Non-Compelled Financial Restatements May Support SOX 304 Clawback Claims

In S.E.C. v. Bardman, No. 3:16-cv-02023 (N.D.Cal. Feb. 8, 2017), the Northern District of California rejected a challenge to “clawback” claims asserted by the Securities Exchange Commission under Sarbanes-Oxley section 304(a) against two former financial officers of Logitech.  The claim asserted — known colloquially as an SOX 304 clawback — requires CEOs and CFOs of publicly-traded companies to reimburse their companies for any bonuses and incentive-based compensation awarded during the 12 month period preceding an accounting restatement due to the issuer’s material noncompliance with its financial reporting obligations.  

The lawsuit asserts that the company’s former Chief Financial Officer and former controller of deliberately understated the magnitude of a write-off for excess parts that were to be used to manufacture an underperforming set-top device.  It is alleged, among other things, that the defendants did this to overstate Logitech’s earnings by more than 27% in 2011, which resulted in additional incentive-based compensation awarded to the executives.   The two executives are alleged to have falsely assumed that the company would build all of the excess components into finished products despite countervailing facts and circumstances.  (More info about the lawsuit is detailed elsewhere and via the SEC’s press release.)

The court’s opinion on Feb. 8 denied defendant Bardman’s motion to dismiss the SOX 304 claim.  It is notable in two key respects:

• The court agreed with the defendants that neither a press release or a Form 8-K concerning the company’s financial performance could be the basis of a SOX 304 disgorgement claim because neither document required compliance with GAAP.  Therefore, they could not serve as basis for a later accounting restatement that occurred on the company’s Form 10-K, which, by contrast, was subject to generally accepted accounting principles (GAAP).

• The court also rejected the argument that that an issuer must be “compelled” or ordered to prepare a financial restatement for liability to attach under SOX 304.  While the court noted that two district courts beyond the Ninth Circuit had reached that conclusion, the court recognized that a “sibling court” in the Northern District of California had already reached the opposite result in S.E.C. v. Jasper, 883 F. Supp. 2d 915, 927 (N.D. Cal. 2010), as amended, 2010 WL 8898216 (N.D. Cal. Nov. 5, 2010), aff’d, 678 F.3d 1116 (9th Cir. 2012).