When a Disclosure may not be Voluntary: Liability for Trade Violations and Sarbanes-Oxley

Article by Leigh T. Hansson, Gregory S. Jacobs and Natalie R. Linendoll

Companies with international trade operations are required to navigate a complex web of laws and regulations, governed by a multitude of government agencies. Corporate officers must make difficult decisions regarding when to disclose export and other trade violations to the government in hopes of avoiding or reducing what could otherwise be severe liability. But are there ever situations where those officers must admit to the government that their company has violated United States trade laws?

In 2002, Congress passed the Sarbanes-Oxley Act (the "SOX") in response to a series of corporate and accounting scandals involving companies such as Enron, WorldCom and Global Crossing. The SOX is multi-faceted legislation that impacts certified public accounting firms, publicly traded companies, corporate attorneys, financial analysts, brokers and dealers. Through its reforms, the SOX seeks to tighten standards for corporate financial disclosure, increase requirements for director independence, and increase penalties for corporate wrongdoing. The SOX is generally applicable to: (1) companies required to file reports with the Securities and Exchange Commission ("SEC") under the Securities Exchange Act of 1934 and (2) companies that have a registration statement on file with the SEC under the Securities Act of 1933. Foreign companies with securities listed on United States markets must also comply with the SOX. As discussed below, the SOX’s disclosure requirements may take away the voluntary nature of disclosure to the government for public companies with international trade operations.

Under the SOX, both the Chief Executive Officer ("CEO") and the Chief Financial Officer ("CFO") are required to certify in their quarterly and annual reports that: (1) they reviewed the report being filed; (2) the report does not contain any untrue statements of material fact or omit any material facts; and (3) the financial statements fairly present the financial condition of the company. The officers must also certify that they are responsible for establishing and maintaining internal controls for the company. The CEO and CFO must design corporate-wide disclosure controls and procedures to ensure that material information is made known to them. Lack of knowledge is not a defense if the officers failed to implement an effective compliance system. The SOX increases the penalties for false certification of financial reports with fines of up to $5 million and prison terms of up to 20 years. Additionally, if a company restates its financial statements as a result of material misconduct, CEOs and CFOs may face forfeiture of certain bonuses and profits.

An important step in preventing potential liability for trade violations is the development of a comprehensive compliance program. An effective compliance program is tailored to the specific business structure, products, processes, and control environment of the company at issue. A compliance program generally includes the following compliance elements: a strong commitment from senior management to company-wide compliance; a specific delegation of authority from senior management to the persons responsible for internal compliance; a clear and concise summary of the relevant laws and regulations with a targeted analysis of how these laws and regulations apply to the company as a whole and its employees on an individual basis; a series of step-by-step order-processing flowcharts and checklists which break down the individual compliance responsibilities of all relevant company actors; a product classification system; a transaction screening program; a consistent and comprehensive training program; a recordkeeping program; internal and external audit schedules and procedures; a notification procedure for potential violations; and internal disciplinary policies for employees who knowingly violate any of the compliance procedures implemented by the company.

According to the SOX, officers must disclose "on a rapid and current basis" material changes in the financial condition or operations of the company "in plain English." 15 U.S.C. § 78m(l). Examples of required financial disclosures include: (1) entry into material agreements not made in the ordinary course of business; (2) termination or reduction of a business relationship with a significant customer; (3) the creation of a direct or contingent financial obligation that is material to the company; and (4) an appointment or departure of a director, CEO, CFO or Chief Operating Officer ("COO"). Under the SOX, companies should disclose potential liabilities in their financial reports because such liabilities would represent a "contingent financial obligation."

Because potential liability stemming from violations of trade laws and regulations may have an effect on a company’s financial well-being, the CEO and CFO of a publicly traded company may have an obligation under the SOX to disclose any material import, export, and trade issues. This disclosure obligation may be at odds with the traditionally voluntary nature of reporting trade violations. A hypothetical illustrates this point: The CEO of a publicly traded, multinational corporation discovers that the company may have exported a significant number of defense articles without an export license in violation of the International Traffic in Arms Regulations ("ITAR"). Under ITAR, the corporation would normally have discretion as to whether it should make a voluntary disclosure to the Directorate of Defense Trade Controls ("DDTC"). However, under the SOX, because the CEO has discovered a material contingent financial obligation, he or she may have a duty to disclose this information in the company’s financial reports. Such disclosure could then lead to liability under ITAR.

In another hypothetical, auditors discover suspicious payments on the books of a multinational, publicly traded corporation that they suspect may be bribes to foreign officials in violation of the Foreign Corrupt Practices Act ("FCPA"), and they inform the CEO and CFO of the company. Under FCPA, the CEO and CFO would have no duty to disclose those potentially illegal payments. However, because the company could potentially face large civil and criminal penalties as a result of the violations (see the FCPA "Enforcement Highlights" in this issue), the SOX may require the CEO and CFO to disclose the contingent liability in the company’s financial reports.

In a final hypothetical, the CEO of a publicly traded corporation learns that the company has not been properly marking the country of origin of imported items in accordance with U.S. Customs and Border Protection ("Customs") regulations. While the Customs regulations do not require a company to disclose such an omission, because of the penalties associated with violations of country of origin marking requirements, again, the officers may be required under the SOX to disclose the potential liability.

These hypotheticals demonstrate how the financial disclosure requirement of the SOX may have serious consequences for corporations with international trade operations. While the requirement that a publicly traded company disclose its violations of United States trade law may seem to be a harsh result, the good news is that voluntary disclosure is often the best option for a company in such a situation. As a key mitigating factor used by agencies to determine the extent of any liability on the part of the company, voluntary disclosure generally results in dramatically reduced fines and penalties, provided that the disclosure is made before the government learns of the possible violation.

In order to comply with the SOX, businesses must demonstrate a commitment to trade compliance, including the development of a compliance program, maintaining procedures for restricted party screening, license determination and tariff classification. In addition, corporate officers must ensure that adequate internal reporting controls and procedures are in place in their companies. In order to comply with the financial disclosure provisions of the SOX, these officers may be required to disclose trade violations where such disclosure would otherwise be voluntary. However, making these disclosures is likely already in the company’s best interests.

This article is presented for informational purposes only and is not intended to constitute legal advice.