The Ninth Circuit Court of Appeals has held that the certification requirement of Exchange Act Rule 13a-14 provides the SEC with a cause of action not only against CEOs and CFOs who do not file required certifications, but also against CEOs and CFOs who certify false or misleading statements. The appellate panel also determined that the disgorgement remedy authorized under Section 304 of Sarbanes-Oxley applied regardless of whether a restatement was caused by the personal misconduct of an issuer’s CEO and CFO or by other issuer misconduct. (SEC v. Jensen, August 31, 2016, Clifton, R.).
Basin Water. The underlying case before the court involved an SEC enforcement action brought against Peter Jensen, the former CEO of Basin Water, Inc. and Thomas Tekulve, its former CFO. Jensen founded Basin Water in 1999 to manufacture water treatment units that would provide municipalities with clean drinking water. In 2004, Jensen hired Tekulve as CFO.
Alleged scheme. The SEC alleged that Jensen and Tekulve engaged in a scheme to fraudulently overstate the company’s financial results. The alleged scheme involved what the SEC viewed as Basin’s failure to comply with GAAP in financial reports to the SEC. The SEC alleged that Basin recognized revenue from sales that were contingent or had not yet been finalized and Basin recognized sales revenue from loans made to Special Purpose Entities (SPE), which used that money to purchase water treatment units from Basin with no reasonable expectation that the SPEs would ever repay such loans.
The SEC filed suit in 2011 alleging that Jensen and Tekulve participated in a scheme to defraud Basin investors by reporting millions of dollars in revenue that were never realized. The SEC alleged that Jensen and Tekulve each received several hundred thousand dollars of incentive-based compensation in the form of salary and bonuses, and equity based compensation in the form of shares of Basin stock, during the period in which they were allegedly causing Basin to inflate its revenues fraudulently.
After Jensen and Tekulve left the company in 2008, Basin restated its financial statements for 2006 and 2007.
District court. The district court granted partial summary judgment to Jensen and Tekulve on the SEC’s claim under Exchange Act Rule 13a-14, which requires that an issuer’s CEO and CFO certify the accuracy of the issuers’ financial reports. The district court held that the rule required CEOs and CFOs to certify certain financial statements but did not provide a cause of action against officers who certified false statements.
On appeal, the SEC challenged the grant of partial summary judgment. The SEC also challenged the court’s legal conclusion that Section 304 of the Sarbanes-Oxley Act (SOX 304) required CEOs and CFOs to disgorge incentive and equity based compensation if their companies issued an accounting restatement because of the officers own misconduct but not if the restatement was caused by issuer misconduct in which the officers were not directly involved.
Rule 13a-14. In reversing and remanding the decision of the district court, the Ninth Circuit said that the wording of the rule supports the conclusion that a mere signature is not enough for compliance.
The court said that Rule 13a-14, like other rules promulgated under Section 13 of The Exchange Act, includes an implicit truthfulness requirement. It is not enough 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 was accurate, the court said.
SOX 304. The SEC also challenged the district court’s determination that Jensen and Tekulve did not violate SOX 304 because Basin’s misstatement was not issued due to any misconduct on the part of the individual defendants. The panel agreed with the SEC, noting that Congress intended to craft a broad remedy that focused on disgorging unearned profits rather than punishing individual wrongdoing.
Thus, the court said, in accordance with its text and legislative history, 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.
The case is No. 14-55221.
Attorneys: Karen Lynn Matteson for the SEC. William Hobbes Forman (Scheper Kim & Harris LLP) for Peter L. Jensen.
Companies: Basin Water, Inc.
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