Noteworthy US Securities Litigation
On 31 August 2016, the federal appellate court based in San Francisco reversed a lower court's ruling with respect to chief executive officer ("CEO") and chief financial officer ("CFO") liability under Section 304 ("Section 304") of the Sarbanes-Oxley Act ("SOX") and Rule 13a-14 ("Rule 13a-14") of the Securities Exchange Act of 1934 (the "Exchange Act"). The court held that CEOs and CFOs are subject to disgorgement under Section 304 following an accounting restatement as long as the restatements were issued because of misconduct, even if the defendant was not involved in that misconduct. In addition, the court held that Rule 13a-14 creates a cause of action against CEOs and CFOs not only if they fail to sign certifications of financial requirements that are required by SOX, but also if they sign false certifications.
The lower court in this case found that the company prematurely recognised revenue in six transactions, shortly after its initial public offering, thereby substantially overstating its revenues. Both the CEO and CFO received significant incentive-based compensation during the period of overstatement. However, the CEO and CFO were not found by the lower court to have acted with fraudulent intent or personal misconduct.
That court held, following a bench trial, that Section 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. Section 304 requires that if a restatement is required because of material non-compliance consisting of misconduct, the CEO and CFO are required to reimburse the issuer for equity and incentive-based compensation received for the 12 months following the misstated financials. In reversing the lower court's ruling, the appellate court agreed with the SEC that the misconduct that gives rise to disgorgement is that of the issuer, rather than the personal misconduct of the CEO and CFO.
On a separate issue, the appellate court reversed the district court's grant of summary judgment in favour of the defendants, which dismissed the SEC's claim under Rule 13a-14 (promulgated under Section 302 of SOX). That rule requires certain reports filed with the SEC, including quarterly and annual financial reports, to contain a certification signed by the issuer's CEO and CFO attesting to the accuracy of the report's financial statements. The court here held, contrary to the lower court's ruling, that Rule 13a-14 contains an "implicit truthfulness requirement," and thus creates a cause of action permitting the SEC to bring claims for making false certifications, in addition to claims based on the failure to make SOX certifications and independent of other provisions of the Exchange Act prohibiting fraudulent (as opposed to untrue) statements. The court, however, declined to determine the precise mental state required for a violation of Rule 13a-14, or how that mental state compares to the intent requirement under Section 10(b) of the Exchange Act, because the parties did not address that issue.
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