Defendant was the CEO and Chairman of Engineered Support Systems, Inc. (Engineered Support). Engineered Support issued stock options to employees and non-employee directors, including defendant, under shareholder-approved stock option plans. Between 1997 and 2002, defendant was responsible for authorizing the company’s stock option awards, and he personally signed stock option award letters from 1997 through 2001. Under the terms of the plans, awarded options vested immediately and were exercisable at the closing price on the date of the award.
The Securities and Exchange Commission alleged that between 1997 and 2002, with the defendant’s knowledge, participation and consent, the company repeatedly issued backdated stock options that contained a lower exercise price than its closing stock price on the date the options were actually awarded. The SEC asserted that, as a result, option recipients improperly received increased compensation of approximately $20 million, of which defendant received nearly $9 million.
The SEC sought relief against defendant under various provisions of the securities laws, including Section 304 of Sarbanes-Oxley Act, which provides that if a company issuing stock “is required to prepare an accounting restatement” due to its material non-compliance with any financial reporting requirement under the securities laws, the company’s CEO and CFO must reimburse the company for any bonus, incentive-based and equity-based compensation received during a statutorily specified period together with any profits realized from the sale of company securities during such period.
Defendant moved to dismiss the Section 304 claim on the ground that Engineered Support never filed an accounting restatement. The SEC countered that, though never filed, restatements were required under general accounting principles because the company’s financial statements contained material errors. After noting that the Eighth Circuit had yet to rule on this issue, the court found that the ordinary meaning of the words in the statute required that a financial restatement actually have been ordered and a restatement actually have been filed before penalties could be imposed under Section 304. Accordingly, the court granted defendant’s motion to dismiss the Sarbanes-Oxley claim. (SEC v. Shanahan, 2008 WL 5211909 (E.D. Mo. Dec. 12, 2008))