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SEC Administrative Law Judge Gets It Right When Talking About The Books And Records And Internal Controls Provisions

great job

These pages have frequently highlighted legislative history relevant to the Foreign Corrupt Practices Act’s books and records and internal controls provisions (see here among numerous other posts) as well as prior SEC guidance on these provisions including most notably a 1981 speech by Harold Williams (Chairman of the SEC).

Demonstrating once again that this “old” legal authority and guidance remains relevant in the FCPA’s modern era, in this recent administrative order, James Grimes (an SEC Administrative Law Judge) accurately stated:

“The Senate bill that contained the proposed new paragraph (2) would have required issuers to “make and keep books, records, and accounts which accurately and fairly reflect” the “transactions and dispositions of” the issuer’s assets. Concerned that the emphasized language would require an “unrealistic” “degree of exactitude and precision,” the conference committee rejected the phrase accurately and fairly in favor of the phrase in reasonable detail. The conference committee believed the adopted language made “clear that [an] issuer’s records should reflect transactions in conformity with accepted methods of recording economic events and effectively prevent off-the-books slush funds and payments of bribes.”

The Commission provided guidance about Section 13(b)(2)(A) through an address delivered in 1981 by then-Chairman Harold M. Williams.17 Chairman Williams addressed the perception that “technical and insignificant errors in corporate records or weaknesses in corporate internal accounting controls” could lead to civil or criminal liability. Noting the use of the word reasonable in paragraph (2), Chairman Williams stated that paragraph (2) did not require “absolute exactitude or that a company’s control system meet some absolute ideal.” Section 13(b)(2) was instead subject to “a de minim[i]s exemption, though not in absolute, quantitative terms.”

Chairman Williams also explained that Congress considered but rejected materiality as the appropriate standard under Section 13(b)(2). He described materiality as both “inadequate” and “[un]realistic,” noting that for large companies, a materiality standard would permit misstatements in corporate books and records “in the millions of dollars.” Indeed, Congress enacted Section 13(b)(2)(A) because of “off-book expenditures, slush funds, and questionable payments,” involving amounts that would fall far below a materiality threshold.

Chairman Williams then explained that the Commission would look to a variety of factors to decide whether a violation occurred. It would consider “the adequacy of the [issuer’s] internal control system …, the involvement of top management in the violation, and the corrective actions taken once the violation was uncovered.” Further, “intentional circumventions … of accounting controls by a low-level employee would not always be considered violations of the Act by the issuer,” if the violations were committed “without the knowledge of top management, with an adequate system of internal control, and with appropriate corrective action taken by the issuer.” Excepting situations in which senior officials are complicit, if “discovery and correction expeditiously follow, no failing in the company’s internal accounting system would have existed.” Instead, “routine discovery and correction would evidence” the system’s “effectiveness.” But Chairman Williams cautioned that:

there can be no relaxation of the proscription against the creation or maintenance of any fund that is designed to be used for ‘off-books’ payments outside the issuer’s system of internal accounting control, or against obstructing or circumventing in any significant respect the issuer’s system of internal controls by misstatement to auditors or related means.

In 1988, Congress added paragraph (7) to Section 13(b).29 Paragraph (7) defines reasonable detail, as used in Section 13(b)(2)(A), as “such level of detail and degree of assurance as would satisfy prudent officials in the conduct of their own affairs.” House and Senate conferees adopted the term prudent officials to make clear that an “unrealistic degree of exactitude or precision” was not required. The conferees also explained that they deleted proposed cost-benefit language because “[t]he concept of reasonableness” already implicates “the weighing of a number of relevant factors, including the costs of compliance.”

(emphasis in original)

Is it possible to reconcile the above observations by an SEC administrative judge about the FCPA’s books and records and internal controls provisions with SEC enforcement theories in many recent FCPA enforcement actions?

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