Enron fallout spurs securities fraud bill: the Corporate and Criminal Fraud Accountability Act would create penalties for illegal document shredding and increase protections for whistleblowers. (Capital edge: legislative & regulatory update).

In the wake of the Enron/ Arthur Andersen scandal, Washington policy makers are pursuing reforms that would affect how records and information managers do their jobs in the future.

On April 25, the Senate Judiciary Committee overwhelmingly approved by voice vote Senate Bill 2010, the Corporate and Criminal Fraud Accountability Act of 2002. The bill establishes penalties for illegal document shredding, increases protections for corporate whistleblowers, requires that auditing documents be preserved for five years, and prevents violators of securities laws from using bankruptcy as a shield to escape liability.

Sen. Patrick Leahy (D-Vt.), chairman of the Senate Judiciary Committee, introduced the bill on March 12 with co-sponsors Sen. Thomas Daschle (D-S.D.), Sen. Richard Durbin (D-Ill.), and Sen. Tom Harkin (D-Iowa). The measure aims to prevent corporate fraud, protect corporate fraud victims, preserve material evidence related to a corporate fraud incident, and hold corporate fraud scofflaws accountable for their criminal wrongdoing. S.2010 provides for criminal prosecution and enhanced criminal penalties for those who defraud investors in publicly traded securities or alter or destroy physical or testimonial evidence related to the fraudulent transaction. It also disallows the debt incurred in violation of securities fraud laws from being discharged in bankruptcy.

"As a former prosecutor," Leahy said, "I was surprised to learn that unlike bank fraud, healthcare fraud, and bankruptcy fraud, there is no specific federal crime of `securities fraud' to protect victims of fraud related to publicly traded companies."

In securities fraud cases, federal prosecutors at present must use statutes relating to mail and wire charges that carry maximum penalties of only five years' imprisonment and require prosecutors to directly link the securities fraud to the use of mail or interstate telephony to carry out the fraud. Alternatively, a charge of willful violation of certain specific securities laws or regulations may be brought, but proving willful violations of existing law has allowed defendants to argue that they did not possess the requisite criminal intent.

Closing Loopholes

Supporters hope the bill, if passed, will help standardize laws that apply to records and information management. Currently, criminal laws relating to the destruction or fabrication of evidence, including the shredding of financial and audit records, are a patchwork of laws that is often misinterpreted. Lawmakers said that S.2010 is necessary because current federal law relating to obstruction of justice in document destruction cases is littered with loopholes and burdensome proof requirements. For example, under current provisions it is a crime for an individual to persuade another person to destroy documents, but it is not against the law if that individual destroys the same documents himself/herself.

"This bill is about accountability and transparency," Leahy explained. "Transparency instills confidence, and accountability helps enforce transparency and forthright financial decisions."

Currently, U.S. federal statutes lack a clear requirement of what kind of work product auditors must retain in order to support auditing conclusions that may be examined at a later time by federal regulators and law enforcement officials.

The current obstruction of justice charges against Arthur Andersen have been brought under a "witness tampering" statute of the federal criminal code because no specific charge of document shredding exists that can be brought against the firm. According to the Senate Judiciary Committee Report on S.2010, the Andersen example has forced prosecutors to "proceed under the legal fiction that the defendants are being prosecuted for telling other people to shred documents, not simply for destroying evidence themselves. Although prosecutors have been able to bring charges thus far in the case, in a case with a single person doing the shredding, this legal hurdle might present an insurmountable bar to a successful prosecution. When a person destroys evidence with the intent of obstructing any type of investigation and the matter is within the jurisdiction of a federal agency, overly technical distinctions should neither hinder nor prevent prosecution and punishment."

The committee report further states, "even more surprising, in the context of audits and reviews conducted under the Securities and Exchange Act of 1934, there is currently no clear statutory requirement that accountants retain the most basic work papers to support the conclusions reached and opinions expressed in their audits, much less more detailed records, to facilitate determinations by federal regulators and law enforcement officials of whether a corporation or its accountants tried to mislead the public, as in the Enron matter."

Anti-Shredding Felonies

In an attempt to prevent and/or discourage behavior similar to that of Enron and Arthur Andersen's in the future, legislators introduced S.2010. The bill would create two new anti-shredding felonies designed to set clear requirements for preserving financial audit documents and close loopholes in current laws. The Leahy measure seeks to unify these into a more coherent statutory regime relating to document destruction and provide a definitive clarification of what can and cannot be destroyed. The destruction of evidence to obstruct an investigation is made illegal whether or not shredding occurs when records are under subpoena.

The bill creates a new felony that specifically applies to the willful failure to preserve audit papers of publicly traded companies for at least five years. The bill requires the Securities and Exchange Commission to draft rules within 180 days of the bill's enactment pertaining to the retention of categories of electronic and nonelectronic audit records that contain opinions, conclusions, analysis or financial data, in addition to actual work papers.

State securities fraud investigations have been hampered by short statute of limitation rules, which require discovery of evidence of fraud within three years. Several states that lost millions by investing state pension funds in Enron stocks have had to forgo claims against the disgraced Houston energy trading firm. Washington state, for example, lost nearly $50 million in Enron securities fraud traced back to 1997 and 1998, and it is not currently recoverable under the current statute of limitations.

"The intent of the provision is simple: people should not be destroying, altering, or falsifying documents to obstruct any government function ... this section could also be used to prosecute a person who actually destroys the records himself in addition to one who persuades another to do so, ending yet another technical distinction which burdens successful prosecution of wrongdoers," the Senate Judiciary Committee Report states.

The bill requests that the United States Sentencing Commission, which sets federal sentencing guidelines, create a sentencing framework for shredding violations that allows a judge to consider the totality of the circumstances surrounding the fraud (e.g., the number of affected victims) when deciding criminal penalties.

An identical House measure, H.R. 4098, was referred to the House Judiciary Committee in May, introduced by Rep. John Conyers (D-Mich.), who serves as ranking member. But senior staff for Rep. Conyers remain skeptical that any action will be taken this year.

The Leahy and Conyers bills have been endorsed by the North American Securities Administrators Association, state attorneys general from Kansas, Oklahoma, Oregon, Georgia, Washington, Ohio, and Vermont, the AFL-CIO, the Consumers Union, the Consumer Federation of America, and the National Whistleblower Center.

Despite the support, however, and in light of the Bush Administration's intense focus on the war on terrorism and homeland security, sources say S.2010 has been moved to the back-burner. Thus, the likelihood of this legislation passing during the current legislative session is remote at best.

Three Major Components of S.2010

1) It provides new, better tools to effectively prosecute and punish criminals who defraud investors.

* It creates a new, 10-year felony for defrauding shareholders of publicly traded companies. It creates a five-year felony that could be used effectively in cases where a person destroys or creates evidence with an intent to obstruct a criminal investigation. It also creates another five-year felony that applies to the willful failure to preserve audit papers of companies that issue securities.

* It addresses a gap in our sentencing scheme and proposes increasing the jail time for criminals who victimize many people or who financially devastate their victims.

* It gives state attorneys general and the Securities and Exchange Commission (SEC) the power to bring cases under the civil Racketeer-Influenced and Corrupt Organizations (RICO) act.

2) It provides tools to improve investigators' and regulators' ability to preserve and collect evidence that proves fraud.

* It creates, for the first time, federal protection for whistleblowers when they take lawful actions to disclose information or otherwise assist criminal investigators, federal regulators, Congress, supervisors, or parties in a judicial proceeding in detecting and stopping fraud.

* It creates two new document destruction felonies to fill numerous gaps in our obstruction of justice laws. It has a tough anti-shredding provision and a new statute for preserving audit papers, requiring that they be maintained for five years.

3) It protects fraud victims' rights to recover.

* It allows corporate whistleblowers whose careers are ruined by retaliation to recover damages.

* It stops those who violate U.S. securities laws from hiding assets in bankruptcy, giving fraud victims a better chance at recovery.

* It adopts a suggestion made by previous SEC chairmen to extend the short statute of limitations (three years from date of fraud or one year from date of discovery) to allow fraud victims enough time to unravel these complex cases--five years after the date of the fraud or three years from the date of discovery.

Bob Tillman is Director of Public Relations and Advocacy for ARMA International. He may be reached at [e-mail].