Shearman & Sterling LLP | Government Regulatory Enforcement Blog | Northern District Of California Limits SEC’s Disgorgement Reach Under SOX 304<br >  
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  • Northern District Of California Limits SEC’s Disgorgement Reach Under SOX 304
     
    02/14/2017
    On February 8, 2017, United States District Judge Jon S. Tigar of the United States District Court for the Northern District of California granted in part defendant Erik Bardman’s motion to dismiss the Securities and Exchange Commission’s claim for disgorgement of certain compensation pursuant to Sarbanes-Oxley Act Section 304 (“SOX 304”).  Order, SEC v. Bardman, No. 3:16-cv-02023 (N.D. Cal. Feb. 8, 2017).  Mr. Bardman is a former Chief Financial Officer of Logitech International SA.  The Court held that neither an earnings release nor a Form 8-K announcing and attaching an earnings release can be the basis of a SOX 304 disgorgement claim because any purported material noncompliance with a financial reporting requirement in those documents does not cause or require a company to issue an accounting restatement. 
     
    On April 19, 2016, after a financial restatement by Logitech on November 14, 2014, the SEC filed its complaint alleging that Logitech fraudulently overstated its operating income, falsely represented that Logitech’s accounting complied with Generally Accepted Accounting Principles, and misrepresented to Logitech’s auditors the condition of Logitech’s parts inventory with respect to a short-lived new product called Revue.  The SEC claimed that it was entitled to disgorgement of any bonuses or equity-based compensation provided to Bardman in the 12-month period after an allegedly fraudulent earnings release that was issued on April 27, 2011 reporting financial results for fiscal year 2011, which was incorporated in a Form 8-K filing on April 28, 2011.  The SEC also claimed SOX 304 disgorgement for the 12-month period after Logitech’s Form 10-K for fiscal year 2011 (which was later restated) was filed on May 27, 2011.  The Court held that the first two dates could not trigger SOX 304 or serve as the “starting” date for disgorgement because neither document caused or required the company to issue a restatement, and thus only bonuses and equity-based compensation issued between May 27, 2011 (the date of the Form 10-K) and May 27, 2012 were subject to SOX 304 disgorgement.
     
    Since its inception, SOX 304 has been infamous for its lack of specificity.  Judge Conway of the Middle District of Florida once noted that “the Sarbanes-Oxley Act was passed in a hurry,” Mehlenbacher v. Jitaru, No. 6:04CV1118ORL-22KRS, 2005 WL 4585859, at *10 (M.D. Fla. June 6, 2005), and the Duquesne Law Review described the law as a “Current Model in the Law of Unintended Consequences.”  Cowart, Kourtney T., The Sarbanes-Oxley Act:  How a Current Model in the Law of Unintended Consequences May Affect Securities Litigation, 42 Duq. L. Rev. 293, 302-03 (Winter 2004).  This ruling, however, brings some clarity to practitioners and corporate executives alike.  Moving forward, the clawback provisions of SOX 304 are arguably now limited to the 12-month period following the issuance of any materially noncompliant financial statements that result in a restatement (such as a Form 10-K or 10-Q), not any earnings release, Form 8-K or other document furnished to the SEC that may contain similar financial information as that contained in the financial statements found in a Form 10-K or 10-Q.  

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