Assessing the deterrent effect of the Sarbanes-Oxley Act's certification provisions: a comparative analysis using the Foreign Corrupt Practices Act.

Author:Lacey, Kathleen A.


In the 1970s, Congress reacted to the financial wrongdoing of Lockheed Corp. and others by enacting [section] 102 of the Foreign Corrupt Practices Act (FCPA), which (1) requires corporations to keep records that accurately reflect financial transactions and (2) mandates a system of internal accounting controls. Going a step further in 2002, Congress responded to the Enron scandal by imposing personal accountability on chief executive officers in the Sarbanes-Oxley Act (SOA). After recounting responses prior to the existence of the Securities and Exchange Commission (SEC) to corporate abuses and the historical background of the SEC's requirements for corporate financial reporting and disclosure, the Authors examine whether lessons can be drawn from the FCPA experience regarding the deterrent effect of the SOA's corresponding provisions against fraudulent and unethical behavior.

TABLE OF CONTENTS I. INTRODUCTION II. HISTORICAL BACKGROUND A. Historical Context of Corporate Abuses Leading to State Action on Disclosure: 1694-1852 B. State Action and Federal Activities in the Securities Area Before the 1933 Act: 1852-1933 C. Chronology of Disclosure and Reporting Legislation: 1933-present D. Historical Context for Increasing Personal Accountability of Corporate Officers E. The Evolution of Corporate Abuses and the FCPA and SOA III. THE SIMILARITY OF CORPORATE REPORTING ISSUES AND THE LEGISLATIVE RESPONSE TO THE WATERGATE SLUSH FUND DEBACLE AND RECENT ACCOUNTING FRAUD SCANDALS A. Reporting Issues in and the Legislative Response to the Watergate Slush Fund Debacle Resulting in Passage of the Foreign Corrupt Practices Act 1. The Faulty Accounting Systems Used by U.S. Corporations in the Watergate Scandal 2. "Voluntary Disclosure Program" Before the Adoption of the FCPA 3. The Anti-Bribery and Accounting Provisions of the FCPA 4. The Statutory Language That Expanded the Role of the SEC B. Reporting Issues in and the Legislative Response to Recent Accounting Fraud Scandals Resulting in the Passage of the Sarbanes-Oxley Act 1. The Faulty Accounting Systems Used by Enron 2. The SEC Order Requiring Certification of Existing Financial Statements Before the Adoption of the Sarbanes-Oxley Act 3. Sarbanes-Oxley: Section 302's Certification Requirement 4. Sarbanes-Oxley: Section 906's Certification Requirement 5. SEC Rules Implementing the Provisions of the Sarbanes-Oxley Act IV. THE POSSIBILITY OF SUCCESS OF THE CEO CERTIFICATION PROVISIONS OF SARBANES-OXLEY BASED ON CURRENT LEGAL ISSUES, EXPERIENCE WITH THE FCPA, AND ADDITIONAL FACTORS A. Currently Pending Legal Issues Concerning the Certification Provisions of the Sarbanes-Oxley Act That May Negatively Affect Its Success 1. Potential Due Process Concerns 2. The Pending HealthSouth Case B. Following the Learning Curve (or Lack Thereof) of a Corporate Wrongdoer From the FCPA to the SOA 1. 1976: Lockheed Bribery I--One of the Precipitating Factors for the Passage of the FCPA 2. 1986-1992: Lockheed Bribery II--Lesson Ignored! 3. 1995: Lockheed Bribery III--Lesson Yet Unlearned! 4. 2004: Lockheed IV--A Change of Culture? C. Additional Factors That Can Be Used to Make Assumptions About the Possibility of Success 1. The United States' Ranking in Transparency International's 2004 Corruption Perception Index and Its 2002 Bribes Perception Index (as an Indicator of the Effect of Legislation, Regulation, and Judicial Decisions in the United States after 1977) a. Corruption Perception Index b. Bribe Payers Perception Index c. A Review of the CPI and BPI Results After the Passage of Criminal Penalties for Bribery in the Organization of Economic Cooperation and Development's 1999 Convention on Combating Bribery of Foreign Officials in International Business Transactions 2. The Recent Reduction in the Number of Corporate Fraud Cases V. CONCLUSION I. INTRODUCTION

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act (hereinafter, SOA or Sarbanes-Oxley). (1) A number of its provisions impose formal financial reporting responsibilities on corporate-governance gatekeepers--namely, officers, directors, auditors, attorneys, and securities analysts. (2) Congress intended these financial disclosure requirements to establish a healthy capital market.

The Authors will address the likely success of the SOA provision that requires chief executive officers (CEOs) and chief financial officers (CFOs) to be personally accountable with regard to their reporting and disclosure responsibilities, (3) in effect subjecting them to potential criminal penalties for knowing or willful violations. (4) The SOA's accounting requirement--that CEOs and CFOs certify the financial statements as being fair and complete--along with its requirement for the disclosure of deficiencies in internal controls (5) are reminiscent of the accounting requirements for fair and accurate recordkeeping and implementation of internal controls imposed upon issuers (i.e., corporations) under the 1977 Foreign Corrupt Practices Act (FCPA). (6)

A pending critical issue is whether Sarbanes-Oxley will accomplish its goal of halting or substantially deterring corrupt and unethical corporate conduct. In each decade of recent history, major business scandals have occurred--along with accompanying legislative, regulatory, and judicial reactions. During the late 1980s and early 1990s, the savings and loan crisis severely jolted the U.S. public. The industry was crumbling because, for example, Charles Keating, CEO of Lincoln Savings and Loan, had been using federally insured deposits to fund risky personal investments in real estate and junk bonds. (7) Symbols of the business excesses of the 1980s include flagrant insider trading by Ivan Boesky, Michael Milken, Dennis Levine, and R. Foster Winans. (8) Analogously, looking back to the 1970s, one finds similar accounting manipulations and off-the-books transactions in addition to slush funds and misleading accounting entries intended by Lockheed and other major corporations to hide their bribery of foreign officials to obtain contracts that were discovered during the Watergate investigations. (9) The first decade of the twenty-first century has seen a global shockwave with the implosion of many major U.S. corporations, including Enron, (10) WorldCom, (11) Tyco, (12) and HealthSouth. (13) And the huge European Parmalat scandal occurred in December 2003. (14)

Many analogies can be made between the reaction of legislators and regulators to accounting misconduct of the Lockheed-era of the 1970s, on the one hand, and the Enron-era of 2002 on the other. These analogies provide a basis for assessing the possibility that SOA will deter accounting fraud in the future. Both the Lockheed and Enron scandals involved misleading and deceptive accounting practices. Congress reacted to the financial manipulations of Lockheed and other corporate bribers by enacting [section]102 of the FCPA, which required issuers to make and keep books, records, and accounts that, with reasonable detail, accurately and fairly reflect transactions and dispositions of assets; it also required issuers to devise and maintain a system of internal accounting controls. (15) Congress responded similarly to the Enron scandal, except that the onus to report accurately fell not on the corporations (i.e., the "issuers"), but instead on CEOs personally. SOA [section] 906(a) requires CEOs and CFOs to certify that financial statements filed with the Securities and Exchange Commission (SEC) are true and correct. (16) Section 302 of the SOA, which also contains a certification requirement, additionally mandates that CEOs implement effective internal controls to ensure that financial statements are true and correct and disclose any deficiencies or fraud by anyone who has significant control over the production of financial statements. (17)

After recognizing the similarities between the Enron and Lockheed situations, it is useful to determine how successful the legislation was--after more than two decades of the FCPA's increased reporting requirements--in halting the accounting misrepresentations that hid acts of corporate bribery. This information may provide a way to forecast the success of introducing increased personal accountability into corporate reporting requirements as a mechanism to deter Enron-like conduct in which top corporate officers willingly engage or turn a "blind eye" to accounting schemes that falsely inflate profits. It may also provide further insight into the progressive development of SEC corporate reporting requirements, which were initially created at the federal level in the 1934 Securities and Exchange Act. (18)

In this Article, after recounting pre-SEC historical responses to business and corporate abuses, the Authors trace the historical background of the SEC's corporate financial reporting and disclosure requirements, discuss the progression to personal accountability of corporate officers from Rule 10b-5 to the present, and outline the evolution of corporate abuses from the 1977 FCPA to the 2002 SOA. The Authors then examine the similarities of reporting issues arising from the passage of the FCPA and the SOA. They also compare currently pending SOA reporting issues in the case of HealthSouth Corp. (hereinafter, HRC or HealthSouth) to FCPA reporting issues arising repeatedly in a number of Lockheed cases. Finally, the Authors evaluate additional factors that can be used to assess the possibility of the success of the SOA's certification requirements in deterring corrupt and unethical behavior.


    Corporate abuse and misconduct have been plaguing the investing public since the seventeenth century. It is important to review the types of fraudulent activities that through the centuries have driven governments and regulators to protect prospective victims. Finally, since the CEO personal certification requirements represent the furthest inroads made toward personal...

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