Sarbanes-Oxley Certifications and Personal Liability.

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Section 302 and 906 of SOX impose personal certification requirements on senior officers. A certification signed under Section 302 requires the certifying officer’s “knowledge” of the information certified. A certification signed under Section 906 requires the certifying officer’s “belief” that the information certified is “correct in all material respects.” Under Section 906, any “knowing” violation results in up to ten years’ imprisonment. Under Section 302, most violations present civil enforcement exposure under an SEC lawsuit, with possible prosecution for a false certification that triggers the applicability of another criminal statute. If an officer leaves his or her company after signing a Sarbanes-Oxley certification, this has no effect on the officer’s (or the officeholder’s) exposure resulting from a potential SOX investigation.

Section 304 of SOX imposes liability upon senior officers in order to recoup compensation. Specifically, “if, after any applicable certification, the issuer is required to prepare accounting or other financial statement disclosure or report required to be filed under this chapter, and as a result of noncompliance, misconduct, or a material violation of any applicable provision of federal securities law, rule, or regulation, has committed or commits a material misstatement or omission, the chief executive officer and chief financial officer shall reimburse any bonus or other incentive-based or equity-based compensation” (15 U.S.C. § 7243(a)).

Congress enacted the Sarbanes-Oxley Act of 2002 primarily in response to corporate fraud allegations against Enron Corporation and WorldCom, among others. SOX continues to play a prominent role in the federal criminal justice system, and corporate officers must be prepared to defend themselves in federal grand jury proceedings initiated by federal authorities.

Who must sign SOX certifications for which reports?

Section 906 Certifications

Section 906 of SOX requires the principal executive officer and principal financial officer, or equivalent officers as the case may be, to personally certify the accuracy of a company’s “periodic report.” A “periodic report” under Section 906 refers to any periodic report required by either Section 13(a) or 15(d) of the Securities Exchange Act of 1934. In practice, this includes:

• Form 10-K (annual report)
• Form 10-Q (quarterly report)
• Form 20-F or 40-F (annual report by foreign private issuers)

Section 302 Certifications

SOX Section 302 is implemented by the SEC through Rule 13a-14 and Rule 15d-14. Rule 13a-14 applies to issuers that are reporting under Section 13(a) of the Exchange Act; and Rule 15d-14 applies to issuers that are reporting under Section 15(d) of the Exchange Act. Along the lines of Section 906, Rules 13a-14 and 15d-14 impose certification obligations upon CEOs and CFOs (or their equivalents).

Which Forms Require Section 302 Certifications?

The Forms 10-K, 10-Q, 20-F, and 40-F all require Section 302 certifications. With that said, foreign private issuers only have to certify their annual reports (Form 20-F or Form 40-F) under Section 302.

Which Amendments Trigger New SOX Certifications?

If an issuer files an amended Form 10-K or Form 10-Q, then the certifications under Section 302 must be renewed. If an amended periodic report filed with the SEC contains revised financial statements, then the certifications under Section 906 must also be renewed.

Which “Officers” are Required to Certify?

The certification requirements of both Section 302 and Section 906 apply to “acting officers” as well. This includes:

• Any individual serving as acting CEO, acting CFO, or acting principal executive officer or principal financial officer.
• Any individual who, while not named as CEO, CFO, or principal executive or financial officer, is performing those roles.

In other words, the certification obligation attaches to the function of serving as a CEO or CFO, regardless of the individual’s title.

Which Certification Is Needed in Which Scenario?

When assessing exposure under Section 302 and/or Section 906, it is important to determine whether a company’s CEO, CFO, or principal officer had to certify a Form 10-K, Form 10-Q, Form 20-F, or Form 40-F. These certifications can lead to both civil and criminal consequences.

For example, if a company’s annual report on Form 10-K contains a material misstatement, then its CEO and CFO may face both Section 302 (civil) and Section 906 (criminal) liability.

Summary Checklist for SOX Certification Analysis

A comprehensive SOX certification analysis requires answers to the following questions:

• Is the issuer subject to Section 13(a) or 15(d) of the Exchange Act?
• Was it a Form 10-K, Form 10-Q, Form 20-F, or Form 40-F?
• Was this form the original or an amended filing?
• Did the filing contain revised financial statements?
• Which officers (acting or named) signed the certification?

When does a false Section 906 certification become criminal?

How is a Section 906 Violation Defined as Criminal?

The fair-presentation statement is one of two statements that a Section 906 certification requires. Although this fair-presentation statement is “not limited to” GAAP compliance, it may encompass compliance with GAAP. Any knowingly false representation within this statement (and within the “fair-statement” or “financial-statement” statements) will result in criminal liability.

What are the Possible Criminal Penalties for a Willful Section 906 Violation?

A knowing violation of Section 906 may result in a fine of up to $1 million or up to 10 years’ imprisonment. A willful violation may result in a fine of up to $5 million or up to 20 years’ imprisonment. These criminal penalties apply only in criminal prosecutions in the federal court system.

What is the Difference Between a “Knowing” Violation and a “Willful” Violation?

Although Sarbanes-Oxley creates a distinction between “knowing” and “willful” violations, it does not define the terms “knowing” and “willful.” There is very little court jurisprudence defining these terms specifically within the context of Section 906, and there appears to be little indication that the distinction has any practical implications. The majority of criminal cases involving Section 906 violations have not differentiated between these terms.

Can a Company’s CEO, CFO, or Other Principal Officer Be Criminally Charged under Section 906 Just Because the Company’s Periodic Report Was Inaccurate?

In short: No. At least until the Company’s CEO, CFO, or other principal officer knows (or willfully ignores the fact) that the Company’s periodic report is inaccurate, the officer’s certification of that report under Section 906 will not provide grounds for a criminal charge. With that being said, federal prosecutors must prove the existence of a “guilty mind” (mens rea), and in criminal cases involving corporate governance, prosecutors generally take advantage of various factors to prove “knowledge,” including:

Are Conscious Avoidance (Deliberate Ignorance) and Willful Blindness Evidence of Knowledge in a Section 906 Criminal Case?

Generally, yes, as these concepts have been upheld as evidence of “knowledge” in various other criminal cases. At the same time, these concepts have been criticized as being inherently vague and often lacking the necessary standard of proof required by the Due Process Clause of the Fifth Amendment. Thus, defendants should ensure that their attorneys aggressively challenge assertions of “conscious avoidance” and “willful blindness” in a criminal case involving a potential Section 906 violation.

Which Agency Pursues Civil Enforcement and Which Agency Pursues Criminal Enforcement Under Section 906?

Section 906 is a criminal statute, enforced in federal court by the U.S. Department of Justice; the U.S. Securities and Exchange Commission (SEC) brings the corresponding civil enforcement actions under Section 302 and Rules 13a-14 and 15d-14. However, the SEC can refer cases to the DOJ when it discovers evidence of criminal conduct.

Which Statute’s Limitations Period Applies in a Section 906 Criminal Case?

Although the DOJ generally brings criminal enforcement actions under Section 906 under the 18 U.S.C. § 1350 (the statutory citation for Section 906 of the Sarbanes-Oxley Act), prosecutors rely on 18 U.S.C. § 3282(a), which applies a five-year statute of limitations.

Can Contemporaneous Warnings and Intentional Concealment Be Used as Evidence of Knowledge in a Section 906 Criminal Case?

Generally, yes, since both can be used to prove knowledge. So, even if a company’s CEO, CFO, or other principal officer certifies a report while being “credibly informed” that it is accurate, evidence of contemporaneously filed internal warnings, or evidence of intentional concealment, can be used to impeach the officer’s credibility and establish “knowledge” of the certification’s falsity.

If any of this describes your situation, it is worth talking it through with counsel. Spodek Law Group can be reached at 212-300-5196.

What civil exposure follows a false or missing certification?

Can a Company’s CEO, CFO, or Other Principal Officer Be Criminally Charged under Section 906 for Failing to Sign the Certification?

According to Section 906, “no person shall be subject to criminal penalty for omission of any certification.” Thus, a criminal charge under Section 906 does not stem from a simple omission of a certification.

Can a Company’s CEO, CFO, or Other Principal Officer Be Civilly Liable under Section 906 for Failing to Sign the Certification?

Yes, if the officer signs a statement certifying the periodic report under Section 906, then he or she (and the issuer) must sign a certification under Rule 13a-14 and/or Rule 15d-14, as the case may be. Filing a report that lacks a certification under Rule 13a-14 or Rule 15d-14 constitutes a violation of an issuer’s applicable reporting obligations, subject to the SEC’s civil enforcement authority (though the CEO or CFO of an issuer who omits signing the certification can still be exempted from civil liability for certifying the issuance of the report under Section 906).

Does Section 906 (18 U.S.C. § 1350) Provide a Private Civil Cause of Action for Securities Fraud?

No. 18 U.S.C. § 1350, which embodies Section 906 of SOX, does not contain any express provision creating a private civil cause of action against CEOs, CFOs, or other principal officers for fraud. While some courts have indicated a willingness to infer a private right of action (under the “implied private right of action” doctrine), the majority of federal courts have rejected implied private claims under this section.

Can a Company Indemnify Its Officers Against Liability Under Section 906 (and/or Section 302) of Sarbanes-Oxley?

Since Sections 302 and 906 do not mention indemnification, this is a matter of applicable state corporate law. However, for most issuers, advancement and indemnification are governed by the company’s bylaws, charter, or indemnification agreement; so it is important for issuers to ensure that their documents adequately address issues of indemnification under the applicable governing corporate law.

Can a Company Advance the Defense Costs of Its Officers Who Are Subject to Civil or Criminal Enforcement Under Section 906 (and/or Section 302) of Sarbanes-Oxley?

As with indemnification, this depends on (i) the company’s charter, bylaws, or indemnification agreement, and (ii) the applicable state law governing corporate activities (e.g., the Delaware General Corporation Law).

Are Directors’ and Officers’ (D&O) Insurance Policies Available to Cover Defense Costs for Alleged SOX Violations?

D&O insurance policies should cover defense costs for alleged violations of Rule 13a-14 and/or Rule 15d-14 (i.e., alleged violations of Section 302) and alleged violations of Section 906 of SOX. However, the extent of coverage will be subject to (i) the specific language and terms of the insurance policy, (ii) any specific exclusions that apply, and (iii) the applicable insurability law.

What Other Remedies Does the SEC Have in Case of a Violation of Rule 13a-14 or Rule 15d-14?

In addition to seeking disgorgement, prejudgment interest, and officer-and-director bars, the SEC can ask federal district courts for injunctive relief in cases of violations of Rule 13a-14 and/or Rule 15d-14. Federal district courts have the authority to issue permanent or preliminary injunctions; and, in appropriate cases, these federal courts have the authority to impose civil penalties.

Can control failures or professional reliance determine personal liability?

Does “Control Failure” Lead to Section 302 Liability?

Section 302 requires the certifying CEO or CFO to conclude based on “the issuer’s disclosure controls and procedures” that all information required to be disclosed in the periodic report “has been disclosed.” As a result, a deficiency in the issuer’s disclosure controls and procedures may lead to a Section 302 violation, but it is not necessary that the deficiency results in the filing of an inaccurate report.

At the same time, a Section 302 certification does not certify that all of a company’s internal controls are “flawless,” nor does it certify that all of a company’s accounting controls are necessarily “effective.”

Can Officers Establish “Good Faith” by Relying on Business-Unit Certifications (i.e., “Sub-Certifications”)?

As a matter of practical administration, it is not feasible for a Company’s CEO, CFO, or other principal officer to independently verify all the information required to be disclosed in the company’s annual or quarterly reports. To this end, many companies require the certifications of various other officers and employees, often referred to as “sub-certifications.”

Can these sub-certifications serve as evidence of an officer’s good faith? Generally, yes, but an officer’s reliance on sub-certifications, the information that underlies the sub-certifications, and/or the processes and policies used to generate the certifications will generally not be determinative as to whether the officer “knowingly” or “willfully” falsified the periodic report under Section 906 of SOX.

Can Good-Faith Professional Reliance Serve as an Affirmative Defense Against a Section 302 or Section 906 Violation?

Generally, yes. However, this defense only applies if the officer’s reliance was “reasonable,” and this in turn means that the officer’s reliance was justified. As with reliance on sub-certifications (i.e., Reliance on Company Personnel), reliance on professional advisors’ (i.e., Reliance on Auditors, Reliance on Counsel) certifications will generally not constitute a full defense against Section 302 or Section 906 violations.

Does “Control Failure” Lead to Section 906 Criminal Liability?

Not necessarily. There is a distinction between a deficiency in internal controls and a “knowing” or “willful” falsification under Section 906. In fact, courts have held that an “internal-control failure alone does not necessarily render the CEO or CFO’s certification knowingly false under Section 906(b).”

What Is the Difference Between Section 404(a) and Section 404(b) of SOX?

SOX Section 404 contains two components:

• Section 404(a) of SOX requires management to make an assessment of the issuer’s internal control over financial reporting as of the end of its most recent fiscal year.
• Section 404(b) of SOX requires (i) an issuer’s auditor to attest to, and report on, the issuer’s annual assessment of its internal control over financial reporting, and (ii) the auditor to attest to, and report on, the effectiveness of the issuer’s internal control over financial reporting.

These two separate requirements are imposed by different parts of SOX. Section 404(a) applies to all issuers; and, Section 404(b) applies to issuers not otherwise exempt (or excepted) under this subsection.

When can SOX clawbacks recover an officer’s compensation?

When Can Compensation Be Recovered Under Section 304 of Sarbanes-Oxley?

Recovery of compensation under Section 304 of SOX (15 U.S.C. § 7243) becomes possible “if, after any applicable certification, the issuer is required to prepare accounting or other financial statement disclosure or report required to be filed under this chapter, and as a result of noncompliance, misconduct, or a material violation of any applicable provision of federal securities law, rule, or regulation, has committed or commits a material misstatement or omission.”

• With this in mind, in order to be eligible for the “clawback” of the CEO’s or CFO’s bonus or other incentive-based or equity-based compensation, Section 304 requires material noncompliance, misconduct, or a material violation that causes the issuer to file a “required” restatement.
• Generally, a “required” restatement means a correction that corrects a “Big R” restatement (i.e., a correction that determines that the previously filed financial statements should no longer be relied upon).
• The 12-month look-forward period for Section 304 applies to a Company’s CEO, CFO, or principal executive officer or principal financial officer.

Does Recovery of Incentive-Based Compensation Under Section 304 Require a Finding of Personal Misconduct of the CEO or CFO?

No, at least not since the SEC’s landmark decision in SEC v. Jensen. In Jensen, the Court upheld the SEC’s authority to pursue Section 304 recovery without evidence of personal misconduct (i.e., “wrongdoing”) by the CEO or CFO in question. Thus, as long as the issuer has committed a “material misstatement or omission,” recovery of the Company’s CEO’s, CFO’s, and/or principal officers’ incentive-based compensation is possible.

Does Rule 10D-1 Reach Covered Executive Officers Other Than CEOs and CFOs?

Yes. Rule 10D-1 reaches a broad category of “covered executive officers” that is larger than the category of officers covered by Section 304 of SOX. As a result, for exchanges listed in the United States, a Company’s “covered executive officers” can include, among others, the Company’s (i) الرئيس التنفيذي, (ii) Chief Financial Officer, and (iii) any other officer that the exchange considers to be a “covered executive officer” based on the officer’s (i) employment relationship, (ii) the scope of the officer’s authority, or (iii) the officer’s direct or indirect responsibility for overseeing the company’s compliance with the Dodd-Frank Act.

How Does the Recovery Period for Rule 10D-1 Compare to the Recovery Period for Section 304?

The recovery period for Rule 10D-1 is generally shorter than the recovery period for Section 304. The recovery period for Rule 10D-1 generally reaches three fiscal years (or the reporting periods that are included in a restated financial statement).

Does Rule 10D-1 Apply in Case of a “Big R” Restatement or “Little r” Restatement?

Rule 10D-1 applies in both “Big R” and “little r” restatements. As a result, the range of circumstances that can trigger Rule 10D-1 recovery is broad.

Does Rule 10D-1 Implement SOX?

No. Rule 10D-1 implements an Exchange Act clawback mandate imposed by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Rule 10D-1 recovery is also distinct from Section 304 recovery in that it:

• Does not require misconduct or fault of the covered executive officer, and/or;
• Is not limited to a Company’s CEO and CFO.

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