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Aug. 31 — Two former executives of a now failed water-treatment concern are back on the hook in a Securities and Exchange Commission enforcement action over their alleged roles in a fraudulent revenue recognition scheme ( SEC v. Jensen, 2016 BL 284083, 9th Cir., No. 14-55221, 8/31/16 ).
A rule requiring top executives to certify the accuracy of the company's financial statements allows the agency to sue officials who sign off on false or misleading statements, the U.S. Court of Appeals for the Ninth Circuit said Aug. 31—not just executives who don't file the required certifications.
Judge Richard Clifton also held that executives of companies that restate their financials may be required to disgorge their compensation under Section 304 of the Sarbanes Oxley Act, even if they weren't directly involved in the misconduct that prompted the restatement.
“Our trial judge found that there was absolutely no evidence of fraud, and that the SEC’s witnesses were not credible,” Los Angeles lawyer William Forman, counsel to defendant Peter Jensen, told Bloomberg BNA in an e-mail. “Should the SEC elect to re-try this case and proceed on its discredited theories and witnesses, we fully expect to win again in front of a jury,” Forman, of Scheper Kim & Harris, said.
According to the SEC, Jensen, Basin Water Inc.'s chief executive officer, and Thomas Tekulve Jr., the concern's former chief financial officer, improperly recognized revenue to disguise the company's true financial condition.
In late 2013, the district court dismissed the allegations, saying the SEC didn't show that the defendants engaged in accounting improprieties (243 SLD, 12/18/13). The SEC appealed (29 SLD, 2/12/14).
Reversing and remanding, the appeals court first disagreed with the district court's interpretation of Rule 13a-14 under the 1934 Securities Exchange Act, which requires the CEO and CFO to certify the accuracy of the company's financial reports. It concluded that the rule gives the SEC a cause of action not only against officials that don't file the required certifications, but against those that certify false or misleading statements. “Rule 13a-14, like other rules promulgated under Section 13 of the Exchange Act, includes an implicit truthfulness requirement,” the appeals court said.
The appeals court also disagreed that under SOX Section 304, CEOs and CFOs must disgorge incentive and equity-based compensation if they cause the company to restate its financials, but not if the restatement was caused by misconduct in which they weren't directly involved.
“In accordance with its text and legislative history, we hold 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.”
Judge Carlos Bea concurred generally in the panel's decision, but wrote separately to clarify the scope of the new legal rules set out in the holding.
Paul G. Alvarez argued for the SEC. David C. Scheper, Scheper Kim & Harris, Los Angeles, argued for Jensen. Seth Aronson, O'Melveny & Myers, Los Angeles, argued for Tekulve. The SEC didn't respond to an e-mailed request for comment.
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