The Sarbanes-Oxley Act of 2002: Part II

Date: January 30, 2003


A. Extended Statute of Limitations for Securities Fraud. Section 804 of the Act extends the statute of limitations for private rights of action involving claims of fraud, deceit, manipulation or contrivance in contravention of a regulatory requirement under the securities laws, to the earlier of

  • (i) two (2) years after discovery of the facts constituting the violation or
  • (ii) five (5) years after such violation (from one year/three years under prior law).

B. “Whistleblower” Protections. Section 806 of the Act provides a civil cause of action for employees of reporting companies who are discharged or suffer employment discrimination as a result of so called “whistleblowing” activities. The Act also provides protection to employees who testify or participate in or file certain securities or antifraud suits. An employee whose rights are violated under this provision will be entitled to seek relief including reinstatement, back pay and special damages including attorney fees and litigation costs. The protection also applies to any “contractors, subcontractors or agents” of the reporting company.

Section 1107 of the Act provides for fines and imprisonment of up to 10 years for anyone who “knowingly, with the intent to retaliate,” takes any action harmful to any whistleblower. This provision is not limited to securities law matters, but is applicable to any U.S. Federal offenses.

C. Criminal Penalties. Effective immediately, the Act creates several new crimes for securities violations, including the following. 

  • Document Destruction and Tampering. Section 802 of the Act makes destroying, altering or falsifying records with the intent to impede or influence any federal investigation or bankruptcy proceeding a federal crime punishable by a fine and a prison sentence of up to 20 years. Section 802 also requires auditors to maintain all audit or workpapers for five (5) years. Knowing and willful violations are punishable by a fine and a prison sentence of up to 10 years.
  • New Securities Fraud Felony. Section 807 of the Act creates a new federal securities felony for knowingly executing a scheme to defraud investors in connection with any security. Violations are punishable by a fine and a prison sentence of up to 25 years. The Act also significantly increases the maximum fines and prison sentences for other existing securities-related crimes, including significant increases in the penalties under the Exchange Act for willful violations and false and misleading statements. In addition, the Act requires the U.S. Sentencing Commission to consider the adoption of new federal sentencing guidelines to deter, prevent and punish the growing incidence of serious fraud offenses.

D. Non Discharge of Securities Liabilities. Section 803 of the Act amends the bankruptcy code to prevent the use of bankruptcy to avoid liability incurred due to federal or state securities laws violations or for common law fraud in connection with securities transactions.

E. Officer and Director Bars. Section 1105 of the Act amends the Exchange Act and the Securities Act to empower the SEC to bar persons in administrative cease and desist proceedings from serving as officers or directors if they have violated Section 10(b) of the Exchange Act or Section 17(a)(1) of the Securities Act, or the rules or regulations thereunder, and if their conduct demonstrated “unfitness” to serve as an officer or director, as opposed to the prior standard of “substantial unfitness”.

F. Attorney Professional Responsibility. Section 307 of the Act directs the SEC to adopt rules of professional conduct applicable to attorneys representing reporting companies, 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. This duty is broader than the rules imposed on attorneys under The American Bar Association’s Model Rules of Professional Conduct, adopted in most states, which require lawyers who detect violations of duties owed to the organization or substantial illegal activity that may be imputed to the organization to “proceed as is reasonably necessary in the best interest of the organization.” Model Rule 1.13(b). The SEC’s rules must be adopted with 180 days of enactment (i.e., by January 26, 2003) and hopefully will address the conflict with the Model Rules.

G. Analyst Conflict of Interest Rules. Section 501 of the Act requires the SEC, or a securities exchange upon the direction of the SEC, to adopt rules reasonably designed to address conflicts of interest relating to analyst recommendations of securities. The SEC approved rules adopted by the NASD and NYSE in May 2002 8to reduce conflicts of interest on the part of securities analysts and firms in connection with the publication of research reports and other securities recommendations. In addition, on August 2, 2002, the SEC proposed a new Regulation AC that would require research analysts to certify the accuracy of their reports and disclose compensation related to their recommendations. The rules recently adopted by the NASD and NYSE and the proposed Regulation AC appear to comply with the Act's requirements.

*8 See SEC Order Approving Proposed Rule Changes Relating to Research Analyst Conflicts of Interest (Release No. 34-415908 (May 10, 2002)).