Client Fraud And The Securities Lawyer'SDuty Of Confidentiality

I. INTRODUCTIONUnder the current Model Rules of Professional Conduct and state codes of professional responsibility, there exists a conflict between the lawyers' duty of confidentiality to their clients and the lawyers' duty to disclose an ongoing fraud or other crime. That conflict raises a number of critical ethical issues for the securities practitioner as well as the bar in general. Under what circumstances does a lawyer have the obligation, or at least the discretion, to disregard the attorney-client privilege and the duty of confidentiality owed to a client when the lawyer knows that the client is engaged in the commission of a fraud? May the lawyer continue the engagement on behalf of the client or must he or she resign? If the lawyer resigns, must he or she remain silent and observe the continuing commission of a crime, or does the lawyer have a duty, or at least the right, to warn the intended victim and to assist in preventing or rectifying the injury?These questions have been hotly debated within the legal profession in general and within the securities bar in particular for a number of years. They have been raised in enforcement actions instituted by the Securities and Exchange Commission (SEC),(1) as well as in private actions under the federal securities laws.(2) They are now being raised again in no uncertain terms by the Office of Thrift Supervision which has arisen from the ashes of the savings and loan debacle with the mission of recouping as much of the losses from failed institutions as possible.(3) This agency has sought to fulfill its mission by making claims against the legal and accounting firms that served the insolvent institutions--claims that often are predicated on novel concepts of a lawyer's duty.(4)II. ABA MODEL RULE 1.6 AND FINANCIAL FRAUDSLawyers frequently find themselves struggling with the conflict between their duty to keep client confidences and their duty to avoid participation in a fraud. For the securities lawyer that conflict may become particularly severe when the lawyer learns that the disclosures disseminated by a publicly held client are materially false ad misleading. For example, suppose that in a merger of a publicly held company the lawyers for the company that is being acquired learn prior to closing that the shareholders have approved the merger on the basis of financial statements showing substantial earnings when in fact the company had substantial losses. Under what circumstances can the firm continue to represent the client in connection with the merger? Does the firm have any obligation to disclose the facts to the acquiring company and its shareholders who approved the merger on the basis of materially false and misleading financial statements?A threshold issue may well be what law of professional responsibility applies. This question, like all choice-of-law issues, may be complicated by the complexity of many modern legal transactions. The deal may have been negotiated in West Virginia with the closing scheduled to take place in Virginia. The parties may be incorporated under the laws of Maryland and Delaware and have their principal places of business in New York and New Jersey. The law firm may be a District of Columbia firm with offices in five jurisdictions, and the individual lawyers may be members of the bar in various jurisdictions.Under these circumstances, the quickest way to get a handle on the issue might well be with the ABA Model Rules of Professional Conduct (Model Rules). These rules have been adopted in some form or another by 38 jurisdictions, albeit with substantial variations among them.(5)Rule 1.6 of the Model Rules governs the confidentiality of client information.(6) The rule states that a lawyer shall not reveal information relating to the representation of a client without the client's authorization, except when a lawyer reasonably believes that it is necessary to prevent a client from committing a criminal action likely to result in death or substantial bodily harm, or to establish a claim or defense in a suit involving the lawyer which arises out of the representation. …