Abstract

Accounting fraud may be the most pervasive type of fraud infecting modern corporations. As demonstrated by recent cases, such schemes may be facilitated by management directors and senior executives who know how to hide fraud within the camouflage of legitimate transactions, by non-management directors who fail to investigate obvious red flags, by ineffective internal control systems, and by accountants, lawyers, bankers and analysts who are captured by their clients. Executives who know of accounting fraud and take no steps to prevent the fraud may be liable for violating fiduciary duties as set forth in state corporation statutes or for violating disclosure requirements as set forth in federal securities law. This article proposes that both management and non-management directors who knowingly or recklessly engage in accounting and financial fraud are unfit to serve and should be barred from serving as officers and directors of publicly traded corporations. In particular, it proposes that non-management directors' reckless failure to respond to red flags may amount to an intentional omission of material information, and violate the Securities Exchange Act section 10(b), among other federal laws. Further, non-management directors who fail to take action should be found unfit to serve as company executives. Moreover, directors who knowingly or recklessly fail to halt or to disclose accounting fraud and similar unlawful behavior should be temporarily or permanently barred from serving as officers of directors of public corporations.