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Project: Corporate Counsel - Legal Service Providers
The Impact Of The Sarbanes-Oxley Act: If You Can't Teach That Old Dog New Tricks, You May Have To Visit Him At The Pound
By Michael Prounis
With the President's signing of the Corporate Fraud Accountability Act of 2002, also known as the Sarbanes-Oxley Act of 2002 or H.R.3763, the world has changed for CEO's. This law is the culmination of months of public anger at an unparalleled level of corporate scandal. More high-profile situations have arisen this year than over the course of my 25-year career in legal system consulting. Scandals involving the likes of Enron, Andersen, WorldCom, Global Crossing, Imclone and at least a dozen others that have shaken markets, rattled investors and led to a wholesale change in the regulatory environment. The Sarbanes-Oxley Act is an act to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes. It is an amazing piece of legislation in its open acknowledgement that corporate executives, public accountants and even the legal profession urgently need "adult supervision." The enlightened notion of self-regulation will soon end for these professional services.
Conspicuously absent from the President's signing ceremony were any accountants, CEO's or CFO's; however, corporate executives are not the only ones targeted by this new law. Now within the rifle scopes of the Securities & Exchange Commission ("SEC") are the in-house counsel and corporate lawyers who practice before them. To date, accountants and lawyers have largely been self-regulated by the AICPA, ABA, FASB or by the state bar associations. Going forward the Public Company Accounting Oversight Board, which consists of five SEC appointed members, will oversee the auditing of public concerns. Critics have said the unwillingness of these two professions to make meaningful regulatory changes has led to the loss of their independence. The new law places a tremendous burden on corporate lawyers and in-house counsel to ensure that their disclosures are consistently trustworthy and defensible from a process standpoint. The SEC will soon be offering official rules of professional conduct for lawyers, and they already possess the power to ban a lawyer from practicing before the Commission.
Attorneys practicing before the Commission in the representation of issuers will be subject to many new SEC rules of professional conduct, including rules requiring them to report to the chief legal officer or CEO any "evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof" and, if there is not an appropriate response, to the Audit Committee or other committee consisting solely of independent directors [§ 307]. Much of the media hype that has also related to this Act has centered around the need for CEO's and CFO's to sign off on their financial statements and the creation of an entirely new accounting oversight regimen. But I submit that the bigger story will be how new SEC rules impact lawyers and their information disclosures. The regulators expect that all businesses will be trustworthy in their information disclosures or face severe consequences. Given the frequent intersect between public and private information disclosures (i.e., civil disputes, class actions and government investigations), often the exact same corporate information will be requested by different parties. Sloppy or incomplete information disclosure in one matter can now directly impact the others and place corporate executives in harms way!
In that sense, the Sarbanes-Oxley Act of 2002 changes the notion of corporate document preservation, filtering and production obligations and of what's expected of lawyers with respect to official corporate records keeping. While it specifically speaks to accounting records and audit work papers, the SEC rules will likely apply to all official corporate disclosures including certain legal work product and certain categories of business records. What will the precise impact of Sarbannes-Oxley be on corporate electronic records management policy? It's too early to tell, but expect more companies to stumble or possibly self-destruct when unexpectedly drawn into some high-profile situation where their actions or lack thereof detonate a discovery time bomb with respect to information disclosure.
Up until now, for lawyers, honest information disclosure was first an ethical obligation and second a rule of civil procedure; now it is both an ethical obligation and rule, but also a federal law, punishable by fines and up to 20 years in prison. After making significant strides in recent ABA popularity polls (i.e., post 9/11), lawyers have just taken a few steps backward in the trust department. The notion of self-regulation of professionals is going extinct. The trust carpet has been pulled out from under them by this legislation. Now, regulators can apply new pressures on lawyers, should they wish to extract concessions or if they wish to question the integrity of some corporate information disclosure.
Smart practitioners will be proactive in making sure that all information disclosures are complete and defendable from a process standpoint. Simply asking your clients to print what they think might be responsive to a civil or governmental inquiry is probably not good enough. Regulators will be sure to note the qualitative difference and appreciate the completeness of your information disclosure. Regulators may equate your overall trustworthiness to a large extent with the quality and completeness of your information disclosure.
The Sarbanes-Oxley Act increased the stakes for sloppy "e-lawyering" with respect to corporate disclosures to government regulators, as well as to the public and to litigants in a dispute. e-lawyering being the task of determining what are the relevant information sources, which data is responsive to an information request, etc. Most lawyers are not trained or particularly well versed in the art of electronic discovery and production. They typically wing it or are coached by an expert, or an IT professional. The combination of sloppy e-lawyering with the Sarbanes-Oxley Act has all the ingredients needed for a colossal meltdown like Andersen or worse.
Up until now, the penalties for sloppy e-lawyering or partial information disclosure have been exceptionally mild. Now regulators and plaintiffs can reference a federal statute, under which fines and jail time can be imposed for obstruction of justice, alteration of evidence and partial information disclosure. The practice of law has just gotten a whole lot riskier!
New investments will be required to protect companies and their executives from charges of untrustworthy information disclosure. The problem here goes something like this - in the context of a document production to regulators, your failure to do an adequate job in collecting and filtering the information to be disclosed constitutes a federal crime under Sarbanes-Oxley. The determination by regulators that your initial information disclosure (e.g., Hart Scott Rodino document production) was incomplete, can get you charged with a criminal violation. How about if you don't ask the right questions and it is later discovered that the key principals involved also had wireless e-mail, used instant messaging, sent e-mail from their home computer, kept contact information on a PDA, you could go to jail. It is a crime, punishable by imprisonment of up to 20 years, to "corruptly" alter, destroy, mutilate, or conceal records or documents with the intent to impair their integrity or availability in an official proceeding; or to otherwise obstruct, influence, or impede a proceeding (or attempt to do so) [§ 1102]. With Sarbanes-Oxley, any information exchange can come back to haunt any lawyer, accountant, CFO or CEO years later.
It is time to insist that your law firm and law department either create or enforce a standard corporate practice for trustworthy information disclosure! Running ad-hoc, like so many law firms and law departments do is a recipe for disaster under this new regulatory environment. Being able to credibly demonstrate that a corporate information exchange was complete and trustworthy will save more than money or time. It can save your reputation.
The lack of clear and concise standards in this general area is problematic. In the context of civil document productions, the lack of electronic discovery and production rules or Court-imposed standards has created a wild-west type situation, where any number of solutions could be imposed on similar fact patterns, depending upon the effectiveness of the negotiators and the sophistication of the Court. Yet, with the exception of BCCI, (where a law firm partner voluntarily withdrew from legal practice for 18 months to settle evidence alteration charges with the Manhattan District Attorney), up until now, the penalties for evidence alteration or partial information disclosure have been mild. We will see what, if any, criminal penalties are applied to lawyers connected with the Enron or any of the other popular, high-profile scandals. It is highly likely that someone will be either fined, suspended or quite possibly jailed under laws on the books pre- Sarbanes-Oxley.
But it always takes a shock to wake people up. If the Andersen obstruction case didn't do it, perhaps Sarbanes-Oxley will get the attention of key corporate decision makers to immediately influence corporate policy in this area. Today, responding to a subpoena or a document request has become more challenging because we must deal with a proliferation of electronic records lodged in a multitude of different places. In many cases, the records can be automatically deleted or overwritten on a regular basis. Systems need to be put in place that will quickly ferret out requested material before it is lost or deleted. Failure to comply with a subpoena or a discovery request can easily be characterized as obstruction of justice.
Develop standardized information disclosure practices (i.e., electronic discovery and production plan) so that when the request for information comes in, the in-house lawyers know where to look, how to look for it and what actions to take to protect the company and prevent mistakes from creeping into your preservation, discovery or production process. Likewise, law firms need to adopt formal electronic discovery and production practices that can withstand scrutiny from outside parties.
Tools exist to track, document and authenticate the integrity of any corporate information disclosure/exchange (See www.evidenceexchange.com's approach to electronic discovery & production and the authentication of digital evidence). Adopt formal training programs for your professionals on e-lawyering and safe record-keeping practices, so that you can assure your executives and/or corporate clients that best practices are consistently being applied to all of your client matters and materials. You'd be surprised at how little consistency there is right now amongst companies, law firms and lawyers when it comes to information disclosure. Don't let these inconsistencies be deemed to be mistakes, and signal the beginning of an Andersen-like "lose the company" scenario. Much depends on the new SEC rules and how aggressive the SEC becomes in pursuing its newfound authority, but suffice it to say, this is not a particularly good time to be irritating SEC enforcement personnel. Make your information disclosures consistent and trustworthy by paying careful attention to source document preservation, data collection/filtering process and documenting the precise chain of custody. Solid documentation, useable output and a well-organized disclosure/production effort can often calm even the most skeptical regulator or plaintiff.
Michael Prounis is the CEO and Co-Founder of Evidence Exchange, a three year old Electronic Discovery software & service company. He has worked in Legal Information Systems since 1977, having founded Arthur Andersen & Co. S.C.'s initial offering in the area (1982-1989) as well as co-founding Prounis Consulting Group, Inc. (1989-1996), which in 1996 was sold in part to Alco Standard Corporation (1996-1999). His specific experience with Electronic Discovery & Production goes back to 1987. Evidence Exchange is located at 21 Penn Plaza, NY, NY 10001. The phone number is (212) 594-2500 or michael.prounis@evidenceexchange.com.
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