Reporting “Up” Obligations

Michael W. Peregrine and William P. Schuman are partners at McDermott Will & Emery LLP. This post is based on a McDermott Will & Emery publication authored by Mr. Peregrine, Mr. Schuman, Eugene I. Goldman, and Kelsey J. Leingang. The views expressed herein do not necessarily reflect the views of McDermott Will & Emery LLP or its clients.

A recent decision of a state bar disciplinary commission has important implications for the risk oversight obligations of the governing board. According to various media reports, the Michigan Attorney Grievance Commission declined to pursue six former General Motors Co. in-house counsel for failing to disclose to consumers the safety risks of an alleged defective automotive product. [1] The reporting practices (or lack thereof) by members of the GM in-house counsel department were a major part of that company’s broader ignition switch controversy. As such, the circumstances surrounding the Commission’s action are a useful reminder on how in-house counsel can support the flow of material information to the board, and enable the board to discharge its oversight responsibilities more effectively.

The Grievance Commission’s decision involved critical issues relating to the application of Section 1.13(b) (Organization as a Client) and Section 1.6 (Confidentiality of Information) under the Model Rules of Professional Conduct—ethical standards with significant relevance to in-house counsel of companies in highly regulated industries. In general, these Rules place certain reporting and confidentiality obligations on counsel once becoming aware that a corporate agent is engaged in action, intends to act or refuses to act in a manner 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 that is likely to result in substantial injury to the organization.

Such knowledge may require counsel to refer the matter to higher (and sometimes the highest) authority in the corporation—or, if referral has been futile, may allow counsel to reveal confidential client information to external sources (but in tightly prescribed circumstances). Note, however, that these reporting “up” and “out” obligations vary from state to state. For example, some states permit external reporting if necessary to prevent the risk of death or bodily harm. Other states (e.g., California) strictly proscribe “reporting out” (except in extremely limited circumstances).

The Securities and Exchange Commission has promulgated similar rules for attorneys appearing and practicing before the Commission. [2] For these attorneys, the Rules: (a) require them to report evidence of a material violation of the securities laws—or a breach of fiduciary duty—to the chief legal officer of the issuer and, in certain circumstances, to the governing board; and (b) permit them—in certain circumstances—to disclose outside the organization confidential information relating to the lawyer’s appearance before the Commission, without issuer authorization. [3] Such disclosure would typically be appropriate only in the most extreme circumstances.

Clarity on internal management-to-board reporting is critical to positioning corporate governance to exercise compliance and risk oversight, among its other major responsibilities. The ability of board and committee members to be responsive and attentive fiduciaries depends in large part on their ability to receive key risk and compliance information in a manner, context and time frame that are meaningful to the board/committee. A fulsome understanding of counsel’s professional “reporting up” and “out” obligations will serve not only to sharpen expectations of counsel’s duties, but also to support the board’s critical oversight role.

According to media reports, the Michigan issue arose in the context of a complaint filed by the father of an alleged ignition switch victim. The basic allegation was that certain GM inside counsel violated their professional obligations by failing to make a public disclosure of the ignition switch issues of which they were purportedly aware. (GM’s internal investigation, conducted by former U.S. Attorney Anton Valukas, concluded that the GM general counsel was not informed by the subordinates of the ignition switch issues until very shortly before the problems became public.) [4] According to media reports, the Michigan Grievance Commission declined to pursue the complaint. Likely critical to this determination was the fact that Michigan professional rules do not require counsel to disclose confidential information necessary to warn consumers at risk of death or bodily harm. [5]

It is uncertain whether the Grievance Commission was also called upon to consider sanctions for subordinate counsel’s failure to report switch issues to the GM general counsel. As one leading ethics observer noted, it may have been that GM did not file a separate complaint with the Commission in connection with the reporting lapse. [6]

This Michigan decision underscores the important confluence of corporate governance and professional responsibility. The application of Rules 1.13(b) and 1.6 has been of particular significance since the advent of Sarbanes-Oxley. Following the recommendation of the American Bar Association, many state rules of professional responsibility were amended to clarify and expand these Rules to embrace heightened corporate responsibility.

The amendments to Rule 1.13(b) and 1.6 served to (a) refine the role of lawyers in supporting the flow of information and analysis on legal compliance matters within the corporation they represent; and (b) clarify the limitations placed on the lawyer’s ability to disclose to third parties confidential information with respect to the client’s potential criminal or fraudulent conduct. The expectation was that the new rules would help prevent the types of internal oversight, reporting and disclosure failures which contributed so heavily to the notorious pre-Sarbanes corporate scandals. [7]

The Michigan decision provides a useful opportunity to remind the board about the relationship between its risk oversight responsibilities and in-house counsel’s professional responsibilities regarding “reporting up” and “reporting out.” Greater board awareness of the circumstances in which the company’s lawyers are required to make internal (and external) reporting of major risks serves at least four key purposes: first, it confirms the critical role that in-house counsel are expected to perform in support of the board’s oversight responsibilities; second, it impels the board to remove any perceived barriers to counsel’s ability to report to the board; third, it allows the board to set clear expectations with counsel regarding the exercise of these reporting obligations; and fourth, it may prompt the board to supplement these professional obligations with additional, corporation-specific reporting and notification protocols.

The decision may also serve as a valuable reminder to in-house counsel to confirm their understanding of the requirements of Model Rules 1.13(b) and 1.6 in the states in which members of the in-house counsel department are licensed and practice. It is particularly important to understand the steps that serve as a predicate to reporting to higher organizational authority, and whether the applicable Rule contemplates “reporting out” or “noisy withdrawal.” Also important is an understanding of the proper interpretation of key Rule 1.13(b) “trigger events,” e.g., what constitutes “known”; “likely to result in substantial injury to the organization”; “as is reasonably necessary in the best interest of the organization”; and “if warranted by the circumstances.”

These requirements may differ from both the Model Rules, and from each other, depending upon the relevant jurisdiction. California’s strict limitations on the “reporting out” option is a good example (i.e., permitting disclosure of a client’s confidential information only to prevent a criminal act that the attorney reasonably believes would result in the death of, or substantial bodily harm to, an individual). [8] In addition, there is also the potential for conflict between the interpretation of the state rules, and the SEC’s Section 205 Rules (particularly with respect to the “reporting out” option”). Risk oversight principles should prompt institution of corporate governance procedures that seek to assure counsel’s familiarity with the applicable rules.

The nexus of the Michigan decision to the GM controversy also commends two additional reporting refinements. First, an organization’s general counsel should be encouraged to adopt specific guidelines on the types of issues that should be elevated to the general counsel’s attention from associate general counsel and the entire in-house legal group. Similarly, the associate general counsel should be instructed to request the general counsel’s guidance when legal and risk processes are not operating in a timely and effective manner.

Summary

Board oversight of risk and other key matters will be enhanced when there is a shared governance/management understanding of the in-house lawyer’s upstream reporting obligations. These obligations support effective governance practices by supplementing existing risk reporting mechanisms, and by providing a “safety valve” in the extraordinary instance of leadership inattention.

The recent decision of the Michigan Attorney Grievance Commission in the GM matter provides a current and compelling platform from which the board and senior management can discuss the “reporting up” and “out” obligations of in-house counsel, and how those obligations can best be brought to bear in support of effective risk oversight practices.

Endnotes:

[1] Sue Reisinger, Fired GM Lawyers Won’t Face State Discipline, Corp. Counsel (Mar. 29, 2016), http://www.corpcounsel.com/id=1202753623655/Fired-GM-Lawyers-Wont-Face-State-Discipline; Mike Spector, Michigan Won’t Discipline Lawyers in GM Ignition Case, Wall St. J. (Mar. 27, 2016), http://www.wsj.com/articles/michigan-won-t-discipline-lawyers-in-gm-ignition-case-1459080002.
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[2] Standards of Professional Conduct for Attorneys, 17 C.F.R. Part 205.
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[3] 17 C.F.R. § 205.3(d)(2).
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[4] Anton R. Valukas, Report to Board of Directors of General Motors Company Regarding Ignition Switch Recalls (May 29, 2014), available at http://www.nytimes.com/interactive/2014/06/05/business/06gm-report-doc.html.
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[5] MI Rules of Prof’l Conduct R. 1.6.
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[6] See Spector, supra note 1.
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[7] Am. Bar Ass’n Task Force on Corp. Responsibility, Report of the American Bar Association Task Force on Corporate Responsibility, 59 Bus. Law. 145 (Nov. 2003).
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[8] CA Rules of Prof’l Conduct R. 3-100.
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