The enforcement of previous legislation offers important lessons on how the new executive certification requirements will be applied
By Dale H. Oliver and Joseph N. Akrotirianakis
Dale H. Oliver is a partner and Joseph N. Akrotirianakis is an associate in the Los Angeles office of Quinn Emanuel Urquhart Oliver & Hedges LLP. Oliver and Akrotirianakis specialize in government investigations and business litigation.
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On July 30, 2002, in response to the recent wave of corporate accounting scandals, President Bush signed into law the Sarbanes-Oxley Act.1 Sections 901 through 906 of Sarbanes-Oxley are collectively titled the White-Collar Criminal Penalties Enhancement Act of 2002. The WCCPEA requires CEOs and CFOs to certify the accuracy of corporate financial statements required to be filed with the SEC. The act also imposes tough criminal penalties on senior executives of companies found to have committed accounting fraud or to have failed to “fairly present” their company’s financial condition in reports filed with the SEC.2 It remains to be seen whether the newly required certifications represent significantly increased exposure for these senior executives, but analogous experience with longstanding certification requirements for senior executives of government contractors provides insight as to how corporate officers can best survive in a business climate now fraught with potential pitfalls.
In the mid-1980s, like today, newspaper headlines screamed allegations of fraudulent business practices. The mid-1980s uproar stemmed from charges that federal government defense contractors were intentionally including unallowable costs in proposals for government reimbursement of overhead expenses. In response, Congress passed several laws in part aimed at punishing those who attempted to defraud the federal government. One such provision is Section 911(a)(1) of the National Defense Authorization Act for Fiscal Year 1986.3 This section requires a senior executive of a government contractor to certify, to the best of his or her knowledge and belief, that all costs included in an indirect cost proposal were allowable under the cost principles of the Federal Acquisition Regulation and its supplements.4 This certificate was commonly referred to as the Weinberger Certificate, after then-Secretary of Defense Caspar W. Weinberger, at whose insistence this requirement was first promulgated as a regulation.
Even then the idea of government contractor certification was not a novel one. The Contract Disputes Act of 1978 (CDA),5 which governs contract disputes with the government, has, since its enactment, provided that all claims against the government that exceed $100,000 must be accompanied by a certification that:
• The “claim is made in good faith.”
• The data supporting the claim “are accurate and complete to the best of [the] knowledge and belief” of the certifier.
• “[T]he amount requested accurately reflects the contract adjustment for which the contractor believes the government is liable.”
• “[T]he certifier is duly authorized to certify the claim on behalf of the contractor.”6
The purpose of a certification requirement such as that imposed by the CDA is to trigger potential liability for a fraudulent claim.7 Criminal liability can ensue.
As with the new WCCPEA, the regulation implementing the Weinberger Certificate requirement mandates that the certificate be executed by a company’s senior executives, who personally face potential criminal liability if the representations contained in the certification are shown to be inaccurate.8 A senior executive who files a false Weinberger Certificate may face a significant monetary fine as well as five years’ imprisonment.9
Use of Certification Provisions
Government defense contractors have been confronted with certification requirements for more than 20 years, and now the WCCPEA extends similar liability to the CEOs and CFOs of nearly all companies required to report to the SEC. Issues that have arisen in the defense contracting context provide guidance in the new WCCPEA era. Still, before the wide reach of certification requirements, and despite the challenges of proving the mens rea requirements contained in federal criminal statutes, corporate officers have been held criminally liable for violations committed by other employees under what has become known as the responsible corporate officer doctrine.10 Mental state elements may be established pursuant to this and related doctrines through factors other than proof of actual knowledge on the part of corporate officers themselves.
The responsible corporate officer doctrine grew out of the U.S. Supreme Court’s 5-4 decision in United States v. Dotterweich.11 The Court in Dotterweich addressed whether a corporate president could be held criminally liable for a corporation’s sale of adulterated or misbranded drugs in violation of a misdemeanor provision of the Food, Drug, and Cosmetic Act.12 Because the FDCA section under which the officer was prosecuted contained no express mental state requirement, the Court held that an individual acting on behalf of a company who was even “remotely entangled in the proscribed shipment” could be held strictly liable for the alleged violation.13
Attorneys representing corporate officer defendants have argued—generally successfully to date—that the responsible corporate officer doctrine should apply only in cases, such as Dotterweich, that involve misdemeanor prosecutions under strict liability statutes like the FDCA. A few prosecutors, however, have won felony convictions of corporate managers and executives in circumstances in which the proof establishing the requirement of criminal “knowledge” was based on little more than the executive’s title alone. In prosecutions brought under federal environmental criminal laws, for example, jurors have been persuaded to infer criminal knowledge based on a corporate officer’s title and the duties shown to accompany that title. In essence, the defendant is held liable for what he or she should have known given his or her title within the organization and the duties that accompany that position in the context of the relevant regulatory scheme.14
In United States v. Dee,15 the U.S. Court of Appeals for the Fourth Circuit sanctioned what is likely the broadest imposition of constructive knowledge in the context of a federal criminal statute that expressly requires proof of a knowing violation. In Dee, three individuals were charged with and convicted of violating the Resource Conservation and Recovery Act16 by knowingly “storing, treating and disposing of hazardous wastes” at the chemical plant where one of the defendants was “responsible for operations and maintenance.”17 Two of the defendants were superiors of the third defendant, and they had no direct involvement in the commission of the acts charged. The defendants appealed their convictions and raised, among other issues, a challenge to the jury instructions. The Fourth Circuit held that “[a]s a whole, the instructions ‘fairly and adequately state[d] the pertinent legal principles involved.’”18 The jury in Dee had been instructed that:
Among the circumstances you may consider in determining the defendant’s knowledge are their positions in the organization, including their responsibilities under the regulations and under any applicable policies. Thus you may, but need not, infer that a defendant knew facts which you find that they should have known given their positions in the organization, their relationship to other employees, or any applicable policies or regulation. Again, this is only one factor which you may consider in determining whether the government has established knowledge beyond a reasonable doubt….19
Far reaching as such an instruction is, it still requires the government to prove a “responsible relationship” between a defendant’s position and the conduct alleged.
Convictions of corporate officers have also been upheld under statutes requiring a knowing violation based on the substitution of conscious avoidance of knowledge in place of actual knowledge. United States v. Hanlon20 involved a prosecution of a corporation’s president, COO, and attorney for, among other offenses, “knowingly” making false statements in connection with obtaining loans from a federally insured bank.21 The defendants conceded that a fraudulent scheme existed (undertaken by others, who fled prosecution) but asserted that their preparation of various false documents constituted unknowing participation in illegal acts. All three defendants were convicted.22
On appeal, the defendants claimed that the government had presented insufficient evidence of guilty knowledge. At trial, the court had given a “conscious avoidance” instruction, also known as an ostrich or, within the Ninth Circuit, a Jewell23 instruction. The court instructed the jury that:
The element of knowledge of a given fact under this false statement or overvalued security charge may be satisfied by proof that a defendant acted with reckless disregard of what the truth was, unless he actually believed the contrary to be true. One may not deliberately close his eyes to what otherwise would have been obvious to him.24
The Second Circuit upheld the convictions, holding that “a finding of guilty knowledge may not be avoided by a showing that the defendant closed his eyes to what was going on about him.”25 The appellate court stated that “‘see no evil’ is not a maxim in which the criminal defendant should take any comfort.”26
The WCCPEA’s certification requirement increases the liability that CEOs and CFOs would otherwise face because, in the context of SEC reporting accuracy requirements, it reaches even beyond the knowledge instruction given in Dee.
The WCCPEA’s certification provision even eliminates the need to establish knowledge by proving a “responsible relation” between a corporate officer defendant’s title and the criminal conduct alleged. Indeed, the WCCPEA instead creates 1) a responsible relation between a company’s most senior officers and the accuracy of the company’s financial statements, and 2) a duty, within the scope of this prescribed responsibility, to ensure personally that the company’s reports to the SEC “fairly present” the company’s financial condition.
As with the new WCCPEA, the Weinberger Certificate requirement enhanced the government’s ability to prove criminal knowledge on the part of a certifying corporate executive without proving actual knowledge. Through the use of certifications, the government can avoid difficulties it might otherwise face in establishing a criminal statute’s mental state requirement. By creating statutory responsibilities and duties by title alone, the certification requirement disposes of making preliminary inquiry into an officer’s duties and responsibility to infer knowledge that should accompany a title. The available avenues for establishing the requisite mens rea under the False Statements Act (FSA)27 illustrate the potential exposure senior executives will face under the new WCCPEA provisions.
A violation of the FSA may be established through proof that the defendant had the specific intent to make a false or fraudulent statement. Much lesser showings, however, have been held sufficient to establish that a defendant “knowingly and willfully” executed a false certification in violation of the FSA.28 As in Hanlon, this requirement is also satisfied by proof of a conscious purpose to avoid learning the truth, indicating a “deliberate ignorance.”29 Prosecutors frequently request—and, when potentially applicable, receive—a Jewell or conscious avoidance jury instruction.30 The purpose of such an instruction is “to prevent [the defendant] from circumventing criminal sanctions merely by deliberately closing his eyes to the obvious risk that he is engaging in unlawful conduct.”31 Such instructions have long been held to be acceptable in prosecutions under the FSA.32
Some defendants have attempted to avert criminal liability by claiming reliance on expert advice. The so-called reliance on expert defense in FSA prosecutions, however, is held to apply only when the defendant can demonstrate that his or her accountant or attorney was presented with all relevant facts, and the defendant was “specifically advised” as to “the course of conduct taken.”33 The same standard can be expected to apply under the new WCCPEA.
Practical Considerations for Sarbanes-Oxley Compliance
With the history of prosecutions under the FSA and the certification requirements of the current legislation, corporate officers must undertake particularly conscientious measures to protect themselves against the possibility of criminal liability. The investigations and prosecutions of senior government contractor officials under the FSA and similar statutes provide insight into the potential criminal liability created by the new legislation’s requirement of the “fair” presentation of financial statements.
More than one approach is often available as an appropriate accounting treatment. In very few circumstances is there simply one right answer, and choosing among available options is somewhat subjective. Therefore, the focus of the WCCPEA and the required certification should be defined in terms of adequate disclosure. Senior officials must continually keep in mind the importance of disclosure when they are seeking to minimize their exposure. Crucial to an adequate representation of financial statements is disclosure of choice of accounting methodology and the operative facts incident to that choice. This emphasis on disclosure accordingly bespeaks caution: When in doubt, a full description of the accounting decision underlying the financial statements is required. Officials should avoid being “cute” when describing the company’s financial condition.
In addition, though purchasers of securities may have differing levels of expertise in reviewing financial statements, corporate officials should consider an approach that aims for the lowest common denominator when describing their corporate finances. Senior executives can reduce the risk of being viewed as obscuring a company’s financial condition by expressing it in understandable and simple terms accompanied by disclosure of any qualification of the company’s financial statements. Courts will likely reference the average purchasing public in assigning liability for misstatement.34 Ambiguity and vague statements may be considered smoke screens for deceptive practices—and under the WCCPEA, where there is smoke, there is statutorily prescribed fire. Clarity is therefore at a premium in seeking to avoid liability.
The certifications that are required by the WCCPEA may be executed to the best of the knowledge and belief of signing CEOs and CFOs. Certifying executives cannot, however, evade liability by avoiding acquisition of knowledge. The courts will likely impose a duty on these individuals to be reasonably informed of the material financial facts necessary to prepare publicly disseminated financial information. As such, certifying officers have a duty to undertake a reasonable investigation of the company’s financial condition. Indeed, the SEC’s proposed rule implementing the certification requirements of the Sarbanes-Oxley Act contemplates that signing officers both establish and maintain internal controls to record, process, summarize, and report financial data.35 Under the certification requirement, an officer would vouch that the company implemented “such internal controls to ensure that material information relating to the issuer and its consolidated subsidiaries is made known to such officers by others within those entities” and that these internal controls are effective. Certifying senior executives cannot simply pass along these new obligations to subordinates.
Senior corporate officials should not be required, however, to be guarantors of the accuracy of the company’s financials—and innocent mistakes are bound to occur. To reduce the risk that these errors can later be characterized as “corporate malfeasance,” companies should employ compliance programs tailored to their SEC reporting requirements. Such programs can include accounting training programs, tiered certifications by subordinates responsible for financial reporting, strengthened internal auditing, and formal inquiries of advisers. The latter should involve reports by accounting, legal, and financial advisers, specific discussion of close questions or judgmental areas, and mandatory written advice of outside advisers regarding the propriety of accounting judgments and the adequacy of the disclosures. The key to these programs is the manifestation of reasonable and well-intentioned good faith compliance. Such efforts will establish credibility, and that credibility will assist in avoiding criminal prosecutions in the first instance. A company should never allow itself to be seen as being at the low end of the compliance spectrum when judged against other companies also subject to the reporting strictures of the Sarbanes-Oxley Act.
The duty imposed by the act’s certification requirement most probably does not end once a financial statement is submitted. Upon discovery that a statement contains an error, immediate correction and disclosure of the correction will likely be required. Otherwise, silence with knowledge of an inaccuracy can be characterized as an ongoing conspiracy to mislead. Allegations of this type can entangle people who had no participation in the original omission or inaccuracy. Restated financials are certain to become the norm in the wake of the new law.
Early indication of any potential errors in financial statements must be assiduously investigated. Government contractors discovered, sometimes through painful experience, the advantages of being proactive in investigating possible accounting errors. A company’s legal position (and that of its senior officials) in any subsequent litigation is enhanced significantly if the company has aggressively sought to understand and, if required, to correct financial irregularities. An early effort to investigate and correct errors also helps establish the company’s credibility with prosecutors and, if necessary, the jury.
An investigation based upon reasonable suspicion that a problem exists should be formal and thorough. Individuals not directly involved in the problem should conduct the review and, if possible, the investigation should be under the direction of the company’s counsel. A strong and competent internal audit structure within the company is useful in this activity. An early investigation fosters the required preservation of documents, an understanding of the possible problems presented, and the possibility of taking remedial action before being compelled to do so in the face of a criminal prosecution. Truly, being forewarned is to be forearmed.
The Prospect of a Government Investigation
The WCCPEA’s creation of a duty for CEOs and CFOs means that certifying senior officials will automatically be considered—and will likely be targeted—in any contemplated criminal prosecution of their company for omissions or inaccuracies in financial statements. This fact alone may substantially enhance the government’s prosecutorial enthusiasm. The inclusion of the most senior officials of a company substantially increases the publicity value of a prosecution—and the new legislation provides ready identification of “live bodies” on whom the government can focus in pursuing such a prosecution. The inclusion of senior officials also substantially enhances the ability of the government to pressure defendants to settle, particularly given the severity of the criminal sanctions that can be sought against these individuals. All these factors will promote the expenditure of resources by the government in pursuing prosecutions under the new law.
Often, initial discussions with and disclosures to federal investigators establish credibility and head off prosecutions. The government’s prosecutorial resources are limited, and prosecutors can be expected to pick the easiest targets. An early conclusion that company officials have acted reasonably will substantially dampen prosecutorial zeal. Reasonable and reasoned responses in advance of the formal initiation of criminal prosecution may go a long way toward ensuring that a company and its senior officials can avoid being caught up in a prosecution. To be prosecuted is to lose, even if the company and its officials ultimately prevail at trial. Putting together a response team when faced with the knowledge of prosecutorial interest is essential and should be done immediately.
The phenomenon of focusing on senior company officials in seeking to ensure accurate and complete financial statements is not going to go away, even as the headlines recede from the front pages of national newspapers. New cases under the FSA and the False Claims Act36 arising out of government contracts are still being actively pursued and prosecuted today, almost 20 years after the initial publicity that led to the enactment of those laws. The bureaucracy for prosecuting such cases is in place, and government expertise is assembled.
Thus, government contractors have come to live with the fact that their senior executives face potential criminal liability for improper certifications. Their corporate peers must now follow their lead, because the Sarbanes-Oxley Act creates a new environment in which the personal criminal exposure of senior corporate executives has increased.
1 The Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745.
2 The WCCPEA certification requirements are enacted as 18 U.S.C. §1350, “Failure of corporate officers to certify financial reports,” which provides:
(a) CERTIFICATION OF PERIODIC FINANCIAL REPORTS.—Each periodic report containing financial statements filed by an issuer with the Securities Exchange Commission pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m(a) or 78o(d)) shall be accompanied by a written statement by the chief executive officer and chief financial officer (or equivalent thereof) of the issuer.
(b) CONTENT.—The statement required under subsection (a) shall certify that the periodic report containing the financial statements fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)) and that information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer.
(c) CRIMINAL PENALTIES.—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 set forth in this section shall be fined not more than $5,000,000, or imprisoned not more than 20 years, or both.
3 National Defense Authorization Act for Fiscal Year 1986, Pub. L. No. 99-145, 99 Stat. 583 (1986). Section 911(a)(1) of the act was enacted as 10 U.S.C. §2324.
4 See 10 U.S.C. §2324(h); 48 C.F.R. §52.242-4.
5 The Contract Disputes Act of 1978, 41 U.S.C. §§601-613.
6 41 U.S.C. §605(c). This requirement is implemented by 48 C.F.R. §52.233-1(d)(1), which sets forth the language of the required certification:
I certify that the claim is made in good faith; that the supporting data are accurate and complete to the best of my knowledge and belief; that the amount requested accurately reflects the contract adjustment for which the Contractor believes the Government is liable; and that I am duly authorized to certify the claim on behalf of the Contractor.
48 C.F.R. §52.233-1(d)(1)(iii).
7 Skelly & Loy v. United States, 685 F. 2d 414, 418 n.11 (Ct. Cl. 1982); see Fischbach & Moore Int’l. Corp. v. Christopher, 987 F. 2d 759, 763 (Fed. Cir. 1993); Medina Constr. Ltd. v. United States, 43 Fed. Cl. 537, 547 (1999).
8 See 48 C.F.R. §52.242-4(a)(3) (requiring that the certification be “signed by an individual of the Contractor’s organization at a level no lower than a vice president or chief financial officer of the business segment of the Contractor that submits the proposal”).
9 18 U.S.C. §§287, 1001(a), 3571.
10 The responsible corporate officer doctrine has been characterized as imposing criminal liability on a corporate officer “if, by virtue of his or her position and authority within the company, the defendant had the power to prevent or correct the conduct which gave rise to the violation.” Barbara DiTata, Proof of Knowledge under RCRA and the Use of the Responsible Corporate Officer Doctrine, 7 Fordham Envtl. L.J. 795, 806-07 (1996).
11 United States v. Dotterweich, 320 U.S. 277 (1943).
12 21 U.S.C. §§301-392.
13 Dotterweich, 320 U.S. at 284.
14 See, e.g., United States v. Johnson & Towers, Inc., 741 F. 2d 662, 670 (3d Cir. 1984) (stating, in a prosecution under federal environmental law, that knowledge “may be inferred by the jury as to those individuals who hold the requisite responsible positions with the corporate defendant”).
15 United States v. Dee, 912 F. 2d 741 (4th Cir. 1990).
16 The Resource Conservation and Recovery Act, 42 U.S.C. §§6901-6987.
17 Dee, 912 F. 2d at 743.
18 Id. at 746 n.8 (citing Hogg’s Oyster Co. v. United States, 676 F. 2d 1015, 1019 (4th Cir. 1982)).
19 Jane F. Barrett & Veronica M. Clarke, Perspectives on the Knowledge Requirement of Section 6982(d) of RCRA after United States v. Dee, 59 Geo. Wash. L. Rev. 862, 872 (1991) (quoting district court record in Dee) (emphasis added).
20 United States v. Hanlon, 548 F. 2d 1096 (2d Cir. 1977).
21 This is a violation of 18 U.S.C. §1014.
22 Hanlon, 548 F. 2d at 1098-99. In addition to convictions under 18 U.S.C. §1014, the defendants were convicted of conspiracy (18 U.S.C. §371); aiding and abetting the receipt of a bribe by bank officers (18 U.S.C. §§2, 215); and wire fraud (18 U.S.C. §1343).
23 United States v. Jewell, 532 F. 2d 697 (9th Cir. 1976). In Jewell, the evidence showed that the defendant and a friend declined the offer of a stranger they met in Mexico to buy marijuana but accepted $100 from him to drive a car across the border to Los Angeles. At trial the defendant testified that he was aware that the vehicle had a secret compartment in the trunk and that he checked the glove box, under the seat, and the trunk because he thought there was probably something illegal in the car. The defendant also testified, however, that he did not investigate the secret compartment. See id. at 699 n.2. The Ninth Circuit upheld the trial court’s jury instruction permitting the government to prove the defendant’s knowledge of possession by establishing that the defendant had “made a conscious purpose to disregard the nature of that which was in the vehicle, with a conscious purpose to avoid learning the truth.” See id. at 700.
24 Hanlon, 548 F. 2d at 1100 n.7 (emphasis added).
25 Id. at 1101.
27 The False Statements Act, 18 U.S.C. §1001.
28 It should be noted that, although the FSA requires proof that a false statement is made both “knowingly and willfully,” the new WCCPEA imposes criminal liability when a senior executive commits a “knowing” violation of the certification provision—and there are separate, heightened penalties when the violation is “willful.”
29 See United States v. Schaffer, 600 F. 2d 1120, 1122 (5th Cir. 1979) (“The requirement of an intent to deceive coupled with reckless indifference to the truth or falsity of the statement is the equivalent of knowledge.”).
30 The Ninth Circuit today provides a model Jewell instruction:
You may find that the defendant acted knowingly if you find beyond a reasonable doubt that the defendant was aware of a high probability that [e.g., drugs were in the defendant’s automobile] and deliberately avoided learning the truth.
You may not find such knowledge, however, if you find that the defendant actually believed that [e.g., no drugs were in the defendant’s automobile], or if you find that the defendant was simply careless.
9th Cir. Crim. Jury Instr. §5.7 (2000 ed.).
31 United States v. Evans, 559 F.2d 244, 246 (5th Cir. 1977).
32 See, e.g., United States v. Lennartz, 948 F. 2d 363, 369-70 (7th Cir. 1991); Evans, 559 F. 2d at 246 (“Construing ‘knowingly’ in a criminal statute to include willful blindness to the existence of a fact is no radical concept in the law.”).
33 United States v. McLennan, 563 F. 2d 943, 946 (9th Cir. 1977) (Duniway, J., with Choy, J., concurring specially in the result); see also United States v. Johnson, 730 F. 2d 683, 686 (11th Cir. 1984).
34 Cf. TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 450 (1976).
35 See Proposed Rule: Certification of Disclosure in Companies’ Quarterly and Annual Reports, 17 C.F.R. §§232, 240, 249 (Release No. 34-46300, S7-21-02) (proposed Aug. 2, 2002).
36 The False Claims Act, 31 U.S.C. §§3729 et seq.
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