A new case from the 9th Circuit, SEC v. Jensen, is the first circuit court case to confirm the SEC’s position that the “clawback” provisions of SOX 304 provide for a disgorgement remedy against CEOs and CFOs when the issuer has restated its financial statements as a result of misconduct, even if the CEO and CFO are not alleged to have engaged in the misconduct themselves. Likewise, in another first, the three-judge panel concluded that the certification requirements of Rule 13a-14 create a potential cause of action against the signatories, not just, as defendants claimed, in the event that they had failed to sign and file the mandated certifications, but also for false statements in the certifications that were filed, even though the Rule does not explicitly require truthfulness.

Rule 13a–14, adopted in 2002 under SOX, requires each principal executive and principal financial officer of a public company to sign and file with each periodic report a certification as to, among other things, the accuracy of the financial statements and the effectiveness of disclosure controls and internal controls. SOX 304 provides that, if “an issuer is required to prepare an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws,” the CEO and CFO must reimburse the issuer for incentive- or equity-based compensation received and any profits realized from the sale of securities of the issuer during a specified 12-month period. Although the provision was enacted in 2002, it wasn’t until 2009 that the SEC brought its first case against executives seeking disgorgement of compensation under SOX 304 because of a restatement involving alleged accounting fraud, notwithstanding the absence of allegations of misconduct against those executives. That case was settled in 2011, after a district court refused to grant the executives’ motion to dismiss. And, as the panel in Jensen indicates, “most district courts to have examined [the issue] have concluded that SOX 304 does not require CEOs or CFOs to have personally engaged in misconduct before they are required to disgorge profits under that statute.”

Jensen involved allegations by the SEC that the CEO and CFO of the issuer participated in a scheme to defraud investors by improperly reporting millions of dollars in revenue that, under GAAP, should not have been recognized. After a bench trial, the district court found in favor of defendants on the facts of the case and also reached two legal conclusions: (1) that Rule 13a-14 requires CEOs and CFOs to certify the financial statements but does not provide a cause of action against the officers if the certifications are false (granting summary judgment in favor of defendants on that claim); and (2) that SOX 304 would require the officers to disgorge only if the restatement was the result of the officers’ own misconduct. The 9th Circuit panel reversed, vacating the lower court’s findings of fact and judgments and remanding the case for a jury trial (holding that the lower court erred in concluding that the SEC had waived its right to a jury trial and that the error was not harmless).

With regard to Rule 13a-14, on de novo review, the panel concluded that the “wording of Rule 13a–14 supports the conclusion that a mere signature is not enough for compliance” and that, by dictionary “definition, one cannot certify a fact about which one is ignorant or which one knows is false.” As with other similar rules under Section 13, the panel maintained, Rule 13a-14 includes “an implicit truthfulness requirement. It is not enough for CEOs and CFOs to sign their names to a document certifying that SEC filings include no material misstatements or omissions without a sufficient basis to believe that the certification is accurate.” Rather, the signers should be held responsible for statements made in the certifications.

The panel also conducted a de novo review of the district court’s legal conclusions regarding SOX 304. After examining the plain language and legislative history of the statute, along with prior lower court cases, the court held that “SOX 304 allows the SEC to seek disgorgement from CEOs and CFOs even if the triggering restatement did not result from misconduct on the part of those officers. This is consistent with our conclusion elsewhere that the reimbursement provision is an equitable and not a legal remedy.” In particular, the panel noted that executives need not be personally aware or responsible for the misconduct to have benefitted unfairly financially from it. As a result, “disgorgement is merited to prevent corporate officers from profiting from the proceeds of misconduct, whether it is their own misconduct or the misconduct of the companies they are paid to run.”

The concurrence, while “generally concur[ring] in the panel’s analysis and disposition,” maintained that “[w]hat is culpably ‘false’ [under Rule 13a-14] and what constitutes ‘misconduct’ [under SOX 304] are central to the disposition of this case.” The panel, however, had expressly declined to address those issues. In particular, panel did not reach the question of whether a particular mental state was required to establish a violation of Rule 13a-14. But in the view of the concurring judge, “not every inaccurate certification is ‘false’ within the meaning of the rule.” Instead, the concurrence would require that the SEC show some “mental culpability,” permitting liability for false certification “only where a CEO or CFO acts with knowledge or at least recklessness as to the falsity of a certification.” He drew support for his conclusion both from the dictionary definition of “false” and from his theory that the claims against the CEO and CFO were really for aiding and abetting the issuer in its misconduct, which, he contended, would require the officer to have knowingly or recklessly aided the issuer’s commission of securities fraud.

Similarly, the panel also expressly declined to address the issue of the meaning of “misconduct” under SOX 304. And again, the concurrence took issue with that position, contending that the panel should have addressed “what qualifies as ‘misconduct’ as necessary to trigger disgorgement under SOX 304….” The concurring judge advocated adoption of “a plain language understanding of the word, which Merriam Webster defines as ‘1. mismanagement’ or ‘2. intentional wrongdoing’….” In his view, “‘misconduct’ requires an intentional violation of a law or standard (such as GAAP) on the part of the issuer, which can be shown by evidence that any employee of the issuer (not only the CEO or CFO), acting within the course and scope of that employee’s agency, intentionally violated a law or corporate standard.” It remains to be seen whether other circuits chart the same course as the panel opinion or find more compelling the concurring opinion’s requirements of mental culpability and intentional violation.