November 05, 2020

Sarbanes-Oxley Act

Sarbanes-Oxley Act

Legal Ethics, Confidentiality, and the Organizational Client
      Larry P. Scriggins, 58(1): 123–144 (Nov. 2002)
The ethical rules governing lawyers representing organizational clients when the lawyer encounters actual or potential criminal or fraudulent conduct on the part of the client, or those acting for it, are in sharp focus today. Although there is uniformity in some respects, there are significant differences among the existing rules in the states, the Model Rules of Professional Conduct as recommended by the ABA Commission on Evaluation of the Rules of Professional Conduct (the Ethics 2000 Commission), those rules as approved by the ABA House of Delegates, and the recommendations of the ABA Task Force on Corporate Responsibility in its preliminary report dated July 16, 2002 (printed at p. 189). The Sarbanes-Oxley Act enacted on July 30, 2002, directs the Securities and Exchange Commission (SEC) to adopt ethical rules for lawyers representing issuers before it dealing with actions lawyers should take within the organization when there is evidence of financial fraud, and authorizes the SEC to adopt additional rules for that situation. The author discusses the differences among existing rules, the ABA Commission's recommendations, and the recommendations in the preliminary report of the ABA Task Force on Corporate Responsibility currently in the process of review in public hearings. The author suggests that the original recommendations of the Ethics 2000 Commission represent the best choice for the states, that the SEC should adopt rules consistent with those recommendations as to action within the organization, and that the SEC should not promulgate rules that would place lawyers in the position of acting under differing and conflicting standards in the same matter.

Enron and the Corporate Lawyer
      Roger C. Cramton, 58(1): 143–188 (Nov. 2002)
The Enron collapse and other corporate failures, some accompanied by massive fraud, have raised questions concerning a lawyer's responsibilities when the lawyer learns, or has reason to know, that agents of the corporation are engaged in conduct that is unlawful or that is in violation of their fiduciary duty to the corporation. The legal and ethical rules governing a lawyer's responsibility in these troublesome situations are controverted, often ambiguous or discretionary, and sometimes lawyer-protective. This Article summarizes the law governing such matters as the scienter requirement, the duty to make further inquiry when circumstances suggest the possibility of misconduct by corporate agents, and the new requirement included in the Sarbanes-Oxley Act of 2002 that the lawyer "climb the corporate ladder" to the board of directors, if necessary, to prevent or rectify the wrongful conduct. The vexing question of disclosure of confidential information outside the corporation is also considered. The Article closes with recommendations for legislative, regulatory or rule changes that would provide greater guidance to lawyers and more protection to public interests.

SEC Debarment of Officers and Directors After Sarbanes-Oxley
      Jayne W. Barnard, 59(2): 391–419 (Feb. 2004)
The Sarbanes-Oxley Act provides that a securities law violator may be suspended or barred from serving as an officer or director of a public company, provided the violator is found to be "unfit." Suspension and bar orders may be entered by a federal district court at the conclusion of a litigated proceeding. Under Sarbanes-Oxley, a suspension or bar order may now also be issued by the Commission at the conclusion of a cease-and-desist proceeding. In either case, the standard is the same-"unfitness." This Article examines the new suspension and bar regime established under the Act. It suggests some arguments that might be made in opposition to the threat of a suspension or bar order, and also proposes some procedural guidelines to govern suspension and bar cases.

Report of the Task Force on Exchange Act Section 21(a) Written Statements
      Committee on Federal Regulation of Securities, ABA Section of Business Law, 59(2): 531–68 (Feb. 2004)

Fiduciary Duties of Directors of a Corporation in the Vicinity of Insolvency and After Initiation of a Bankruptcy Case
      Myron M. Sheinfeld & Judy L. Harris, 60(1): 79—107 (Nov. 2004)
This article discusses the general fiduciary duties of directors of corporations and how those duties are altered when a corporation is in the zone or vicinity of insolvency and when the corporation is insolvent. The different tests for determining a corporation's insolvency are outlined. The article also analyzes the fiduciary duties of directors in a Chapter 11 bankruptcy case. In particular, the article discusses directors' duties in managing the bankruptcy estate, directors' responsibilities under Sarbanes-Oxley, and the exculpations of directors that are permitted in Chapter 11 plans of reorganization. The article provides directors with practical guidelines for properly exercising their fiduciary duties in Chapter 11.

Cross–Border Tender Offers and Other Business Combination Transactions and the U.S. Federal Securities Laws: An Overview
      Jeffrey W. Rubin, John M. Basnage, and William J. Curtin, III, 61(3):1071—1134 (May 2006)
In structuring cross–border tender offers and other business combination transactions, parties must consider carefully the potential application of U.S. federal securities laws and regulations to their transaction. By understanding the extent to which a proposed transaction will be subject to the provisions of U.S. federal securities laws and regulations, parties may be able to structure their transaction in a manner that avoids the imposition of unanticipated or burdensome disclosure and procedural requirements and also may be able to minimize potential conflicts between U.S. laws and regulations and foreign legal or market requirements. This article provides a broad overview of U.S. federal securities laws and regulations applicable to cross–border tender offers and other business combination transactions, including a detailed discussion of Regulations 14D and 14E under the Securities Exchange Act and the principal accommodations afforded to foreign private issuers thereunder.

Independent Directors as Securities Monitors
     Hillary A. Sale, 61(4):1375-1412 (August 2006)
This paper considers the role of independent directors of public companies as securities monitors. Rather than engaging in the debate about whether independent directors are good or bad, important or unimportant, the paper takes their existence and basic governance role as a given, focusing instead on what recent statements from Securities and Exchange Commission officials indicating an increased focus on independent directors and their role in preventing securities fraud. The paper notes that the SEC believes that independent directors are on the board to act, at least in part, as securities monitors. This securities monitor role is another aspect of the information-forcing-substance disclosure model that the SEC has used to achieve improved corporate governance. Although directors face heightened risk when they draft or sign disclosure documents, they also have an ongoing responsibility to be informed of developments within the company, ensure good processes for accurate disclosures, and make reasonable efforts to assure that disclosures are adequate. Independent directors with expertise should be involved in reviewing and, sometimes, drafting statements. All directors, however, should be fully aware of the company's press releases, public statements, and communications with security holders and sufficiently engaged and active to question and correct inadequate disclosures. In addition to defining the role of independent directors as securities monitors, the article reviews the liability independent directors might face under private causes of action and contrasts it with the SEC's enforcement powers and remedies. The article describes some of the SEC's prior statements that emphasize the role of independent directors as securities monitors and the importance of their providing both guidance and check and balance.

Internal Investigations and the Defense of Corporations in the Sarbanes-Oxley Era
     Robert S. Bennett, Alan Kriegel, Carl S. Rauh, and Charles F. Walker, 62(1): 55–88 (Nov. 2006)
Internal investigations long have been an integral part of the successful defense of corporations against charges of misconduct, as well as an important board and management tool for assessing questionable practices. With the heightened standards of conduct and increased exposure created by Sarbanes-Oxley, this essential instrument for safeguarding corporate interests has become even more crucial in identifying and managing risk in the enforcement arena. This article examines from a practitioner's standpoint when and how internal investigations should be conducted in order to protect the corporation in criminal, civil and administrative proceedings. Particular attention is paid to the issues created by a concurrent government investigation and in dealing with employees and former employees in the course of an investigation. The article also addresses the role of the Audit Committee under Sarbanes-Oxley, and the important issue of reporting the findings of the investigation to appropriate corporate officials. The subject of self-reporting by the Company to enforcement authorities is considered as well. In this context, the article explores the SEC's position on crediting self-reporting and cooperation as set forth in the Seaboard report; Department of Justice policy as embodied in the Thompson Memorandum; and the impact of the Federal Sentencing Guidelines for Organizations.

Using Sarbanes-Oxley Act to Reward Honest Corporations
     Tamar Frankel, 62(1): 161–192 (Nov. 2006)
The Sarbanes-Oxley Act offers an opportunity to reward truthful corporations and their management, offering them a competitive advantage by relieving them from some of the Act's provisions. Corporate culture plays an important role in a corporation's honest behavior. One size does not fit all in matters of organizational integrity. The provisions of the Sarbanes-Oxley Act that apply the same internal controls and governance rules on all public corporations impose unnecessary costs on honest corporations by requiring them to change one set of good habits that are part of the corporate culture for another mandated by law. This essay suggests that relief from some of the internal controls rules imposed by the Sarbanes-Oxley Act might be an effective way to reward corporations for their honest behavior rather than punishing them. The essay outlines a number of methods by which this objective can be achieved.

The Missing Link in Sarbanes–Oxley: Enactment of the "Change of Control Board" Concept, or Extension of the Audit Committee Provisions to Mergers and Acquisitions
      Samuel C. Thompson, Jr., 63(1): 81–124 (November 2007)
To address (1) the conflicts of interest that can arise in the acquisition of publicly held target corporations in various types of hostile and consensual merger and acquisition ("M&A") transactions, and (2) the risk of overpayment in major acquisitions by publicly held acquirors, Congress should require the appointment by the U.S. Securities and Exchange Commission ("SEC") of a disinterested Change of Control Board for such targets and acquirors. This Board would have complete authority over the acquisition process, and a federal uniform standard of review, the business judgment rule, would apply in determining if the board acted properly, thereby significantly reducing litigation in M&A transactions. Many features of the Change of Control Board proposal are similar to those provided for audit committees in the Sarbanes–Oxley Act of 2002; thus, this proposal is a logical extension of those audit committee provisions. In the event Congress does not enact the Change of Control Board proposal, many of the concepts underlying the proposal should be implemented by the SEC through its rulemaking authority under the audit committee provisions.

Should the SEC Be a Collection Agency for Defrauded Investors?
      Barbara Black, 63(2): 317–346 (February 2008)
One of the important functions of the U.S. Securities and Exchange Commission ("the SEC") is enforcing the securities laws and punishing violators. Collecting damages for defrauded investors was not, historically, an important part of the agency's mission; rather, that was the function of private securities fraud class actions. Section 308 (the "Fair Fund provision") of the Sarbanes–Oxley Act of 2002 gives the SEC a more prominent role in compensating investors and allows the agency, in some circumstances, to distribute civil penalties to defrauded investors. The SEC has established Fair Funds in a number of high–profile cases and has taken pride in the large amounts of money it has obtained for investors. Meanwhile, section 308 has become an instrument in the business community's campaign against private securities fraud class actions.

This Article reviews the background of the SEC's disgorgement and penalty powers, the history and language of section 308, and SEC enforcement actions against corporations in financial fraud cases and then looks at the business community's reaction to section 308 and recent SEC enforcement actions. The Article concludes that the SEC's increased emphasis on section 308 could lead to a weakening of its effectiveness as an enforcement agency and further erode support for private securities litigation—an unfortunate outcome for investors.

Disgorgement: Punitive Demands and Remedial Offers
      Elaine Buckberg and Frederick C. Dunbar, 63(2): 347–382 (February 2008)
U.S. Securities and Exchange Commission ("SEC") enforcement actions against corporate executives accused of securities fraud have become more visible since the Sarbanes–Oxley of 2002 set new standards to ensure that executives are held individually responsible for corporate fraud. Although long available to the SEC, the disgorgement remedy gained greater prominence because of the Sarbanes–Oxley Act requirement that the chief executive officer and chief financial officer of any company restating its financials due to material non–compliance disgorge incentive or equity–based compensation and profits from sales of stock following the false reporting. The SEC may also seek disgorgement from other executives and of other benefits, including any increment to pension or other retirement plans. Traditionally, class actions were the primary means by which shareholders sued officers and directors for securities claims. But the deterrent value of such lawsuits is arguably compromised because these cases almost always settle—and the employer and its directors' and officers' liability carrier usually fund the full settlement.

Computing accurately the benefits to the executive from the fraud requires an analysis of causation similar to that performed by the U.S. Supreme Court in Dura Pharmaceuticals, Inc. v. Broudo. In the case of an executive benefiting from inflated shares, the approach to measuring the inflation per share at the time of the purchase and sale is the same one as would be used in a shareholder class action. If the wrongdoing included fraudulent accounting leading to higher executive pay, then a similar causation standard applies—namely, how did the defendant's compensation change as a direct result of the fraudulent financials. For some types of accounting violations, such as recognition of revenue in the wrong year, the gains in executive compensation in the year the revenue was recognized are offset, at least to some extent, by the loss in compensation in the year the revenue should have been recognized. The principles of proximate cause and offsetting in disgorgement are grounded in both economics and securities fraud case law.

The Clawback Provision of Sarbanes-Oxley: An Underutilized Incentive to Keep the Corporate House Clean
      Rachael E. Schwartz, 64(1): 1-36 (November 2008)
The Sarbanes-Oxley Act of 2002, passed in the wake of corporate scandals involving misstated financial reports, included a provision for certain compensation and profits from the sale of company stock to be "clawed back" from chief executive officers and chief financial officers of companies that are required to restate their financials, due to material non-compliance with any financial reporting requirement of the securities laws as a result of misconduct. Courts have determined that only the Securities and Exchange Commission may sue to enforce this clawback provision. In the six years following passage of the law, there have been Sarbanes-Oxley clawbacks in only a small number of cases, each one an options backdating case involving allegations that the officer affected personally committed fraud. This Article takes the position that the clawback provision has no scienter requirement and its application should not be limited to officers who have personally engaged in misconduct. Rather, the wording of Sarbanes-Oxley, its legislative history, and the policies it serves call for the clawback to be applied to the chief executive officers and chief financial officers of companies that are required to restate their financials due to material non-compliance with any financial reporting requirement of the securities laws as a result of misconduct, regardless of whether those officers actively participated in the wrongdoing, knew of and failed to correct the wrongdoing, or were oblivious to wrongdoing by employees subject to their control. This general rule can be made subject to an exemption for circumstances involving certain misconduct by non-management employees.

Disclosure Obligations Under the Federal Securities Laws in Government Investigations
      David M. Stuart and David A. Wilson, 64(4): 973-998 (August 2009)
With the prevalence of government investigations into corporate conduct, public companies frequently face decisions about whether, when, how, and where to disclose to investors the existence of such investigations and the facts learned in the course of, or as a result of, those investigations. While the federal securities laws (and the rules and regulations promulgated thereunder) require disclosure of specific events that may arise during an investigation, neither those laws nor the courts that have interpreted them provide clear guidance for many of the disclosure decisions that must be made over the course of an investigation. As a result, counsel must carefully analyze numerous facts and circumstances, understand the company's previous disclosures, make "materiality" assessments, and determine whether to make disclosure in a current report or wait until the next periodic filing. This Article seeks to present, through an analysis of precedent disclosures, caselaw, rules, and practical ramifications, the considerations counsel must take into account in evaluating disclosure decisions in the context of an investigation. These considerations can help counsel avoid having a disclosure decision worsen the already difficult circumstances posed by the investigation itself.

Caveat Auditor: Back to First Principles
      David R. Herwitz, 65(1): 95–106 (November 2009)
The Sarbanes-Oxley Act of 2002 ("SOX") substantially revised the rules governing auditors of public companies, in an effort to counter the auditing weaknesses exposed in the Enron, WorldCom, and similar fiascos. Among the most important changes were a substantial upgrade in the role and responsibility of corporate audit committees, and the creation of a new agency, the Public Company Accounting Oversight Board ("PCAOB"), to take complete charge of overseeing auditors and all aspects of the auditing process. Some commentators have expressed disappointment in the SOX efforts to reform public company auditing, and this subject is likely to receive renewed attention in view of the U.S. Supreme Court's grant of certiorari in Free Enterprise Fund v. PCAOB, a case challenging the constitutionality of the PCAOB. This Article takes the position that rather than focusing on audit committees, effective reform of auditing lies in a significant step-up in the responsibility of auditors, by returning to the original purpose of an audit: to provide as fair and meaningful a picture as possible of a company's financial performance. The Article argues that in applying this high standard to a company's proposed financial statements, the auditor should express its "present fairly" opinion without any limitation based upon GAAP; in addition, whenever there are reasonable alternatives to any of the accounting treatments utilized in the company's financial statements, the auditor's report should disclose the reason for the choice made, as well as whether the auditor would have made the same choice if deciding on its own.

General Counsel Buffeted by Compliance Demands and Client Pressures May Face Personal Peril
     E. Norman Veasey and Christine T. Di Guglielmo,68(1): 57 - 80 (November 2012)
In the "New Reality" of the world of corporate general counsel, the challenges and tensions thrust upon one holding that office have intensified exponentially. Not only does the general counsel uniquely straddle the world of business and law in giving advice to the management and directors of her client (the corporation) but also she may find herself personally in the crosshairs of regulators, prosecutors, and litigants. So, as the rhetoric and real pressures increase to target the general counsel, she must have and use the skills, balance, independence, and courage to be simultaneously the persuasive counselor for her corporate client while being attuned to the need for self-preservation. The lessons from the past targeting of general counsel and other in-house lawyers are ominous. But the quintessential general counsel, acting as both persuasive counselor and a leader in setting the corporation's ethical tone, will do the right thing and thus be prepared to deal with these challenges and tensions.

From Regulation to Prosecution to Cooperation: Trends in Corporate White Collar Crime Enforcement and the Evolving Role of the White Collar Criminal Defense Attorney
     Robert S. Bennett, Hilary Holt LoCicero, and Brooks M. Hanner; 68(2): 411-438 (February 2013)
This article traces the steady growth of criminal law into fields that had previously been addressed by civil statutes, particularly in relation to the concept of corporate criminal liability. The article also describes the means through which the federal government has encouraged cooperation between corporations that are being investigated and their investigators. This fundamental shift in how corporate misconduct is treated by the federal government has reframed the role of a criminal defense attorney who defends corporations and executives. Any lawyer facing such a task must be willing to incorporate new strategies into daily practice while also evaluating the theoretical considerations governing what it means to “bet the company.”

SEC Enforcement Actions and Issuer Litigation in the Context of a "Short Attack"
     Charles F. Walker and Colin D. Forbes; 68(3): 687-738 (July 2013)
Issuers faced with a short attack—short selling of the issuer’s stock combined with the spread of negative rumors—may contemplate defensive strategies such as litigation and contacting government regulators, in addition to the investor and public relations efforts that are typically utilized in the wake of negative media coverage. Precedent calls for caution in these circumstances, as the record shows that the results of such strategies are mixed, with the SEC often turning its investigative focus to the issuer, and with costly litigation frequently resulting in compromise. This article begins with a discussion of the recent history of regulatory and legislative efforts to address concerns around short attacks and “naked” short selling. It then turns to a discussion of the SEC enforcement cases and private litigation relating to short attacks, and concludes that the SEC has appropriately brought enforcement cases only in clear-cut instances of fraud, while policing the margins through enforcement of the technical requirements of Regulation SHO. The article shows that the SEC enforcement record in this area, and the proof issues generally attendant to these cases, present important considerations for issuers who perceive themselves under siege in a short attack.

New FASB Rules on Accounting for Leases: A Sarbanes-Oxley Promise Delivered
     Donald J. Weidner, 72(2): 367-404 (Spring 2017)
Congress responded to the first financial accounting scandals of the new millennium by enacting the Sarbanes-Oxley Act of 2002, which required the Securities and Exchange Commission (“SEC”) to study issuers’ filings and report on whether their financial statements reflect the economics of off-balance sheet arrangements to investors in a transparent fashion. In 2005, the SEC reported that there “may be approximately $1.25 trillion in non-cancellable future cash obligations committed under operating leases that are not recognized on issuer balance sheets, but are instead disclosed in the notes to the financial statements.” Accordingly, the SEC requested that the Financial Accounting Standards Board (“FASB”) craft new rules to record more lessee liabilities on the balance sheet.

In 2016, the FASB issued sweeping new rules that affect virtually every firm that leases assets “such as real estate, airplanes, and manufacturing equipment.” In a dramatic change in approach, every lease extending more than twelve months will be capitalized and recorded on the lessee’s balance sheet as reflecting both a “right-of-use asset” and a corresponding liability. The new rules move away from the formalism of bright-line rules and toward an affirmative obligation to record economic substance. This article provides an overview of the history, policy, and mechanics of the new rules, which are likely to have a significant economic impact on many companies.

Compliance and Ethics Programs: What Lawyers Need to Know to Understand the Development of This Field
     Steven A. Lauer and Joseph E. Murphy, 75(4): 2541-2566 (Fall 2020)
Corporate compliance programs, a relatively new phenomenon in the corporate arena, have evolved over the past few decades. What challenges have compliance professionals encountered during that short history? What issues might they face in the coming years? The authors review that history and render some educated guesses as to the answers to that last question in this article.