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Matt T. Morley Rene R. Sorell

Michael A. Smith

Thursday, April 17, 2003

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Overview ♦ Whistle Blowing and Bounty Hunting ♦ United States

− Qui Tam − SEC Final Rule Regarding Professional Conduct for Lawyers

♦ Examples of how U.S. rules operate ♦ Canada

− Law Society of Upper Canada Professional Conduct Rules − OSC Cases

♦ Where Are We Going?

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The History of Whistle Blowing and Bounty Hunting WHISTLE BLOWING BOUNTY HUNTING • Unsavory connotations associated with

whistleblowers: tattle tale, snitch, stoolpigeon

• provides inducements to expose wrongdoing

• Significant history in the United States but little history in Canada

• Supplements government enforcement activity with active private intervention compared to passive whistle blowing intervention

• U.S. history part of a trio of public enforcement measures including whistle blowing, bounty hunting and private enforcement of many public laws such as securities laws

• Bounty hunters frequently participate actively in prosecuting offenders

• Historical theory: - Whistleblowers conserve government resources - Whistleblowers can also often be wrongdoers turned informant in order to win immunity from prosecution - For the pure of heart, it is often associated with “patriotism”

• Historically - Sovereigns offered bounties in the form of part of the estate of an opponent - Historical “wanted dead or alive” approaches

• False Claims Act relating to defence contractors where the Act authorizes private parties to bring actions in the name of the government against violators

• Protecting whistleblowers is critical - Common law protections for employees reporting criminal activity of fellow employees

- Sarbanes-Oxley section 806 prohibits harassing or demoting employees who provide information assisting in investigations under certain sections of SOX

• Contemporary bounty hunters employ lawyers

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Examples of Legislation WHISTLE BLOWING BOUNTY HUNTING • U.S. Statutes • - Internal Revenue Service reward program

- Section 307 of the Sarbanes-Oxley Act - 1988 Insider Trading and Securities Fraud Enforcement Act

In the U.S., retaliation against a whistleblower not covered by a special statutory protection has been a matter of state law, and the level of protection afforded to whistleblowers in this way has been relatively weak.

• Canadian Statutes - Money Laundering Act

• More modern examples of bounty hunting include statutory provisions under U.S. competition laws which, for example, encourage private prosecution by trebling damages for various forms of practices recoverable in civil suits by private litigants.

• Under new amendments to the Ontario Securities Act, the Commission has the power to order all amounts obtained by non-compliance (not just profits) to be disgorged. See para 127(1)10 of Securities Act (Ontario), which came into effect April 17, 2003.

• SEC Rule requires an attorney to report evidence of any material violation of securities laws or breach of fiduciary duty or other similar violation to the general counsel or chief executive officer of the company. If such person does not appropriately respond, the attorney is to report the evidence to the Audit Committee.

• Bounty hunting advances today include the development of modern class action litigation enabling otherwise uneconomically small private enforcement actions to be brought by enterprising lawyers who, with contingent fees, are very much part of the bounty hunting environment in the United States.

• Qui Tam suits.

Ontario law will eventually include private right of action enabling private sector recoveries against companies and the defendants associated with the production of misleading statements and documents

- Primary deterrence purpose with a private action recovery inducement

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United States ♦ Qui Tam ♦ SEC Rule Regarding Professional Conduct for Lawyers

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♦

An example of U.S. Bounty Hunting Legislation – Federal False Claims Act

♦ Basic Concept − statutory provision that allows private citizens – whistleblowers – to bring lawsuits

on behalf of government against persons who use government funds in a fraudulent way

− allows whistleblowers to receive a portion of any funds that are recovered by the qui tam lawsuit

− anyone can file a qui tam lawsuit

♦ Federal False Claims Act − originally enacted in 1863 to fight defence contractor fraud − Congress amended Act in 1943 to provide for reward to the whistleblower − originally a person could not file a qui tam lawsuit if the government had prior

knowledge of the charges − Congress amended Act again in 1986 as follows:

♣ raise the amount of the reward ♣ raise the amount of the damages that could be imposed on defendants ♣ today a person can file a qui tam lawsuit even if the government had prior

knowledg

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Qui Tam Cases ♦ Qui Tam Case Types

− mischarging − product and service substitution − false negotiation or defective pricing − false certification of entitlement for benefits

♦ Whistleblower Protections − 1986 amendment protects the whistleblower from:

♣ harassment ♣ demotion ♣ wrongful termination

− extends to anyone who investigates, testifies, initiates, or assists

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SOX section 806 ♦ New U.S. Federal Cause of Action

− Employees of public companies − Cannot be discharged, demoted, suspended, harassed for providing information

or otherwise assisting a law enforcement investigation − Criminal liability for retaliation against whistleblower – SOX 1107

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SEC Final Rule – What Categories of Attorneys are Affected?

♦ Basic Concepts − Final Rule designed to implement section 307 of Sarbanes-Oxley − standards of professional conduct apply to attorneys appearing and practicing

before the SEC in any way in the representation of issuers − extension of comment period regarding originally proposed “noisy withdrawal”

provisions with new alternative proposal

♦ Lawyers Affected

− U.S. Based “Outside-Lawyers” ♣ yes, if attorney-client relationship ♣ yes, if they have notice that the documents they are preparing or assisting

in preparing will be filed with or submitted to the SEC

− Foreign Lawyers ♣ no, if not admitted in the U.S. ♣ no, if does not advise clients regarding U.S. law ♣ yes, to the extent they are advising on U.S. law

• UNLESS, they provide such advice in consultation with U.S. counsel

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SEC Final Rule – What is the Test and the Response? ♦ The Test and Reporting Requirements

− Material Violation Reporting ♣ attorney must report evidence of a material violation

• objective standard imposed • credible evidence needed; it must be “unreasonable, under the

circumstances, for a prudent and competent attorney not to conclude that it is reasonably likely that a material violation has occurred, is ongoing or is about to occur”

− “Up-the-Ladder” Reporting Options ♣ within the issuer to chief legal officer or CEO ♣ if chief legal officer or CEO does not respond appropriately

• report to audit committee; or • committee of independent directors; or • “Qualified Legal Compliance Committee (QLCC)

♦ issuer established board sub-committee ♦ must include at least one member of audit committee ♦ must include a minimum of two independent directors ♦ outside-lawyers can report to this committee; or

• full board of directors

− Scope of Unauthorized Disclosure by Lawyers ♣ consent of issuer client not required ♣ whistleblower can reveal confidential information related to representation ♣ required threshold for disclosure

• prevent issuer from committing a material violation likely to cause substantial financial injury to the financial interests or property of the issuer or investors

• prevent issuer from committing an illegal act • rectify the consequences of a material violation or illegal act in which

the attorney’s services has been used

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Relationship of SOX Rule to Bar Conduct Rules and Private Rights of Action

♦ State Bar Professional Conduct Rules ♣ SEC Rule governs in the event of a conflict with state law ♣ does not pre-empt the ability of a state to impose more rigorous obligations

if not inconsistent with the Rule

♦ No Private Cause of Action ♣ no private cause of action arising out of the Rule ♣ only the SEC can enforce compliance

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SEC Final Rule – “Noisy Withdrawal” ♦ Original Proposal

− Outside Counsel ♣ If attorney suspects that a material violation is likely to result in substantial

injury to the issuer or its investors, then there is required “up the ladder” reporting

♣ If attorney reports “up the ladder” and is not satisfied, then attorney required to: • withdraw or cease from representing the issuer and indicate that the

withdrawal is based on “professional considerations” • notify in writing the SEC • disaffirm any opinion, document, representation, etc. that may give rise

to the material violation ♣ does not apply if QLCC mechanism utilized

− In-house Counsel ♣ Same circumstances as above ♣ If attorney reports “up the ladder” and is not satisfied, then attorney

required to: • notify the SEC within one business day that he will disaffirm any

opinion, document, representation, etc. that may give rise to the material violation

• disaffirm in writing to the SEC regarding such opinion, document, affirmation or similar bi-product

• no requirement to resign from in-house position ♣ does not apply if QLCC mechanism utilized

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SEC Final Rule – “Noisy Withdrawal” ♦ Revised Proposal

− Outside Counsel ♣ withdraw or cease from representing the issuer indicated that the

withdrawal is based on professional considerations ♣ notify the issuer in writing

− In-house Counsel ♣ cease forthwith from any further participation in the matter in question ♣ notify the issuer in writing that it has not provided a timely and appropriate

response to the report of evidence of a material violation

− Issuer Response ♣ Must publicly disclose the attorney’s withdrawal or written notice ♣ Report on 8-K, 20-F or 40-F within two days of receiving attorney’s notice

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Example: Cross-Border Issuer Does a US Public Offer The People of Big Oil Co.

♦ Big Oil Co. is a large Canadian oil and gas company, headquartered in Calgary, but with significant operations in Canada, the United States and South America. It is listed for trading on the TSX and the NYSE. It has the following three lawyers on staff:

♣ Mary, the General Counsel, located in Calgary and licensed to practise law

in Alberta only;

♣ Sam, an Assistant General Counsel, located in the company’s Houston office and licensed to practise law in Texas only;

♣ Sue, another Assistant General Counsel, responsible for Canadian and US compliance work, located in Calgary and licensed to practise law in Alberta and New York;

Pete is the Vice – President, Business Development of Big Oil Co. and Jane is Big Oil Co.’s external U.S. counsel.

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Example: Cross-Border Issuer Does a US Public Offer The Facts

♦ Big Oil Co. is in the process of preparing a registration statement in order to publicly offer some high yield notes in the U.S. The Vice President, Business Development, of Big Oil Co., Pete, is leading the prospectus drafting in Houston and is assisted by Sam. Mary and Sue attend the drafting session from Calgary by conference call. During the course of one of the prospectus drafting sessions in Houston with the underwriters, Pete presents a set of oil and gas reserve numbers that Sam, Mary and Sue know are inflated significantly. Mary and Sue say nothing. Sam confronts Pete during a break and is told to “be quiet or the deal will crater and you’ll be fired”. One of the U.S. attorneys acting for the underwriters overhears Pete’s and Sam’s discussion. Sam does not mention anything during the remainder of the drafting session. Pete’s set of oil and gas reserve numbers get put into the draft prospectus. Later that evening, Sam calls Big Oil Company’s external U.S. counsel, Jane, who has been assisting with the offering, and informs her of Pete’s deception.

♦ Back in Calgary, Mary and Sue, also fearing the loss of their jobs if the deal doesn’t go forward, agree not to mention Pete’s deception to anyone. Indeed, Mary has decided to use Pete’s falsified oil and gas reserve numbers as part of her response to a recent enquiry from the Ontario Securities Commission regarding the accuracy of Big Oil’s operating data contained in previous filings with the OSC.

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Example: Cross-Border Issuer Does a US Public Offer The Questions:

1. What are Sam’s, Big Oil’s US internal counsel, whistle blowing obligations?

2. If Sam does nothing, does Mary, Big Oil’s Canadian internal counsel, have any whistle blowing obligations?

3. If Sam and Mary do nothing, does Sue, Big Oil’s dual-qualified internal counsel, have any whistle-blowing obligations?

4. Does the U.S. attorney for the underwriters have a whistle-blowing obligation?

5. What are Jane’s, Big Oil’s external U.S. counsel, obligations?

6. What sort of trouble is Mary getting herself into with the OSC?

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Canada ♦ Law Society of Upper Canada Professional Conduct Rules ♦ OSC Cases

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Professional Conduct Requirements ♦ Basic Duties as a Lawyer

− Lawyer has a duty to carry on the practice of law and discharge all responsibilities to clients, tribunals, the public, and other members of the profession honourably and with integrity – Rule 1.03(a)

− Lawyer shall not knowingly assist or encourage any dishonesty, fraud, crime or illegal conduct – Rule 2.05(5)

− Lawyer must hold in strict confidence client confidential information – Rule 2.03(1) ♣ few exceptions:

• disclose if required by law or by order of a tribunal – Rule 2.03(2) • imminent risk to an identifiable group or person of death or serious

bodily harm – Rule 2.03(3) • if alleged lawyer or lawyer’s associates guilty of misfeasance involving a

client’s affairs – Rule 2.03(4) ♣ nevertheless, the lawyer “shall not disclose more information than is

required” – Rules 2.03(2)-(4). − lawyer’s duties are owed to the organization as a whole; not individual officers,

employees or agents of the organization. Therefore, can report up the line as high as the board of directors if there is no reaction.

♦ Justified or Permitted Disclosure of Confidential Information − If confronted by client misconduct

♣ ask that the matter be reconsidered ♣ up-the-ladder reporting is permissible if not satisfied ♣ if still not satisfied, may be appropriate for the lawyer to resign – Rule 2.09

♦ Failure to adhere to these Duties can result in Law Society discipline proceedings − censure − suspension − revocation of licence

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Law Society v. SEC ♦ “Noisy Withdrawal”

− SEC requirement is at odds with Law Society’s prohibition on any form of disclosure of confidential information

− Law Society does not permit disclosure to prevent a client’s fraudulent act or a client’s act that the lawyer reasonably believes will cause serious financial loss

− client’s confidential information cannot be waived by the lawyer ♣ R. v. McClure [2001] 1 S.C.R. 445 at 503.

♦ Whistle Blowing − money laundering legislation imposed whistle blowing reporting obligations to the

federal government for suspicious activity − withdrawn by federal government − law universally viewed as breach of Charter of Rights and Freedoms

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OSC Cases ♦ Canadian Tire (1987)

− attempt to circumvent a coattail provision − OSC takes notes of law society Rule 1 and applies it to the securities context

♦ Tulk and Orsini (1991) − attempt to formulate a technical way to circumvent OSC rules − law society does not have exclusive jurisdiction in regulating lawyers

♦ Standard Trustco (1992) − procedure to be followed by boards of directors in the face of financial regulators’

concerns − limits on the extent to which boards of directors may rely on management − duties and responsibilities of directors and officers

♦ Osgoode Holdings (1992) − bad preparation of documents − OSC does not censure lawyer but states it is deeply troubled

♦ YBM (Lawrence Wilder) (2001) − misleading statements to the OSC on behalf of client by failing to fully disclose − found guilty by OSC − Divisional Court held that the OSC can involve itself in the professional conduct of

lawyers

♦ ATI Technologies (Sally Daub) (2003) − misleading chronology of events in connection with investigation

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Where Are We Going? ♦ lawyers can no longer rely on client confidentiality ♦ clients can no longer rely on attorney confidentiality ♦ must serve several masters

− OSC − SEC − State/Provincial Bar Associations