Shearman & Sterling LLP | Government Regulatory Enforcement Blog | Ninth Circuit Supports Expansive Interpretation Of SOX 304<br >  
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  • Ninth Circuit Supports Expansive Interpretation Of SOX 304
     
    09/12/2016
    On August 31, 2016, the United States Court of Appeals for the Ninth Circuit vacated a judgment in favor of Peter Jensen and Thomas Tekulve, Jr., former officers of Basin Water, Inc., and remanded for a jury trial.  SEC v. Jensen, No. 14-55221 (9th Cir. Aug. 31, 2016).  The Court held, in relevant part, that the officers could be subject to the disgorgement provisions of Section 304 of the Sarbanes-Oxley Act (“SOX 304”) following the company’s accounting restatements as long as the restatements were issued due to misconduct, even if that misconduct was not on the part of the defendants. 
     
    On November 7, 2012, Judge Manuel L. Real of the Central District of California granted partial summary judgment for defendants, holding that Rule 13a-14 of the Exchange Act did not provide a cause of action against officers who certify false financial reports.  On December 10, 2013, after a bench trial, Judge Real held that SOX 304 requires officers to disgorge incentive-based and equity-based compensation only if the company issues an accounting restatement because of the officers’ own misconduct, but not if the accounting restatement was caused by the issuer’s misconduct.   
     
    In reversing, the Ninth Circuit reasoned that SOX 304 is not concerned with individual misconduct on the part of the officers, but rather with misconduct of the issuer.  The Court, while noting that no other Circuit court had addressed that specific question, concluded that such an interpretation of SOX 304 was consistent with the plain language and legislative history of the statute, as well as most district courts’ interpretations of SOX 304.  The Court concluded that Judge Real erred because disgorgement is merited to prevent corporate officers from profiting from misconduct, whether their own or that of the company.  The Court further held that Rule 13a-14 provided the SEC with a cause of action against officers who certified false or misleading statements and that the SEC was entitled to a jury trial on remand.
     
    This case could have an important precedential effect, since the Ninth Circuit is the first Circuit court to address the issue.  By permitting the SEC to seek disgorgement of incentive-based and equity-based compensation from officers following a restatement, even where they have personally committed no wrongdoing, the Ninth Circuit has given the SEC significant leverage.  However, future defendants may still argue that because SOX 304 only permits disgorgement following a restatement “due to the material noncompliance of the issuer, as a result of misconduct,” that misconduct must reach certain levels within the company to be actionable.  Indeed, although the Ninth Circuit’s Jensen decision will provide a challenge to future defendants, the Court did not define “misconduct.”  Thus, defendants facing SOX 304 claims will still have avenues to argue that SOX 304 should not require disgorgement merely because a restatement took place.

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