Opinion

Alison Frankel

The Bentonville Black SOX? Wal-Mart’s Sarbanes-Oxley problem

By Alison Frankel
April 23, 2012

The follow-up to the New York Times blockbuster scoop on Wal-Mart’s alleged cover-up of $24 million in Mexican bribes has, quite rightly, focused on the company’s potential Foreign Corrupt Practices Act exposure. But that’s not the only law Wal-Mart and its executives should be worrying about.

Good old Sarbanes-Oxley, passed in 2002 in the wake of accounting scandals at Enron, WorldCom, Tyco, Adelphia and other public companies, was intended to prevent exactly the kind of cover-up Wal-Mart allegedly engaged in, according to the Times report. The 10-year-old law imposed gatekeeper duties on corporate lawyers, who are supposed to report material violations of the securities laws up the chain of command, all the way to the audit committee of the board, if necessary. SOX also requires corporations and their auditors to report on the company’s internal controls for financial reporting – and requires that CEOs and CFOs certify the material accuracy of financial reports. According to securities-law experts, if the Times allegations are true, Wal-Mart may have run afoul of all these provisions.

The bribery allegations originated with a Wal-Mart lawyer in Mexico, who told Wal-Mart International’s general counsel, Maritza Munich, about the “irregularities.” She authorized a preliminary investigation by outside counsel in Mexico, then – quite appropriately – reported the findings to Wal-Mart’s then-General Counsel Thomas Mars, among other senior officials. Mars brought in Willkie Farr & Gallagher, which proposed that it conduct a far-reaching internal investigation. So far, so good.

But instead of hiring Willkie, Mars allegedly sent the Mexico bribery probe back down the ladder to the company’s internal investigations unit. According to the Times, investigators turned up unsettling evidence implicating both a fast-rising Wal-Mart de Mexico executive and Wal-Mart de Mexico’s general counsel in the bribery and accounting cover-up. In a preliminary draft report in December 2005, the lead in-house investigator wrote: “There is reasonable suspicion to believe that Mexican and USA laws have been violated.”

Foreign bribery wasn’t the cause celebre in 2005 that it has become today, but according to the Times, the company’s vice-chairman was already concerned about the “unacceptable risk … the government’s stepped-up enforcement of the Foreign Corrupt Practices Act” posed. So after receiving a preliminary report suggesting the company had broken the law, did Wal-Mart disclose the findings to its own audit committee and to its shareholders?

It did not. According to the Times, then-CEO Lee Scott called a meeting in February 2006 to decide what to do. GC Mars was among the tight group of senior executives who decided to transfer the bribery investigation to the very same Wal-Mart de Mexico general counsel who had been implicated in the preliminary inquiry. The Mexican GC proceeded to wrap up the investigation in a few weeks, finding no clear evidence of bribery or law-breaking, the Times reported.

There are different SOX implications in those (alleged) facts for Wal-Mart’s former top lawyer and its former CEO. The law’s gatekeeper provisions for lawyers were very controversial as the Securities and Exchange Commission drafted its enforcement rule in 2003. Corporate lawyers were concerned that senior execs wouldn’t consult them on serious issues, for fear the lawyers would run to the board. In fact, the SEC has not taken action against any lawyer for failing to report up the chain, according to Columbia Law School professor John Coffee and SEC Actions blogger Thomas Gorman of Dorsey & Whitney. (An SEC spokesman confirmed that there’s been no formal enforcement of the gatekeeper rule.)

“The SEC walked away from the rules,” said Coffee. It’s easy to see why. SOX requires the corporate attorney to take reasonable steps, which means the agency would have to probe the lawyer’s state of mind. There are also attorney-client privilege problems. Gatekeeper cases are apparently a problem the SEC has decided it doesn’t need, and the folks I talked to agreed it’s unlikely Mars will be targeted.

But Coffee, Gorman and UCLA Law School professor Stephen Bainbridge – who was the first to suggest that Wal-Mart might have a SOX problem – all said that the CEO and CFO certifications and internal controls responsibility could tempt the government. The Justice Department has so far brought only one criminal SOX false certification case, against former HealthSouth CEO Richard Scrushy, who was acquitted on the charge. (The SEC has brought “dozens” of false certification enforcement actions, according to a spokesman.)

Bainbridge said, however, that prosecutors have been handed the Wal-Mart case “on a silver platter by the New York Times” and may feel obliged to make an example of the executives who signed off on the company’s filings. “At a bare minimum, there are disclosure problems,” Bainbridge said.

“This could well be the first certification case” in connection with unreported FCPA exposure, added Gorman of Dorsey & Whitney. “Sarbanes-Oxley puts a lot of pressure on companies to do the right thing,” he said. “It’s somewhat surprising to see these allegations about a major company.”

Falsely certifying financial results is no small matter for corporate executives. The criminal statute calls for maximum penalties of $1 million and 10 years’ imprisonment for a false certification and $5 million and 20 years for a willfully false filing.

Bainbridge pointed out that Wal-Mart’s first line of defense to SOX allegations will be to argue that the alleged Mexican bribery was not material so it didn’t have to be disclosed. Back in 2005 and 2006, as the company was investigating the allegations, there was no Justice Department or SEC case to report to shareholders, and the company’s final report concluded there was no bribery. “You could imagine people saying: ‘We don’t have to disclose,’” said Bainbridge. “You don’t have a certification case unless you have an underlying disclosure case.” (He believes it would be simpler for the SEC to assert a controls case against the corporation.)

Coffee, however, said Wal-Mart’s leaders should be worried. “Senior people were hearing things went bad,” he said. “I don’t know what they knew, but it’s very likely they knew enough to be concerned about the certifications.”

A Wal-Mart spokesman declined to respond to emailed questions about the company’s potential SOX violations.

For more of my posts, please go to Thomson Reuters News & Insight

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PHOTO: Employees walk outside a Wal-Mart store in Mexico City April 21, 2012. U.S. retail giant Wal-Mart Stores Inc squelched its own internal investigation of allegations made by a former executive of its subsidiary in Mexico that the Mexican division had orchestrated a campaign of bribery to grab market dominance, the New York Times reported on Saturday. REUTERS/Bernardo Montoya

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