Opinion Letters and Consequences

[soonerlew]

Opinion Letters and Consequences
« Thread Started on Today at 8:23am »

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This comes courtesy of Denmage at CMKX.net
An interesting read concerning opinion letters and possibly why Roger Glenn should be thinking twice about some things he wrote.
Patrick
cmkxclubhouse.proboards76.com/index.cgi?board=general&action=display&thread=1193750619

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www.cmkx.net/forum/viewtopic.php?t=16452

I wanted to learn more about opinion letters. We hear a lot about Roger Glen and Dvorak writing opinion letters for the release of stock. But I was unclear about the ramafications of these letters. I was quite surprised to come across this on the SEC website:

www.sec.gov/info/municipal/mbonds/bc.htm

Although, this case does not resemble the CMKX situation. Somethings that caught my attention are the SECs position on what a lawyer function is in relation to issuing opinion letters. After reading this case, especially the part I have highlighted in bold text, I felt quite comfortable that the SEC could put some major hurt on any lawyer who has been involved with CMKX and issued an opinion letter.

Denmage



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Municipal Bond Participants:
Bond Counsel


Report under Section 21(a) of the Exchange Act
Attorney's Conduct in Issuing an Opinion Letter Without Conducting An Inquiry Of Underlying Facts Failed to Comport With Applicable Standards of Conduct, Exchange Act Release No. 17831 (June 1, 1981).

Introduction

After consideration by the Commission of the role of the lawyer who represented an underwriter in the public offering of certain industrial revenue bonds, the Commission has determined, in the exercise of its prosecutorial discretion, not to institute an enforcement proceeding against that person, charging aiding and abetting of violations of antifraud provisions of the federal securities laws.n1 This decision not to bring an enforcement action is not based on any conclusion that the lawyer's conduct was even arguably acceptable; to the contrary, the Commission believes that the lawyer failed to carry out his professional obligations under the circumstances described below and, as a result, facilitated violations of the securities laws.n2 The Commission has taken into account certain other factors, including his unfamiliarity with the federal securities laws and the fact that he relied, in a manner inappropriate under the circumstances, upon bond counsel, an experienced securities lawyer. The Commission believes, however, that the public and the bar should be apprised of the conduct of the lawyer in this case and of the Commission's views as to the responsibilities of lawyers who render opinions in connection with securities transactions which affect public investors.

The Facts

In 1977, William M. Gotten, an attorney in Memphis, Tennessee, rendered an opinion, as counsel for an underwriter, in connection with the offer and sale of industrial revenue bonds not required to be registered pursuant to the Securities Act of 1933. The opinion letter, which was drafted for Mr. Gotten's signature by bond counsel in the transaction, falsely stated that the offering circular did not "omit to state a material fact necessary to make the statements therein, in the light of the circumstances under which they were made, not misleading".

Unlike many other industrial bond offerings which are intended to provide funds for the construction of new facilities, the offering in this case was for the purpose of acquiring an existing hospital, which had operated for several years. While the offering circular contained projections of revenues, expenses and earnings, it contained no financial information about the past operations of the hospital. This operating history reflected adversely upon the possibility of future profitable operations and drew into serious question the ability of the issuer to service the debt being issued.

For five years prior to the offering, net income ranged from a loss to a $48,000 profit during a time when the hospital had no mortgage indebtedness or other debt service. Interest expense alone for the first five years of the bond sale was to average about $155,000 per year, or in excess of $100,000 more than the hospital had ever made as profit in the preceding 5 year period. Under a new management company which had operated the hospital during the year immediately preceding the bond offering, with no debt to service, a net profit from operations was realized of only $24,000. Debt service on the new bonds thus required more than $158,000, or an amount equivalent to more than 600% of the hospital's profits during the previous year. This information, clearly both relevant and material to the reasonableness of the income projections, was not disclosed.

Mr. Gotten read the offering circular prior to rendering his opinion. And, although the opinion letter states that the signator has not independently checked or verified most of the material statements in the offering circular, Mr. Gotten, who knew that the issuer was a going concern that had been in operation for a number of years, signed and issued the opinion letter without questioning the omission from the offering circular of financial statements concerning the issuer's prior operating history, reviewing any documents as to the financial status of the issuer, or making inquiry as to results of the operations of prior years.n3 This inquiry was totally inadequate and facilitated the bond closing and the bond sales to the public.

The nature of services performed by lawyers in connection with securities transactions frequently involves the rendering of opinions concerning compliance by their clients with the federal securities laws. This is so because legal opinions are often essential to the completion of the transactions, and the parties and the investing public look to the opinion as the authoritative statement that the matters opined upon are in order. The importance of the role of counsel who render legal opinions in this context has prompted the bar to establish professional standards for lawyers who provide them. The American Bar Association's Committee on Ethics and Professional Responsibility, for example, has addressed the duties of counsel who render securities law opinions in Formal Opinion 335, 60 A.B.A. Jour. 488 (1974).

Formal Opinion 335 relates to opinions written as the basis for transactions involving sales of unregistered securities and establishes that, as a matter of professional standards, a lawyer must make a preliminary inquiry of the client as to the relevant facts before rendering an opinion as to compliance with the federal securities laws. When the facts obtained from the client appear incomplete or inconsistent with facts known to the lawyer, or are otherwise suspect, the lawyer must make further inquiry. n4

And, if after such further inquiry, the lawyer is not satisfied as to all the relevant facts, he should refuse to render an opinion. n5

In addition, Canon 6 of the Model Code of Professional Responsibility of the American Bar Association requires that a lawyer represent his client competently. And Disciplinary Rule 6-101(A) expressly mandates that an attorney shall not handle a legal matter which he knows or should know he is not competent to handle, without associating himself with a lawyer who is competent to handle it, and shall not handle a legal matter without preparation adequate in the circumstances.

The smooth functioning of the securities markets will be subject to serious disruption if the public cannot safely rely on the expertise proffered by lawyers rendering their opinions. Unless lawyers carefully and competently ascertain the relevant facts, and make a reasonable inquiry of their clients to obtain facts not within their personal knowledge, their opinions may facilitate fraudulent transactions in securities. This is so particularly as the investing public looks to the lawyer's opinion as a safeguard against violations of the federal securities laws. As stated by the United States Court of Appeals for the Second Circuit in Securities and Exchange Commission v. Spectrum, Ltd., 489 F.2d 535 (2d Cir. 1973), in discussing the conduct of an attorney who, without conducting any inquiry into the underlying facts, issued a false opinion letter that unregistered shares could be sold without registration, "the preparation of an opinion letter is too essential and the reliance of the public too high to permit due diligence to be cast aside in the name of convenience." n6

And see Securities and Exchange Commission v. Universal Major Industries, Corp., 546 F.2d 1044 (2d Cir. 1976), cert. denied, 434 U.S. 834 (1977) (opinion that securities could be sold without registration); Securities and Exchange Commission v. Frank, 388 F.2d 486 (2d Cr. 1968) (failure of lawyer in drafting a prospectus to make inquiry beyond the facts supplied to him by his client, facts which even a laymen would know were false);

United States v. Crosby, 294 F.2d 928 (2d Cir. 1961) (opinion that unregistered stock was freely transferable); Escott v. Barchris Construction Co., 283 F. Supp 642 (S.D.N.Y. 1968) (failure to investigate the accuracy of registration statement signed by the attorney); cf. Securities and Exchange Commission v. Coven, 581 F.2d 1020 (2d Cir. 1978), cert. denied, 440 U.S. 590 (1979) (letter representing that a sufficient number of shares had been sold to facilitate the closing of an "all or nothing" offering); Securities and Exchange Commission v. Manor Nursing Centers, Inc., 458 F.2d 1082 (2d Cir. 1972) (failure to correct a misleading prospectus).

The Commission has also stated,

"if an attorney furnishes an opinion based solely on hypothetical facts which he has made no effort to verify, and if he knows that his opinion will be relied upon as the basis for a substantial distribution of unregistered securities, a serious question arises as to the propriety of his professional conduct."

Securities Act Release No. 4445 (Securities Exchange Act Release No. 6721), published on February 2, 1962 (cited with approval by the Commission is Securities Act Release No. 5168, July 7, 1971). n7

Conclusion

Under the circumstances described above concerning Mr. Gotten's conduct in rendering an opinion letter, and based on the standards of conduct articulated above, the Commission believes that Mr. Gotten's conduct, without having conducted any inquiry of his client as to the underlying facts on which his opinion was predicated, failed to satisfy applicable standards.

By the Commission.

Footnotes
-[n1]-The Commission is issuing this Report in accordance with its authority under Section 21(a) of the Securities Exchange Act. For further information concerning the related civil action filed against others, see Litigation Release No. 9366.

-[n2]-Ibid.

-[n3]-In that letter, Mr. Gotten also opined that the bonds were exempt from registration with the Commission under the Securities Act and that compliance with the Trust Indenture Act was not required. Although these opinions turned out to be correct, Mr. Gotten had made no attempt to ascertain their applicability or accuracy; instead he relied upon the representations of, among others, the underwriter and bond counsel.

-[n4]-Guidance as to when further inquiry is appropriate is provided in Formal Opinion 335, which states: "* * * the lawyer should, in the first instance, make inquiry of his client as to the relevant facts and receive answers. If any of the alleged facts, or the alleged facts taken as a whole, are incomplete in a material respect; or are suspect, or are inconsistent; or either on their face or on the basis of other known facts are open to question, the lawyer should make further inquiry." 60 A.B.A. Jour. at 489.

-[n5]-Again, guidance is provided in Formal Opinion 335, which cautions: "Where the lawyer concludes that further inquiry of a reasonable nature would not give him sufficient confidence as to all the relevant facts, or for any other reason he does not make the appropriate further inquiries, he should refuse to give an opinion." Id.

-[n6]-See also United States v. Benjamin, 328 F.2d 854, 863 (2d Cir. 1964) involving an opinion that certain securities were exempt from registration under Section 3(a)(1) of the Securities Act: "In our complex society . . . the lawyer's opinion can be [an] instrument for inflicting pecuniary loss more potent than the chisel or the crowbar. * * * Congress could not have intended that men holding themselves out as members of these ancient professions [the accounting and legal professions] should be able to escape criminal liability on a plea of ignorance when they have shut their eyes to what was plainly to be seen or have represented a knowledge they knew they did not possess."

-[n7]-In Release No. 4445, the Commission noted the practice of dealers, when attempting to obtain an exemption under Section 4(1) of the Securities Act, of submitting representations to a lawyer that the sellers of the securities did not hold any of those positions that would render the exemption unavailable. The release stated that a lawyer's opinion based on hypothetical facts would be worthless if the facts were not accurate or if the vital facts were not considered. The release further expounded on the duties of responsible counsel to the effect that "it is the practice of responsible counsel not to furnish an opinion * * * unless such counsel have themselves carefully examined all of the relevant circumstances * * *." Id.

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Injunctive Proceedings
SEC v. Calhoun County Medical Facility, Inc., et al., Civ. Action No. WC-81-61 WK-P (N.D. Miss.), Litigation Release No. 9366 (June 1, 1981) (settled final order).

See "Obligated Persons" section.