In response to a deluge of corporate scandals in the late 1990s and early 2000s, the Sarbanes-Oxley Act of 2002 (Act) implemented sweeping reforms in the area of corporate governance. The Act applies only to public companies that have securities registered with the Securities and Exchange Commission (SEC) under § 12 of the Securities Exchange Act of 1934 (Exchange Act) or are required to file reports under § 13(a) or § 15(d) of the Exchange Act.. The Act covers directors, officers, and shareholders of a public company and professionals who provide services to those companies (for example, accountants and attorneys). The Act specifically prohibits a director or officer from taking “any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant engaged in the performance of an audit . . . for the purpose of rendering such financial statements materially misleading.” The SEC has the authority to enforce regulations adopted to implement this provision of the Act. The focus is now on fraudulent intent. A director or officer may be held liable without regard to whether the audit report (or financial report) is materially misleading.
Chief executive officers (CEOs) and chief financial officers (CFOs) are barred from profiteering by selling company stock or receiving company bonuses during the time that management is misleading the public and regulators about the company’s “poor health.” If the company fails to comply with Exchange Act filing requirements or has to refile a report due to this type of misconduct, the CEO and CFO must disgorge personal profits. This includes any bonus, incentive-based or equity-based compensation, or profits from the sale of a company security that are received in the 12-month period occurring after the first public issuance or the SEC filing that included the non-complying information, whichever occurred first. If misconduct is involved, CEOs and CFOs may have to disgorge bonus and incentive compensation even if they did not personally commit the misconduct. The SEC has the discretion to determine whether to penalize a CEO or CFO on a case-by-case basis. Misconduct by low-level employees may be one instance in which the SEC could determine that disgorgement would not be appropriate.
If a director or officer is compensated with equity security, the Act prohibits the director or officer from acquiring or transferring that equity security during a “blackout period.” A “blackout” is defined as any period of more than three consecutive business days during which at least 50 percent of the participants in the company’s individual account plans are not allowed to buy, sell, or transfer their stock. The term “blackout” does not include regularly scheduled or timely disclosed suspensions or a suspension that involves administration or consolidation of the plan. Under the Act, a company must give plan participants, beneficiaries, directors, officers, and the SEC notice of any blackout period at least 30 days before the period begins. The company can recover any profits made by a director or officer who violates this provision. If the company does not try to recover those profits within 60 days of a shareholder request, the shareholder can file suit on the company’s behalf to recover those profits. There is a two-year statute of limitations on this type of claim, which runs from the date the director or officer acquired the profit.
Directors and officers (and shareholders with 10 or more percent of the company’s stock) are required to file reports evidencing any change of ownership of company securities in “real time,” i.e., within 2 business days of the ownership change. A director or officer may no longer defer filing of a change of ownership report.