Tuesday, January 03, 2012

Federal Judge Asks SEC to Provide Factual Predicate in Settling Enforcement Action Involving Disgorgement of Bonuses

A federal judge has asked the SEC to provide a written factual predicate for why the agency believes the court should find that proposed final judgments in an enforcement action alleging that a company prepared materially inaccurate financial statements and lacked adequate financial controls are fair, reasonable, adequate, and in the public interest. (SEC v. Koss Corporation, No. 2:11-cv-00991, ED Wis). Citing Judge Rakoff’s opinion in SEC v. Citigroup Global Mkt. (SD N.Y. Nov. 28, 2011), Judge Randa specifically requested that the SEC provide, by January 24, 2012, a written factual predicate addressing the adequacy of the proposed final judgment provision regarding disgorgement by the company’s CEO.

The company and its CEO consented to the entry of an injunctive order without admitting or denying the SEC’s allegations. As part of the settlement, the CEO agreed to reimburse the company incentive-based compensation pursuant to Section 304 of the Sarbanes-Oxley Act, which requires CEOs and CFOs to disgorge bonuses and other incentive-based compensation in cases of accounting restatements resulting from material non-compliance with SEC financial reporting requirements.

In a letter to the SEC, Judge Randa noted that the Commission has alleged that the CEO, who was also the company’s CFO, failed to oversee the accounting and financial functions of the company. The SEC relies upon the separate consent documents of the company and the CEO, and has filed proposed final judgments as to each defendant. The letter requests that the SEC address concerns raised by the proposed final judgments and provide a written factual predicate for why it believes the court should find that the proposed final judgments are fair, reasonable, adequate, and in the public interest.

The consent document states that the CEO will be required to reimburse the Company for $242,419 in cash and 160,000 of options, and that bonus reimbursement, together with his previous voluntary reimbursement of bonus amounting to $208,895 represents the CEO’s entire fiscal year 2008, 2009, and 2010, incentive bonuses. Without any factual predicate for how those disgorgement terms were determined and what more, if anything, could have been subject to disgorgement, said Judge Randa, the court cannot assess their fairness and the extent to which they serve the purpose of disgorgement, which is to deprive the violator of unjust enrichment and thereby further the deterrence objectives of the securities laws.

Moreover, the court is concerned that the proposed judgments are not final judgments because they do not expressly state the disposition of the claims against the parties; e.g., dismissal without prejudice, while including a provision for the retention of jurisdiction over the enforcement of the terms of the settlement agreement. With respect to the retention of the Court’s jurisdiction,

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