CEOs Are Diving for Legal Cover

A new rule forcing corporate leaders to vouch personally for the accuracy of their companies’ financial statements has set off a legal scramble, as worried executives search for ways to protect themselves from potential civil or criminal liability.

The Securities and Exchange Commission rule requires chief executives and chief financial officers of large companies to sign sworn statements by mid-August declaring that recent financial reports are accurate and complete.

Though companies always have been required to provide accurate data, the personal declarations could ratchet up executives’ legal liability if errors--honest or otherwise--turn up later.

That has prompted CEOs to take such steps as rechecking accounting procedures, boosting personal liability insurance and forcing subordinates to sign similar statements under oath, experts say.

“Some people are saying, ‘Oh my Lord, what does this mean? What should I do?’ ” said David Becker, a former SEC lawyer now at Cleary Gottlieb Steen & Hamilton in New York. Some executives feel as if they’re “in the cross-hairs,” he said.

The new rule could further roil the stock market in the next few weeks. Federal Reserve Chairman Alan Greenspan and others have predicted that some CEOs, as they review their books, will be forced to restate past financial results.

Executives’ increased legal vulnerability also could have broader implications longer term, some experts say.

At an extreme, it could discourage qualified people from becoming CEOs or CFOs.

“At some point, you rack up the liability so high that you don’t get good people” to take these jobs, said Seth Taube, a securities lawyer at McCarter & English in Newark, N.J.

The SEC enacted the rule June 28 following the wave of corporate accounting scandals that began with Enron Corp.’s collapse in December.

CEOs and CFOs must sign an SEC-scripted statement in which they declare “to the best of [their] knowledge” that their financial reports are correct.

Executives could avoid signing by telling the SEC why they can’t make such an assurance. But few CEOs are expected to take that route because it would raise doubts about their company’s accounting and almost certainly crush their stock.

The rule affects 947 publicly traded companies with annual revenue exceeding $1.2 billion. The forms for many companies, though not all, are due Aug. 14. The deadline depends on which fiscal periods a company uses for its financial reporting.

The sworn statements will apply to the 2001 annual reports that each company already has filed, as well as to quarterly data released so far this year. The SEC has proposed making the rule permanent.

The SEC realizes that chiefs of huge companies can’t verify the accuracy of every financial detail, experts say. But regulators want to force them to pay closer attention to the way their staffs compile and report numbers.

One goal of the SEC rule also is to prevent CEOs from using what has recently been a common defense when companies’ accounting has been exposed as troubled or fraudulent: that the CEO relied on subordinates and was unaware of the financial minutiae.

Some executives say they welcome the new rule.

On Wednesday, Delphi Corp., a Troy, Mich.-based auto-parts maker, became the first company to file the certifications.

J.T. Battenberg III, Delphi’s CEO, said he stands behind his company’s financial statements and believes the SEC rule will allow executives to send a clear message that most companies have used proper accounting.

“We’ve got to do whatever we’ve got to do to protect our companies and our people” amid the cloud of mistrust hanging over corporate America, he said.

Before filing the certifications, Battenberg held meetings with the audit committee of Delphi’s board of directors and with the company’s outside auditors to ensure the accuracy of the financial reports, he said.

Delphi also required the chiefs and CFOs of its seven divisions to sign similar statements, Battenberg said.

However, executives at some companies are unnerved by the unknown legal ramifications of personally certifying the financial results, experts say.

“CEOs are nervous because they don’t know what [will happen] if someone three levels below them makes a mistake,” Taube said.

Some experts predict that many CEOs will do what Battenberg did and require similar sworn statements from subordinates, figuring they could be used as a defense if accounting problems are exposed later.

Executives could face heightened legal exposure in two ways. First, a signed declaration makes it easier for prosecutors to bring criminal charges, especially for perjury.

Also, CEOs could face an increased threat of civil litigation from regulators or from aggrieved investors.

Some executives have sought to limit their liability by asking for permission to modify the wording of the certifications they file. The SEC has balked at the idea.

“We are dismayed that respected members of the bar seem to be spending a great deal of effort in searching for a way to advise CEOs and CFOs on how to weasel out of complying with the clear intent of the order,” said Martin P. Dunn, deputy director of the SEC’s corporation-finance division in Washington.

The agency said it will make the declarations public on its Web site (www.sec.gov) soon after they’re turned in. Companies that file the statements according to the SEC’s specifications will be grouped in one category. Those that don’t will be batched in a second category where their lack of compliance would be readily apparent to investors.

CEOs normally are protected from personal legal liability by so-called directors and officers insurance, which their companies buy for them.

The insurance pays executives’ legal bills and any settlements or judgments if they are shown to have been negligent. It does not cover fraud, however.

D&O; insurance coverage is likely to include the risks created by the new certifications, some experts say.

But if damages exceed the value of the policies, or if companies go bankrupt, executives still could face personal liability.

For that reason, many companies have been trying to ramp up their insurance coverage--one reason D&O; premiums have been rapidly escalating.

D&O; premiums for large companies have surged by 100% to 600% this year over last year, said John Keogh, president of the D&O; unit of giant insurer American International Group in New York, which dominates the D&O; market.