The U.S. District Court for the Western District of Texas says that the Securities and Exchange Commission’s clawback lawsuit against two Arthrocare Corp. (ARTC) executives who received bonuses and compensation following accounting irregularities made by two other company officials can move forward. The defendants, ex-CEO Michael A. Baker and ex-CFO Michael Gluck, have not been charged with misconduct, and the district court said they do not need to have done anything wrong to be sued under the Sarbanes-Oxley Act’s Section 304.
This Texas securities case is one of many resulting from an alleged revenue recognition scam at the medical device manufacturer that was executed by two of its senior executives. (Arthrocare has since restated its financials for 2006 through 2008’s first quarter.) The SEC had argued that even though Baker and Gluck weren’t the charged with wrongdoing, under SOX’s Section 304, they must pay ArthroCare back their stock profits and bonuses that they received during the period of the accounting fraud.
The two men had filed a dismissal motion contending that the statute cannot be interpreted to make CFOs and CEOs with no scienter elements liable. They also claimed that statute’s vagueness not only makes it void but also it has other constitutional deficiencies. Now, however, the district court has denied their motion, finding that no separate misconduct or scienter by the defendants was necessary.
The court said that without ambiguity, the statute’s words “are dispositive” and Section 304 is unambiguous in mandating that CFOs and CEOs pay back the issuer for compensation that qualifies within a year of a filing that the issuer must restate because of misconduct by it or its agents. The district court also rejected the constitutional challenges made by the defendants and disagreed that the statute is constitutionally vague because it doesn’t clarify whose misconduct compels reimbursement. Referring to the statutory language, the court said that the ‘misconduct’ at issue in this case is misconduct by the issuer, and, since issuers include business entities and corporations, their agents, acting within the scope and course of their jobs, are also included within the definition of issuer.
The district court also disagreed with the two men’s contention that Section 304 is unconstitutionally vague. It said that the requirements for CFOs and CEOs are “crystal clear” when read along with the rest of SOX. It also noted that Section 302 tells executives exactly what they have to do to avoid reimbursement liability under Section 304, which is to ensure that the issuer submits financial statements that are accurate.
SEC v. Baker (PDF)
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