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The Washington, D.C., feeding frenzy on Enron Corp.’s spectacular collapse has put a laser-like focus on corporate financial reporting. Fallout from Enron, in combination with expanded government enforcement resources, will increase the Securities and Exchange Commission’s and Justice Department’s interest in these cases. Even before Enron, the SEC was substantially stepping up enforcement against false financials — to such a degree that even expensive and protracted civil litigation could no longer be viewed as the worst of corporate nightmares. Indeed, in the present environment, criminal proceedings in some cases are a certainty. It is, therefore, an increasing priority for in-house counsel to set up mechanisms that can prevent financial reporting problems, spot irregularities, and address the consequences when prevention fails. DO YOUR HOMEWORK The general counsel can take steps to ensure that an effective monitoring system is in place to protect the integrity of the company and its financial statements. The GC can: � Brief top management regarding the legal consequences of accounting and reporting irregularities. This step can raise their consciousness about what is at stake and encourage discussion of any potential problems with the legal team. � Meet regularly with the CFO and other officers to review internal accounting practices, for the purpose of early identification of irregularities or other potential issues. � Establish, in conjunction with the CFO and internal audit department, contact with outside auditors during the annual financial audit process. Also, make certain the auditing firm has access to all required information and personnel to produce accurate financials. Counsel should be prepared to step in to clear any internal impediments that might be in the auditor’s way. � Implement these measures as part of a legal project. That way, the discussions and resulting work will be protected by attorney-client privilege. This is especially important for smaller companies where both the GC and CFO may need outside experts to implement the plan. ASSESSING INTENT Given the complexities of the law in these areas, identifying the boundary between aggressive financial engineering and fraud is difficult. As a result, understanding why some cases merit criminal investigation or prosecution can be complicated. In making that assessment, prosecutors examine a number of factors beyond just accounting and financial statements. One of the most significant issues is corporate culture and intent — in particular, whether the questionable practice is an aberration or reflection of a culture of corporate corruption. Prosecutors will judge whether the suspicious activity is the product of a pervasive atmosphere of disregard for honesty and fair dealing in financial reporting and related practices. Even willful ignorance can land management in legal jeopardy. Under established case law, a prosecutor can show criminal intent by proving that management turned a blind eye toward illegality. If there is evidence of substantial management involvement in creating false financials or in misleading auditors, prosecutors can target both the individuals and the corporation. Under the “collective knowledge doctrine,” knowledge of wrongdoing by individual officers may be imputed to the corporation. Moreover, adherence to generally accepted accounting standards and auditing principles may not be enough to effectively shield the corporation from liability — even where observance of those standards may protect the outside auditing firm. Additionally, conduct after a problem arises can be critical to the prosecutor’s evaluation. Any evidence of efforts to mislead or obstruct investigations or internal inquiries is sure to create new problems and can turn a relatively benign civil enforcement proceeding into a criminal case. DAMAGE CONTROL When a problem arises, it’s up to the GC to move aggressively to control the damage. Consider the following measures: � Immediately inform senior management of the situation, and seek approval for aggressive remedial action, including correcting the questionable practice and disciplining those responsible. � Initiate your own investigation. Getting the facts — completely, accurately, and as early as possible — is critical to establishing the nature and extent of the problem. � Be explicit that no one in the company should destroy any relevant records — even those that may seem innocuous. � Consult legal counsel with expertise in enforcement and prosecutorial practice. � Resist the temptation to engage in a dialogue with the accounting firm that performed the financial audit. Prosecutors and/or plaintiffs counsel may see this contact as an effort to obstruct justice. Ultimately, the company may have no choice but to revise its financial statements. Just as public companies are required to make accurate financial reports, they must also issue restated financials when there is a material change in circumstances. Restatements can be a public relations headache, affecting share price and market perceptions about management. Still, they offer a company the opportunity to mitigate damage. Also, in some situations, contacting regulators in advance of a restatement may assuage their concerns. Additionally, if a criminal investigation is initiated or seems nearly inevitable, early and effective communication with prosecutors will most often put a matter on a better track. In all communications with enforcement authorities, the guiding principle must be candor. That point was driven home in a recent speech by Paul Berger, a senior enforcement official at the SEC, who observed: “Cooperation must be early, meaningful, and complete.” George J. Terwilliger is a partner at New York-�based White & Case LLP. He heads the corporate defense and special litigation projects group in the firm’s Washington, D.C., office and was a prosecutor at the Justice Department for 15 years, including two years as deputy attorney general of the U.S.

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