Securities and Exchange Commission v. Baker et al
Filing
28
ORDER DENYING 12 Motion to Dismiss for Failure to State a Claim; DENYING 13 Motion to Dismiss for Failure to State a Claim. Signed by Judge Sam Sparks. (dm)
IN THE UNITED STATES DISTRICT COURT
FOR THE WESTERN DISTRICT OF TEXAS
AUSTIN DIVISION
SECURITIES AND EXCHANGE COMMISSION,
Plaintiff,
-vs-
Case No. A-12-CA-285-SS
MICHAEL A. BAKER and MICHAEL T. GLUK,
Defendants.
__________________________________________
ORDER
BE IT REMEMBERED on this day the Court reviewed the file in the above-styled cause, and
specifically Defendants Michael A. Baker’s and Michael T. Gluk’s Motions to Dismiss [##12, 13],
Plaintiff Securities and Exchange Commission (SEC)’s Response [#19] thereto, and Defendants’
Replies [##22, 23]. Having considered the documents, the file as a whole, and the governing law,
the Court now enters the following opinion and orders, denying the motions.
Background
This case is one in a series of actions arising out of the Arthrocare securities scandal. Here,
the SEC, acting under § 304 of the Sarbanes–Oxley Act, is seeking statutory reimbursement—on
behalf of Arthrocare—of cash bonuses, incentives, and equity-based compensation (collectively
known as “§ 304 Compensation”) earned by Arthrocare’s CEO (Baker) and CFO (Gluk). The § 304
Compensation the SEC seeks reimbursement of was earned during the years following Arthocare’s
filing of quarterly (Form 10-Q) and annual (Form 10-k) financial statements which were
subsequently restated due to alleged fraud by two senior vice presidents of Arthrocare, John Raffle
and David Applegate.1 The statements in question were filed in 2006, 2007, and the quarter ending
March 31, 2008. Baker and Gluk are not alleged in the Complaint to have committed any conscious
wrongdoing; rather, the SEC argues they are required to reimburse Arthrocare simply because they
were the CEO and CFO at the time (and thus signed the filings which subsequently required
restatements). Baker and Gluk have moved under Rule 12(b)(6) to dismiss the SEC’s complaint,
arguing it fails to state a claim for which relief can be granted because § 304 either cannot be
construed as broadly as the SEC claims; i.e., to impose liability on CEOs and CFOs without any
element of scienter, or, alternatively, because § 304 is unconstitutional. They also raise a statutory
defense in the form of the Civil Asset Forfeiture Reform Act.
Discussion
I.
Motion to Dismiss—Rule 12(b)(6)—Legal Standard
Federal Rule of Civil Procedure 8(a)(2) requires a complaint to contain “a short and plain
statement of the claim showing that the pleader is entitled to relief.” FED . R. CIV . P. 8(a)(2). A
motion under Federal Rule of Civil Procedure 12(b)(6) asks a court to dismiss a complaint for
“failure to state a claim upon which relief can be granted.” FED . R. CIV . P. 12(b)(6). The plaintiff
must plead sufficient facts to state a claim for relief that is facially plausible. Ashcroft v. Iqbal, 556
U.S. 662, 678 (2009); Bell Atl. Corp. v. Twombly, 550 U.S. 544, 570 (2007). “A claim has facial
plausibility when the plaintiff pleads factual content that allows the court to draw the reasonable
inference that the defendant is liable for the misconduct alleged.” Iqbal, 566 U.S. at 678. Although
1
The SEC brought a separate civil proceeding against Raffle and Applegate, which resulted in agreed judgments
favorable to the SEC. See SEC v. Raffle, No. 1:11–CA–540–SS (W .D. Tex. July 12, 2011) (agreed final judgment
against Applegate); id. (W .D. Tex. July 18, 2011) (agreed final judgment against Raffle). A criminal proceeding against
Raffle and Applegate is still pending. See United States v. Raffle, No. 1:12–CR–314–SS (W .D. Tex. Aug. 21, 2012)
(indictment filed).
-2-
a plaintiff’s factual allegations need not establish that the defendant is probably liable, they must
establish more than a “sheer possibility” that a defendant has acted unlawfully. Id. Determining
plausibility is a “context-specific task,” and must be performed in light of a court’s “judicial
experience and common sense.” Id. at 679.
In deciding a motion to dismiss under Rule 12(b)(6), a court generally accepts as true all
factual allegations contained within the complaint. Leatherman v. Tarrant Cnty. Narcotics
Intelligence & Coordination Unit, 507 U.S. 163, 164 (1993). However, a court is not bound to accept
legal conclusions couched as factual allegations. Papasan v. Allain, 478 U.S. 265, 286 (1986).
Although all reasonable inferences will be resolved in favor of the plaintiff, the plaintiff must plead
“specific facts, not mere conclusory allegations.” Tuchman v. DSC Commc’ns Corp., 14 F.3d 1061,
1067 (5th Cir. 1994). In deciding a motion to dismiss, courts may consider the complaint, as well
as other sources such as documents incorporated into the complaint by reference, and matters of
which a court may take judicial notice. Tellabs, Inc. v. Makor Issues & Rights, Ltd., 551 U.S. 308,
322 (2007).
II.
Section 304
Section 304 of the Sarbanes–Oxley Act, entitled “Forfeiture of certain bonuses and profits,”
provides:
(a) Additional compensation prior to noncompliance with Commission financial
reporting requirements
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 chief executive officer and chief financial
officer of the issuer shall reimburse the issuer for—
-3-
(1) any bonus or other incentive-based or equity-based compensation received
by that person from the issuer during the 12-month period following the first
public issuance or filing with the Commission (whichever first occurs) of the
financial document embodying such financial reporting requirement; and
(2) any profits realized from the sale of securities of the issuer during that
12-month period.
(b) Commission exemption authority
The Commission may exempt any person from the application of subsection (a) of
this section, as it deems necessary and appropriate.
15 U.S.C. § 7243 [hereinafter § 304].
Although § 304 does not create any private right of action, it nevertheless “establishes that
the SEC may sue the CEO and CFO of a company when the company has been required to restate
its earnings due to noncompliance with securities laws.” Pirelli Armstrong Tire Corp. Retiree Med.
Benefits Trust ex rel. Fed. Nat’l Mortg. Ass’n v. Raines, 534 F.3d 779, 793 (D.C. Cir. 2008).
“Section 304 by its terms requires CEOs and CFOs to reimburse their company for any bonus or
similar compensation, or any profits realized from the sale of company stock, for the 12–month
period following a false financial report, if the company ‘is required to prepare an accounting
restatement due to the material noncompliance of the [company], as a result of misconduct.’” Cohen
v. Viray, 622 F.3d 188, 193 (2d Cir. 2010) (quoting § 304). “Under § 3(b)(1) of SOX, moreover,
the SEC has authority to enforce § 304 pursuant to its authority to enforce any provision of the
Securities Exchange Act of 1934, 15 U.S.C. § 78u(d)(1).” Id. (citing 15 U.S.C. § 7202(b)(1)).
For reasons best known to the SEC, the Commission has been historically reluctant to utilize
§ 304 in the ten years since Sarbanes–Oxley was enacted. See Alison List, Note, The Lax
Enforcement of Section 304 of Sarbanes–Oxley: Why is the SEC Ignoring its Greatest Asset in the
-4-
Fight Against Corporate Misconduct?, 70 OHIO ST . L.J. 195, 216 (2009). However, a sword does
not cease to be a sword, even though it may languish in the scabbard, and likewise, federal agencies
have discretion in when and how to carry out regulatory enforcement actions. Heckler v. Chaney,
470 U.S. 821, 831 (1985) (“This Court has recognized on several occasions over many years that an
agency’s decision not to prosecute or enforce, whether through civil or criminal process, is a decision
generally committed to an agency’s absolute discretion.”). Indeed, a few scholarly articles have
called upon the SEC to begin wielding § 304 more aggressively. See List, Lax Enforcement, supra,
at 247; Rachael E. Schwartz, The Clawback Provision of Sarbanes–Oxley: An Underutilized
Incentive to Keep the Corporate House Clean, 64 BUS. LAW . 1, 34 (2008). The SEC, perhaps
heeding those calls,2 has filed a number of actions in recent years seeking to compel CEOs and CFOs
to reimburse their employers in the wake of SEC restatements. See, e.g., SEC v. Jasper, No. C
07–06122 JW, 2010 WL 8781211, at *14 (N.D. Cal. July 21, 2010) (order granting SEC’s “motion
to require Defendant to reimburse [the issuer] $1,869,639 pursuant to Section 304(a) of the
Sarbanes–Oxley Act”), aff’d, 678 F.3d 1116 (9th Cir. 2012).
However, most prior actions have involved allegations of improprieties by the CEO or CFO
in question. See, e.g., id. at *2 (“[T]he SEC presented evidence demonstrating that Defendant
intentionally concealed Maxim’s backdating practices from Board members.”). In such cases, § 304
was asserted as an ancillary claim, standing alongside more traditional securities causes of action,
such as violations of § 10(b) of the Securities and Exchange Act. See id. at *1. What is apparently
unusual about this case is the SEC’s decision to seek standalone § 304 reimbursement where, “The
2
Interestingly, the latter article was written by a senior counsel within the SEC’s enforcement division. See
Schwartz, The Clawback Provision, supra, at 1 n.a1.
-5-
Commission does not allege that Baker and Gluk participated in the wrongful conduct.” Pl.’s
Compl. [#1], ¶ 2. Apparently, the SEC has decided to adopt a more aggressive interpretation of the
reach of § 304, as was earlier recommended by an SEC senior counsel. See Schwartz, The Clawback
Provision, supra, at 2 (“This Article considers a key issue in section 304 enforcement. The statutory
language does not require the officer from whom a clawback is sought to have personally engaged
in the misconduct that led to the restatement. Should such a requirement be read into the statute?
This Article explains why it should not.”).
III.
Baker and Gluk’s Arguments
Plainly, the SEC has pled the requisite elements of the statute. There is no question
Arthrocare had to file restatements for the periods in question. Cf. SEC v. Shanahan, 624 F. Supp.
2d 1072, 1078 (E.D. Mo. 2008) (dismissing the SEC’s § 304 claim where no restatement had been
filed). Those restatements were allegedly necessitated by misconduct, namely, the acts of Raffle and
Applegate, which are plausibly attributable under agency principles to Arthrocare. See In re Am.
Int’l Grp., Inc., 965 A.2d 763, 802, 823 (Del. Ch. 2009). And there is no dispute Baker and Gluk
received § 304 Compensation within the time period covered by the Complaint, i.e., within a year
of the various Forms 10-k and 10-q which were subsequently restated.
Baker and Gluk, in the vehicle of Rule 12 motions, nevertheless raise three lines of attack.
First, they argue § 304 should be construed to include additional requirements beyond the import of
the text, specifically: (1) to require misconduct by the corporate officer himself, (2) to define
“misconduct” as an independent violation of securities law, (3) as only providing a remedy for the
SEC when an officer engages in misconduct which is itself a violation of another securities law, or
(4) as constituting an equitable disgorgement provision only (and thus being limited in application
-6-
to cases of misconduct by the officer in question, or thereby limiting recovery to amounts attributable
to the misconduct).
Second, Baker and Gluk challenge the constitutionality of § 304, if it is given the meaning
and effect advocated by the SEC. In particular, they assert it is (1) void for vagueness, (2) violates
the Excessive Fines Clause, and (3) violates the Due Process Clause by not requiring any reasonable
relationship between the triggering conduct and the penalty.
Finally, Baker and Gluk argue the Civil Asset Forfeiture Reform Act (CAFRA)
independently bars a § 304 action against “innocent” officers such as themselves.
The Court is not apprised of any cases addressing the particular challenges raised by Baker
and Gluk, with the partial exception of a decision by the District Court of Arizona, which, like this
case, was a § 304 action brought in the absence of any misconduct by the defendant officer. See SEC
v. Jenkins, 718 F. Supp. 2d 1070, 1072 (D. Ariz. 2010) (“Although the SEC does not allege that
Jenkins personally was aware of the fraudulent concealment perpetrated by various . . . officers,
Jenkins did certify the company’s inaccurate financial statements.”). Jenkins persuasively rejected
similar attempts by the officer defendant to read into the statute a requirement of misconduct by the
officer. Id. at 1075–76. Jenkins declined to address similar constitutional challenges, noting “even
if these constitutional concerns have merit, the facts necessary to decide these constitutional issues
cannot be decided on a motion to dismiss.” Id. at 1076. Finally, Jenkins also declined to rule on the
applicability of CAFRA, finding it was not raised in the motion to dismiss, despite being available
to the defendant when the motion was filed. Id. at 1080. However, Jenkins did express doubts as
to whether CAFRA applies, because CAFRA limits civil forfeiture statutes, which are “in rem
proceeding[s] against a property that is sought to be forfeited to the government,” whereas in seeking
-7-
to enforce § 304, the SEC was attempting to require the officer to reimburse the company (in an in
personam action), not to obtain any forfeiture to the government. Id. at 1080. The Court finds the
reasoning in Jenkins generally sound and persuasive.
The Court now turns to the three groups of arguments raised by Baker and Gluk.
A.
Construction of § 304
1.
Scienter or Separate Misconduct
The Court rejects these claims. The text of the statute plainly contains no such additional
requirements, and absent any ambiguity, the words of the statute itself are dispostive. See
CenterPoint Energy Houston Elec. LLC v. Harris Cnty. Toll Rd. Auth., 436 F.3d 541, 545 (5th Cir.
2006).
Rather, the statute unambiguously requires CEOs and CFOs to reimburse the issuer for any
qualifying compensation they receive within one year of a filing which the issuer is subsequently
forced to restate due to misconduct by the issuer or its agents. See 15 U.S.C. § 7243(a). The handful
of cases which have had occasion to describe the import of § 304 are likewise devoid of any mention
of a scienter requirement. See Cohen, 622 F.3d at 193; Pirelli Armstrong Tire Corp., 534 F.3d at
793. Using persuasive reasoning, and directly addressing this issue, the Arizona District Court
reached the same conclusion:
[T]he Court holds that the text and structure of Section 304 require only the
misconduct of the issuer, but do not necessarily require the specific misconduct of
the issuer’s CEO or CFO.
...
The relevant statutory phrase specifies that the reimbursement obligation is
triggered if an issuer has 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.” 15 U.S.C. § 7243(a). The ordinary,
contemporary and common meaning of that language is that the misconduct of the
-8-
issuer is the misconduct that triggers the reimbursement obligation of the CEO and
the CFO.
...
As the title of the subsection makes plain, it was Congress’s purpose to recapture the
additional compensation paid to a CEO during any period in which the corporate
issuer was not in compliance with financial reporting requirements. A CEO need not
be personally aware of financial misconduct to have received additional
compensation during the period of that misconduct, and to have unfairly benefitted
therefrom. When a CEO either sells stock or receives a bonus in the period of
financial noncompliance, the CEO may unfairly benefit from a misperception of the
financial position of the issuer that results from those misstated financials, even if the
CEO was unaware of the misconduct leading to misstated financials. It is not
irrational for Congress to require that such additional compensation amounts be
repaid to the issuer.
Jenkins, 718 F. Supp. 2d at 1074–75.
And the Northern District of Texas has held likewise: “Section 304 contains no personal
wrongdoing element.” SEC v. Microtune, 783 F. Supp. 2d 867, 886 (N.D. Tex. 2011).
Although it might be surprising at first glance to require CEOs and CFOs to reimburse their
employers when they have not done anything illegal, there are good policy reasons why Congress
may have provided for the broad scope of § 304 suggested by the SEC.
“The SEC’s decision to pursue § 304 relief is not solely intended to reimburse a company;
it also furthers important public purposes. The § 304 remedy is an enforcement mechanism that
ensures the integrity of the financial markets.” Cohen, 622 F.3d at 195. “Imagine if someone told
you that they would take away half of everything you earned this year if you did not catch the
misconduct of one of your employees. You would most likely be highly motivated to catch the
misconduct.” List, Lax Enforcement, supra, at 195. “[Sarbanes–Oxley] . . . requires CEOs and
CFOs to certify their companies’ financial reports, outlaws fraud and deception by managers in the
auditing process, prevents CEOs and CFOs from benefitting from profits they receive as a result of
-9-
misstatements of their company’s financials, and facilitates the imposition of judicial bars against
officers and directors who have violated the securities laws.” S. REP . NO . 107–205, 2002 WL
1443523, at *23 (2002) (emphasis added).
If the legislative history is any indication, Congress had facts similar to this case squarely in
mind in enacting SOX: “Title III includes provisions designed to prevent CEOs or CFOs from
making large profits by selling company stock, or receiving company bonuses, while management
is misleading the public and regulators about the poor health of the company.” Id. at *26 (emphasis
added). That is precisely what happened here: Baker and Gluk received generous compensation,
while two managers, Raffle and Applegate, were misleading the public about Arthrocare’s financial
condition. Furthermore, Congress appears to have specifically wanted to expand instances in which
CEOs and CFOs are required to return certain profits beyond income attributable to a particular
violation:
For a securities law violation, currently an individual may be ordered to disgorge
funds that he or she received “as a result of the violation.” Rather than limiting
disgorgement to these gains, the bill will permit courts to impose any equitable relief
necessary or appropriate to protect, and mitigate harm to, investors.
Id.
To limit the scope of § 304 as Baker and Gluk suggest would render it a meaningless act on
the part of Congress, because the SEC’s power to seek equitable disgorgement of profits gained
through wrongdoing pre-dates Sarbanes–Oxley by many years. SEC v. DiBella, 409 F. Supp. 2d 122,
130 (D. Conn. 2006); John Patrick Kelsh, Section 304 of the Sarbanes–Oxley Act of 2002: The Case
for a Personal Culpability Requirement, 59 BUS. LAW . 1005, 1016 (2004) (“Disgorgement in these
pre-Sarbanes–Oxley proceedings has generally been limited to those instances in which the
-10-
defendant was in clear violation of the securities laws, and the amount required to be disgorged has
been limited to that which is obviously traceable to the underlying wrongdoing.”). Rather, for § 304
to have any meaning beyond mere exhortatory rhetoric, the Court must give effect to the statute as
written, and as argued by the SEC: reimbursement is required without any showing of wrongdoing
by the CEO or CFO, and the amount or reimbursement is not limited to income attributable to the
wrongdoing of others.
In addition, and contrary to Baker and Gluk’s arguments, this interpretation is consistent with
both other provisions of Sarbanes–Oxley, and with securities laws generally. As noted above, § 304
ties in closely with the various duties required of CEOs and CFOs in § 302 of Sarbanes–Oxley,3 and
it creates an incentive for them to be diligent in carrying out those duties. The absence of any
requirement of personal misconduct is in furtherance of that purpose: it ensures corporate officers
cannot simply keep their own hands clean, but must instead be vigilant in ensuring there are adequate
controls to prevent misdeeds by underlings.
In addition, various other securities laws penalize active wrongdoing, either on the basis of
intentional, knowing, or negligent acts or omissions. See 15 U.S.C. §§ 77o, 77q(a), 78; 17 C.F.R.
§§ 240.10b-5, .13a-14. By requiring reimbursement, even in the absence of any wrongdoing,
Congress was logically extending and expanding the regulatory scheme for publicly traded securities
in reaction to the various accounting scandals which triggered Sarbanes–Oxley. By contrast, Baker
and Gluk’s proposed constructions would render § 304 redundant of existing civil and criminal
securities fraud laws.
3
See 15 U.S.C. § 7241 (enumerating various reporting, filing, and certification requirements, which CEOs and
CFOs represent they have faithfully carried out by signing annual and quarterly SEC filings).
-11-
2.
Equitable Disgorgement
In their final construction argument, Baker and Gluk argue § 304 should be construed as
some type of statutory disgorgement provision, equivalent to the long-standing common-law doctrine
of equitable disgorgement. This is significant, because disgorgement on equitable grounds is
generally limited to cases in which the officers themselves have engaged in wrongdoing. See, e.g.,
SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 1978). In arguing § 304 constitutes a statutory
disgorgement remedy, Baker and Gluk principally rely on the following language from Ninth and
Second Circuit decisions: “the reimbursement provision of SOX 304 is considered an equitable
disgorgement remedy,” S.E.C. v. Jasper, 678 F.3d 1116, 1130 (9th Cir. 2012), and “[Section 304]
reflects Congress’s efforts to make high ranking corporate officers of public companies directly
responsible for their actions that have caused material noncompliance with financial reporting
requirements,” Cohen, 622 F.3d at 195. They also point to In re Digimarc, in which the Ninth
Circuit, while finding § 304 does not provide a private cause of action, stated: “Sections 304 and
306, meanwhile, both require non-compliant directors and officers to reimburse the issuer by
disgorging the profits of their noncompliance. . . . They require wrongdoers to reimburse the issuer
for ill-gotten gains . . . .” 549 F.3d 1223, 1232–33 (9th Cir. 2008).
For its part, the SEC argues, inter alia, (1) § 304 is a cause of action, not just a remedy, and
(2) “reimbursement” has a different meaning—one not necessarily connected to misconduct—than
“disgorgement.” Cf. SEC v. AMX Int.’l, Inc., 7 F.3d 71, 74–76 (5th Cir. 1993) (comparing
“disgorgement” to “debt” and “restitution”). The Court agrees. The Court also rejects Baker and
Gluk’s argument for three additional reasons. It is nowhere written that Congress is required to craft
causes of action which precisely mirror existing remedies at law or equity. Section 304 may well
-12-
be sui generis, and the Court sees no reason why Congress was not free to create a unique cause of
action, in addressing the singular events which heralded Sarbanes–Oxley. In addition, Baker and
Gluk’s interpretation cannot be harmonized with the language of § 304, which is devoid of any
necessary link between the acts of the CEO or CFO, and the compensation which is subject to
reimbursement. Finally, the cases they rely on either (1) are not binding on this Court, (2) did not
consider this precise issue, or (3) do not support their position.
Baker and Gluk are correct the Ninth Circuit has held § 304 is an equitable disgorgement
remedy. “Ninth Circuit law is clear that the reimbursement provision of SOX 304 is considered an
equitable disgorgement remedy and not a legal penalty.” Jasper, 678 F.3d at 1130 (relying on In re
Digimarc, 549 F.3d at 1232–33). However, neither Jasper nor Digimarc address whether this in turn
limits § 304 reimbursement to profits attributable to wrongdoing. Even if the Ninth Circuit would
agree with Baker and Gluk, this Court is not bound by its rulings. And, with all respect due to the
Ninth Circuit, the Court would disagree if it so held, for the many reasons listed elsewhere in this
opinion.
This Court is not alone: the Northern District of Texas, addressing whether the statute of
limitations applies to a § 304 action, held § 304 reimbursement is a penalty, not a disgorgement.
Microtune, 783 F. Supp. 2d at 886–87 (holding five-year statute of limitations, codified at 28 U.S.C.
§ 2462, applies to § 304 action). “[T]his very case highlights the difference between Section 304’s
statutory reimbursement remedy and equitable disgorgement—Section 304 contains no personal
wrongdoing element, in contrast to disgorgement, that would require scienter or misconduct on
behalf of the officers in order to trigger reimbursement.” Id. at 886.
-13-
Cohen, the Second Circuit case relied on by Baker and Gluk, in fact distinguished between
§ 304 actions and equitable disgorgement, noting: “It is true the SEC could order disgorgement. The
terms of the indemnification agreement, however, would allow [the CEO and CFO] to pass that
claim on to [the issuer] so that they, individually, would suffer no penalty at all.” 622 F.3d at 195.
Cohen went on to hold that because such a result would frustrate Congressional intent in enacting
§ 304, the indemnification agreement could not stand: a result which it could not have reached if
§ 304 was no more than a codification of the equitable disgorgement remedy.
For all the foregoing reasons, the Court holds § 304 is not equivalent to equitable
disgorgement.4 Having found Baker and Gluk’s arguments regarding the proper construction of
§ 304 lack merit, the Court turns to their constitutional challenges.
B.
Constitutionality of § 304
As a general matter, the Court finds § 304 constitutional on its face. See SEC v. Geswein,
No. 5:10CV1235, 2011 WL 4541303, at *3 (N.D. Ohio Sept. 29, 2011) (rejecting Due Process,
Excessive Fines Clause challenges, upon finding the defendants “have not demonstrated that Section
304 is unconstitutional on its face”). Baker and Gluk have not, and cannot, argue they are members
of any protected class, or otherwise shown fundamental rights are at stake, requiring a heightened
level of scrutiny. Accordingly, only rational basis review applies. See FCC v. Beach Commc’ns,
Inc., 508 U.S. 307, 314 (1993) (“In areas of social and economic policy, a statutory classification that
neither proceeds along suspect lines nor infringes fundamental constitutional rights must be
upheld . . . if there is any reasonably conceivable state of facts that could provide a rational basis for
4
The Court makes no finding as to whether § 304 is a penalty, because it is not necessary to make such a
determination here.
-14-
the classification.”). As discussed above, there is a rational basis for § 304: it creates a personal
incentive for CEOs and CFOs to take their reporting and certification duties seriously.
1.
Void for Vagueness
In their vagueness challenge, Baker and Gluk argue it is unclear whose misconduct will
trigger reimbursement. The Court disagrees. The statute provides: “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 . . . .” 15 U.S.C.
§ 7243(a). Reimbursement is triggered when there is “material noncompliance of the issuer,” and
this phrase is immediately limited by the following clause, “as a result of misconduct.” Accordingly,
the “misconduct” in question is misconduct by the issuer. And, of course, because issuers are
corporations and similar business entities, “issuer” includes its agents, acting within the course and
scope of their employment. See In re Am. Int’l Grp., Inc., 965 A.2d at 802, 823. As a practical
matter, the “who” will also no doubt be limited to those agents of the issuer who are in sufficiently
high-ranking positions as to be able to cause “material noncompliance . . . with any financial
reporting requirement under the securities laws.” 15 U.S.C. § 7243(a). Which, not coincidentally,
is precisely what is alleged to have happened in this case. Raffle and Applegate, who were senior
vice presidents, apparently used their positions of authority to perpetrate serious misconduct, over
a significant period of time. Baker and Gluk should have been monitoring the various internal
controls to guard against such misconduct; they signed the SEC filings in question, and represented
they in fact were actively guarding against noncompliance. As such, they shouldered the risk of
§ 304 reimbursement when noncompliance nevertheless occurred.
-15-
Baker and Gluk also argue § 304 is vague because it does not clearly state when or why
liability will be imposed. The Court again disagrees, because § 304’s requirements upon CEOs and
CFOs are crystal clear, when read in conjunction with the rest of Sarbanes–Oxley. Section 302 of
the Act tells executives precisely what they must do to avoid reimbursement liability under § 304:
they must ensure the issuer files accurate financial statements. And it tells them how they are to go
about doing so, such as by: “establishing and maintaining internal controls,” “design[ing] such
internal controls to ensure that material information relating to the issuer and its consolidated
subsidiaries is made known to such officers by others within those entities,” “evaluat[ing] the
effectiveness of the issuer’s internal controls as of a date within 90 days prior to the report,” and
“present[ing] in the report their conclusions about the effectiveness of their internal controls based
on their evaluation as of that date.” 15 U.S.C. § 7241(a)(4)(A–D).5
In addition, Baker and Gluk’s arguments they had no notice of § 304’s meaning lack merit.
Section 304 was passed years before the events in question, and, as noted above, has been the subject
of a vigorous discussion in legal academia. On these facts, ignorance of the law is no excuse.
2.
Excessive Fines Clause
Baker and Gluk argues § 304 violates the Excessive Fines Clause of the Eight Amendment.
However, the Excessive Fines Clause is inapplicable here, because § 304 only requires
reimbursement to the issuer: no money is forfeited to the government. Austin v. United States, 509
U.S. 602, 609 (1993) (“The Excessive Fines Clause limits the government’s power to extract
5
These are not the only provisions of § 302 which inform CEOs and CFOs of what is expected of them: they
are also required to certify (1) to having read the filing, (2) that it is true and accurate to the best of their knowledge, (3)
they have disclosed to the auditors and the audit committee any deficiencies in the internal controls, (4) disclosure of any
known fraud “that involves management or other employees who have a significant role in the issuer’s internal controls,”
and (5) whether there were any subsequent changes in the internal controls, including corrective actions. 15 U.S.C.
§ 7241(a)(1–3, 5–6).
-16-
payments . . . .”). In addition, the Court finds § 304 is at least partly remedial in nature, and so falls
outside the scope of the Excessive Fines Clause. See id. at 609–10.
3.
Due Process Clause
Baker and Gluk assert § 304 violates the Due Process Clause by not requiring any reasonable
relationship between the triggering conduct and the penalty imposed on an otherwise innocent
person. However, they cite no authority which is on point. For example, BMW of North America,
Inc. v. Gore is irrelevant because it concerns punitive damages awarded against tortfeasors. 517
U.S. 559, 568 (1996). Assuming arguendo § 304 reimbursement is a penalty, the Court finds there
is a reasonable relationship between the triggering conduct and the penalty. First, by signing SEC
filings, corporate officers are making solemn guarantees that they have carefully reviewed the filings
for accuracy, and that such accuracy is underwritten by adequate controls. When, as here, those
controls prove inadequate, and corporate officers are asleep on their watch, it is reasonable for
Congress to impose a penalty. The degree of penalty is reasonable too: it is limited to bonuses,
incentive-based pay, and stock-sales profits. Officers’ base salaries are outside the scope of § 304.
Furthermore, Congress provided a safety valve, namely the SEC’s power to exempt corporate
officers when appropriate.
Baker and Gluk also argue § 304 fails to provide fair notice, but this argument fails, because,
as discussed in the vagueness subsection, supra, Sarbanes–Oxley as a whole providess ample notice
of what conduct is required. Finally, it goes without saying the SEC must file a lawsuit in federal
court in order to force corporate officers to reimburse their employers under § 304; in such
proceedings, the officers have the full panoply of due process protections afforded civil defendants,
-17-
such as, to take a random example, the opportunity to test the adequacy of the SEC’s pleadings via
long and complex Rule 12(b)(6) motions. Accordingly, there is no due process violation.
C.
CAFRA
CAFRA provides: “an innocent owner’s interest in property shall not be forfeited under any
civil forfeiture statute.” 18 U.S.C. § 983(d)(1). CAFRA application is obviously limited to civil
forfeiture statutes, which it defines as “any provision of Federal law providing for the forfeiture of
property other than as a sentence imposed upon conviction of a criminal offense.” Id. § 983(i)(1).
An innocent owner under CAFRA is “an owner who – (i) did not know of the conduct giving rise
to the forfeiture; or (ii) upon learning of the conduct giving rise to the forfeiture, did all that
reasonably could be expected under the circumstances to terminate such use of the property.” Id.
§ 983(d)(2)(A).
The parties dispute whether § 304 is a civil forfeiture statute to which CAFRA applies.
Baker and Gluk argue: (1) § 304 is entitled “Forfeiture of Certain Bonuses and Profits”; (2) several
statutes are specifically exempted from CAFRA, but § 304 is not among them, see id. § 983(i)(2);
and (3) the SEC itself has referred to § 304 as providing for “forfeiture” in public statements, see,
e.g.,
S.E.C.
Lit.
Release
No.
21598,
(J uly
22,
2010),
available
at
http://www.sec.gov/litigation/litreleases/2010/lr21598.htm (reporting a court-ordered “forfeiture of
bonuses and stock sales pursuant to Section 304(a) of the Sarbanes-Oxley Act”).
The Court finds CAFRA is inapplicable to an action under § 304. First and foremost, the
Supreme Court has explained that civil forfeiture actions are in rem proceedings, see United States
-18-
v. Ursery, 518 U.S. 267, 275 (1996),6 whereas § 304 plainly creates an in personam cause of action.
That CAFRA is in fact limited to in rem actions is confirmed by its definition of innocent owner as
being one who “did all that reasonably could be expected under the circumstances to terminate such
use of the property.” 18 U.S.C. § 983(d)(2)(A) (emphasis added). This language is only logical in
the context of in rem forfeiture proceedings: such forfeitures are justified because the owner
permitted the property in question to be used for an illegal purpose. By contrast, a § 304 action has
nothing to do with property being put to an illegal purpose; rather, it is directed at failure to comply
with securities filing requirements.7
In the face of this clear guidance from both the Supreme Court, and the language of the
statutes themselves, the Court rejects Baker and Gluk’s arguments. In particular, the Court cannot
use the language of the title of § 304 to vary the import of the statute itself.
[T]he title of a statute and the heading of a section cannot limit the plain meaning of
the text. For interpretative purposes, they are of use only when they shed light on
some ambiguous word or phrase. They are but tools available for the resolution of a
doubt. But they cannot undo or limit that which the text makes plain.
B’hood of R.R. Trainmen v. Baltimore & O.R. Co., 331 U.S. 519, 528–29 (1947) (citations omitted).
Here, § 304 is unambiguously not an in rem, civil forfeiture statute. Accordingly, the title
of § 304 has no role to play in construing the language of the statute itself. See id.
6
Since the earliest years of this Nation, Congress has authorized the Government to
seek parallel in rem civil forfeiture actions and criminal prosecutions based upon
the same underlying events. . . . [T]he Court dr[aws] a sharp distinction between in
rem civil forfeitures and in personam civil penalties such as fines . . . .
Ursery, 518 U.S. at 274–75.
7
Baker and Gluk argue CAFRA has a broader scope than traditional civil forfeiture actions, which were
predicated on criminal prosecutions, because the exempted statutes include ones which govern forfeiture of property
under circumstances other than prosecutions, such as violations of the Internal Revenue Code, or federal customs law.
This may well be true; but it does not follow that merely because the in rem proceedings covered by CAFRA include
those outside of the criminal context, in personam actions such as § 304 would be covered as well.
-19-
Nor, for that matter, do passing references by the SEC to § 304 constituting a “forfeiture”
have any effect to contradict the meaning of both § 304 and CAFRA. They are the agency
equivalents of dicta; worse than that, a bedrock principle of Congressional delegations to regulatory
agencies is the agency’s interpretations cannot contravene the unambiguous meaning of the federal
law under whose authority they act. Chevron, U.S.A., Inc. v. Natural Res. Def. Council, Inc., 467
U.S. 837, 842–43 (1984). Moreover, the SEC statements Baker and Gluk point to are press releases,
not formal actions by the SEC.
Regarding the fact § 304 is not listed in the statutes exempted from CAFRA, if § 304 is not
a civil forfeiture at all, there would be no need to include it in the listed exemptions.
Finally, § 304 was passed some two years after CAFRA. Congress is presumed to be aware
of existing laws when enacting any new statute. South Dakota v. Yankton Sioux Tribe, 522 U.S. 329,
351 (1998). If Baker and Gluk are correct that CAFRA applies to § 304 proceedings, then it would
follow Congress chose to enact a meaningless statute in § 304, because recovery of compensation
from CEOs and CFOs who are not “innocent owners” is already provided for by various other
provisions of the Sarbanes–Oxley Act and the Securities and Exchange Act—and such recovery,
prior to § 304’s enactment, was limited to wrongdoers, to whom CAFRA’s protection would be
unavailable. Of course, Congress is further presumed to not engage in meaningless acts, cf. Canal
Ins. Co. v. Coleman, 625 F.3d 244, 253 (5th Cir. 2010); as such, the Court finds Congress must have
assumed and intended CAFRA would have no application to § 304.
Conclusion
Apologists for the extraordinarily high compensation given to corporate officers have longjustified such pay by asserting CEOs take “great risks,” and so deserve great rewards. For years, this
-20-
has been a vacuous saw, because corporate law, and private measures such as wide-spread
indemnification of officers by their employers, and the provision of Directors & Officers insurance,
have ensured any “risks” taken by these fearless captains of industry almost never impact their
personal finances.8 In enacting § 304 of Sarbanes–Oxley, Congress determined to put a modest
measure of real risk back into the equation. This was a policy decision, and while its fairness or
wisdom can be debated, its legal effect cannot. Section 304 creates a powerful incentive for CEOs
and CFOs to take their corporate responsibilities very seriously indeed.9 The Court finds the SEC’s
interpretation of § 304 is both correct, and does not offend the Constitution. Nor is CAFRA
applicable. Therefore, the SEC has stated a claim for which relief can be granted.
Accordingly,
IT IS ORDERED that Defendant Michael A. Baker’s Motion to Dismiss [#12] is
DENIED;
IT IS FINALLY ORDERED that Defendant Michael T. Gluk’s Motion to Dismiss
[#13] is DENIED.
SIGNED this the 13th day of November 2012.
____________________________________
SAM SPARKS
UNITED STATES DISTRICT JUDGE
8
Notably, the Second Circuit held a settlement agreement which purported to indemnify a CEO and CFO for
any liability under § 304 was void because “agreements of private parties cannot frustrate the power of a federal agency
to pursue the public’s interests in litigation.” Cohen, 622 F. 3d at 195.
9
It also bears noting there is nothing preventing corporate officers and their employers from avoiding this risk
by negotiating compensation packages which consist solely of a flat salary. Such an arrangement would probably be
effective to contract around § 304, because the reimbursement is limited to “bonus or other incentive-based or
equity-based compensation” and profits from stock sales. 15 U.S.C. § 7243(a)(1–2).
285 ord mot dism jih.frm
-21-
Disclaimer: Justia Dockets & Filings provides public litigation records from the federal appellate and district courts. These filings and docket sheets should not be considered findings of fact or liability, nor do they necessarily reflect the view of Justia.
Why Is My Information Online?