Tuesday, February 07, 2012

Federal Judge Who Questioned SEC Settlement of Enforcement Action Now Indicates Approval

A federal judge who earlier questioned the settlement of an SEC enforcement action has now indicated that he will approve the settlement agreement based on the SEC’s response to the court’s concerns enunciated in a letter of December 20, 2011. SEC v. Koss Corporation, No. 2L11-cv-00991, ED Wis). In a Feb. 1, 2012 letter to the SEC, Judge Randa said that the Commission’s response largely satisfied the court’s concerns. The SEC indicated that it is willing to submit revised final judgments to include the consent provisions.

In the view of the court, the revisions of the “final judgments” are necessary to comply with the governing case law of the Court of Appeals for the Seventh Circuit. Therefore, the court accepted the SEC’s offer to revise its proposed final judgments as stated, citing Blue Cross and Blue Shield Ass’n v. Am. Express Co., 467 F.3d 634, 636-37 (7th Cir. 2006). Further, although continuing to question whether the judgments will be final judgments, the court said it would not withhold its approval based on that concern, citing See SEC v. Sachdeva et al, No. 10-747 (ED Wis Jan. 11, 2011). The court requested that the SEC file the revised documents by Feb. 16,2012.

In its Dec. 20, 2011 letter, the court 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. Citing Judge Rakoff’s opinion in SEC v. Citigroup Global Mkt. (SD N.Y. Nov. 28, 2011), Judge Randa had specifically requested that the SEC provide 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 his first 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 requested 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 in his earlier letter, the court could not 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 was 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.