By Erin McClam
The Associated Press
NEW YORK - The first test of the rigorous new corporate governance law known as the Sarbanes-Oxley Act will probably be the case involving HealthSouth Corp., which regulators have accused of overstating earnings by $2.5 billion through last year.
HealthSouth executives could face charges under the new law for falsely certifying financial results, a crime punishable by up to 20 years in prison. It's the first major fraud case since the law was passed a year ago in response to a string of accounting scandals.
The new law requires chief executive and chief financial officers to certify their company's financial statements and holds them criminally liable for inaccuracies. It stiffens the maximum penalty for securities fraud, makes it a felony to destroy some audit-related documents and extends the statute of limitations on securities fraud.
HealthSouth's ousted chief executive, Richard Scrushy, who signed a certification shortly after the law was passed, has not been criminally charged, but regulators have filed a civil suit accusing him of fraud. A dozen other former executives have agreed to plead guilty to fraud in the criminal investigation.
"I think HealthSouth proves how valuable the certification procedures in Sarbanes-Oxley are," said Jeff Rudman, chairman of securities litigation at Boston-based firm Hale & Dorr. "Sarbanes-Oxley gives the prosecutors a rifle-shot opportunity."
Dozens of corporate executives have been hauled into court since late 2001, when business scandals such as Enron, WorldCom and Tyco began surfacing. But no one has been prosecuted under the new law yet, and it's still not clear how it will be applied in court.
Experts expect the certification requirements to make it much more difficult for executives who preside over companies that suffer massive frauds to slip out of the reach of prosecutors. Former Enron CEO Kenneth Lay and ex-WorldCom chief Bernard Ebbers have not been charged with any crime, although investigations continue.
"Intent is the cornerstone of all financial fraud," said Robert Mintz, a former federal prosecutor. "Requiring CEOs to vouch for the accuracy of those results really raises the bar for the defense."
It may take years before the full impact of the law on white-collar prosecutions is understood. Patterns of corporate malfeasance tend to emerge during so-called bubbles in the stock market, when companies are turning big profits - an environment ripe for cutting corners.
"You're not going to see whether this works until you have another stock market bust and you can see whether these new laws worked to keep the shady operations out of the system," said David Hardesty, author of "Corporate Governance and Accounting Under the Sarbanes-Oxley Act of 2002," a guide for securities industry professionals.
"You can bury a lot of crime in a rising stock market," he said.
Some executives are taking steps to encourage strong ethics and transparency within their own companies so they can sign off on financial statements with more confidence, said Therese Webb, managing director for Chicago-based Parson Consulting, which coaches companies to comply with Sarbanes-Oxley.
"That's why it's important to set that tone at the executive level," Webb said. "People want to make sure that they have their house in order."
One of the law's ramifications may be a trend not written into the legislation. Since Sarbanes-Oxley was enacted, many companies have created their own ethics offices - internal but independent.
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