Sarbanes-Oxley Failing to Keep Promise of Holding Executives Accountable

August 1, 2012

The Sarbanes-Oxley Act of 2002 (“SOX”), passed with much fanfare following the Enron and WorldCom scandals that rocked the financial world, marked a significant step toward reining in reckless and unlawful practices at publicly traded companies. However, ten years after the Act’s passage, it is difficult to view the Act as having fulfilled its potential as an effective disincentive against fraud. As the Wall Street Journal reported on July 29, 2012, this may be due in large part to the government’s failure to successfully prosecute a single criminal case using one of SOX’s most important measures: the false-certification charge.

In addition to its other measures holding accounting firms accountable and protecting whistleblowers against retaliation, SOX sought to toughen penalties for white-collar crimes, and to ensure that senior executives were held personally accountable when their companies engaged in fraud. As a result, the Act mandates that chief executives and chief financial officers certify that their companies’ annual and quarterly reports “fairly present” the company’s finances. If an executive was found to have willfully filed a false certification, the Act provided that the executive could be fined $5 million or sent to prison for 20 years. Prior to SOX, if a company engaged in fraud, it was often the shareholders that were jointly penalized by the Securities and Exchange Commission (“SEC”) or the Department of Justice (“DOJ”). The purpose of this provision was to hold the CEO and CFO of a company personally responsible for their company’s financial reports – with a possible prison sentence as the price of failure – thereby providing a significant deterrent for this type of wrongdoing.

However, without enforcement of this provision, deterrence is lost. As 60 Minutes reported in December 2011, there still has yet to be a single prosecution of a high-ranking Wall Street executive or a major financial firm related to the financial crisis of 2008, despite the fact that there seems to be overwhelming evidence suggesting that CEOs at these companies would have to have been shockingly – perhaps even purposefully – oblivious to have not known about the deficiencies in their company’s internal controls and financial statements. In fact, there have been only a few criminal false-certification charges brought in total in the past decade, and the most prominent of those cases – brought against Richard Scrushy, the former CEO of HealthSouth Corp who was accused in 2003 of directing a $2.7 billion accounting fraud – ended in an acquittal.

The Sarbanes-Oxley Act will only deter companies from engaging in SEC and other federal law violations if CEOs and CFOs fear that failure to comply could result in prison time. It does not require an overly healthy imagination to think that if the CEOs and CFOs heading firms such as Lehman Brothers or Bear Stearns had believed their certifications of their company’s financial reports could have resulted in prison time, they may have taken greater care to ensure their accuracy. Instead, they certified financial statements which later turned out to be wildly inaccurate, and their behavior was justified – at least in a purely self-interested way – as they floated away from the crisis on golden parachutes while the American taxpayer footed the bill for their mistakes.

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