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"Reliance on others" . . .
as a defense to corporate fraud under Sarbanes-Oxley Act

Intent to defraud is an element of proof in criminal prosecutions and non-governmental civil actions for violations of Section 10b and Rule 10b-5, the general anti-fraud provisions and regulations under the Securities Exchange Act of 1934. The impact of the Sarbanes-Oxley Act (SOA) on this defense may vary, depending upon the position of the individual defendant with the company and the type of financial issues underlying the alleged fraudulent misconduct. The defendant claiming the "reliance on others" defense has the burden of proving that he or she justifiably relied on someone else. However, ignoring financial mis-reporting or failure to accurately disclose financial information may not satisfy this burden.

The SOA requires that the CEO and CFO are responsible for establishing and maintaining financial disclosure for the company. CEO and CFO must disclose, based on their most recent evaluations to the company's auditors and audit committee of the board of directors, all significant deficiencies in the operation of internal controls which could adversely affect the company's ability to record, process, summarize and report financial data, and have identified for the company's auditors any material weaknesses in audit controls and any fraud, whether or not material that involves management or other employees who have a significant role in the company's internal controls. The CEO and CFO and other certifying officers have to indicate in the report whether or not there were any significant changes in the internal controls or in other factors that could significantly affect internal controls subsequent to the date of their most recent evaluation. SOA may not affect the "reliance on others" defense. What is important is the person's role as a participant or reviewer, or knowledge of, any improper reporting of financial information. The SOA, along with other recent pronouncements by the SEC, imposes a duty on members of the audit committee to be more involved in the audit and disclosure of financial information. As far as the "reliance on others" defense for alleged improper financial disclosures, the SOA emphasizes the need to implement, enforce and continually evaluate internal controls.

This information is not intended to constitute legal advice, nor a substitute for legal advice.

Reprinted with permission from Trade Vendor Monthly, 2/03

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