Interviewer: Bandana Kohli
Transcribers: Bandana Kohli and Kevin Rodriguez
Interview Date: October 22, 2007, San Francisco, CA.
Q: As a business lawyer who has worked in various practices—Securities and Exchange Commission (SEC), general counsel, and private practice—what would you say are the major differences between each position?
A: I have been fortunate to have had jobs that offered different outlooks on the legal profession. The main difference, in my experience, has been the nature of the responsibilities, which arise from different clients. At the SEC, I was responsible for representing the U.S. government in connection with investigations and legal actions against individuals and companies. I was excited and gratified to represent the public interest and the SEC’s mission of investor protection, but I was also struck by the effects of the power that I had to issue a subpoena or an information request from businesses I investigated. Fortunately, the SEC had, and still has, a process for ensuring that these powers are exercised responsibly.
After my time at the SEC, I served as general counsel of Hambrecht & Quist Group Inc. (H & Q) for eleven years. As general counsel, I oversaw all of the legal and financial aspects of the firm’s business. The serious financial or regulatory consequences of a bad compliance or litigation outcome made this a tremendous responsibility. The comfort and support I received while working there was in large part due to the caliber of outside counsel with whom I was able to work.
In private practice, I am now the outside counsel that my clients rely on to help them solve their problems. In this role, I have multiple clients at a time for the first time in my career, and I feel responsible for obtaining good results for all my clients.
Q: You have worked in many spheres of securities law, including the Stock Options Study at the SEC. In this capacity, you were involved in preparing the landmark Report of the Staff Special Study of the Options Markets to the SEC. Please explain what this report is and its purpose.
A: In December 1978, the staff of the SEC completed the Report of the Staff Special Study. When the SEC received this report, it then forwarded it to the House Committee on Interstate and Foreign Commerce.
Exchange–traded options began as a pilot program by the Chicago Board Options Exchange in 1973. By 1977, trading grew to the point that problems and abuses surfaced. The SEC became concerned about potential abuses in the selling and trading of options markets and, in particular, the SEC was concerned that the products’ sophistication was growing faster than the investors’ ability to understand the products.
I was part of the group that reported on Options Selling Practices. I became part of this group as an enforcement staff member of the SEC’s branch in San Francisco because I had investigated and litigated administrative proceedings against brokerage firms for failing to properly supervise their brokers in connection with options transactions for their customers. One case involved churning of options accounts (excessive trading for the purpose of generating commissions). Another case involved a strategy called “time spreads” that neither the customers nor the brokers’ supervisors understood. In fact, in the investigation of that case, I asked the branch manager whether he reviewed the transaction reports and he testified, “I just sign them and pray.” The branch manager’s testimony and other evidence I discovered during my investigations were cited and discussed in the report to Congress. As a result of this report, the SEC adopted new rules that demanded greater disclosure to investors, enhanced supervision by brokerage firms, and new surveillance procedures by certain exchanges that conducted options trading.
Q: In 2001, after the Enron scandal, Congress created the Sarbanes–Oxley (SOX) Act to hold public companies accountable for their actions affecting the market and investors. How has the Sarbanes–Oxley Act affected your practice as an attorney?
A: SOX has affected our practice in at least three major ways.
First, Section 301 provides that only companies with audit committees can be publicly held. The audit committee must maintain and compensate independent counsel, as it deems necessary, to carry out its duties and assist them in investigations. Companies frequently require their audit committees to conduct investigations into the companies’ accounting practices, for example, with regard to allegations of stock options backdating. Audit Committees and other Board Committees are hiring us to represent them in these investigations.
Second, SOX created the Public Company Accounting Oversight Board (PCAOB), which has investigative and enforcement powers relating to public accounting firms. We are increasingly representing auditors in these investigations and enforcement actions as well.
Third, we are counseling clients on the “up–the–ladder” reporting obligations imposed on in–house counsel by Section 307, which requires in–house attorneys to report up the chain of command of an issuer that has committed a material violation of securities laws or breached a fiduciary duty.
Q: In more recent news, many financial institutions have been writing down billions of dollars in mortgage–backed securities. Could you explain this and how it may affect your law practice?
A: This problem is known as the sub–prime mortgage crisis, which resulted from lenders making loans to borrowers with low credit ratings. Lenders packaged these loans as collateral for debt securities that they then sold to investors. Suddenly, the market for these securities became illiquid. A proliferation of lawsuits ensued, with investors alleging that they were misled as to the risks of the collateralized mortgage obligations. We will be representing financial institutions undergoing governmental investigations into how these bonds were sold, and in litigation relating to the losses that people incurred in purchasing these bonds.
Q: Another recent issue in securities regulation is stock option backdating. Can you explain how the Stock Option Task Force addresses this problem?
A: Increasingly, publicly held companies have been alleged to have backdated stock options granted to their employees. Over 200 companies have disclosed internal stock options investigations and more than 130 companies have admitted that they must restate their financial results.
Our firm has a Stock Option Task Force that addresses the needs of clients relating to the options backdating investigations and litigation. The Stock Option Task Force allows our lawyers to share information and create communications systems to react quickly and effectively on behalf of clients.
Q: Given the financial issues and dilemmas we discussed above, it seems that in–house attorneys can face several ethical issues when dealing with the interest of the corporation versus the interest of the law. In your article, “In–House Ethical Conflicts: Recognizing and Responding to Them,” what are the major ethical conflicts that you address and what are the best ways to respond to them?
A: One of the joys of being an in–house attorney is the opportunity to participate in business decisions and activities in addition to purely legal matters. My co–author and I wrote this article to highlight issues that arise when an in–house lawyer plays both a business role and a legal role at the same company. For example, at various times when I served as general counsel at H&Q, I headed the credit committee, and I supervised the compliance director. I was also chief compliance officer of one of H&Q’s registered venture capital management companies. My co–author was general counsel and chief administrative officer at Robertson Stephens. She was responsible for various departments, including the personnel department.
We raised several ethical questions in our article: What if I have to supervise litigation to collect a loan that I approved as head of the credit committee? What if I need to defend the reasonableness of a compliance program that I have set up? By performing business roles, an in–house lawyer’s judgment, or at least the perception of his independent judgment with respect to those matters, can be compromised. There are no clear or perfect answers to these questions, but it is important for an in–house lawyer to be aware of them and notify his client as to whether he is acting in a business capacity or a legal capacity. I would advise in–house lawyers to use outside counsel or other in–house counsel as a sounding board and a sanity check in these situations.
Q: What, in your opinion, are the most controversial issues that will develop within securities law in the future?
A: Three issues strike me as particularly significant.
The first issue is the globalization of securities markets. In a global economy, capital flows easily from one market to another and, thus, financial markets increasingly compete for capital. Some people think that competition between the markets as to who has the most lenient regulatory framework may arise. Regardless of the outcome of that question, law firms need to be versed in the securities laws of all major financial centers in order to advise their clients effectively.
Another developing issue is the two–tier regulation system. Securities laws develop so that some of the most complex and potentially rewarding investments are available only to wealthy investors. The SEC has issued rules that will increase the level of financial wherewithal that investors will have to demonstrate in order to make certain investments. The SEC views investors’ wealth as a signal of their sophistication and ability to evaluate the risks and merits of their complex investments. This trend will probably continue because investments’ complexity will continue. However, some investors are not pleased with the limits on the availability of these investments. They view these rules as undemocratic because only certain people will have access to them. On the other hand, there is still widespread access for less sophisticated investors who can participate indirectly by purchasing mutual funds that are managed by sophisticated investors.
The third problem relates to the one we have just discussed. The complexity of financial instruments is a continuing problem for investors, regulators and the financial markets. For example, the sub–prime crisis has generated litigation over instruments with names like “mortgage–backed repo bonds.” This is the same kind of problem that I investigated 30 years ago when I participated in the SEC’s Options Study. If investors do not understand financial products, they cannot evaluate the risks. If managers do not understand the products, they cannot properly supervise their salespeople. Finally, if regulators do not understand the products, they cannot effectively regulate them.
Staff of Sec. and Exch. Comm., 96th Cong., Report of the Special Study of the Options Markets to the SEC 76(Comm. Print 1978).
 Sarbanes Oxley Act, 15 U.S.C. § 7202-7266 (2007).
 Steven N. Machtinger & Dana A. Welch, In-House Ethical Conflicts: Recognizing and Responding to Them, 22 Assoc’n of Corp. Couns. Docket 22, 22-36 (2004).
Bandana Kohli is a 3L at University of California, Davis, School of Law.