Library of Motions – Sarbanes-Oxley

The Top Five Areas of Potential Criminal
Exposure Under the Sarbanes-Oxley Act

by John R. Teakell, Dallas, TX
April 2006

        When the Sarbanes -Oxley Act was passed in 2002, many people considered it a hurried reaction to corporate accounting scandals that had then repeatedly been front-page media stories.  The act imposed significant new responsibilities on directors, officers and audit committees, along with potential criminal liability for violations of these new responsibilities.

This writing is intended to identify five areas of potential criminal exposure within the Sarbanes-Oxley Act, and not intended to fully discuss each area or offer solutions for each.
There are five main areas that attorneys need to be aware of when advising their clients so that they may avoid criminal liability under Sarbanes-Oxley.  These areas include: properly certifying periodic reports, never altering corporate documents, securities fraud, the whistleblower provision, and avoiding obstruction of justice charges.

Although the U.S. Securities and Exchange Commission (“SEC”) may never seek criminal penalties during the course of an investigation, the SEC may refer the matter to the Department of Justice (“DOJ”) as a grand jury referral, which could be prosecuted by the U.S. Attorney’s Office.

1.         Certifying Periodic Reports
Sections 906 and 302 of the Sarbanes-Oxley Act enacted twin provisions of the United States Code requiring certification by the CEOs and CFOs of corporate documents; these provisions are 18 U.S.C. §1350 and 15 U.S.C. §7241, respectively.  Each section gives two levels of criminal penalties, depending upon whether the violation was knowing or willful.

       Under 18 U.S.C., all CEOs and CFOs certify, in writing, that every periodic report filed by their public company under §13(a) or §15(d) of the Exchange Act, fairly represents the financial condition of the company.   18 U.S.C. §1350 also provides criminal penalties of up to 20 years for willful violations and up to 10 years imprisonment for violations where the executive knowingly signed a false certification.

Under 15 U.S.C. §7241, a “principal executive officer of officers and principal financial officer of officers ¼ or persons performing similar functions,” of a public company must certify each quarterly and annual report filed by the company under the new Exchange Act Rules §13(a) or §15(d).  Furthermore, “a separate certification must be provided for each certifying officer, and the language of the certification cannot be varied from the language contained in” the statute.  William D. Gould & Dale E. Short, The Sarbanes-Oxley Act of 2002 and its Aftermath.

Certification is made based on the knowledge of the certifying officer, and ignorance will not be a defense to a charge of falsely certifying a quarterly or annual report if the certifying officer should have known that the certification was false.  Therefore, the implementation of §302 of the Sarbanes-Oxley Act “creates a heavy burden on the CEO and CFO to become personally aware of material information on a timely basis, and also makes it difficult to argue in any investigation that the CEO or CFO in fact had no knowledge of material information that was available.”  Kirkland & Ellis LLP, How CEO’s, CFO’s Can Avoid Criminal Exposure Under Sarbanes-Oxley Certification Provisions.

Unlike §906 of the Sarbanes-Oxley Act, most cases of false certifications under §302 will be pursued civilly through SEC proceedings, however the DOJ may seek to prosecute §302 violations under criminal statutes that prohibit the use of mail, telephones or Internet to commit fraud under 18 U.S.C. § 1341 (mail fraud) or 18 U.S.C. § 1343 (wire fraud).  Furthermore, an officer who “willfully” makes a false Sarbanes-Oxley Act §302 certification may be liable for criminal violation of the Exchange Act, which results in a maximum of up to 20 years imprisonment and up to $5 million in fines, under §1106.
It is important for certifying officers to document specific procedures required under the statute. It may be advisable to obtain written certification or representations from other officers and employees directly responsible for the information in the report.

  • Sarbanes-Oxley Act § 807, enhances criminal penalties for securities fraud under 18 U.S.C. § 1348

       Section 807 of the Sarbanes-Oxley Act enhances the criminal penalties for securities fraud under newly created 18 U.S.C. §1348 properly entitled “Securities Fraud.”  18 U.S.C. §1348 provides that:

Whoever knowingly executes, or attempts to execute, a scheme or artifice—
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 to obtain, by means of false or fraudulent pretences, representations, or promises, any 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 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.

            Although the Securities Exchange Act has made securities fraud punishable for several decades, the new provision appears to make a prosecution easier.  For example, the mens rea requirement under the new statute is knowledge, as compared with the willfulness requirement of the Exchange Act.  §1348 also removed the requirement that the fraud be in connection with the purchase or sale of securities.

3.         Altering Corporate Documents
Two provisions of Sarbanes-Oxley were created to increase the government’s ability to convict individuals for altering documents – §§ 802 and 1102.  18 U.S.C. §1519, which is entitled “Destruction, Alteration, or Falsification of Records in Federal Investigations and Bankruptcy” was created under § 802 of the Sarbanes-Oxley Act.  18 U.S.C. §1519 provides that:

Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsified, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.

            18 U.S.C. §1519 increases the government’s ability to prosecute obstruction of justice for alteration or destruction of documents.  This improved ability stems from the key element “intent to impede, obstruct, or influence the ¼ proper administration of any matter,” which does not require a pending or concluded investigation against the individual or corporation for the crime to be proven.  Creamer, 52-May Fed. Law. at 38.  This is because the language of § 1519 is broad enough to potentially cover the destruction of a company’s documents before an investigation occurs. Furthermore, § 1519 “does not require a willful or corrupt state of mind, and thus the government may not need to establish that a defendant intended to violate a known legal duty.”  Id.

       Sarbanes-Oxley § 1102 increases the penalties for destruction or altering of corporate audit records by amending 18 U.S.C. § 1512 entitled “Tampering with a Record or Otherwise Impeding and Official Proceeding.”  18 U.S.C. § 1512 now contains the following new subsection:

(c) Whoever corruptly – alters, destroys, mutilates, or conceals a record, document, or other object, or attempts to do so, with the intent to impair the object’s integrity or availability for use in an official proceeding; or otherwise obstructs, influences, or impedes any official proceeding, or attempts to do so, shall be fined under this title or imprisoned not more than 20 years, or both.

The purpose of amending §1512 is to enhance the current obstruction of justice statute by eliminating the requirement that one who obstructs or impedes an “official proceeding” or alters documents must “corruptly persuade” another to obstruct or impede an official proceeding before being found guilty of obstruction of justice.  Prior to the amendment, anyone who obstructed justice on his or her own without influencing or intimidating another could not be prosecuted under 18 U.S.C. § 1512.
18 U.S.C. § 1520, which also deals with destroying or tampering with corporate audit records, has similarly been enhanced.

4.         Sarbanes-Oxley Act § 1107 – whistleblower provision supported under 18 U.S.C. § 1513

       The Sarbanes-Oxley Act prohibits companies from retaliating against employees who alert the government to possible SEC violations.  In fact, §1107 of the Sarbanes-Oxley Act makes it a crime for anyone to knowingly, with intent to retaliate, take actions against any person including retaliation in connection with the person’s employment, in response to such person providing truthful information to law enforcement regarding a possible federal offense.

The punishment for retaliating includes a fine and imprisonment of not more than ten years pursuant to 18 U.S.C. §1513.

5.         Obstruction of Justice, found in 18 U.S.C. § 1001

Although not specifically included in Sarbanes-Oxley, the obstruction of justice statute commonly used (or commonly threatened) is 18 U.S.C § 1001.  This section has for many years been utilized to threaten prosecution if a person lies to a government official in any matter within the jurisdiction of the United States.  Under 18 U.S.C. §1001, anyone who, “makes a materially false, fictitious or fraudulent statement or representation” can be fined and imprisoned for up to five years.

Also, if a witness testifies falsely under oath before the SEC staff or other government proceeding, he or she may be subject to a perjury conviction.  18 U.S.C. §1621.
Obstruction of justice, found under 18 U.S.C. §1001 and other provisions, is arguably easier to prove than some actual violations of the Sarbanes-Oxley Act.  Obstruction of justice ranges from influencing a witness not to talk to law enforcement to destroying documents.

            In conclusion, the Sarbanes-Oxley Act enhanced criminal prosecutions by focusing on false certifications of company statements, altering documents and potential obstruction of justice.  Although publicly traded companies and their counsel must use caution regarding the process of document certification, and retention of certain documents, equally of concern is any statement made to an investigator or attorney for the government.  A statement made about company procedures or actions, could potentially label the maker of the statement a subject of an investigation, especially if taken out of context or if made when a government agency already has heightened suspicions about a company’s activities.  This evermore underscores the need for company officials and employees to retain counsel prior to meeting with government representatives.

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