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The SEC Takes AIM at Good Soldiers

by Richard A. Levan

Winter 2000, Vol. 63, No. 4

Imagine you are in your office one evening when the head of your firm's accounting department appears in your doorway with what he claims is a modest proposal. The firm, he says, is experiencing a temporary cash crisis, and so all of the firm's attorneys are being asked to pre-record their time this month on big cases that they know they will work on next month. Of course, the accounting chief tells you, the firm will reverse any charges in the succeeding month if the time is not really expended.

It is doubtful that many in the law profession would have trouble dismissing this request as unethical and foolhardy. (Many might also recommend that the CFO start looking immediately for new employment.) This scenario-so brazen by lawyers' standards-goes on every day in accounting and sales departments across the corporate landscape. The pressure exerted on public companies by Wall Street to meet or exceed analysts' expectations is immense and places top managers in a perilous position. Fail to meet earnings estimates and your company's stock will be punished. Inflate your company's performance and you may find yourself punished. The choice is often grim.

This headlong pursuit for corporate profits (or minimal losses in the case of many dot.coms) creates enormous pressure for accounting professionals inside corporations to please senior management by reporting profitable results. At some companies this has led to a practice of "warming" the company's financial data, if not outright "cooking" the corporate books.

The SEC Response
In response to this situation, the Securities and Exchange Commission, the nation's primary watchdog over accounting practices at public companies, has declared open season on those who engage in creative accounting practices in order to boost corporate performance. In September 1999, the SEC filed fifteen cases against sixty-eight companies and individuals in a targeted enforcement sweep based on alleged accounting improprieties. This past September the government struck again. In addition to the filing of eleven new enforcement actions against six companies and thirteen individuals, criminal indictments were handed down against five individuals who now face prosecution by both the SEC and the U.S. Department of Justice.

'Good Soldier Defense'
Perhaps most significant is the fact that many of the defendants in these actions are middle managers, and not the CEOs or CFOs who frequently instigate these schemes. As one senior SEC enforcement official explained, mid-level managers make inviting targets because "[t]he top officers generally cannot commit these financial frauds without the help of those who work for them."

So what is an employee to do when her boss asks her to engage in conduct that she knows or suspects is illegal? One answer is clearly not to play the role of the dutiful soldier.

The defense that one was only following orders, known sometimes as the "Good Soldier Defense," has fared rather poorly in legal circles. The defense fell into general disrepute after World War II with the advent of the Nuremberg Trials and has never made much of a comeback.

SEC decisions involving actions against accountants and investment professionals routinely hold that "[t]hose who assist [in committing wrongful] practices cannot escape culpability by asserting that they acted as 'good soldiers' and, thereby, [claim] that the violative conduct was condoned, or even ordered, by their corporate superiors." Nonetheless, corporate officers and employees in the United States continue to assert the defense when called on the carpet for workplace misconduct.

Just this past summer, two in-house accountants were barred from practicing before the SEC and sanctioned in connection with the SEC's investigation into accounting practices at a major corporation. The investigation uncovered one of the largest financial frauds in corporate history. Not surprisingly, the defendants argued, unsuccessfully, that they were doing only what their superiors had instructed them to do.

The repeated rejection by courts and regulators of the good soldier defense prompts two interrelated questions. First, why do employees continue to rely on the excuse that they were only following orders in order to evade responsibility for their wrongful actions? Second, why do otherwise honest employees engage in misconduct in the first place?

The answer to the latter question is fairly obvious. Most employees lack financial independence and, accordingly, fear for their jobs if they buck their employers' requests. The answer to the first question is more ambiguous.

As a general rule, many people do things at the behest of a superior that they would never dream of doing on their own. Furthermore, if the conduct at issue does not involve outright theft, but something more ambiguous such as the proper time to book revenue, the line between right and wrong can blur. Couple this with a general attitude that the government is only interested in the big fish, and you find people in positions they certainly would prefer to avoid.

While the SEC lacks criminal jurisdiction, it can bar accountants and lawyers from practicing before the Commission, and it can impose a host of other sanctions including fines, injunctions and disgorgement. The SEC can also call in the Department of Justice when it suspects the conduct in question is criminal. Whether civil or criminal, however, the cost of defending a government investigation or enforcement proceeding can be financially devastating to an individual or small company. The personal toll is even harder to quantify. Employees faced with the pressure to please senior management and play for the team must respond carefully at the first suggestion of impropriety. Similarly, corporations must be watchful of managers who seek to boost their own performance, or that of a subsidiary, through the use of creative accounting methods. Neither group can afford the ills that may follow.

Here are some suggestions for companies and employees that find themselves confronted with the prospect of illegal conduct.

Employer Considerations
  1. Don't encourage, permit or tolerate fraud of any kind in the workplace. A willingness to look the other way or bury bad news sends a very loud message to employees about what practices are, and are not, acceptable.

  2. Establish an environment and culture that discourage wrongful conduct and reward the reporting of fraud and dishonesty.

  3. Develop policies and procedures that provide for the detection, reporting and correction of internal misconduct. The failure to implement corporate compliance procedures can result in increased sanctions against the company.

  4. Follow the policies and procedures you implement. Allowing a compliance manual to sit on a shelf can be worse than having no policies at all. Such an overlooked set of procedures can serve as the blueprint for a subsequent government prosecution.

  5. Don't retaliate against employees who report fraud or wrongdoing. There are serious civil consequences for the mistreatment of whistleblowers or others who report corporate wrongdoing. Firing a whistleblower can make an already bad situation worse. It also undermines any effort to establish the culture alluded to in considerations 1-4 above.

Employee Considerations

  1. Don't participate in fraud or misconduct.

  2. Report wrongdoing to the appropriate person in your organization. If told to obey an inappropriate command, report this to a person in a position of higher authority than the person giving the order.

  3. Don't play detective without checking first with an employment lawyer or someone knowledgeable about the liabilities that can arise from an employee conducting her own internal investigation.

  4. Don't copy or remove corporate records. They belong to the company, not to you.

  5. Don't expect to get rich from a whistleblower or qui tam lawsuit. The legacy of tattered lives and shortened careers makes the possibility of a large recovery pale in comparison to any potential benefit.

  6. In-house counsel must be ex-tremely careful not to reveal client confidences when confronted with questions by government investigators or plaintiffs' counsel.

No amount of planning or surveillance can ensure that wrongdoing will never occur in an organization. One thing, however, is certain. Good soldiers may be useful in guarding the corporate ramparts, but they should not claim surprise when they find themselves caught in the line of regulatory fire.