United States: Ethical Issues Often Encountered In Securities Matters

Under the old Model Code, Disciplinary Rule 7- 105 specified:

By 1994, the ABA Model Rules had dropped this language, but some states have retained similar provisions. Moreover, threatening or filing criminal charges in order to gain advantages in civil matters may violate less specific Rules, e. g., 3.1, 3.3, 3.4, 3.5, 3.8, 4.4, 8.4( b) or 8.4( b) or 8.4( e).

In 1992, an ABA ethics committee issued ABA Ethics Opinion 92- 363 (1992). It stated that as long as (i) a criminal proceeding pertains to a civil claim, (ii) the civil claim and potential criminal proceeding are warranted by the law and the facts and (iii) the lawyer does not attempt to exert improper influence over the criminal proceeding, a lawyer may express the possibility of presenting criminal charges against an opposing party in a civil matter to gain relief for a client. E. g., West Virginia State Bar Commission on Legal Ethics v. Printz, 416 S. E. 2nd 720 (W. Va. Sup. Ct. App. 1992) (court found no discipline warranted against attorney who threatened to bring criminal charges against a former employee of the lawyer's client unless the employee repaid embezzled funds).

A fortiori, a lawyer may demand that as part of a settlement, the opposing party refrain from bringing criminal charges against the client, but the required agreement must not violate applicable law.

Threatening disciplinary action against opposing counsel is generally not appropriate (albeit heartfelt), even though not explicitly prescribed by the Model Rules. See ABA Ethics Opinion 94- 83 (1994).

Even the diligent SEC lawyer may topple his/ her halo if zeal overwhelms better judgment. In MacDonald v. Musick, 425 F. 2d 373 (9th Cir. 1970), a prosecutor violated DR 7- 105( A) by adding an additional offense to a criminal complaint after an accused declined the prosecutor's offer to dismiss charges in exchange for a stipulation that probable cause existed for the accused's arrest, which would have precluded a civil proceeding against police officers.

Like prosecutors, legal counsel for corporations dealing with miscreant officers, directors or other employees, as well as counsel for shareholders in derivative class action suits, should take care when alluding to potential criminal proceedings in negotiations to resolve civil liability.

2. Internal Investigations.

When faced with wild publicity about securities fraud and mismanagement, corporations may resort to "internal investigations." These offer demonstrated "upside potential":

1. The company quickly and conveniently obtains information needed to respond and plan optimally in complex and fluid situations;
2. An internal investigation may facilitate cooperation with regulators, who may be more lenient with a company attempting in good faith to weed out troublemakers;
3. Damage exposure in potential civil suits by shareholders may be curtailed by halting misconduct sooner and demonstrating good faith of the corporation;
4. The corporation and its controlling person's coverage position with respect to the company's directors and officers liability insurance carrier may be strengthened; and
5. Adverse publicity impeding the company's business affairs may be mitigated by visible corporate action to rectify problems.

Broker- dealers, given their supervisory responsibilities under Section 15 of the Securities Exchange Act of 1934, may have no choice but to conduct internal investigations upon notice of wrongdoing. E. g., NYSE Rule 342.21, which obligates member firms to "conduct promptly an internal investigation" of specified trades. See also In the matter of John H. Gutfreund, et al., Release No. 34- 31544, 1992 WL362753 (December 3, 1992), in which the SEC opined:

The "downside risk" of an internal investigation is the danger that documents and information which otherwise might have been shielded by an attorney- client privilege will not be protected. See, e. g., Smith v. Alyeska Pipeline Service Co., 538 F. Supp. 977, 980- 82 (D. Del. 1982), aff'd, 758 F. 2d 668 (F. Cir. 1984), cert. denied, 471 U. S. 1066 (1985) (inadvertent waiver revoked privilege as to all information on same subject as mistakenly produced document); Helman v. Murry's Steaks, Inc., 728 F. Supp. 1099 (D. Del. 1990); Weil v. Investment/ Indicators, Research & Management, Inc., 647 F. 2d 18, 24- 25 (9th Cir. 1981).

The work product doctrine, Hickman v. Taylor, 329 U. S. 495 (1947), may shield written statements, memos and notes prepared by a party's counsel in the course of litigation. To be afforded protection, material must be prepared in anticipation of litigation. This may extend to material prepared or collected even before litigation commences. E. g., In re LTV Sec. Litig., 89 FRD 595 (N. D. Tex. 1981) (court held internal investigation sparked by SEC inquiry was in anticipation of litigation, notwithstanding that no civil suit, criminal proceeding, administrative proceeding or other form of legal action had been commenced when the internal investigation began).

Work product protection is not absolute. Unlike material protected by the attorney- client privilege, work product materials may be discoverable when they are essential to the adverse party's prosecution of its case and cannot be otherwise obtained without extreme difficulty.

In a recent high profile case, Kidder Peabody was required to produce interview notes and memos pertaining to the Jett bond trading scheme. In re Kidder Peabody Securities Litigation, 168 FRD 459 (SDNY 1996) 1996 WL 263030 (5/ 17/ 96).

Jett allegedly earned over $10 million in bonuses for trades that caused over $85 million in concealed losses to Kidder. The SEC commenced administrative proceedings to discipline Jett. Kidder and its parent General Electric Co. were sued in a shareholder derivative class action. (See discussion below of conflicts of interest that can arise when attorneys represent several corporate affiliates.) The complaint against parent General Electric was dismissed, but Kidder remained.

The class action plaintiffs demanded production of attorney memoranda recording interviews of Kidder employees by outside counsel for Kidder -- former SEC enforcement chief Gary Lynch of Davis Polk & Wardwell. Kidder claimed that all of the requested documents were protected by the "work product" doctrine and some documents were subject to Kidder's attorney- client privilege.

Plaintiffs, as well as defendant Jett, contended that the documents were not prepared in contemplation of litigation. Moreover, they claimed that any protection was waived when Kidder publicly released the Davis Polk report. In that report, counsel summarized factual findings and recommendations for reform. Plaintiffs contended further that Kidder took advantage of this report in the class action.

The court denied the protection sought by Kidder. It found that Kidder had obviously retained Lynch "in part for the specific purpose of having him conduct an internal inquiry," and "most crucial for [the court's] purposes," that "Kidder would have hired outside counsel to perform such an inquiry even if no litigation had been threatened at the time." Id.

To support its conclusion, the court observed that Gary Lynch was "an ideal choice for Kidder and GE if, as seems obvious, they were concerned to convey the public impression not only of factual innocence, but of their determination to root out any wrongdoing."

As to Kidder's assertion of the attorney- client privilege protecting some interview notes, the court found that "affirmative use of the Lynch report and, by implication, of the underlying interview documents" in the derivative action and related litigation "triggers a waiver of the privilege for those portions of the documents that embody the substance of any statements by Kidder employees interviewed by the Lynch team prior to the issuance of its report." The court further ruled that drafts of the Lynch report remained protected, except for the specific draft supplied by Kidder to the SEC. The court then required Kidder to identify all individuals interviewed by the Lynch team subsequent to the Lynch report, yet declined to allow Kidder attorneys access to notes of Jett's attorney recording Jett's interview sessions with the SEC and Justice Department.

In Upjohn v. United States, 499 U. S. 387 (1981), a strict "control group" test was rejected, and the following factors enumerated to justify applying the attorney- client privilege:

1. The communications were made by employees to the corporate counsel in order for the corporation to secure legal advice;
2. The employees were cooperating with corporate counsel at the direction of corporate superiors;
3. The communications concerned matters within the employees' scope of employment; and
4. The information was not available from upperechelon management.

Application of this test may bear upon the question of which individuals, if any, an attorney representing the corporation may also represent without conflicts of interest.

Not all attorney- corporate client communications are privileged -- particularly when a securities offering is contemplated.

Some courts have presumed that no attorney- client privilege applies to preliminary drafts of securities disclosure documents and communications incident to gathering information included in the prospectus. E. g., In re Grand Jury Proceedings, 727 F. 2d 1352, 1356 (4th Cir. 1984).

Some courts have ruled that the privilege is waived upon publication of the disclosure document. In other words, the attorney- client privilege is retained until a disclosure document is actually published, at which time the privilege is waived for all prior drafts and related work papers. E. g., United States v. Cote, 456 F. 2d 142 (8th Cir. 1972).

Some courts have ruled that the attorney- client privilege is not waived, even after disclosure documents have been published. E. g., SEC v. Texas International Airlines, Inc., 29 FR Serv. 2d 408, 410 (DDC 1979) and Apex Municipal Fund v. N- Group Securities, 841 F. Supp. 1423, 1427028 (SD Tex. 1993) (Documents underwriter supplied counsel to prepare securities offering documents were privileged except as to information in withheld documents that actually appeared in public documents).

An attorney- client privilege may also be waived, when a client intends to commit a crime -- such as securities fraud.

Generally, lawyers in Oregon, Washington or Alaska may reveal client confidences to prevent the client from engaging in at least some types of criminal conduct. See Oregon DR 4101( C)( 3) (A lawyer may reveal "[ t] he intention of the lawyer's client to commit a crime and the information necessary to prevent the crime."); Washington RPC 1.6( b)( 1) (A lawyer may reveal confidences or secrets to the extent the lawyer "reasonably believes necessary . . . [t] o prevent the client from committing a crime . . . "); Alaska RPC 1.6( b)( 1) (A lawyer may reveal information relative to the representation of a client to the extent the lawyer believes necessary "[ t] o prevent the client from committing a criminal or fraudulent act that the lawyer believes is likely to result in death or substantial bodily harm, or substantial injury to a financial interest or property of another.") In Oregon and Washington, there is no limitation as to the type of crime at issue. In contrast, Alaska requires that the crime involve either a likely result of "death or substantial bodily harm, or substantial injury to a financial interest or property of another."

The California approach is more restrictive. On June 3, 1993, the California Supreme Court rejected a proposed new rule, 3- 100, that would have added a duty of confidentiality to California's ethics rules for the first time. California's confidentiality obligation is now solely statutory. See Section 6068( E) of the California Business Professions Code, which has no exceptions allowing disclosure. The rejected rule would have allowed disclosure of information necessary to prevent a client from committing a life- threatening crime.

Some lawyers have assumed that because disclosure of client confidences when a crime is in process is permissive as a disciplinary matter, there is necessarily no obligation or duty to act to which the lawyer can otherwise be held accountable. That is not correct. First, a lawyer cannot knowingly help the client engage in criminal activity. Second, if the applicable substantive criminal or civil tort law pertaining to a matter requires disclosure, a lawyer who does not make disclosure would be at risk as well. Thomas H. Fehn, a California lawyer, demonstrated this point.

In SEC v. Fehn, 97 F. 3d 1276 (9th Cir. 1996) the Ninth Circuit upheld an injunction against Mr. Fehn. Sorting through the "aiding and abetting" rubrick, the court held that Fehn had knowingly participated as a principal in drafting, filing and publishing false quarterly reports of his corporate client.

Fehn not only helped draft and file several misleading quarterly reports, presumably charging the corporation for his legal services, he supplied advice to a related- party individual on that person's assertion of a fifth amendment privilege with respect to quarterly report disclosures by the corporation. In quarterly reports, the corporation had identified the individual, but concealed facts suggesting that the disciplined individual had functioned as the founder and promoter of the company. Query whether Mr. Fehn's legal advice was faithful to his individual client, who asserted the fifth amendment privilege, or his corporate client, which predicated omissions in its quarterly statements upon observation of the individual's Fifth Amendment right.

Fehn represented the corporation, a number of individual managers, and even the underwriter in response to the SEC investigation. Fehn contended that he had no duty to "blow the whistle" on his multiple clients for past violations. The SEC, however, predicated Fehn's liability on his participation in creating and filing the fraudulent documents, along with the "bad faith" inherent in his indefensably bad legal advice. Had Mr. Fehn stuck to advising one client, either the corporation or any one particular individual, he might have faired better.

There is also potential for disciplinary action when an attorney who says something to a third party in the belief that it is true, and who subsequently learns that what he or she said is not true, does not do anything to prevent a third party's subsequent reliance on the known erroneous statement. See The Ethical Lawyer Section 22.15 (OSB CLE 1991 & Supp. 1994). Whenever third parties may rely to their detriment on statements or documents prepared by a lawyer but later known by the lawyer to be false, the lawyer should cut- off any claim of right to rely. This is a proper course of conduct in all West Coast states. See ABA Formal Ethics Op. No. 92- 366.

In Kline v. First Western Government Securities, Inc., 24 F. 3d 480 (3d Cir. 1994) investors sued a law firm for misrepresentations in a tax opinion included in securities offering documents, based on the firm's tax opinion letter. The law firm was exposed to fraud liability, even though it had premised its opinion on facts represented by its client and explicitly warned investors that the law firm had conducted no independent investigation into the accuracy of those facts. Moreover, the court found that the firm had a duty to investigate, to avoid omissions of material fact in the opinion letter and disclose when, by omission, the tax opinion could mislead third parties, such as the investors.

In FDIC v. O'Melveny & Meyers, 969 F. 2d 744 (9th Cir. 1992), the Ninth Circuit exposed a law firm to liability to the former savings and loan client corporation, even though the corporation's directors and officers may have misled the law firm in order to involve the firm in the former client's fraud. This case highlights the need for counsel always to separate a corporation from its directors and officers, no matter how unified the corporate client's management may be.

An attorney may represent several parties. During that representation communications with both parties are covered by the privilege. However, if a subsequent dispute between the two parties arises, either one may compel disclosure of the previously confidential communications. E. g., Seattle Northwest Securities Corp. v. SDG Holding Co., 61 Wn. App. 725, 736- 37 (1991). Counsel should consider the downstream problems that could arise when evaluating whether to represent several clients with not- entirely- common interests.

When several parties need individual counsel, but wish to cooperate in a joint defense, a joint defense agreement can be arranged to maintain confidentiality of communications passing among counsel and parties in the joint defense group. In re Conner Bonds Litigation, CCH Fed. Sec. L. Rep., ¶ 94, 328 (Ed. NC 1989, citing In re: LTV Securities Litigation, 89 FRD 595 (ND text 1981).

A joint defense attorney- client privilege, however, may not be asserted to obtain "blanket protection over an undifferentiated group of documents, but must be specifically asserted with respect to particular documents." In re Conner Bonds Litigation, citing U. S. v. El Paso Co., 682 Fd. 2d 530 (5th Cir. 1982) cert. denied, 466 U. S. 944 (1984).

When a corporation and various of its officers, directors and employees are exposed to federal securities fraud and related state law liability, a joint defense arrangement may work best for lawyers and clients alike. Separate counsel can represent the corporation and each one, or groups of, the individuals. Of course, the company's officers will presume that the "conspiratorial lawyers" are simply helping their buddies to "feed at the federal securities fraud trough" on the assumption that the lawyer buddies will someday reciprocate. In other words, it is the clients (and their insurance carriers) who will pay the heavy price of separate counsel for each exposed person or corporation.

This dynamic, however, can later be altered to the benefit of all. After initial investigations by separate attorneys, clusters of individuals or companies with common interests can be determined by counsel. Lead counsel for groups of prospective defendants can then be established, so that ultimately fewer lawyers are performing redundant services. This practice supplies the benefit of individual representation at the outset, when little is known about common interests and potential conflicts. As more information is gained, at the expense of redundant legal work, the redundancies can be eliminated as additional information reveals fewer conflicts and more common interests. All that is required is that counsel and parties cooperate with each other and control their respective egos. Collectively, attorney fees can be reduced by designating "lead counsel" to spearhead interests common to clusters of defense group members, while leaving individual interests that diverge to each separate counsel.

A prominent example of the resolution of two competing interests -- minimizing legal fees of defendants collectively, but minimizing conflicts of interest to maximize legal zeal -- is a prominent local case, Hines v. Dataline Systems, 114 Wn. 2d 127, 787 P. 2d 8 (1990). In that case, investors had purchased stock in defendant Dataline at different times, creating different exposures as to the corporation and a number of its directors, key officers and its outside counsel. Several key officers shared legal counsel, several investordirectors shared counsel and Dataline's outside counsel had its own attorney. The results of the case emphasized the conflicts that would have been inherent in any one law firm attempting to represent all defendants.

Outside legal counsel for Dataline had behaved admirably, and claims against them were dismissed on summary judgment (after lengthy appeals -- better late than never). Facts in the case revealed that outside directors had the ability to control the corporation, some directors claimed reliance on the advice of legal counsel in fulfilling their duties and legal counsel claimed reliance on statements by officers and directors regarding the key information at issue (the health of the CEO who had been stricken with a brain aneurysm and underwent several surgeries).

A similar case emerged from the Seattle area years ago and also highlighted the very different legal positions of various directors, officers and professionals involved in a corporation's securities transactions. See Burgess v. Premiere Corp., 727 F. 2d 826 (1984) (claims against several directors dismissed based on inactivity due in one instance to health problems and in the other to lack of business acumen).

These decisions highlight the conflicts of interest manifest in any securities offering gone wrong, when liability of the corporation, various directors and officers, legal counsel and other professionals must be assessed.

An example of how conflicts of interest between a corporation and various of its directors could arise, even when federal securities law liability itself exposes no conflict, is Arnold v. Society for Savings Bancorp, Inc., 678 A. 2d 533 (Del. S. Ct. 1996).

In a merger dispute, directors had been shielded from personal liability by their corporation's certificate of incorporation because they had acted in good faith, notwithstanding that disclosure violations had occurred in their company's proxy statement. Under Delaware law, the court refused to hold a corporation directly liable for its directors' breach of disclosure obligations in proxy materials addressing a proposed merger. The court stated that notwithstanding the existence of liability under federal securities law, the court would refrain from disrupting existing relationships and duties among corporations, their directors and stockholders.

When analyzing potential conflicts of interest to assess whether multiple party representation is feasible after a problematic securities transaction, legal counsel should take care to address liability beyond exposure under federal securities statutes.

Rule 4.2 of the ABA Model Rules of Professional Conduct regulates ex parte contacts with adverse parties. When two opposing parties are individuals, adhering to the rule while remaining a zealous advocate is simple.

Observation of Rule 4.2 becomes tricky when opposing parties are large corporations with many existing and former employees.

Some courts have interpreted Rule 4.2 to bar an opposing counsel from interviewing even former employees of an adverse party corporation on matters pertaining to the litigation, unless consent of the opposing party's counsel is obtained. Public Service Electric and Gas Co. v. Associated Electric & Gas Insurance Services Ltd., 745 Fed. Supp. 1037 (DCNJ 1990).

Other courts have rejected this "bright line" test. Some prefer a murkier test, leaving counsel to gamble whether to violate the Code of Ethics or underrepresent the client. For example, in Wright v. Group Health Hospital, 103 Wn. 2d 1982, 691 P. 2d 564 (1984), the Supreme Court of Washington addressed Code of Professional Responsibility Disciplinary Rule 7- 104 (A) and (A)( 1).

In that case, Washington's Supreme Court reviewed various tests used by other authorities to sort out when an attorney adverse to a corporation could interview employees or former employees of the corporation ex parte. The Wright v. Group Health Hospital opinion stated:

103 Wn. 2d at 200.

It is questionable whether the principles on which this decision rests are compatible with the principles underlying the corporation attorney/ client privilege articulated in U. S. v. Upjohn, supra. For example, a low level computer programmer employee knowledgeable of a devastating bug in the corporation's top- selling program could be interviewed by corporate counsel, and under U. S. v. Upjohn, the communication could be privileged.

Ironically, under Wright v. Group Health Hospital, that same employee could be interviewed by opposing counsel in a civil suit in which the defective program was a material issue. Under Wright, counsel for the programmer's corporate employer, having interviewed the employee under an assumption of privilege per Upjohn, would have no right to attend the interview by opposing counsel.

Would the programmer- employee be capable of asserting the attorney/ client privilege at appropriate points during the opposing counsel interview and thereby properly refuse to answer some questions and properly answer others without waiving the employer corporation's attorney- client privilege? Perhaps so, according to Wright v. Group Health.

The Washington Supreme Court held that "it was improper for Group Health to advise its employees not to speak with plaintiffs' attorneys." Id at 103 Wn. 2d 203. The court did state, however, that "This opinion shall not be construed in any manner . . . so as to require an employee of a corporation to meet ex parte with adverse counsel." Id. (emphasis added).

So what happens when adverse counsel without warning contacts low level programmer- employee and starts asking questions about programmer- employee's discussions with counsel for the employer? Presumably, counsel for the corporate employer could prevent such problems by advising all employees to cooperate with opposing counsel, but not agree to interviews with adverse counsel without first contacting counsel for their employer, and arranging for a mutually convenient time to be interviewed by adverse counsel, with employer's counsel attending. Of course, the low level employees may need separate individual counsel for advice on how to proceed in this difficult situation-- to avoid getting sued or fired. Hopefully, counsel for the employer would not attempt to represent the employees individually as well.

Citing Disciplinary Rule 5- 105 under Canon 5 of the Virginia Code of Professional Responsibility, the court in A. H. Robins Co. Inc., Bankruptcy Case No. 85- 01397- R slip. op. (Bankr. E. D. Va., Oct. 29, 1986) disqualified the law firm of Skadden Arps from representing debtor A. H. Robbins because Skadden had supplied, and proposed to continue to supply, legal advice to Aetna Life and Casualty Co. (an adverse party) on a narrow range of unrelated matters. The court cited DR105( A) and (C):

The court also cited Canon 9 which provides "a lawyer shall avoid even the appearance of professional impropriety."

The A. H. Robbins court found no conflict of interest at the time Skadden's representation was challenged. Having found "no actual conflict exists," the court nonetheless ruled:

While Skadden Arps' attorneys may not have appreciated the "officious intermeddler" approach of the A. H. Robbins bankruptcy judge, attorneys in other cases might call it prophetic.

In a Virginia federal court proceeding, a contractor corporation attempted to block a former subsidiary, which had since become an independent corporation, from disclosing allegedly attorney- client privileged information in the former subsidiary's possession. In re Grand Jury Subpoenas, 89- 3 and 89- 4, 734 Fed. Supp. 1207 (E. D. Va. 1990).

The contractor corporation had secured a U. S. Army contract. While the contract was in effect, one of the contractor's internal divisions was performing on it. The division later became a wholly owned subsidiary, after which it was sold and was no longer affiliated with its former contractor parent.

Subsequently, grand jury subpoenas were issued to the former subsidiary. The subsidiary notified the government that it would waive attorney- client privileges and produce all responsive documents. The contractor sought to quash the subpoenas, contending that it retained standing to assert the attorney- client privilege and work- product protection applicable to the subpoenaed documents. The court found that the power to invoke or waive a corporate attorney- client privilege was dependent on corporate control. When control of the subsidiary was transferred to new management, the power to invoke or waive the attorney- client privilege and work- product protection passed to the new management of the former subsidiary.

New management chose to waive the privilege. The court stated that new management needed the freedom to fulfill fiduciary duties to act in the former subsidiary's best interest. New management's freedom necessarily included the ability to invoke or waive the attorney- client privilege of the subsidiary corporation without interference from the former parent.

On appeal, the Fourth Circuit saw the issue from a different angle. In re Grand Jury Subpoenas 89- 3 and 89- 4, 902 F. 2d 244 (4th Cir. 1990). The Fourth Circuit partially reversed the lower court ruling and held that the former subsidiary could not produce some of the subpoenaed documents. It held that a joint defense privilege applied, covering both attorney- client and work- product material and that the joint defense privilege was not restricted to co- defendants or coparties in a particular ongoing or contemplated proceeding. Id, 902 F. 2d at 249:

Id.

Discussing a number of joint defense privilege cases, the Fourth Circuit stated,

Id., 902 F. 2d at 248- 49 (other citations omitted).

When evaluating conflicts in representation pro and con brother- sister corporations, courts have not always applied disciplinary rules as stringently as the A. H. Robbins bankruptcy court did with unrelated adversaries. E. g. Pennwalt Corp. v. Plough, Inc., 85 FRD 264 (D. Del. 1980). In that case, Dechert Price, Pennwalt's counsel, had also represented a sister corporation, Scholl, of the opposing party Plough, concurrent with Dechert Price's representation of Pennwalt in the pending litigation. Plough sought to disqualify Dechert Price. The court declined to apply a "per se" rule, and applied a "substantial relationship test," under which the court could "ensure the absolute and unfettered loyalty" of counsel to both clients. Id. 85 FRD at 269.

The Pennwalt court held that representation of a corporate client did not, by definition, establish an attorney- client relationship with any or all affiliates of the client "for the simple factual reason" that the attorney "has never represented" the sister corporation. Id. at 268. The court also rejected a "prophylactic rule for disqualification" in such circumstances because "vigorous advocacy cannot change the fact" that the corporate client "is a corporate entity distinct from" the sister corporation. Id. Instead, the Pennwalt court ruled that to resolve the disqualification issue, courts must "carefully sift all of the facts and circumstances . . . and weigh the same against the specific goals and objectives of the Canons." Id. at 269 (quoting Akerly v. Red Barn System, Inc., 551 F. 2d 539, 543 (3d Cir. 1977).

The Pennwalt court's "sifting" of the facts in that case is instructive to all counsel weighing the benefits of multiple representation (earn additional fees) against the burdens of subsequent regurgitation of fees and defense of malpractice lawsuits. The court noted that the headquarters of Scholl, the sister corporation, along with its own personnel and legal departments, previously located in Chicago, were soon to be merged in a single office in Memphis, Tennessee. 85 FRD at 272- 73. Scholl and Plough, both subsidiaries of a common parent, were to be "placed in the same division, with the CEO of the division sitting on both boards of directors, and more importantly, the upcoming headquarters consolidation with the personnel of one legal department under what would be the active supervision of the same attorney." Id. at 272. The court observed that "[ i] t is difficult to perceive how there could be free, unfettered communications between [Dechert Price] and Scholl after the merger" of the two sister corporations into a single location. Id. at 273.

Nonetheless, the court refused to disqualify Dechert Price because before the merger of the sister corporations no conflict existed, and the firm withdrew from representation of Scholl before the merger took place. Moreover, no substantial relationship existed between the pending litigation and Dechert Price's representation of Scholl. Id. at 270- 71, 273. Other cases addressing this issue include Hartford Accident and Indemnity Co. v. RJR Nabisco, Inc., 721 F. Supp. 534, 53839 (SDNY 1989); In re Wingspread Corp., 152 BR 861 (Bankr. SDNY 1993); U. S. v Nabisco, Inc., 117 FRD 40 (EDNY 1987); Gleuck v. Jonathan Logan, Inc., 653 F. 2d 746, 749 (2d Cir. 1981); Teradyne, Inc. v. Hewlitt Packard, 1991 WL 239940 (ND Cal. 1991) (unreported case); Klein v. Churchill Cole Corp., 612 F. Supp. 247, 242 (SDNY 1985); Stratagem Development Corp. v. Heron Int'l. NV, 756 F. Supp. 789, 792 (SDNY 1991) (counsel disqualified "because the liabilities of a subsidiary corporation directly affect the bottom line of a corporate parent").

In Ethics Opinion No. 1989- 113, the California State Bar observed, "[ i] t is the corporate entity actually represented, rather than any affiliated corporation, which is the client." 1989 WL 253261.

In that opinion, the California Bar addressed the following issue:

The California Bar's Standing Committee on Professional Responsibility and Conduct concluded:

California Ethics Opinion 1989- 113, 1989 WL 253261, at 1. "The sole client is the corporate entity actually represented":

Id. at 2- 3. An attorney "owes undivided allegiance only to the corporate entity which he or she represents rather than any affiliated persons or entities." Id. Moreover, "persons who choose to become incorporated may not evade the consequences of corporate separateness when that would suit their convenience." Croxton v. Crowley Maritime Corp., 817 P. 2d 460, 464 (Alaska 1991) (quoting H. Henn & I Alexander, Laws of Corporations Section 149 at 357 (3d Ed. 1993).

When a securities transaction has "blown up," outside counsel in firms that have represented several affiliated corporations must face the possibility of being disqualified altogether from representing any. A rule of thumb to ascertain affiliate conflicts, based on the cases and ethical opinions selected above, would be to track the flow of confidential information from each of the affiliated companies to the attorney. If the attorney has in the past represented a single corporation, and advised in- house counsel or top executives not to disclose confidential information obtained from affiliates not represented by outside counsel, then the attorney may handle matters adverse to the affiliated corporations not previously represented. Once an outside counsel has obtained information from a corporate client that flowed from the confidential records of an affiliate, however, it will be very difficult to isolate the confidential information from an adverse matter.

Another rule of thumb is the constitution and location of top management of each corporate affiliate. It is easier to observe confidentiality restrictions among affiliates when they have boards of directors that do not overlap (e. g., no common directors), their officers are not common and their headquarters are in different geographic locations. Moreover, since information tends to flow up, rather than sideways, it will also be easier for counsel to observe strict confidentiality barriers when counsel represents a sister corporation and proposes to handle a matter adverse to a brother company. When counsel has represented a parent, it will be difficult to demonstrate that information did not flow up from an adverse subsidiary to the client parent.

A recent Ninth Circuit case exemplifies the pitfalls for the cagey attorney who attempts to outfox federal prosecutors -- particularly to protect client funds so that fees can be paid.

In SEC v. Interlink Data Network of Los Angeles, 77 F. 3d 1201 (9th Cir. 1996) the Ninth Circuit dealt with the government's ability to freeze funds in a lawyer's accounts. The opinion highlights the difference between advance deposits for the payment of future fees versus preliminary payment of flat fees (old- fashion "retainer"). Advance fee deposits cover fees that will not be earned until future legal services are provided. These deposits are the client's money and must be placed in the firm's trust account. Failure to place such funds in a trust account can lead to severe disciplinary action. E. g., Oregon DR 9- 101( A); Washington RPC 1.14( a); California Rule of Professional Conduct 4- 100( a).

On the other hand, funds that are understood to be earned when received must not be placed in a trust account or discipline will result. Moreover, a written agreement is required whenever a non- refundable fixed fee is to be collected in advance of performing work. See In re Gastineau, 317 Or. 545, 857 P. 2d 136 (1933). If not a definitive agreement signed by all, at least a letter acknowledging the nature of the advance non- refundable fixed fee payment is necessary.

In establishing the amount of an advance non- refundable fee deposit (such that the government could not freeze it), the lawyer should keep in mind that a fee agreement that appears reasonable at the outset but proves excessive in retrospect may obligate the lawyer to refund or forego the excessive portion of the fee. Id.

Ninth Circuit precedent may thwart assertion of a privilege by an attorney and client seeking to avoid producing their fee arrangement -- such as an agreement to evade a freeze on client funds. E. g., Tornay v. United States, 840 F. 2d 1424, 1428 (9th Cir. 1988) (fee information not privileged unless in exceptional case disclosure would unavoidably reveal other privileged information).

Be careful what you ask for, you may just get it.