              ure to fulfill his gatekeeper role” was a cause of ESI’s filing of the materially false Form 10-Q. The
              SEC ordered that Mr. Isselmann cease and desist from causing any future violations of Section 13(a)
              and the Exchange Act and Rules 12b-20 and 13a-13 thereunder. Without admitting or denying the
              SEC’s findings, Mr. Isselmann consented to the entry of a cease and desist order against him and paid
                                            5
              a civil penalty of $50,000.

              In the Matter of Stanley P. Silverstein, Exchange Act Release No. 49676 (May 11, 2004).

              In this action, the SEC made the following findings: Stanley Silverstein, the former Vice President,
              General Counsel and Secretary of The Warnaco Group, Inc. (“Warnaco”), willfully aided and abetted
              and caused Warnaco’s violation of certain reporting requirements of the Exchange Act. Warnaco mate-
              rially misstated the reasons for its financial restatement in its 1998 Annual Report on Form 10-K by
              attributing the restatement to the write-off of certain costs identified in connection with the adoption
                                             6
              of a new accounting standard. Mr. Silverstein was present during certain meetings between senior
              management and PricewaterhouseCoopers LLP (“PwC”), Warnaco’s independent public accountants at
              that time, during which PwC determined the restatement could not be attributed to the adoption of
              the new accounting standard. As General Counsel of Warnaco, Mr. Silverstein reviewed the 1998
              Form 10-K and approved its filing. Because of his attendance at these meetings, the SEC found that
              Mr. Silverstein knew, or should have known, that the 1998 Annual Report mischaracterized the cause
              of the restatement.



              4
                  The SEC’s findings in each of the proceedings discussed below were made pursuant to the relevant respondent’s
                  offer of settlement and are not binding on any other person or entity in the same or any other proceeding.

              5
                  SEC Charges Former Executives of Electro Scientific Industries, Inc. with Financial Reporting Fraud, SEC
                  Litigation Release No. 18896 (September 24, 2004).
     Page 2




              6
                  Warnaco later corrected this disclosure in 2000 when it filed an amended 1998 Form 10-K.
HRO Alert                                       SEC Increases Scrutiny of Attorneys
              Mr. Silverstein reviewed and signed a Form 10-Q for the third quarter of 2000 that contained misleading
              disclosures about Warnaco’s debt and cash in order to avoid violation of a debt-to-equity ratio under a
              material agreement. At the request of Warnaco’s former CFO, Mr. Silverstein sent a letter to the inde-
              pendent auditors confirming that Warnaco and its lenders had entered into a legally enforceable agree-
              ment as of September 29, 2000 that supported the accounting treatment of the debt when, in fact, no
              such agreement existed. The SEC found that Mr. Silverstein knew, or should have known, that the
              Form 10-Q did not accurately represent Warnaco’s debt and cash.

              Without admitting or denying the SEC’s findings, Mr. Silverstein consented to the entry of an order
              against him and agreed that for a period of two years after the issuance of such order, he would not (a)
              sign any documents to be filed with the SEC, except for filings made in his individual capacity relating
              to stock holdings, and (b) participate in or be responsible for the preparation or review of any docu-
              ments to be filed with the SEC, except for those filings made in his individual capacity that relate to
              his personal holdings. The SEC censured Mr. Silverstein and ordered him to cease and desist from
              causing any future violations of Section 13(a) of the Exchange Act, and Rules 12b-20, 13a-1 and 13a-
              13 promulgated thereunder. The SEC also ordered Mr. Silverstein to pay certain disgorgement and pre-
              judgment interest.

              In the Matter of Steve Woghin, Esq., Exchange Act Release No. 50653 (November 10, 2004).

              In this action, the SEC made the following findings: Steve Woghin, the former General Counsel of
              Computer Associates International, Inc. (“Computer Associates”), along with three other executives,
              willfully took action that caused Computer Associates to improperly recognize revenue. In order to meet
              Wall Street quarterly earnings estimates, Computer Associates, at the prompting of the charged execu-
              tives including Mr. Woghin, routinely kept its books open after the end of the quarter to record revenue
              from agreements and sales executed after the end of the quarter. Mr. Woghin signed a Form S-3 and
              Form S-4 amendment that were filed with the SEC even though he knew the statements contained
              therein to be materially false and misleading. Additionally, Mr. Woghin approved backdated contracts,
              drafted a contract with misleading dates and allowed Computer Associates’ legal department to approve
              contracts even though he knew those contracts contained false signature dates and that Computer
              Associates would improperly recognize revenue from these contracts in the previous quarter.

              By aiding and abetting Computer Associates in improperly recognizing revenue, Mr. Woghin violated
              Sections 10(b) and 13(b)(5) of the Exchange Act. Mr. Woghin consented to a permanent injunction
              “prohibiting him from violating the antifraud reporting, books and records and internal control provisions
              of the federal securities laws.” Additionally, Mr. Woghin was permanently barred from serving as an officer
              or director of a public company. Disgorgement and civil penalties against Mr. Woghin are still pending.

              In the Matter of James A. Fitzhenry, Exchange Act Release No. 46870 (November 21, 2002).

              In this action, the SEC made the following findings: James A. Fitzhenry, the former General Counsel
              and Secretary of FLIR Systems, Inc. (“FLIR”), made material misrepresentations and omitted material
              information in certain management representation letters provided to FLIR’s independent auditors in
              connection with FLIR’s 1998 year-end audit. Specifically, FLIR improperly recognized revenues from two
              purported sales to an independent sales representative based on non-binding letters of intent. At the
              request of FLIR’s President and Chief Executive Officer and in connection with the 1998 year-end audit,
              Mr. Fitzhenry attempted to negotiate a binding and unconditional agreement with the sales representative
              but was unsuccessful. A short while later, Mr. Fitzhenry signed two management representation letters to
              the independent auditors that confirmed that the sales representative had a fixed commitment to pur-
     Page 3




              chase the goods. He failed to disclose to the auditors the conditional nature of the transactions.
HRO Alert                                        SEC Increases Scrutiny of Attorneys
              Based on these findings, the SEC found that Mr. Fitzhenry willfully violated Rule 13b2-2 of the
              Exchange Act which prohibits officers and directors of an issuer from making certain materially false or
              misleading statements to an accountant in connection with (a) any audit or examination of the financial
              statements of the issuer required to be made or (b) the preparation or filing of any document or report
              required to be filed with the SEC. Without admitting or denying the SEC’s findings, Mr. Fitzhenry con-
              sented to the entry of an order against him denying him the privilege of appearing or practicing before
              the SEC as an attorney for five years and ordering him to cease and desist from committing or causing
              any future violations of Rule 13b2-2 of the Exchange Act.

              SIGNIFICANCE OF THESE SEC ENFORCEMENT ACTIONS

              While there have been many other SEC enforcement actions against attorneys during the past two years,
              the actions discussed above are important in that the corporate misconduct in question generally seems
              to have been initiated by officers other than the general counsel. Instead of trying to correct or remedy
              the misconduct, the general counsel involved in each of the above actions perpetuated the misconduct
              by failing to report it to the Board or Audit Committee, by filing Exchange Act reports containing the
              misleading disclosure and/or by supporting the misleading disclosure in letters to the independent audi-
              tors. Therefore, these actions appear to involve situations “where attorneys could have avoided prob-
              lems if they had heeded Elihu Root’s advice.”

              PROFESSIONAL RESPONSIBILITY RULES FOR ATTORNEYS

              The federal legislators addressed the role of attorneys in preventing corporate misconduct in Section
              307 of the Sarbanes-Oxley Act, which required the SEC to set minimum standards of professional con-
              duct for those appearing and practicing before the SEC. The SEC implemented Section 307 by adopt-
              ing Part 205, which requires attorneys appearing and practicing before the SEC in the representation of
              issuers to report “up-the-ladder” evidence of a material violation of U.S. federal or state securities laws,
              a material breach of fiduciary duty arising under U.S. federal or state law or a similar material violation
              of any U.S. federal or state law. The possible sanctions against attorneys who violate these professional
              responsibility rules include civil injunctions and monetary penalties, cease and desist orders, officer
              and director bars, censure and temporary or permanent denial of the privilege to appear or practice
              before the SEC.

              Part 205 became effective on August 5, 2003, and to date we are unaware of any SEC enforcement
              action brought against an attorney under these rules. Given the time that it takes for the SEC to inves-
              tigate possible wrongdoing, however, the absence of any enforcement action under these new standards
              should not be taken as an indication of the SEC’s unwillingness to enforce and prosecute under Part
              205, especially in view of the public statements regarding attorney enforcement actions made by SEC
              staff members such as Mr. Cutler’s remarks quoted above. Rather, attorneys would be wise to pay par-
              ticular focus to the Part 205 requirements given the already heightened scrutiny of attorneys by the
              SEC. Additionally, attorneys should be aware that certain proposed provisions of Part 205, most
              notably the “noisy withdrawal” provision, were put out for comment and, although the comment period
              expired with no further rules being released, the provisions have not necessarily been abandoned by the
              SEC and could be approved at some future date.
     Page 4
HRO Alert                                                    SEC Increases Scrutiny of Attorneys
               INTERNAL INVESTIGATIONS — NEW AREA OF SEC FOCUS

               Mr. Cutler concluded his discussion about attorneys as gatekeepers by identifying the role of attorneys
               in internal investigations as a particular area of focus:

                              We have more to do in this area. Based on our current investigative docket, I think you
                              can expect to see one or more actions against lawyers who, we believe, assisted their
                              clients in engaging in illegal late trading or market timing arrangements that harmed
                              mutual fund investors. We are also considering actions against lawyers, both in-house
                              and outside counsel, who assisted their companies or clients in covering up evidence of
                              fraud, or prepared, or signed off on, misleading disclosures regarding the company’s con-
                              dition. One area of particular focus for us is the role of lawyers in internal investigations
                              of their clients or companies. We are concerned that, in some instances, lawyers may
                              have conducted investigations in such a manner as to help hide ongoing fraud, or may
                              have taken actions to actively obstruct such investigations.

               Mr. Cutler’s comments and a recent news story demonstrate the SEC’s increasing focus on both in-
               house and outside counsel who assist companies with disclosures in public filings or with internal
               investigations. A December news article reported that the SEC is threatening to file a complaint
                                                                                                       6
               against a lawyer retained to assist a public company with its internal accounting probe. If com-
               menced, such a lawsuit (like the enforcement actions discussed above) will make clear that a new,
               higher standard for attorneys as gatekeepers is being established by the SEC. The message from the
               SEC that all attorneys, whether in-house or outside counsel, should heed is this: even if you were not
               directly responsible for corporate misconduct, if you were aware of it and did nothing or aided in its
               cover-up, you should expect to hear from the SEC.



               This article is a periodic publication of Holme Roberts & Owen LLP and should not be construed as legal advice or legal opinion on any
               specific facts or circumstances, nor is it intended to address specific disclosure or compliance issues that may arise in particular     cir-
               cumstances or provide an exhaustive discussion of the topics discussed herein. The contents are intended for general informational pur-
               poses only, and you are urged to consult counsel concerning your own situation and any specific legal questions you may have.          For
               further information regarding the topics described herein, please contact any of the persons listed on the first page by telephone at (303)
               861-7000 or by email at the addresses listed.




               7
                   SEC Threatens Ex-Brobeck Lawyer Over Client’s Probe, People Say, Bloomberg News (December 6, 2004).




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