In securities fraud cases, a finance chief’s expertise should not imply that he or she is guilty of intentional deception, according to a federal appeals court that recently overturned a former CFO’s conviction.
The defendant’s “presumed knowledge of GAAP as a qualified CFO does not make him criminally responsible for his every conceivable mistake,” wrote Judge Richard Clifton of the U.S. Court of Appeals for the Ninth Circuit in a decision made last month in the case of Prabhat Goyal. Goyal, who was finance chief of software company Network Associates (now McAfee) between 1997 and 2001, had been convicted in 2007 on 15 counts of securities fraud, filing false reports with the Securities and Exchange Commission, and making false statements to auditors while he was at Network Associates.
Tossing out the conviction, the appeals judges concluded the government’s original case failed to show that Goyal had fraudulent intent. Their opinion highlights the difficulty that prosecutors have in sifting through the complexities of a CFO’s position to find evidence that the executive “knowingly” falsified documents, which is considered a criminal act. Civil courts are better suited than criminal courts to deal with “conduct that falls in a gray area of arguable legality,” according to Chief Judge Alex Kozinski, who wrote the concurring opinion in the acquittal.
The decision could cause prosecutors to forgo a criminal case if their proof of intent is shaky. “[The judges are saying] that criminal justice perhaps ought to be considered a last resort, not a first response,” says Douglas Berman, a professor at Ohio State University’s Moritz College of Law.
In his opinion, which has attracted the attention of securities lawyers, Kozinski reprimanded prosecutors. “This is just one of a string of recent cases in which courts have found that federal prosecutors overreached by trying to stretch criminal law beyond its proper bounds,” he wrote. His examples included the Department of Justice’s failed case against Arthur Andersen in its probe against Enron’s auditors.
In its original case, the government claimed that Network Associates violated generally accepted accounting principles by prematurely recognizing some revenue on deals with a distributor. Prosecutors disputed the company’s use of sell-in accounting, which lets manufacturers record revenue when its products ship as long as it accounts for future rebates, discounts, and returns. The appeals court dropped Goyal’s fraud charges by disagreeing that these alleged GAAP violations had a material effect on the company’s overall revenue figures. (The judges did not weigh in on whether the company indeed did not follow GAAP.)
The appeals court also found that prosecutors failed to show that Goyal knowingly made false statements to his accounting firm, PricewaterhouseCoopers. Part of the accusation stemmed from the fact that some letters were not shared with the auditors. These documents would have clarified the full sales terms Network Associates had with a business partner, which could have negated its ability to use sell-in accounting. But Goyal had contended that the auditors had access to “all sales terms,” and the appeals court concluded that the letters did not constitute proof that Goyal “willfully and knowingly misled PWC.”
Rather, by acquitting Goyal, the judges decided his only “crime” was fulfilling his CFO duties. “Goyal’s desire to meet [Network Associates's] revenue targets, and his knowledge of and participation in deals to help make that happen, [are] simply evidence of Goyal’s doing his job diligently,” wrote Judge Clifton. Indeed, he added, “If simply understanding accounting rules or optimizing a company’s performance were enough to establish scienter [knowledge of wrongdoing], then any action by a company’s chief financial officer that a juror could conclude in hindsight was false or misleading could subject him to fraud liability without regard to intent to deceive.”
Goyal’s attorney, Seth Waxman of law firm WilmerHale, says his client “has done the CFO profession a great service by essentially making it clear to government prosecutors that there are limits to what truly constitutes wrongdoing or criminal behavior.” Waxman says the appeals judges’ decision to overturn his client’s conviction and not send the case back to the lower court is unusual.
Still, Goyal’s acquittal may not necessarily give comfort to finance executives concerned about their personal liability. “The reality in many white-collar investigations is that the target of the investigation doesn’t know that he or she has done something wrong until the investigation has stopped and the government has picked things apart in hindsight,” says Matthew Jacobs, a partner at law firm McDermott Will & Emery.