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Cutler Says Enforcement Staff Will Focus on Role of Gatekeepers

SEC enforcement chief Stephen Cutler, in remarks at the UCLA School of Law, said that it may not come as a surprise that as memories about recent corporate scandals fade, critics have questioned the costs and benefits of the Sarbanes-Oxley Act. While acknowledging that the costs are not insignificant, Cutler said it would be a profound mistake to roll back the Act's provisions without giving them an opportunity to work. He added that the compliance costs are likely to be higher in the first year or two than they will be in future years.

One of the key themes of the Sarbanes-Oxley Act was the role of the gatekeepers in the capital markets. Cutler reviewed the enforcement staff's initiatives to hold gatekeepers accountable for failing to comply with their legal responsibilities. With respect to auditors, Cutler said the staff has changed its approach. In the past, the SEC focused on individual auditors for deficient audits, but now it more frequently considers the firm's responsibility for those audits.

Cutler pointed to a recent fine against Grant Thornton in connection with the financial reporting failure at MCA Financial Corp. In that action, the SEC imposed its first ever requirement that a firm invest in fraud detection training for all of its auditors. In other actions involving accounting firms, the SEC imposed a penalty against PricewaterhouseCoopers for aiding and abetting the reporting violations of Warnaco and barred Ernst & Young from taking on new audit clients for six months for violating the auditor independence rules. The SEC is currently litigating with KPMG over the firm's allegedly deficient audits of Xerox Corp.

Some may question the benefits of holding an entity responsible for securities law violations, but Cutler maintained that both organizations and people commit crimes. Securities law violations are often the product of the corporate culture, he explained. The SEC believes that enterprise liability can have a significant deterrent and preventive effect. The SEC hopes that the potential threat of an action against an accounting firm will encourage firms to take a greater role in ensuring that auditors are properly discharging their critical gatekeeping role.

Cutler emphasized that firm liability is not a substitute for individual liability. The SEC will continue to pursue individual auditors, he said, such as the bar it imposed against a PricewaterhouseCoopers engagement partner for failing to heed red flags in the audit of Anicom, and the auditors at Ernst & Young who failed to detect that Cendant's financial statements did not comply with generally accepted accounting principles.

The SEC has also stepped up its scrutiny of the role of lawyers in the corporate frauds it investigates, according to Cutler. Lawyers have been named as respondents or defendants in more than 30 enforcement actions over the past two years. About half of the actions have been against outside counsel. Cutler said the staff has more to do in this area, including actions against lawyers who may have assisted their clients in engaging in illegal late trading or market timing arrangements that harmed mutual fund investors. Cutler added that a particular focus of the staff is on the role of lawyers in internal investigations of their clients and whether some have taken actions to obstruct the investigations or hide ongoing frauds.

The staff will also focus on the role of outside directors during investigations and whether they are serving as guardians for the shareholders, especially in transactions involving company management. Cutler noted that the Sarbanes-Oxley Act also lowered the standard by which the SEC may seek to bar an officer or director from further service with a public company. In the past two years, since the passage of the Act, the staff has sought approximately 300 bars.

In order to prevent a recurrence of the corporate abuses that led to the passage of the Act, Cutler said the SEC will focus on the themes of that legislation: holding gatekeepers responsible, aggressively pursuing attempts to obstruct investigations and requiring personal accountability by those "in the corner offices of America's public companies."