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Sarbanes-Oxley
SOA-Effective Dates

Background: More Opportunities for Lawyers?

We reviewed briefly the adoption of Sarbanes-Oxley (see § 2:1, 2:3, 2:5) in connection with our discussion of the new statute of limitations. Click HERE. On the one hand, the Act in connection with SEC enforcement, as we will discuss in that context, attempts to encourage the Commission to seek disgorgement and penalties in actions initiated by it with a view to making those funds available to defrauded investors. Some saw this as an effort on the part of some members of Congress to make private actions on behalf of defrauded investors obsolete, or at least a poor alternative. Melvyn Weiss of the Milberg Weiss firm saw this attempt as “taking away an incentive from the private bar to use their skills” to help investors. He added, “the S.E.C. won’t be able to handle all these cases. I don’t care how much money they give them.”[1] The Act does not amend the PSLRA or directly impact the PSLRA pleading standards, and studiously avoids giving direct aid and comfort to securities fraud class action lawyers except as to the extended period of limitations and in one other limited respect that we will discuss. Some commentators, nonetheless, saw the Act as providing “new grounds for investors to go to court, and allows them more time to do so.”[2] The latter, “more time to do so,” clearly is correct as to the statute of limitations. Professor Joseph Grundfest, a former SEC Commissioner who as a Professor of Law at Stanford keeps the score on plaintiffs’ lawyers at the Securities Class Action Clearinghouse, is quoted: “It is more opportunities for the plaintiffs’ lawyers. There’s no doubt about that.”[3]  See § 2:9.l

In this segment, we are going to explore the more opportunities for lawyers beyond the new statute of limitations. In this context, we will consider first the provisions of the Act that may provide a basis for new private class actions. We also will consider other provisions of the Act that may indirectly assist class action lawyers by indirectly aiding in pleading a securities fraud case that will withstand the Rule 9(b)/PSLRA pleading provisions. Section 306 is the one provision of Sarbanes-Oxley that specifically creates a private action,[4] but it is unlikely to attract the securities fraud class action lawyer and the occasion for bringing such actions is likely to be rare. See § 2:10. For that reason we are going to pay little attention to it other than to briefly note that it provides that it is unlawful for any executive officer or director during a pension fund  plan (e.g. 401(k)) blackout period relating to individual accounts holding equity shares of the issuer to buy or sell any equity security of the issuer acquired by the officer or director in connection with his employment or services in that capacity.[5]. Section 306 mimics Section 16(b) of the Exchange Act (see § 1.13) in that it provides that the corporation shall have the right to recover any profit realized as a result of a violation of this provision, without regard to the officers or directors intent, and, if the corporation fails to act when requested by a shareholder, any shareholder may bring a derivative action on behalf of the issuer.[6] Since unlike Section 16(b) it is unlawful to violate this provision, violations are not going to be a common occurrence and what is at stake in any event is not likely to be enough to attract the class action bar other than exceptional circumstances..

There is also the possibility that some provisions of the Act may create an implied private cause of action. Rule 10b-5, after all, is an implied private cause of action. The provision creating a new statute of limitations expressly provides that nothing contained therein “shall create a new, private right of action.”[7] The new provision[8] making it unlawful for an officer or director of a public company to fraudulently influence or mislead the auditors auditing the company’s financial statements expressly provides that the Commission has exclusive authority to enforce this provision in “any civil proceeding.”[9] A provision giving the Commission similar exclusive enforcement authority in a civil proceeding with respect to real-time disclosures included in H.R. 3763 from which the real-time disclosure provision was taken was not included in the Act as adopted.  Except for the two noted provisions,[10] there is no express language limiting implied private actions with respect to the numerous provisions creating crimes and otherwise making specific acts or failure to act unlawful. The Act could readily have provided that nothing contained herein shall be deemed to create an implied private action. Contrariwise, it could have readily created express private actions if that were the intention of Congress. The Supreme Court since 1975 has not been very plaintiff friendly in implying a private right of action if the statute makes prescribed conduct unlawful, includes other remedies, and does not expressly provide for a private right of action.[11] See § 1.04[1].

Section 304 may be the provision of the Act with the best prospect of a court implying a private cause of action. Section 304 provides that if a company is required to restate its financial statements because of any material noncompliance with a financial reporting requirement, the chief executive officer and chief financial officer are to reimburse the issuer for any bonus, incentive-based, or equity-based compensation and the profit from any sale of securities during a relevant period.[12] The provision refers to noncompliance “as a result of misconduct,” which we tentatively translate to mean “wrongful,” but it is not precisely clear what degree of culpability this requires or by whom. This provision remarkably does not say who has the right to pursue such corporate officers. The possibilities that we will explore include (1) whether the SEC is or can bring the action compelling the CEO and CFO to reimburse the issuer, (2) whether the corporation can bring the action seeking reimbursement, and (3) whether a shareholder can bring the action if after demand the corporation fails to do so. The latter two would seem appropriate since it is the issuer that is to be reimbursed, but strangely although included as part of the same Title III as Section 306 unlike Section 306 it does not expressly provide that the corporation can bring such action and if it fails to do so a shareholder can bring the action. There is also the fact that the relief sought is similar to the new type of disgorgement the Commission has been seeking post Enron  except the remedy under Section 304 is reimbursement of the issuer. If we assume that it does create a private action, we also ask who is likely to bring such an action? See § 2:11. The elements of a Section 304 action are discussed at § 2:12.

There is a provision of the Act that may assist the persistent securities fraud class action lawyer and may even encourage them to go after prospective defendants who no longer appear to be deep pockets. The Act is unforgiving of judicially or administratively imposed financial obligations incurred by corporate officers and others arising out of their securities related misdeeds. Section 803[13] is applicable to any person and precludes the discharge in bankruptcy for any debt arising from the violation of any federal or state securities laws; the regulations adopted thereunder; common law fraud, deceit, or manipulation in connection with the purchase or sale of a security if it is the result of any judgment, order, or decree entered in any federal or state judicial or administrative proceeding. It specifically includes a settlement entered into by the debtor and “any court or administrative order for any damages, fine, penalty, citation, restitutionary payment, disgorgement payment, attorney fee, cost, or other payment owed by the debtor.”

The potential in terms of providing “more opportunities” for the class action lawyers may exist in a number of other areas, including the non-exhaustive list of provisions that follows:

1. The “confession” by WorldCom on June 25, 2002 that it had overstated its income during 2001 and the first quarter of 2002 in staggering amounts by the simple device of capitalizing operating expenses rather than deducting them from revenues in determining net income[14] took the SEC so aback it almost immediately entered two  unprecedented  but related orders. On June 26, the Commission announced that it ordered WorldCom to immediately “file, under oath, a detailed report of the circumstances and specifics of these matters.” See § 2:3. The following day the Commission entered an Order[15] requiring 947 domestic reporting (companies with revenues in excess of $1.2 billion annually) to file within a prescribed time period commencing on August 15, 2002, a one time sworn certification by the CEO and CFO of the companies periodic reports. The sworn statement required the execution of a prescribed certification to the effect that none of the certified reports contained an untrue or misleading statement of a material fact. The Commission posted on its web site charts showing for each of the 947 companies whether the sworn statement was filed as prescribed or whether the statement varied from the prescribed statement and includes links to the filed statements. The chart as to the non-complying companies was very revealing and undoubtedly piqued the curiosity of one or more class action lawyers as well as leading to a number of restatements and amended reports. Click HERE to go to the charts on the SEC’s web site. The certification by 947 companies was a one time event and whatever consequences it may have will soon be in the past. The Commission previously proposed to routinely require the CEO and CFO to certify the companies periodic reports filed under the Exchange Act. Before the Commission acted on its proposal, the concept of requiring the CEO and CFO of all reporting companies to certify periodic reports was built into Section 302 of Sarbanes Oxley. The Commission was required to adopt implementing rules by August 29, 2002, which it promptly did. See § 2:13. In the process the Commission added some innovations of its own including the requirement of establishing disclosure controls and procedures designed to assure the availabilityand impose responsbility for collecting information necessary to prepare periodic reports.. See § 2:14. The Commission has mandated the content of the certification form and it cannot be deviated from. See § 2:15.  Section 906 separately requires a similar self-implementing certification and makes it unlawful to furnish the certification.  Section 404 requires an annual internal controls report in which management must assess the effectiveness of its internal controls for financial reporting.. See Section 2:16.

2. There is no affirmative duty under the securities laws to disclose material developments as they occur. The disclosure duty under the securities laws is to disclose what is required in filed reports and anything that omission of which might make a statement including in the report materially misleading. A public company also has a duty in making statements to the market not to make a materially false or misleading statement. Judge Easterbrook put it as follows: “Much of plaintiffs’ argument reads as if firms have an absolute duty to disclose all information material to stock prices as soon as news comes into their possession. Yet that is not the way the securities laws work. We do not have a system of continuous disclosure. Instead firms are entitled to keep silent (about good news as well as bad news) unless positive law creates a duty to disclose.” See Gallagher v. Abbott Laboratories, 69 F.3d 806, (7th Cir. 2001). Sarbanes-Oxley may change this in certain limited respects. Section 409 of Sarbanes Oxley  adds to Section 13 of the Exchange Act a provision providing that reporting companies, in accordance with rules adopted by the Commission, shall:[16] disclose in plain English

–   on a rapid and current basis

–   material changes in the financial condition and operations of the company

–    including trend and qualitative information.

The Commission had previously proposed its own real-time reporting by amending the requirements relating to Form 8-K, which prescribes the current reports that must be filed with the Commission on the occurrence of specific events. The proposal accelerates the time within which such reports must be filed  and increases several-fold the events that trigger the need to file such reports. See § 2:17.

3. Section 307 required the Commission by January 26, 2003 to adopt rules “setting forth minimum standards of professional conduct for attorneys appearing and practicing before the Commission.” The rules must include what the sponsors of the amendment referred to as requiring attorneys who become aware of violations of the securities laws by the client (or employer) to go up the corporate ladder seeking “appropriate remedial measures.” See § 2:18. The Commission proposed rules implementing Section 307 that go beyond the up-the-ladder provisions of Sarbanes-Oxley, by providing what attorneys are to do (make a “noisy withdrawal”) when they go up-the-ladder and come to a dead end. The later aspect of the proposed rules has stirred an unprecedented negative reaction from securities practitioners who are up in arms and it remains to be seen whether it will be adopted or can be adopted by the January 26, 2003. Section 307 in any event, and particularly if the more controversial aspects of the proposed rules are adopted, mandates a dramatic change in the manner in which securities law is practiced. The rules constitute a new Part 205 to Title 17 of the Code of Federal Regulations and consist of rules 1 (17 C.F.R. § 205.1) through 7 (17 C.F.R. § 205.6). See § 2:19'. The rules spell out two ways of going up the ladder--(1) the hard way contemplated by Section 3.07 (see § 2:20), and (2) by going to a Qualified Legal Compliance Committee and transferring the responsibility to it (see § 2:21).

4. Trading by insiders is an important component of attempting to show motive and opportunity as a basis for pleading scienter. See § 3.06. The Amended complaint   in Enron places a good deal of focus, for example, on the insider trading by the individual defendants (see, e.g. par. 401 listing insider sales of 20,7 million shares resulting in almost $1.2 billion in proceeds), although Judge Harmon has not ruled on the individual defendants’ motion to dismiss as yet. The Sarbanes-Oxley Act provides some aid to plaintiffs in this regard in two respects. Section 16(a) required insiders to report transactions in equity securities of the issuer registered under the Exchange Act within 10 days after the end of the month in which the transaction occurs. Section 403 of Sarbanes-Oxley amends Section 16(a) of the Exchange Act to require insiders to report such transactions on Form 4 by the end of the second business day following the transaction. See § 1.14. The filing of Form 4s electronically on EDGAR previously was optional. Sarbanes Oxley mandates that the Commission require Form 4s to be filed electronically on EDGAR by no later than July 31, 2003. The Commission adopted rules implementing Section 403 and providing for only limited exceptions to the accelerated filing of such forms,[17] and has proposed amendments to the EDGAR rules that will require Form 4s to be filed electronically well before the July 31, 2003 deadline.[18]  The Commission has established a website (https://www.onlineforms.edgarfiling.sec.gov) devoted exclusively to preparing and transmitting Form 4s electronically via EDGAR. This will make information relating to insider trading available earlier and more accessible directly through EDGAR or on the various services that track this information. In regard to the latter, use the Online links to go to Quote.com. Enter MSFT (or any other appropriate symbol for a security) in the Quote(s) field and click on submit. Then click on Insider to go to insider trading reports relating to Microsoft. Other services provide more lengthy histories including www.marketguide.com and Vickers (www.argusgroup.com). Vickers reports go back several years, but require a modest fee. To view General Electric insider trading report from Vickers click HERE.

5. The Act creates a Public Company Accounting Oversight Board that in due course will be periodically inspecting all accounting firms reporting on the financial statements of public companies, issuing inspection reports, investigating violations of securities laws by public accounting firms, initiating disciplinary proceedings and imposing sanctions. The Act, however, goes to unprecedented lengths to keep this information from being publicly available at least until very late in the disciplinary process. On completion of the inspection, a draft inspection report is to be prepared and, in accordance with rules adopted by the Board, the firm is to be given an opportunity to review and respond to the draft report.[19] For each inspection, the Board is to prepare a final report of its findings and make copies of it available to the Commission and the state regulatory authority. The report of inspections, the result of investigations, and the proceedings to impose disciplinary sanction, and the findings of the Board are all subject to provisions that keep them from being subject to civil discovery or other legal process and exempt from disclosure under the Freedom of Information Act unless and until presented in a public proceeding or otherwise released in accordance with procedures governing disciplinary hearings.[20] The Act remarkably provides with respect to disciplinary proceedings that hearings “shall not be public,” unless the Board orders otherwise for good cause.” Further, it can do so only “with the consent of the parties to such hearing.”[21] .