Implications of SEC Order and Proposed Rules Requiring Personal Attestations by CEOs and CFOs of Periodic SEC Reports
July 2002
On June 27, 2002, the U.S. Securities and Exchange Commission (SEC) ordered principal executive and principal financial officers of 947 U.S.-based publicly traded companies (those with revenues during the last fiscal year of more than $1.2 billion) to file on a one-time basis sworn statements attesting to the accuracy of their companies’ financial and other information contained in the current year’s SEC filings.
The SEC stated that its order is intended to assure the investing public and the SEC that the corporate disclosure in reports already filed this year with the SEC is in compliance with federal securities laws, or provide information quickly about those companies where that is not the case. Attached to the SEC’s order is a listing of the companies that are subject to the order, as well as the form of statement that the designated CEOs and CFOs must submit.
As detailed below, although the required attestations will not fundamentally alter the nature of the personal liability of officers, the signers of the attestations will have potential new liability for any false statements in the attestations themselves. The order was issued as an unprecedented mandate on individual officers under a remarkable claim of investigative authority by the SEC. It follows a series of recent extraordinary events involving financial statement irregularities of companies from Enron Corporation to WorldCom, Inc. The order is independent of, but in effect substantially similar to, a separate SEC proposal discussed below that, if adopted, would require quarterly and annual certifications by CEOs and CFOs on an ongoing basis.
Obligations of CEOs and CFOs under the Order
In the sworn statement, the designated CEOs and CFOs must personally attest that the company’s most recent periodic reports are materially truthful and complete or explain why such a statement would be incorrect. In either case, such statement shall further declare in writing, under oath, whether or not the contents of the statement have been reviewed with the company’s audit committee, or in the absence of an audit committee, the independent members of the company’s board of directors. The certifications will apply to the following:
- the company’s most recent annual report on Form 10-K filed with the SEC;
- all of the company’s reports on Form 10-Q, all reports on Form 8-K and all definitive proxy materials filed with the SEC subsequent to the filing of the most recent Form 10-K; and
- any amendments to any of the above.
The officers are required to file their written statements with the SEC no later than the close of business on the first date that their company is required to file a Form 10-K or Form 10-Q with the SEC on or after August 14, 2002. The SEC intends to make the certifications available to the public on the SEC website.
The Exposure to Civil Liability of Designated CEOs and CFOs under the Federal Securities Laws Prior to the Issuance of the Order
A key issue the order poses is whether the certifications will affect the exposure to personal liability under the federal securities laws of those who execute such attestations. Even absent a certification as now required by the order, CEOs and CFOs faced substantial exposure to personal liability under the federal securities laws. CFOs typically sign Forms 10-Q every quarter and CEOs and CFOs are required to sign Forms 10-K annually. Generally, the CEOs and CFOs are personally responsible for the accuracy and completeness of the statements in the Forms 10-Q and 10-K that they sign, as are the companies on whose behalf the reports are prepared and filed. Thus, in the event that a Form 10-Q or 10-K is materially misleading, either because of an untrue statement or omission of a material fact, the officers who sign such forms can be held personally liable under the federal securities laws.
For example, Section 10(b) of the Securities and Exchange Act of 1934 (Exchange Act), and Rule 10b-5 promulgated thereunder, broadly prohibit untrue statements and omissions of material fact in connection with the purchase or sale of securities. These provisions are broad and cover situations in which a CEO or CFO makes a materially misleading statement by signing a Form 10-Q or 10-K. Similarly, under Section 18(a), anyone who purchased or sold a security in reliance on a false or misleading statement of material fact included in the Forms 10-Q or 10-K can bring an action against the person who signed the document containing the misleading statement.
Indeed, a CEO or CFO may be exposed to personal liability for a materially misleading statement in Forms 10-Q and 10-K, even if he or she did not actually sign the form containing such statements. Under Section 20(a) of the Exchange Act, any person, such as a CEO or CFO, who controls any other person who violated the Exchange Act, such as a public company, may be liable jointly and severally and to the same extent as the violator. Thus, under Section 20(a), potential liability extends beyond those who sign Forms 10-Q and 10-K to those who control the company on whose behalf the form is filed.
New Exposure to Civil Liability of CEOs and CFOs under the Commission’s Order
The attestations required will not fundamentally alter the nature of the personal liability of corporate officers who sign Forms 10-Q and 10-K. All signers of such documents are and will continue to be at risk of personal liability for any material misstatements or omissions in those documents. The attestations will, however, constitute "statements" of the attesting officers in addition to any statements in the company’s public filings the attesting officer signs. The attestations may themselves be materially misleading and, thus, subject the signers to personal liability. Therefore, in addition to potential liability for material misstatements or omissions contained in Forms 10-Q, 10-K or 8-K, officers signing statements pursuant to the order may be liable under any of the theories of liability discussed above, among others, based solely on the signing of the sworn statement, regardless of whether the officer signed any other document, such as a Form 10-Q or 10-K.
If the statement is untrue at the time it is signed because the attesting officer knew that the underlying Form 10-Q or 10-K either omitted a material fact or contained an untrue statement of material fact, the attesting officer can be held personally liable based solely on the attestation itself. If the CEO or CFO believed that the statement was true at the time of signing, but one of the reports to which the attestation applied in fact contained a materially misleading statement, the CEO or CFO would presumably not be subject to liability exposure because the attestation was made to the best of his or her knowledge.
Finally, because the attestation is based on a review of the specified public filings with the SEC, attesting CEOs and CFOs should actually review those documents before executing an attestation. Failing to do so could constitute an independent misstatement.
Pending SEC Rule Proposal for Ongoing Management Certifications of Periodic Reports
The implications of the order are substantially similar to those that would arise under a pending SEC proposal (contained in Release No. 34-46079, issued June 17, 2002) to amend rules under the Exchange Act to require the principal executive and financial officers of all U.S. SEC registrants to certify in writing that each officer has read each Form 10-Q and 10-K filed by their companies and that each report is true in all important respects without omission of any material information. Comments on Release No. 34-46079 are due to the SEC by August 19, 2002.
Under the proposed new rules, public companies would also be required to maintain procedures sufficient to provide reasonable assurance that the company is able to collect, process and disclose the information required in the company’s Forms 10-Q, 10-K and 8-K. The proposed rules would require that before filing the Form 10-K, the company must evaluate the effectiveness of the design and operation of its reporting procedures. In addition, the company’s principal executive officer, principal financial officer and board of directors must review the results of the evaluation. The CEO and CFO would be required to certify in the annual report that they had reviewed the results of the evaluation.
The SEC proposal recommends but does not require that each company create a committee responsible for materiality determinations and timely disclosure. The release suggested that such a committee include officers such as the controller, general counsel, principal risk management officer, chief investor relations officer, among others.
The SEC’s order and rule proposals are a direct result of highly publicized events calling into question the general accuracy and reliability of the financial statements and other information publicly reported by substantial companies. The order and other SEC actions will, in all likelihood, not be the last federal regulatory initiatives in this area. In addition to further SEC action, there is the possibility of congressional action. Given the risks to individual officers arising from the certifications required by the June 27th order and the intense scrutiny of public companies and their executives, public companies should begin immediately to undertake a thorough reevaluation of their reporting policies and procedures to ensure compliance with current and prospective law and public expectations.
