<<

. 31
( 82 .)



>>

In determining, for the purpose of paragraph (3) of subsection (b) of this section,
what constitutes reasonable investigation and reasonable ground for belief, the stan-
dard of reasonableness shall be that required of a prudent man in the management of
his property.11

Furthermore, Section 12 of the act provides additional liability regarding any
transactions that are false or misleading in connection with the issuance of the
securities. Thus a director has not only a potential liability with respect to the reg-
istration statement but also a liability concerning the written and/or oral represen-
tations in the offering prospectus.12
Section 13 of the act establishes a limitation in order to enforce a civil action
against the wrongdoers.

No action shall be maintained to enforce any liability created under section 77k or
771 (2) of this title unless brought within one year after the discovery of the untrue
statement or the omission, or after such discovery should have been made by the ex-
ercise of reasonable diligence, or, if the action is to enforce a liability created under
section 771 (1) of this title, unless brought within one year after the violation upon
which it is based. In no event shall any such action be brought to enforce a liability
created under section 77k or 771 (1) of this title more than three years after the se-
curity was bona fide offered to the public, or under section 771 (2) of this title more
than three years after the sale.13

Finally, these penalties may be assessed under the Securities Act of 1933.

Any person who willfully violates any of the provisions of this subchapter, or the
rules and regulations promulgated by the Commission under authority thereof, or
any person who willfully, in a registration statement filed under this subchapter,
makes any untrue statement of a material fact or omits to state any material fact re-
quired to be stated therein or necessary to make the statements therein not mislead-
ing, shall upon conviction be fined not more than $5,000 or imprisoned not more
than five years, or both.14

The primary purpose of this act is to regu-
Securities Exchange Act of 1934
late the public sales of the securities through the securities exchanges or brokers
after the original sale of the securities. This act also provides the impetus for the
Securities and Exchange Commission. More specifically, Section 18 of the act
provides this liability for misleading statements:

(a) Any person who shall make or cause to be made any statement in any applica-
tion, report, or document filed pursuant to this chapter or any rule or regulation
thereunder or any undertaking contained in a registration statement as provided

11
Ibid., Sec. 77 k.
12
U.S. Code, Title 15, Sec. 771.
13
U.S. Code, Title 15, Sec. 77m.
14
U.S. Code, Title 15, Sec. 77x.
General Legal Responsibilities 149


in subsection (d) of section 78o of this title, which statement was at the time and
in the light of the circumstances under which it was made false or misleading
with respect to any material fact, shall be liable to any person (not knowing that
such statement was false or misleading) who, in reliance upon such statement,
shall have purchased or sold a security at a price which was affected by such
statement, for damages caused by such reliance, unless the person sued shall
prove that he acted in good faith and had no knowledge that such statement was
false or misleading. A person seeking to enforce such liability may sue at law or
in equity in any court of competent jurisdiction. In any such suit the court may,
in its discretion, require an undertaking for the payment of the costs of such suit,
and assess reasonable costs, including reasonable attorney™s fees, against either
party litigant.
(c) No action shall be maintained to enforce any liability created under this section
unless brought within one year after the discovery of the facts constituting the
cause of action and within three years after such cause of action accrued.15

In contrast to the 1933 act, a plaintiff must prove that he or she relied on a mis-
statement of fact or omission of fact in the financial statements and as a result suf-
fered a loss.
Furthermore, Section 10(b) of the act establishes an antifraud provision, which
indicates that it is illegal “to use or employ . . . any manipulative or deceptive de-
vices” regarding the security transactions.16 Equally important, the SEC enacted
Rule 10 (b)-5, which provides the following:

It shall be unlawful for any person, directly or indirectly, by the use of any means . . .
(a) to employ any device, scheme, or artifice to defraud,
(b) to make any untrue statement of a material fact or to omit to state a material fact
necessary in order to make the statements made, in the light of the circumstances
under which they were made, not misleading, or,
(c) to engage in any act, practice, or course of business which operates or would op-
erate as a fraud or deceit upon any person, in connection with purchase or sale
of any security.17

Thus Rule 10 (b)-5 can hold directors liable primarily because of clause (b). In
short, this particular rule increases the director™s liability, which did not exist under
the provisions of the act.
In addition, the 1934 act provides these penalties:

(a) Any person who willfully violates any provision of this chapter, or any rule or
regulation thereunder the violation of which is made unlawful or the observance
of which is required under the terms of this chapter, or any person who willfully
and knowingly makes, or causes to be made, any statement in any applica-
tion, report, or document required to be filed under this chapter or any rule or


15
U.S. Code, Title 15, Sec. 78r.
16
U.S. Code, Title 15, Sec. 78j.
17
Code of Federal Regulations, Sec. 240, 10(b)-5.
150 The Legal Position of the Audit Committee


regulation thereunder or any undertaking contained in a registration statement as
provided in subsection (d) of section 78o of this title, which statement was false
or misleading with respect to any material fact, shall upon conviction be fined
not more than $10,000, or imprisoned not more than two years, or both, except
that when such person is an exchange, a fine not exceeding $500,000 may be im-
posed; but no person shall be subject to imprisonment under this section for the
violation of any rule or regulation if he proves that he had no knowledge of such
rule or regulation.18

Several additional federal acts are briefly set forth below. (See Chapter 1 for
other congressional legislation and Appendixes E and F for the Foreign Corrupt
Practices Act with amendments and the Federal Deposit Insurance Corporation
Improvement Act of 1991 on this book™s website.)

The Private Securities Reform Act of 1995
During the latter half of 1995, Congress enacted the Private Securities Litigation
Reform Act of 1995 based on House bill 1058 and Senate bill 240. The major ob-
jective of this reform legislation was to curb the number of abusive securities class
action suits. Of particular interest to audit committees is Section 301, “Fraud De-
tection and Disclosure,” and Section 10A, “Audit Requirements.” While Section
10A does not expand the auditors™ responsibility to detect fraud or illegal acts, it
does require auditors who detect illegal acts to report their findings to the Securi-
ties and Exchange Commission if the client company fails to take appropriate re-
medial action on such acts that have a material effect on the financial statements.
If the necessary remedial action has not been taken, the auditors are required to no-
tify the board of directors in writing. Based on these events, the board is required
to submit the report to the SEC within one business day. If the board fails to no-
tify the SEC, then the auditors are required to submit their report to the SEC the
next business day.19

Fraud and False Statements Act
Whoever, in any matter within the jurisdiction of any department or agency of the
United States knowingly and willfully falsifies, conceals or covers up by any trick,
scheme, or device a material fact, or makes any false, fictitious or fraudulent state-
ments or representations, or makes or uses any false writing or document knowing
the same to contain any false, fictitious or fraudulent statement or entry, shall be
fined not more than $10,000 or imprisoned not more than five years, or both.20

18
U.S. Code, Title 15, Sec. 78ff.
19
The act is contained in Title 1 of Public Law No. 104-67, December 22, 1995. Sections 301 and 10A
are contained in Title 3 of Public Law No. 104-67, December 22, 1995. For further discussion, see the
act with respect to such matters as proportionate liability, safe harbor for forward-looking statements,
and loss causation principle. Also see the U.S. Federal Sentencing Commission™s Federal Sentencing
Guidelines for Organizations (Washington, DC: U.S. Federal Sentencing Commission, 1990) for an
expanded discussion on encouraging effective programs to prevent and detect violations of law; Ed-
ward J. Boyle and Fred N. Knopf, “The Private Securities Litigation Reform Act of 1995, CPA Jour-
nal 66, No. 4 (April 1996), pp. 44“47; and Daniel L. Goldwasser, “The Private Securities Act of 1995:
Impact on Accountants,” CPA Journal 67, No. 6 (June 1997), pp. 72“75.
General Legal Responsibilities 151


Mail Fraud Act
Whoever, having devised or intending to devise any scheme or artifice to defraud, or
for obtaining money or property by means of false or fraudulent pretenses, repre-
sentations, or promises, or to sell, dispose of, loan, exchange, alter, give away, dis-
tribute, supply, or furnish or produce for unlawful use any counterfeit or spurious
coin, obligation, security, or other article, or anything represented to be or intimated
to or held out to be such counterfeit or spurious articles, for the purpose of execut-
ing such scheme or artifice or attempting so to do, places in any post office or au-
thorized depository for mail matter, any matter or thing whatever to be sent or
delivered by the Postal Service, or takes or receives therefrom, any such matter or
thing, or knowingly causes to be delivered by mail according to the direction thereon,
or at the place at which it is directed to be delivered by the person to whom it is ad-
dressed, any such matter or thing, shall be fined not more than $1,000 or imprisoned
not more than five years, or both.21
Whoever, having devised or intending to devise any scheme or artifice to defraud, or
for obtaining money or property by means of false or fraudulent pretenses, represen-
tations, or promises, transmits or causes to be transmitted by means of wire, radio, or
television communication in interstate or foreign commerce, any writings, signs, sig-
nals, pictures, or sounds for the purpose of executing such scheme or artifice, shall be
fined not more than $1,000 or imprisoned not more than five years, or both.22


Conspiracy Act
If two or more persons conspire to commit any offense against the United States, or
to defraud the United States, or any agency thereof in any manner or for any purpose,
and one or more of such persons do any act to effect the object of the conspiracy, each
shall be fined not more than $10,000 or imprisoned not more than five years, or both.
If, however, the offense, the commission of which is the object of the conspiracy, is
a misdemeanor only, the punishment for such conspiracy shall not exceed the max-
imum punishment provided for such misdemeanor.23


Income Taxes24
Any person who:
1. Declaration under penalties of perjury. Willfully makes and subscribes any re-
turn, statement or other document, which contains or is verified by a written de-
claration that it is made under the penalties of perjury, and which he does not
believe to be true and correct as to every material matter; or
2. Aid or assistance. Willfully aids or assists in, or procures, counsels or advises
the preparation or presentation under, or in connection with any matter arising
under, the internal revenue laws, of a return, affidavit, claim or other document,

20
U.S. Code, Title 18, Sec. 1001.
21
Ibid., Sec. 1341.
22
Ibid., Sec. 1343.
23
Ibid., Sec. 371.
24
It may be advisable to request the outside auditors to remind executives that tax returns must be
filed. The audit committee should make certain that the returns were filed appropriately through dis-
cussions with the auditors.
152 The Legal Position of the Audit Committee


which is fraudulent or is false as to any material matter, whether or not such fal-
sity or fraud is with the knowledge or consent of the person authorized or re-
quired to present such return, affidavit, claim or document; or
3. Fraudulent bonds, permits, and entries. Simulates or falsely or fraudulently
executes or signs any bond, permit, entry, or other document required by the pro-
visions of the internal revenue laws, or by any regulation made in pursuance
thereof, or procures the same to be falsely or fraudulently executed or advises,
aids in, or connives at such execution thereof; or
4. Removal or concealment with intent to defraud. Removes, deposits, or conceals,
or is concerned in removing, depositing, or concealing any goods or commodities
for or in respect whereof any tax is or shall be imposed, or any property upon which
levy is authorized by section 6331, with intent to evade or defeat the assessment or
collection of any tax imposed by this title; or
5. Compromises and closing agreements. In connection with any compromise under
section 7122, or offer of such compromise, or in connection with any closing agree-
ment under section 7121, or offer to enter into any such agreement, willfully”
A. Concealment of property. Conceals from any officer or employee of the United
States any property belonging to the estate of a taxpayer or other person liable in re-
spect of the tax, or
B. Withholding, falsifying, and destroying records. Receives, withholds, destroys,
mutilates, or falsifies any book, document, or record, or makes any false state-
ment, relating to the estate or financial condition of the taxpayer or other person
liable in respect of the tax; shall be guilty of a felony and, upon conviction
thereof, shall be fined not more than $5,000, or imprisoned not more than 3 years,
or both, together with the cost of prosecution.25

Any person who willfully delivers or discloses to the Secretary or his delegate any
list, return, account, statement, or other document, known by him to be fraudulent or
to be false as to any material matter, shall be fined not more than $1,000, or impris-
oned not more than 1 year, or both. Any person required pursuant to sections 6047
(b) or (c), 6056, or 6104 (d) to furnish any information to the Secretary or any other
person who willfully furnishes to the Secretary or such other person any information
known by him to be fraudulent or to be false as to any material matter shall be fined
not more than $1,000, or imprisoned not more than 1 year, or both.26



LEGAL CASES INVOLVING THE AUDIT COMMITTEE
During the 1970s and 1980s, litigation involving the audit committee exemplified
the significance of the audit director™s role. The Securities and Exchange Com-
mission™s increased enforcement of the provisions of the federal securities laws
has imposed greater professional responsibilities on the committee. As one notable
conservative columnist and editor stated, “The evolution of the director™s respon-
sibility is running ahead of inflation. . . . The contemporary director is supposed to
know more about accounting . . . and more about the law.”27 Several legal cases are

25
Internal Revenue Code, Sec. 7206.
26
Ibid., Sec. 7207.
27

<<

. 31
( 82 .)



>>