16 September 2002
10 May 2013
12 September 2013
6 February 2014
7 June 2013
19 June 2013
The September return to work is always a shock to the system. This year, the shock is set to be worse than ever. On 30 July, President Bush signed the US Sarbanes-Oxley Act 2002 into law. As part of the act's broad-reaching corporate governance reforms, it takes aim squarely at white collar crime and increases dramatically the liability exposure of officers and directors of public companies, as well as their lawyers.
It is essential to bear in mind that the act does not distinguish between US and non-US public companies. This means that, for example, officers and directors (and their lawyers) of a company listed in the US will be subject to the act, whether the company is incorporated in Paris, Texas, or Paris, France.
New white collar crimes and enhanced penalties
The act creates several new white collar crimes, including a new crime for securities fraud, which carries a 25-year maximum penalty. It also makes it easier for prosecutors to prove fraud on facts that do not fit easily within existing definitions. And the act makes the attempt or conspiracy to commit an offence under the US securities laws subject to the same penalties as those prescribed for the offence itself.
In addition, the act imposes tough new penalties for document destruction. It establishes a fine and potential imprisonment of not more than 20 years for anyone who "knowingly alters, destroys, mutilates, conceals, covers up, falsifies or makes a false entry in" any document with the object of thwarting or influencing any federal investigation or administrative proceeding. It also provides for a fine and up to 20 years in prison for anyone who "corruptly alters, destroys, mutilates or conceals" a document with the intent to impair the document's integrity or its use in an official proceeding, and also for any individual who "otherwise obstructs, influences, or impedes any official proceeding, or attempts to do so". It is striking that the penalties for document destruction are equal to the maximum penalty for attempted murder of a testifying witness.
The Securities and Exchange Commission's sanctions against officers and directors
Under the act, the Securities and Exchange Commission (SEC) can now more easily obtain orders barring individuals from serving, temporarily or permanently, as directors or officers of public companies - the so-called 'D&O bar'. Previously, if the SEC wanted to bar an officer or director from employment, it had to file suit and prove its case in a US court. Now, the SEC may obtain a D&O bar in an administrative proceeding in which individuals are found to have committed fraud. As a result, corporate executives face the possibility of losing their livelihood, temporarily or permanently, without a prior finding of a securities violation by any judge or jury.
While giving the SEC the power to obtain a D&O bar in a non-judicial proceeding, the act also lowers the standard for debarment. Previously, the SEC was required to demonstrate that an individual possessed "substantial unfitness" to serve as an officer or director, which was generally understood to equate to "egregious misconduct" or "repeated violations of the securities laws". But the SEC's burden of proof now drops from "substantial unfitness" to simply "unfitness". There can be little doubt that the new language will yield more aggressive use of the D&O bar sanction by the SEC and harsher results for individuals.
In addition, the act grants the SEC power to seek a temporary freeze of "extraordinary payments" to corporate officers and directors during the course of an SEC investigation into possible securities law violations. The temporary freeze can become permanent if the SEC decides to charge the issuer, officer or director with violations of the securities laws, at least until the conclusion of any legal proceedings. This change in the law exposes officers and directors to potential lengthy delays in compensation while the issue of liability is being decided.
The SEC's regulation of lawyers
Lawyers do not get off scot free under the act. In particular, the act subjects corporate legal counsel to unprecedented SEC scrutiny, as well as greater risk of malpractice claims and shareholder suits.
Under the act, the SEC is required by 26 January 2003 to issue rules setting out "minimum standards of professional conduct" for attorneys "appearing and practicing before the SEC in any way in the representation" of public companies. The rules will apparently include lawyers of public companies (whether US or non-US) regardless of where they practise.
For some 20 years, the SEC has not attempted to regulate the professional conduct of attorneys, except if their conduct violated the US securities laws. This will now change. The rules require that an attorney must "report evidence of a material violation of securities law or breach of fiduciary duty or similar violation" by a public company (or any agent of a public chief executive of the company). If the legal counsel or chief executive "does not appropriately respond to the evidence", the attorney must report the evidence to the audit committee, or another committee of the board of directors comprised solely of independent directors.
These minimum rules of conduct raise thorny issues. Among other things, what will the SEC regard as similar violations to a violation of securities law or a breach of fiduciary duty? The rules will force attorneys to make judgements about whether evidence reflects a material violation. With hindsight, judgement calls like this may easily be second-guessed. Moreover, the rules will require attorneys to assess whether the chief legal counsel or chief executive has responded appropriately to the reported evidence. These vague guideposts will leave in-house counsel at sea. But it must be remembered that the act appears to impose them equally on outside counsel, who may have no means of knowing how, if at all, matters are resolved in the corporate executive suite or board room.
The act will also create difficult attorney-client privilege issues. On the surface, the act seems to preserve privilege (at least under US analysis of this issue) by restricting the reporting obligation to the corporate client. But the corporate client has the right to waive privilege in a later proceeding - for example, during an SEC investigation. This means that the new rules of conduct expose the reporting attorney and the company's chief legal counsel or chief executive to potential liability for malpractice or other breach of duty, as well as SEC regulatory action. And it is not at all clear whether the rules will be in conflict with client confidentiality requirements of non-US jurisdictions.
The Sarbanes-Oxley Act is complex and far-reaching. Much remains to be filled in by SEC rule-making and by court interpretation. So fasten your seatbelts - this promises to be a bumpy ride.
Alex Cohen is a partner and Michael Dunn an associate at Latham & Watkins' US securities practice in London