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'Knowingly' Vague: Intent In The FCPA


What does it mean to "knowingly" falsify corporate records in violation of Section 13(b)(5) of the Foreign Corrupt Practices Act? Is a negligent accounting error enough? Or must the government prove scienter — i.e., that the defendant falsified records with the "intent to deceive, manipulate or defraud?" And what is the difference, if any, between the intent element of Section 13(b)(5), and of U.S. Securities and Exchange Commission Rule 13b2-1, which also prohibits records falsification, but which does not require that such falsification be committed "knowingly?"

The need for answers to these questions is urgent. As they continue to ramp up their FCPA-enforcement activities, furthermore, both the SEC and the U.S. Department of Justice are relying on Section 13(b)(5) and Rule 13b2-1 claims to prosecute alleged bribery-related malfeasance that otherwise might not be reachable under U.S. law. If "knowingly" equals scienter, then Section 13(b)(5) liability includes a finding of fraudulent intent, a factor that could weigh heavily in a court's determination of what sanction to impose. And, if a scienter element is to be engrafted onto these "books and records" claims, then defendants plainly are entitled to a jury instruction that defines "scienter" in this context.

Unfortunately, neither the courts nor the agencies that are charged with implementing the FCPA have provided a clear definition of Section 13(b)(5)'s and Rule 13b2-1's intent element. It is possible, however, to divine an interpretation of "knowingly" from the FCPA's legislative history, and from the administrative record from the making of Rule 13b2-1. A review of these materials indicates that — notwithstanding the SEC's omission of the word "knowingly" from the text of Rule 13b2-1 — the intent elements of that rule and of Section 13(b)(5) are identical to each other, and are different from the intent element of any other securities law.

Section 13(b)(5) And Rule 13b2-1

The Foreign Corrupt Practices Act was intended to prevent corporations from using secret slush funds to bribe government officials. The SEC is empowered to bring civil enforcement actions, while the Justice Department handles criminal prosecutions.

The act's provisions fall into two categories: 1) statutes that prohibit the payment of bribes; and 2) laws that require public corporations to accurately account for company assets. The FCPA's "books and records" requirement is found in Sections 13(b)(2)(A) and 13(b)(5).

Section 13(b)(2)(A) requires companies to "make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer."

Section 13(b)(5) states that no person shall "knowingly falsify any book, record or account" that is described in Section 13(b)(2)(A).

Section 13(b)(2)(A) and Section 13(b)(5) both apply to internal records, and neither has a materiality requirement. Section 13(b)(5) liability can attach, therefore, even if the record falsification is not material, and even if it has no effect on any SEC filing or other public disclosure.

The SEC also has its own corporate-accounting rules, including Rule 13b2-1. This rule states that: "[n]o person shall directly or indirectly, falsify or cause to be falsified, any book, record or account subject to Section 13(b)(2)(A) of the Securities Exchange Act."

Like Section 13(b)(5), Rule 13b2-1's prohibition reaches immaterial falsifications of internal corporate records that do not impact companies' publicly reported financials.

The Government's Reliance On "Books And Records" Claims In FCPA Anti-Bribery Enforcement Actions

Almost immediately after the FCPA became effective, its accounting provisions took on a life of their own. The SEC made a practice of including "tagalong" FCPA "books and records" claims into all sorts of civil enforcement actions, most of which had nothing to do with bribery. The act's anti-bribery provisions, in contrast, went largely unenforced.

Over the past few years, however, the SEC has increased its anti-bribery enforcement activities significantly. At first, FCPA defendants were charged under both the anti-bribery and the accounting statutes of the act — i.e., the SEC would allege that the defendant bribed an official, and then hid the bribe with improper accounting. But over the past two years, the government has started using expansive interpretations of the FCPA's "books and records" provisions to prosecute bribery-related conduct that the act's anti-bribery laws might not prohibit.

In January 2010, for example, the SEC settled a civil suit and issued an administrative cease-and-desist order against NATCO Inc. Allegedly, an official in Kazakhstan extracted bribes from NATCO's subsidiary by threatening the subsidiary's employees. This conduct arguably was not actionable under the FCPA's anti-bribery laws — at least one court has held that those laws do not apply to victims of extortion.

The SEC asserted that NATCO still was liable under the FCPA's accounting provisions, however, because NATCO's consolidated financial statements did not accurately record the bribes. The SEC took this position even though it made no allegation that anyone at NATCO actually knew about the bribes, or that NATCO's subsidiary's accounting was wrong.

"Knowingly" Vague

Unfortunately, it is unclear from the case law whether actual knowledge of accounting improprieties is necessary to support Section 13(b)(5) liability. Although the SEC has been pursuing "books and records" actions for more than two decades, no consensus has emerged about whether Section 13(b)(5)'s "knowingly" element requires proof of scienter and, if not, what lesser intent standard should apply. The majority of courts have held that "knowingly" sets the bar lower than scienter, without explaining where the bar actually is. But a few cases indicate that proof of scienter is required. And the SEC's position has been all over the map.

The judicial and legislative branches' failure to determine conclusively whether an instruction and evidence of "scienter" is necessary to prove a "knowing" violation of Section 13(b)(5) appears to have resulted in part from their failure to begin their analyses by defining "scienter" itself. Although articulated as a single element — "a mental state embracing intent to deceive, manipulate or defraud" — "scienter" actually has two prongs:

Intentional Falsehood: A misrepresentation that either the actor knows is false, or that is so obviously untrue that any reasonable person would have known.
Intent To Mislead: The actor must make the falsehood with the intent that someone else will be deceived, or "with recklessness so severe that it is the functional equivalent of intent."

In the context of an FCPA "books and records" claim, therefore, a "scienter" element would require proof that:

1. Intentional Falsification: The defendant intentionally or recklessly caused a corporate book, record or account to be inaccurate.

2. Intent To Mislead: The defendant falsified the record with the actual or constructive intent to deceive, manipulate or defraud.

Congress's Intent: Intentional Falsification, But Not Scienter

The legislative history reveals that Congress incorporated only the first prong of "scienter" into Section 13(b)(5)'s "knowingly" element. To prevail, the government must prove that the defendant intended to create a false document. It is not necessary to prove, however, that the defendant intended the false document to mislead anyone. Congress intended, furthermore, that Section 13(b)(5)'s intent element would be the same as Rule 13b2-1's, even though the rule's text does not include any "knowingly" requirement.

This unique "knowingly" standard exists because the SEC promulgated Rule 13b2-1 before Congress passed Section 13(b)(5). The section codified the SEC's stated interpretation of the rule, not the other way around as many courts and even SEC attorneys have assumed.

Congress passed the FCPA in response to a 1976 report from the SEC on corporate corruption. That SEC report recommended that Congress pass legislation that would outlaw bribery and the falsification of corporate records. The SEC also instituted its own rule-making, proposing regulations that mirrored the agency's recommendations to Congress.

The FCPA that Congress passed in 1977 did make bribes illegal. It also included Section 13(b)(2), which imposes an affirmative obligation on public companies to "devise and maintain a system of internal accounting controls sufficient to provide reasonable assurances" that the company will "make and keep books, records and accounts which, in reasonable detail, accurately and fairly reflect [its] transactions and dispositions of [its] assets."

The 1977 Senate's FCPA bill also included a provision that would have made it illegal to falsify records. The Senate committee's report makes it clear that the committee's inclusion of the word "knowingly" was intended to create a unique standard that required proof of scienter's first prong — an intentional falsification:

"The committee believes that the inclusion of the ‘knowingly' standard is appropriate because of the danger, inherent in matters relating to financial recordkeeping, that inadvertent misstatements or minor discrepancies arising from an unwitting error in judgment might be deemed actionable ... The inclusion of this standard is intended to be limited to matters arising under these new subsections and not to any other provisions of the securities laws ... The knowledge required is that the person be aware that he is or may be making a false statement or causing corporate records to be falsified through a conscious undertaking or due to his conscious disregard for the truth."

There is no evidence, however, that the Senate intended for the "knowingly" standard to incorporate scienter's second prong — an intent to "intent to deceive, manipulate or defraud." This makes sense — Section 13(b)(5) is not a disclosure provision. It was intended to deter and punish false statements in internal corporate records, even records that no one other than the falsifier ever will see, and that have zero impact on any company's reported financials.

Ultimately, the committee that reconciled the House's and Senate's versions of the 1977 FCPA decided not to prohibit document falsification, noting that the SEC had "already published for comment rules designed to accomplish similar objectives under existing authority." The SEC in fact promulgated such a rule in 1979: Rule 13b2-1.

Although the SEC omitted the word "knowingly" from the final rule's text, the record from the Rule 13b2-1 rule-making demonstrates that the commission ultimately adopted, as a matter of policy, an intent standard for Rule 13b2-1 that was substantively identical to the one that the 1977 Senate committee had proposed. A document falsification must be intentional — the SEC would not prosecute "inadvertent and inconsequential errors." The SEC expressly rejected, however, requests that the rule be subject to a "scienter" standard:

"After careful consideration of the comments, the commission has determined that a ‘scienter' requirement should not be included in the rule ... [Section 13(b)(2)(A)] does not require perfection but only that books, records and accounts ‘in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the issuer.' In addition, the legislative history reflects that ‘standards or [sic] reasonableness' are to be used in applying this provision."

For almost a decade, the SEC's FCPA "books and records" authority was based on the symbiotic relationship between Section 13(b)(2) and Rule 13b2-1. Section 13(b)(2) requires companied to keep records that reflected the disposition of corporate assets "in reasonable detail." Rule 13b2-1 prohibited intentionally falsifying any of the documents that were required by Section 13(b)(2), even if the defendant did not falsify with an intent to deceive.

The Section 13(b)(2)/Rule 13b2-1 regime did not, however, provide any intent element for Justice Department prosecutions alleging violations of Section 13(b)(2). So Congress passed Section 13(b)(5) in 1988, which states that Section 13(b)(A) criminal liability can attach only where the defendant falsifies "knowingly." The Conference Report clarified that Section 13(b)(5)'s "knowingly" element was intended to codify the SEC's stated Rule 13b2-1 "enforcement policy that penalties not be imposed for insignificant or technical infractions or inadvertent conduct."

Unfortunately, Congress's inclusion of the word "knowingly" in Section 13(b)(5)'s text only has muddied the waters further. Many assume incorrectly that Section 13(b)(5) and Rule 13b2-1 have different intent elements, when they actually are identical to each other. Both require intentional falsification. Neither requires scienter.


At least one appeal to the Ninth Circuit that seeks an authoritative definition of the intent element of Section 13(b)(5) and Rule 13b2-1 claims. The court should address the issue squarely — the building wave of FCPA-enforcement actions has made these claims too important to allow their intent elements to remain vague.

Patrick Richard is a partner in Nossaman's San Francisco office and chairman of the firm's litigation department.

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