S ARBANES -O XLEY S N EW C RIMES , E NHANCED P ENALTIES AND W AYS TO - PDF document

S ARBANES -O XLEY ’ S N EW C RIMES , E NHANCED P ENALTIES AND W AYS TO A VOID T HEM Mark A. Rush, Esquire Kirkpatrick & Lockhart LLP

I. INTRODUCTION The Sarbanes-Oxley Act of 2002 (the “Act”) is the Congressional response to the highly publicized corporate failures of 2001. The Act created a number of new criminal offenses and increased penalties for existing offenses. For forward-thinking corporations, these developments present corporations the opportunity to re-examine their business ethics, compliance procedures and safeguards against fraud. Many of the “new” crimes created by the Act could have been prosecuted under existing federal law. However, both the language and requirements of the Act indicate that its purpose is to create an environment where good corporate governance is the standard from the CEO down. The Act facilitates that standard by requiring the corporate control group to “know” the details of its business and to certify compliance with the law. The Act provides for criminal citations and severe sanctions for failing that standard and knowledge. Broadly stated, the new crimes under the Act impose a requirement of truthfulness, accuracy and responsiveness in an effort to make corporate governance more transparent. In the new world created by the Act, knowledge by the control group and effective corporate compliance programs are crucial. Thus, perhaps the most important preventative actions a corporation can take in response to the Act is to: (i) ensure that its control group is informed through appropriate audits and/or internal investigations and (ii) then create or continue its compliance and training programs, demanding and facilitating an ethical and lawful work environment. This article reviews the new statute and significant changes in the enforcement regime and sentencing issues. It highlights the benefits of corporate reform through the institution or further development of compliance programs and internal investigations. It also discusses pragmatic approaches and considerations when drafting a corporate policy and guide to employees who may be contacted by law enforcement officials.

II. THE NEW OFFENSES, EXPANDED PENALTIES, AND SENTENCING GUIDELINES UNDER SARBANES-OXLEY 1 A. The New Offenses The Sarbanes-Oxley Act of 2002 created what has been characterized as “the new crime of corporate securities fraud.” While most, if not all, of the conduct the act penalizes was already punishable through existing criminal statutes covering mail fraud, wire fraud, aiding and abetting, conspiracy and obstruction of justice, in passing the Act, Congress intended to make clear that all offenses involving publicly traded companies now may — and should — be prosecuted under federal criminal law. As a result, it is likely that more law enforcement resources will be dedicated to investigating and prosecuting suspected violations. 1. Securities fraud Section 807 of the Act creates the new federal criminal offense of securities fraud. It provides: Whoever knowingly executes, or attempts to execute, a scheme or artifice— (1) to defraud any person in connection with any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 781) or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 780(d)); or (2) to obtain, by means of false or fraudulent pretenses, representations, or promises, money or property in connection with the purchase or sale of any security of an issuer with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 781) or that is required to 1 For a more thorough discussion of the Sarbanes-Oxley Act and Compliance, See S ARBANES -O XLEY PLANNING & COMPLIANCE , K IRKPATRICK & L OCKHART LLP (Thompson Publishing Group, 2003). Contact Mark A. Rush, Esq. at mrush@kl.com if you are interested in receiving a copy of the publication.

file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 780(d)); shall be fined under this title, or imprisoned not more than 25 years, or both. a. General principles Most of the conduct criminalized under this section could have been prosecuted prior to enactment of the Act under the more generic mail or wire fraud statutes. However, Congress felt that the corporate climate in publicly traded companies demanded a more specific statute, with a threat of more substantial punishment, to stress the importance of strict compliance with the securities laws. Actual periods of incarceration are calculated through application of the Sentencing Guidelines, which have been amended pursuant to the Act. b. “Knowingly” and “Willfully” This new crime punishes conduct that is committed “knowingly,” even if it is not committed “willfully.” The distinction between these terms is extremely important in criminal law, as “knowingly” generally denotes a lower level of intent, meaning only that the offender knows he or she is taking the proscribed action, even if he or she does not know that doing so is a crime. “Willfully,” by contrast, indicates that the offender is aware that what he or she is doing constitutes fraud, but does it anyway. The legislative history surrounding the Act indicates that Congress specifically chose to eliminate the requirement under the mail and wire fraud statutes that the conduct at issue in this new statute be “willful.” Aggressive prosecutors may latch on to this distinction to prosecute CEOs or

CFOs for more technical violations of the rules than in the past, even if the officers do not have the level of willfulness previously required. However, in practice, the distinction may not have much effect, since the proof of “knowing” conduct and “willful” conduct tends to overlap. Moreover, in the long run, the courts will need to determine if such a prosecution can stand. Nonetheless, public companies — and their executives — must be aware that this distinction may permit a more aggressive criminal enforcement program. 2. Failure of corporate officers to certify financial reports Section 906 of the Act requires CEOs and CFOs to certify financial reports for publicly traded companies. It provides: Whoever: (1) certifies any statement as set forth in subsections (a) and (b) of this section knowing that the periodic report accompanying the statement does not comport with all the requirements set forth in this section shall be fined not more than $1,000,000 or imprisoned not more than 10 years, or both; or (2) willfully certifies any statement as set forth in subsections (a) and (b) of this section knowing that the periodic report accompanying the statement does not comport with all the requirements in this section shall be fined not more than $5,000,000, or imprisoned not more than 20 years, or both. a. General principles Under this provision, codified at 18 U.S.C. § 1350, CEOs and CFOs are required to certify that their company’s financial statements fully comply with the reporting obligations of the securities laws and

that they fairly represent, in all material respects, the financial condition and operating results of the company. Penalties for violating the provision vary depending on the level of intent. An officer who certifies a periodic report that he knows does not comport with the reporting requirements of the federal securities laws (§§ 13(a) and 15(d) of the Securities Exchange Act of 1934) may be fined not more than $1 million and imprisoned not more than 10 years. If the officer acts “willfully,” the penalty is a fine of not more than $5 million and imprisonment of not more than 20 years. It is the first provision, which punishes “knowing” conduct, which poses the most risk for executives. For example, even if a CEO or CFO does not direct that a fraudulent report be made (which would be classified as willful conduct), he or she can now be prosecuted for making a certification if he or she knows the report is inaccurate. Aggressive federal prosecutors might even attempt to prosecute individuals who did not create or direct the creation of false financials, but who were deliberately indifferent to the truth or falsity of the reports or who failed to perform any due diligence to ensure they were correct. Accordingly, due diligence and good corporate compliance policies are essential to avoid such prosecutions. Offenses relating to obstructing investigations 2 3. 2 These offenses do not directly implicate a corporation’s internal investigation. However, it is important to note that most recently the Department of Justice has increased the frequency of requests that corporations under investigation waive their work product privilege. Accordingly, an employee who obstructs an internal investigation beyond mere “silence” may not only find himself unemployed but may also become subject to charges of obstruction of justice in the event of a waiver.