In SEC v. Shanahan, 2008 WL 5211909 (E.D. Mo. Dec. 12, 2008), the United States District Court was asked to clarify the scope of the forfeiture provisions of Section 304 of the Sarbanes-Oxley Act, 15 U.S.C. § 7243. There, the court held that a CEO or a CFO may be required to forfeit certain compensation or profits following a breach of SEC financial reporting requirements, but that the forfeiture obligation will be triggered only if the issuer actually files a restatement. 2008 WL 5211909, at *5.  

Section 304 was designed to prevent executives from “profit[ing] from erroneous financial statements.” Senate Comm. on Banking, Housing, and Urban Affairs, 107th Cong., Public Company Accounting Reform and Investor Protection Act of 2002, Report to Accompany S. 2673 Together with Additional Views, S. Rep. No. 107- 205 (June 26, 2002), at 26. The forfeiture obligation is tied to the “prepar[ation of] an accounting restatement due to [] material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws . . . .” 15 U.S.C. § 7243(a). In construing this provision, most experts have agreed that an actual restatement must precede any forfeiture obligations. See, e.g., John T. Bostelman, The Sarbanes-Oxley Deskbook §26:4.3 (2009).

In Shanahan, however, the SEC advocated a much broader interpretation of the statute. The Commission charged two executives with various claims relating to the issuance of backdated stock options. 2008 WL 5211909, at *3. Pursuant to Section 304, the SEC requested that the court order one of the defendants to repay certain compensation and profits realized from stock sales following the filing of an allegedly erroneous Form 10-K. Id. at *4. Both sides agreed that the issuer had not filed a restatement. The defendant challenged the applicability of Section 304, arguing that it applied only if an actual restatement occurs. Id. at *5. In contrast, the SEC took the position that Section 304 applied any time a “restatement was required under general accounting principles,” regardless of whether the company actually undertook a restatement. Id.

Relying on legislative history and standard statutory interpretation principles, the court agreed with the defendant and held that “the ordinary, contemporary, common meaning of Section 304 is that, before penalties may be imposed, an issuer must be compelled or ordered to prepare a financial restatement, and must actually file the restatement.” Id. The court declined the more expansive interpretation advocated by the SEC that forfeiture of compensation and profits could be demanded anytime a restatement should have been filed. Id.

Most Section 304 cases involve actual restatements, but, here, the SEC sought to expand the scope of that section to those instances where it could be argued a “constructive” restatement had occurred. Shanahan is the first reported decision on this issue. Despite this court’s rejection of a broader reading of the statute, the SEC may nevertheless attempt to argue in other jurisdictions that an issuer’s decision to refrain from filing a restatement should not foreclose the application of the forfeiture provisions of Sarbanes-Oxley.