Professional Documents
Culture Documents
• In general, Sarbanes-Oxley
– increases criminal penalties for securities fraud, including financial fraud;
– eases the standard for barring persons who commit securities fraud from serving
as officers and directors of public companies;
– permits the SEC to pursue such officer and director bars in administrative
proceedings as well as in the courts;
– adds sanctions and strengthens existing sanctions, regarding destruction,
alteration or falsification of records in investigations, and destruction of audit
records;
– provides a longer statute of limitations for securities fraud;
– Includes whistle blower protections; and
– limits discharge of securities law violators’ debts in bankruptcy
ANY VIOLATION OF SARBANES-OXLEY MAY
BE PROSECUTED AS A VIOLATION OF THE
EXCHANGE ACT
• Sarbanes-Oxley Section 3(b)(1) provides:
A violation by any person of this Act, any rule or regulation of
the Commission under this Act, of any rule of the [Public
Company Accounting Oversight Board] shall be treated for all
purposes in the same manner as a violation of the Securities
Exchange Act of 1934 (15 U.S.C. 78a et seq.) or the rules or
regulations issued thereunder, consistent with the provisions of
this Act, and any such person shall be subject to the same
penalties, and the same extent, as for a violation of that Act or such
rules or regulations.
STATUTORY BASIS OF DIRECTORS’ LIABILITY
FEDERAL SECURITIES LAWS
• Exchange Act antifraud provisions of Section 10(b) and Rule 10b-5, for which the
courts have implied a private right of action
• Scienter or recklessness requirement
• In connection with the purchase or sale of a security requirement
• Exchange Act Section 18(a) imposes liability;y on “[a]ny person who shall make
or cause to be made” a false or misleading statement in an Exchange Act report.
Liability is to the purchaser or seller of a security at a price affected by the false
or misleading statement, for damages caused by such reliance, unless the
defendant can prove that he acted in good faith and had no knowledge that such
statement was false or misleading
• Exchange Act Section 20(a) controlling person liability. “Every person who,
directly or indirectly, controls any person liable under any provision of this title or
of any rule or regulation thereunder shall also be liable jointly and severally with
and to the same extent as such controlled person to any person to whom such
controlled person is liable, unless the controlling person acted in good faith and
did not directly or indirectly induce the act or acts constituting the violation or
cause of action
• Securities Act of 1933. Potential civil liability under Sections 11 and 12(a)2
DIRECTORS’ DUTY OF CARE
• Audit committees of directors are charged with financial oversight
responsibility as delegated by the full board of directors
• Accordingly, both audit committee members and the full board of
directors have a duty of care to the company and its shareholders
• Discharge of this duty generally requires, among other things:
– That board members be duly diligent and act in good faith
– In the case of audit committee members, the duty of care requires members to:
• Be fully informed and observe committee processes, which include
attendance, proactive questioning and discussion with management and the
independent auditors
• Ensure that the company has an adequate system of internal controls to
monitor red flags and preserve the integrity of financial reporting; and
• Oversee the financial reporting process, which requires confirmation of the
outside auditors’ independence and necessitates an understanding of the
company’s business, its risks and critical accounting policies
CAREMARK INT’L. DERIVATIVE LITIGATION
• In this leading case, 698 A.2d 959 (Del.Ch. 1996), the Delaware Chancery Court
held that the board of directors’ duty of oversight includes a duty to ensure that
“appropriate information and reporting systems” exist to provide the board with
access to timely accurate and adequate information to ensure corporate compliance
and business performance; however, the level of detail required is a matter of
business judgment
• Caremark suggests that in evaluating a company’s management systems and the
structure of internal controls, board (or audit committee) members should test and
challenge those systems rather than just relying on the auditors’ and management’s
reports to identify any deficiencies
• While Caremark represents a departure from prior case law that recognized a
presumption of business regularity and did not impose affirmative obligations on
directors absent cause for suspicion. Caremark nevertheless follows a traditional
business judgment rule analysis in holding that directors are able to fulfill their duty
of monitoring under Delaware law by making a good faith, reasonable effort to
implement an adequate reporting system
• Compare the SEC’s Report of Investigation in W.R. Grace & Co. (Exchange Act.
Rel. No. 34-39157 (Sept. 30, 1997)), indicating: “An officer or director may rely
upon the company’s procedures for determining what disclosure is required only if
he or she has a reasonable basis for believing that those procedures have resulted in
full consideration of those issues”
PROVISIONS Of U.S. LAWS THAT MITIGATE
THE POTENTIAL CIVIL LIABILITY OF
DIRECTORS
• Business judgment rule
• Due diligence defenses
• Good faith reliance upon the records of the corporation and upon
such information, reports opinions or statements provided by
corporate officers, employees, board committees and
professional advisors; e.g. Section Del Gen. Corp. Law, Section
141(e)
• Charter provisions that limit liability for damages for breach of
the duty of care; e.g. Del Gen. Corp. Law. Section 102(b)(7)
• Indemnification and contribution
• Insurance
CONCLUSIONS
• Sarbanes-Oxley makes it easier to prosecute securities fraud, particularly financial
fraud.
• One of the most direct ways in which the Act accomplishes this objective is to place
greater responsibility on senior management and directors, particularly independent
directors and audit committee members, by requiring them to take a substantially
more proactive role in overseeing and monitoring the financial reporting process,
including disclosure and reporting systems and internal controls
• While Sarbanes-Oxley increases civil and criminal enforcement authority over the
conduct of corporate officers and directors, it does not purport to change the civil
liability provisions that may apply to directors’ conduct under federal securities laws
or the common law duty of care
• However, there is no question that potential civil liability for directors will be greater
after Sarbanes-Oxley
• For those countries considering provisions, such as Sarbanes-Oxley, that place
increased responsibilities on directors, the prospect of directors’ civil liability such
liability should be viewed in the context of whether there are sufficient legal
defenses and other provisions available to mitigate such liability without
compromising directorial responsibility, so that corporations will be able to attract
and retain qualified corporate directors