In In re Digimarc Corporation Derivative Litigation, 2008 WL 5171347 (9th Cir. Dec. 11, 2008), the United States Court of Appeals for the Ninth Circuit held that Section 304 of the Sarbanes-Oxley Act (15 U.S.C. § 7243), which provides for the forfeiture of certain bonuses and profits when corporate officers fail to comply with securities law reporting requirements, does not create a private right of action. Though several district courts had already arrived at the same conclusion, the issue was one of “first impression” for the Ninth Circuit Court of Appeals. The ruling thus prevents individual shareholders from pursuing recovery of bonuses and stock sale proceeds from officers in situations where the company is required to issue a restatement of its financials as a result misconduct.
In 2004, Digimarc, a supplier of personal identification systems, announced that it had “likely overestimated earnings for the previous six quarters.” A subsequent restatement of its financial results for the period showed that Digimarc had overstated its earnings by approximately $2.7 million. Shortly after the announcement, two lawsuits were brought against the company. One suit was filed in the federal district court in Oregon, alleging violations of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934. Another suit, styled as shareholder derivative action, was brought in California alleging state law violations, including breach of fiduciary duty, abuse of control, gross mismanagement and waste of corporate assets.
Digimarc moved to dismiss the California state court action on forum non conveniens grounds, and the court agreed. Plaintiff then filed suit in Oregon, adding to their original state law claims a new claim under Section 304 of the Sarbanes-Oxley Act. Digimarc brought a motion to dismiss the new complaint for lack of federal subject matter jurisdiction. Among other things, Digimarc argued that there was no private right of action under Section 304, and that, as a result, there was no federal question jurisdiction. The district court agreed, and granted the motion to dismiss. Plaintiff appealed.
The Ninth Circuit reasoned that the question of whether a private right of action exists under Section 304 of the Sarbanes Oxley Act turned largely on legislative intent--whether Congress intended for Section 304 to create a private right of action. The Court concluded it did not. First, the Court looked to the express language of Section 304, finding that there was no express private right of action. Second, the Court turned to whether there was an implied private right of action. The Court concluded there was no implied right of action, applying long-standing United States Supreme Court authority regarding whether and when to imply a private right of action in a federal statute.
Plaintiff argued that the text of Section 303 of the Sarbanes-Oxley Act should guide the Court in its interpretation of Section 304. Section 303 prohibits officers and directors from “taking any action to fraudulently influence, coerce, manipulate, or mislead any independent public or certified accountant,” and makes a specific note that the SEC, and not private litigants, can enforce this section. Plaintiff maintained that if Congress wanted to prevent private litigants from utilizing Section 304 as a cause of action, it could have made a similar provision in Section 304.
The Court rejected this interpretation, finding that plaintiff’s construction would turn decided precedent “on its head,” creating a presumption that Congress “affirmatively intended to create rights of action in sections where it omitted such an express denial.”
Instead, the Court looked to Section 306, which creates “an action to recover profits” for insider trading conducted during pension fund blackout period “that may be instituted at law or in equity in any court of competent jurisdiction by the issuer, or by the owner of any security of the issuer.” Given Congress’ explicit statement of a private right of action for litigants in Section 306, the Court held, it could not “find in Congress’ silence in Section 304 an intent to create a private right of action where it was not silent in creating such a right to similar equitable remedies in other sections of the same Act.” As a result, the Court concluded “the text and structure of the Sarbanes-Oxley do not demonstrate an intent to create a private right of action under 304.”
Digimarc stands as the first federal court appellate decision explicitly addressing the question of whether a private right of action exists under Section 304 of the Sarbanes-Oxley Act. The decision means that plaintiffs have no private right to seek disgorgement from corporate officers of incentive-based compensation that was given in the year following the issuance of a financial report which, as a result of misconduct, was thereafter subject to an accounting restatement. It will also raise questions about enforcement of Section 304; whether corporations will bring actions against their former or current executive officers and directors on their own volition, and whether, and the extent to which, the SEC will aggressively pursue enforcement.