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Sarbanes-Oxley Update: SEC Issues Final Rules Prohibiting Improper Influence on Auditors

This article was edited and reviewed by FindLaw Attorney Writers | Last reviewed March 26, 2008

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The Securities and Exchange Commission has issued final rules prohibiting corporate directors and officers (and those acting under their direction) from exercising improper influence on auditors as required by Section 303(a) of the Sarbanes-Oxley Act of 2002. The new rules, added to the "books and records" falsification provisions in Rule 13b2-2 under the Securities Exchange Act of 1934, prohibit "any action to coerce, manipulate, mislead or fraudulently influence any independent public or certified public accountant engaged in the performance of an audit or review of financial statements that [are to be filed with the SEC] if that person knew or should have known that such action, if successful, could result in rendering the issuer's financial statements materially misleading." See SEC Release No. 34-47890, which you can access at http://www.sec.gov/rules/final/34-47890.htm

Violation of the new prohibition may result in cease-and-desist orders, injunctions as well as civil or criminal penalties. The new prohibition goes into effect on June 27, 2003.

Scope of Coverage

The adopting release clarifies that the prohibition applies to any type of issuer (including both domestic and foreign companies as well as registered investment companies) that files financial statements with the SEC. It also clarifies that those acting "under the direction" of a director or officer may include persons outside their supervisory chain of command, including lower level employees, corporate vendors, customers, creditors, attorneys, auditor personnel, securities professionals and consultants. In the case of registered investment companies, such persons may also include, among others, officers, directors and employees of the investment company's investment adviser, sponsor, depositor, administrator, principal underwriter, custodian, transfer agent or other service providers.

Types of Conduct Constituting Violation

The adopting release lays out an illustrative list of types of conduct that could lead to violation of the new prohibition, including:

  • offering or paying bribes or other financial incentives, including offering future employment (even employment not violating the cooling-off periods in the auditor independence rules) or contracts for non-audit services (even those permitted under auditor independence rules),
  • providing an auditor with an inaccurate or misleading legal analysis,
  • threatening to cancel or canceling existing non-audit or audit engagements if the auditor objects to the issuer's accounting,
  • seeking to have a partner removed from the audit engagement because the partner objects to the issuer's accounting,
  • blackmailing, and
  • making physical threats.

The adopting release indicates that, under appropriate circumstances, improper influence could also result from:

  • knowingly providing to the auditor inadequate or misleading information that is key to the audit,
  • transferring managers or principals from the audit engagement, and
  • when predicated by an intent to defraud, verbal abuse, creating undue time pressure on the auditors, not providing information to auditors on a timely basis and not being available to discuss matters with auditors on a timely basis.
Negligence Versus Fraud

The adopting release also clarifies that negligent (as opposed to intentional or reckless) behavior may be sufficient to violate the prohibition. The SEC emphasized that the adverb "fraudulently" applies only to the verb "influence" in the new Rule 13b2-2 provisions. While the terms "coerce" and "manipulate" may connote "purposeful action" involving "pressure, threats, trickery, intimidation," the adopting release notes that taking action to "mislead" may involve some lesser degree of purposefulness.

Troubling Reach

In the post-Enron era, few can argue with a tough prohibition on improper influence, coercion or deceptions directed at the watchdogs of financial statement integrity. The potential reach of the new prohibition in Rule 13b2-2, however, is troubling. The SEC's assurance in the adopting release that "[w]e do not intend to hold any party accountable for honest and reasonable mistakes or to sanction those who actively debate accounting or auditing issues" is not a binding part of the rule. It remains to be seen whether the rule will restore resiliency to the watchdogs or simply detract from the multi-faceted dialog that is also an essential element to financial statement quality.

Disclaimer

©2003 Dorsey & Whitney LLP. This Corporate Update is intended for general information purposes only and should not be construed as legal advice or legal opinions on any specific facts or circumstances. Members of the Dorsey & Whitney LLP Corporate Group will be pleased to provide further information regarding the matters discussed in this Corporate Update.

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