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September 14, 2016

Author:

sycr.com

Ninth Circuit Expands Public Company CEO and


CFO Personal Liability for Certifications and
Financial Restatements
The Ninth Circuit Court of Appeal recently answered two questions that should get the
attention of every chief executive officer and chief financial officer of a public company.

John Cannon
Shareholder
(949) 725-4107
Jcannon@sycr.com
John F. Cannon is chair of
Stradling's litigation practice.

On August 31, 2016, in SEC v. Jensen, --- F. 3d ---, No. 14-55221, the Ninth
Circuit ruled that the bonuses, incentive and equity compensation of CEOs and CFOs
are subject to the disgorgement remedies authorized under Section 304 of Sarbanes
Oxley if an issuer files a restatement, regardless of whether personal misconduct of an
issuers CEO or CFO, or other issuer misconduct, caused the restatement.

Section 304 of Sarbanes Oxley provides that the chief executive officer and
chief financial officer of the issuer shall reimburse the issuer for (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, if the issuer is required to
prepare an accounting restatement due to the material non-compliance of the issuer,
as a result of misconduct, with any financial reporting requirement under the
securities laws.
Accordingly, if an issuer is required to file a restatement, both the CEOs and
the CFOs prior year bonuses, incentive and equity compensation are subject to
disgorgement irrespective of whether the CEO or CFO participated in any misconduct.

The Court also found that certifications of financials by CEOs and CFOs under
Rule 13a14 include an implicit truthfulness requirement thereby exposing CEOs and
CFOs to claims based upon the inaccuracy of the certification itself. A cause of action
against a CEO or CFO may be based upon an allegation that the certification is false,
independent of the existing provisions in the Exchange Act that prohibit fraudulent
statements.

Rule 13a-14 requires that for every report filed under Section 13(a) of the
Exchange Act, including Form 10-Q and 10-K financial reports, each principal

executive and principal financial officer of the issuer must sign a certification as to the
accuracy of the financial statements within the report. Certifications must provide,
among other things, that the signing officers . . . are responsible for establishing and
maintaining internal controls, and that those controls ensure that material
information relating to the issuer . . . is made known to such officers. 15 U.S.C.
7241(a)(4). The signing officers are also required to certify that, based on the
officers knowledge, the report does not contain any untrue statement of a material
fact or omit to state a material fact necessary in order to make the statements made, in
light of the circumstances under which such statements were made, not misleading.
Id. 7241(a)(2).
It is not enough, the Court ruled, for CEOs and CFOs to sign their names to a
document certifying that SEC filings include no material misstatements or omissions,
without a sufficient basis to believe that the certification is accurate.

In both instances, the Ninth Circuit expressly avoided addressing the mental
state of the CEO or CFO needed for a violation. It did so in spite of citing language in
Section 304 requiring misconduct by an issuer for a violation and finding an
inherent truthfulness element and need for a belief by the CEO and CFO in the
accuracy of the certification for a violation of Rule 13a-14. With this decision, the
Ninth Circuit appears to be taking a step closer to making CEOs and CFOs strictly liable
for the contents of issuer financials. A concurring opinion observed that the majority
should provide the necessary guidance tethering the claims to the underlying purpose
of the rules (to prevent fraud and misconduct) by specifying the scienter requirement
for these claims. The majority stated, however (in footnotes), that scienter was not
addressed in the briefs before the Ninth Circuit so it would exercise its discretion and
not address the issue. This omission is unfortunate. While the Ninth Circuit purports
to be settling the law, in reality, by avoiding the critical element of personal scienter, it
has unnecessarily injected uncertainty.

John Cannon
(949) 725-4107
jcannon@sycr.com

This publication is provided for your convenience and does not constitute legal advice. It is
prepared for the general information of our clients and other interested persons. This publication
should not be acted upon in any specific situation without appropriate legal advice.

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