No IN THE SUPREME COURT OF THE UNITED STATES. Brian Bosco, Petitioner, Jasmine Lee, Petitioner, Ronald Prince, Petitioner,

Transcription

1 No IN THE SUPREME COURT OF THE UNITED STATES Brian Bosco, Petitioner, AND Jasmine Lee, Petitioner, AND Ronald Prince, Petitioner, v. SECURITIES AND EXCHANGE COMMISSION, Respondent, ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FOURTEENTH CIRCUIT BRIEF FOR PETITIONERS Team P8 Counsel for the Petitioners

2 TABLE OF CONTENTS TABLE OF CONTENTS... i TABLE OF AUTHORITIES... ii QUESTIONS PRESENTED... vi STATEMENT OF THE CASE... 1 STATEMENT OF FACTS... 2 SUMMARY OF THE ARGUMENT... 5 ARGUMENT I. UNDER RULE 13A-14 THERE IS NO CAUSE OF ACTION AGAINST CEOS AND CFOS WHO CERTIFY FALSE FINANCIAL STATEMENTS WHERE THEY DID NOT HAVE ACTUAL KNOWLEDGE OF THE FALSITY, AND THE DISGORGEMENT REMEDY UNDER 304 OF THE SARBANES-OXLEY ACT OF 2002 REQUIRES PERSONAL MISCONDUCT OF CEOS AND CFOS A. Rule 13a-14 does not provide a cause of action against certifying officers where they did not have actual knowledge of the falsity because both direct and aiding abetting liability require actual knowledge B. The disgorgement remedy under 304 of the Sarbanes-Oxley Act requires personal misconduct of CEOs and CFOs II. THE SEC S DISGORGEMENT CLAIM CONSTITUTES A PENALTY OR FORFEITURE WITHIN THE MEANING OF 2462 S FIVE-YEAR STATUTE OF LIMITATIONS A. The SEC s disgorgement claim is punitive in effect and thus acts as a penalty B. Forfeiture and disgorgement are effectively synonyms and thus are time barred under C. Limiting the SEC s ability to recover penalties beyond a five-year limit alleviates serious policy considerations CONCLUSION i

3 TABLE OF AUTHORITIES Cases Alvarado v. Cajun Operating Co., 588 F.3d 1261 (9th Cir. 2009) Austin v. United States, 509 U.S. 602 (1993) BMW of North America, Inc. v. Gore, 517 U.S. 559 (1996) Boos v. Barry, 485 U.S. 312 (1988) Bordenkircher v. Hayes, 434 U.S. 357 (1978)... 9, 25, 26, 28 Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984)... 9, 27 City of Chicago v. Morales, 527 U.S. 41 (1999)... 23, 24 Consol. Bank, N.A., Hialeah, Florida v. U.S. Dep't of Treasury, Office of Comptroller of Currency, 118 F.3d 1461 (11th Cir. 1997) Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)... 7, 13, 17, 20, 21 FCC v. Fox TV Stations, Inc., 132 S. Ct (2012)... 9, 22, 23, 24 Gabelli v. SEC, 133 S. Ct (2013)... 11, 31, 37 Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9th Cir. 1990)... 6, 13, 17, 18 Howard v. Everex Systems, Inc., 228 F.3d 1057 (9th Cir. 2000)... 8, 17, 18 In re ibasis, Inc. Derivative Litigation, 532 F.Supp.2d 214 (D. Mass. 2007) Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996)... 11, 29, 31 Kolender v. Lawson, 461 U.S. 352 (1983)... 22, 24 Levine v. Diamanthuset, Inc., 950 F.2d 1478 (9th Cir. 1991) Meeker v. Lehigh Valley R.R. Co., 236 U.S. 412 (1915) Perrin v. United States, 444 U.S. 37 (1979)... 19, 36 ii

4 Pioneer Inv. Servs. Co. v. Brunswick Assoc. Ltd. Partnership, 507 U.S. 380 (1993) Ponce v. S.E.C., 345 F.3d 725 (2010)...7, 8, 15, 16, 18 R.R. Telegraphers v. Ry. Express Agency, Inc., 321 U.S. 342 (1944) Riordian v. SEC, 627 F.3d 1230 (D.C. Cir. 2010) Rutti v. Lojack Corp., Inc., 596 F.3d 1046 (9th Cir. 2010) SEC v. Retail Pro, Inc., 2010 WL (S.D. Cal. 2010)... 27, 28 SEC v. Baker, 2012 WL (W.D. Tex. 2012)...10, 23, 24, 27 SEC v. Blatt, 583 F.2d 1325 (5th Cir. 1978) SEC v. Fehn, 97 F.3d 1276 (9th Cir. 1996)... 13, 15, 17 SEC v. First City Financial Corp., F.2d 1215 (D.C. Cir. 1989)... 30, 35 SEC v. Graham, 823 F.3d 1357 (11th Cir. 2016)... 34, 36 SEC v. Jenkins, 718 F.Supp.2d 1070 (D. Ariz., 2010)... 18, 19, 26 SEC v. Jensen, 835 F.3d 1100 (9th Cir. 2016)... 6, 12, 13, 14, 17, 19 SEC v. Kokesh, 834 F.3d 1158 (10th Cir. 2016) SEC v. MacDonald, 699 F.2d 47 (1st Cir. 1983) SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082 (2d Cir. 1972) SEC v. Mercury Interactive, LLC, 2009 WL (N.D. Cal. 2009) SEC v. National Securities, Inc., 393 U.S (1969) SEC v. Platforms Wireless Int l Corp., 617 F.3d 1072 (9th Cir. 2010) SEC v. Shanahan, 646 F.3d 536 (8th Cir. 2011) SEC v. Tambone, 550 F. 3d 106 (1st Cir. 2008) SEC v. Telsey, 144 B.R. 563 (Bankr. S.D. Fla. 1992) iii

5 SEC v. Warde, 151 F.3d 42 (2d Cir. 1998) SEC v. Life Partners Holdings, Inc., 2013 WL (W.D. Tex. 2013) Sheldon v. Metro-Goldwyn Pictures Corp., 309 U.S. 390 (1940) Skilling v. United States, 561 U.S. 358 (2010)... 10, 22, 26 TXO Prod. Corp. v. Alliance Res. Corp., 509 U.S. 443 (1993) United States v. Bajakajian, 524 U.S. 321 (1998)... 9, 10, 25, 28 United States v. Contorinis, 692 F.3d 136 (2d Cir. 2012)... 32, 34 United States v. Daas, 198 F.3d 1167 (9th Cir. 1999)... 8, 20 United States v. Ursery, 518 U.S. 267 (1996) United States v. Ward, U.S. 242 (1980) Upton v. SEC, 75 F.3d 92 (2d Cir. 1996) Women's Med. Ctr. v. Bell, 248 F.3d 411 (5th Cir. 2001) Zacharias v. SEC, 569 F.3d 458 (D.C. Cir. 2009) Statutes 15 U.S.C , 12, 13, 20, U.S.C. 78m...10, 11, 27, U.S.C. 78r... 6, U.S.C. 78t...7, 8, 17, 18, U.S.C. 77o U.S.C , 19, 20, 24, 25, U.S.C U.S.C iv

6 Other Authorities Certification of Disclosure in Companies Quarterly and Annual Reports, Exchange Act Release No. 8124, 2002 WL , at *9 (Aug. 28, 2002) [ Release No ]... 6, 12 Disgorgement, Black s Law Dictionary (10th ed. 2014) Forfeiture, Black s Law Dictionary (10 th ed. 2014) H.R. REP , , 17 S. REP , Regulations 17 C.F.R C.F.R a v

7 QUESTIONS PRESENTED 1. Whether under Rule 13a 14 promulgated under the Sarbanes-Oxley Act of 2002, provides a cause of action against chief executive officers and chief financial officers who certify false financial statements, when they did not have actual knowledge of the falsity, and whether the disgorgement remedy pursuant to Section 304 of the Sarbanes-Oxley Act of 2002 requires personal misconduct by the chief executive officers and chief financial officers. 2. Whether the five-year statute of limitations in 28 U.S.C applies to disgorgement claims in a securities law violation and constitutes a civil penalty or forfeiture when the disgorgement amount includes discretionary bonuses and compensation, which is both collateral to the fraudulent conduct and in the possession of third parties. vi

8 STATEMENT OF THE CASE On January 1, 2016, the United States Securities and Exchange Commission ( SEC ) filed a civil action against Brian Bosco, Jasmine Lee, and Ronald Prince (collectively, the Petitioners ) in the District Court for the District of Fordham. (R. at 6). The complaint alleged that Prince had participated in a scheme to defraud Burlingham Inc. s ( Burlingham ) investors by causing the company to report millions of dollars of unearned revenue in contravention of Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act ), and Rule 10b 5 promulgated therein. Id. Furthermore, the complaint alleged that Bosco and Lee violated Rule 13a 14, promulgated under the Sarbanes-Oxley Act of 2002 ( Rule 13a 14 ), by certifying Burlingham s false and misleading 10-K financial statements for fiscal year Id. Additionally, the SEC claimed that the financial restatements resulting from the false certification triggered a disgorgement remedy pursuant to Section 304 of the Sarbanes-Oxley Act of 2002 ( SOX 304 ). Id. In June 2016, Bosco and Lee filed a motion for summary judgment under Rule 56 of the Federal Rules of Civil Procedure. Id. The SEC filed a cross-motion for summary judgment against Bosco and Lee, and simultaneously filed a motion for summary judgment against Prince. Id. The district court denied Bosco and Lee s motion and granted both the SEC s cross-motion and motion against Prince. Id. The district court held that a cause of action exists under Rule 13a 14 against a company s Chief Executive Officer ( CEO ) and Chief Financial Officer ( CFO ) who certify false financial 1

9 statements, regardless of their knowledge of the falsity of the statements. (R. at 6 7). Moreover, the district court held that SOX 304 requires the CEO and CFO to disgorge incentive-based and equity-based compensation due to a company s accounting restatement, even if the directors were not involved in the misconduct that caused the restatement. (R. at 7). Lastly, the district court held that the SEC s disgorgement claims were not time barred by 28 U.S.C Id. The district court ordered disgorgement against Bosco and Lee in the amount of $600,000 and $475,000 respectively. Id. The district court ordered Prince to disgorge $1,770,000, which included: (1) $1,025,000 earned from forty-one side letters; (2) $495,000 containing all bonuses and other discretionary compensation from the periods of January 2008 through January 2010, and January 2014 through January 2015; and (3) $250,000 in bonuses that another executive earned during the relevant periods. Id. On January 12, 2017, the Fourteenth Circuit affirmed both of the district court s holding. (R. at 11, 13, 17). Shortly thereafter, on February 1, 2017, this Court granted Petitioner s writ of certiorari. (R. at 32.) STATEMENT OF FACTS Burlingham, is a microchip manufacturer, which was founded in 1981 by its former CEO, Veronica Uchekwe. (R. at 1). The company s smartphone microchip business, which is managed by the Communications Division (the Division ), is its largest revenue and net income generator. (R. at 2). 2

10 Prince became Burlingham s Executive Vice President in 2002, and was responsible for managing the Division. Id. Prince along with Henrietta Conrad, served as the Division s only executive managers. Id. Under Prince s management, Burlingham expanded its smartphone microchip business into the robust Chinese market, which mainly sold smartphones in the United Kingdom ( UK ) market. Id. All of Burlingham s executives were compensated through a discretionary bonus system, which was determined at the close of each fiscal year by its board s Compensation Committee. Id. Individual manager s compensation and discretionary bonuses were calculated by analyzing the company s financial and operating performance using metrics such as revenue, profit, market share, retention of employees, and integration of acquired businesses. Id. For example, in March 2009, Burlingham entered into a lucrative contract with a major producer of computer tablets. Id. As a result of the successful contract, Burlingham awarded each executive officer a $45,000 discretionary bonus. Id. Notably, Prince s compensation was not directly tied to the smartphone business success. Id. Instead, seventy-five percent of his salary was comprised of the above-referenced discretionary bonus. Id. As a result, Prince felt that his compensation arrangement was inadequate to establish financial security for his family. Id. From January 2008 to January 2010, Prince secretly negotiated unilateral termination rights into purchase agreements with certain Chinese smartphone manufacturers. Id. The termination rights permitted purchasers 3

11 to unilaterally terminate their purchase agreements in the event that the UK s GDP projected a 2% or more decline. Id. The termination rights automatically terminated two years after the effective date of the side letter. Id. Prince received $25,000 for each side letter containing the unilateral termination rights, and was paid an additional $50,000 if the unilateral termination was exercised. Id. Prince executed a total of thirty side letters during this time period. Id. The side letters were never provided to Uchekwe, Burlingham s auditors, or its attorneys. Id. In 2011, Burlingham s board of directors named Bosco as Uchekwe s successor. Id. Bosco selected Jasmine Lee as the company s new CFO. (R. at 4). The two were known as hands-on managers, and worked closely to maintain the company s internal compliance and controls pursuant to the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act ). Id. This included signing and certifying Burlingham s financial statements for each SEC filing. Id. In 2014, the Petitioners attended a technology conference. Id. During the conference, the CEO of a major Japanese smartphone manufactured approached both Bosco and Lee separately, to discuss adding deal sweeteners such as unilateral termination rights into his company s contract with Burlingham. Id. Both Bosco and Lee ignored the request. Id. However, after the conference concluded, Bosco and Lee discussed the CEO s request for unilateral termination rights. Id. The two executives discussed investigating the request, but ultimately did nothing. Id. 4

12 Also in 2014, Prince once again began entering into side letters with Chinese manufactures. Id. From January 2014 to January 2015, Prince executed eleven side letters containing unilateral termination agreements. Id. In 2015, the UK s GDP declined by 2.5%, and five out of the eleven above-mentioned purchasers exercised their termination rights. (R. at 4 5). As a result, Bosco and Lee immediately launched an investigation and placed Prince on an indefinite leave of absence. (R. at 5). Bosco also notified Burlingham s chairman of the board about the side letters and their potential material adverse impact on the company s 2015 financial condition, as well as impact on its operations, and its first quarter s financial result. Id. The following week, Burlingham s board met and appointed a committee of outside directors (the Special Committee ) to investigate Prince s conduct. Id. The Special Committee uncovered that Prince s scheme had been in place during 2008, 2009, and 2014, and as a result substantially affected the company s 2014 financial statements, which were filed on January 1, Id. Burlingham s 2014 financial statements would require correction to reclassify income related to the Chinese microchip smartphone contracts affected by Prince s conduct. Id. Accordingly, the company prepared and filed a restated 10-K for Id. SUMMARY OF THE ARGUMENT The SEC must show that the certifying CEOs and CFOs had knowledge of the falsity to substantiate a Rule 13a-14 cause of action. Section 302 of Sarbanes-Oxley ( SOX 302 ), the Rule under which Rule 13a-14 was 5

13 promulgated, requires officers to certify as to the accuracy of financial statements, based on the officer s knowledge. 15 U.S.C Under direct liability the SEC must establish that the certifying officer personally committed the wrong, and either knowingly or with inexcusable negligence certified the financial report that contained false information. SEC v. Jensen, 835 F.3d 1100, 1112 (9th Cir. 2016); Hollinger v. Titan Capital Corp., 914 F.2d 1564, (9th Cir. 1990). In Release No the SEC recognized the knowledge requirement as well as a good faith defense for officers who certified without knowledge of the falsity. Certification of Disclosure in Companies Quarterly and Annual Reports, Exchange Act Release No. 8124, 2002 WL , at *9 (Aug. 28, 2002) [ Release No ]; 15 U.S.C. 78r. Additionally, aiding and abetting liability in securities fraud requires: (1) the existence of an independent primary wrong, (2) actual knowledge or reckless disregard by the alleged aider and abettor of the wrong and of his or her role in furthering it, and (3) substantial assistance in the wrong. Ponce v. S.E.C., 345 F.3d 725, 726 (2010). Recklessness under securities fraud is a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it. Id. The knowledge requirement is further supported by other antifraud securities statues such as 10(b) and 15(d), which also require knowledge. Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). Further, officers who certified 6

14 financial documents without knowledge of the falsity are entitled to a good faith defense against aiding and abetting liability. 15 U.S.C. 78t. Here, since Bosco and Lee were not personally involved in the fraud and both did not have knowledge of the falsity, the SEC cannot substantiate a direct liability 13a-14 claim against them. (R. at 7). Additionally, Bosco and Lee did not recklessly disregard or willfully aid and abet Prince s fraud, nor did they knowingly provide substantial assistance. Thus the SEC cannot substantiate a 13a-14 claim against them under an aiding and abetting theory. Ponce, 345 F.3d at 737. Finally, Bosco and Lee are vindicated under the good faith defense, as they had no knowledge of the fraud and lacked effective participation. 15 USC 78t; Howard v. Everex Systems, Inc., 228 F.3d 1057, 1065 (9th Cir. 2000). Therefore, the Appellate Court erred in upholding the District Courts ruling that Rule 13a-14 provides a cause of action against officers who certify false statements, even when the officers were unaware of the falsity. (R. at 7-6, 9). SOX 304 must require personal misconduct of CEOs and CFOs to trigger disgorgement. An opposing interpretation is contrary to basic rules of interpretation and would render the statute unconstitutional. The unadulterated words of the statute are unclear because SOX 304 does not define whose misconduct requires disgorgement. 15 U.S.C However, since other statutes closely associated with SOX 304 require personal misconduct, to remain consistent with the statutory scheme, SOX 304 must also personal misconduct. United States v. Daas, 198 F.3d 1167, 1174 (9th Cir. 7

15 1999). Further, House Report No clarifies that disgorgement is required only in cases where the Commission can prove extreme misconduct on the part of that officer or director. H.R. REP , 44 (emphasis added). Since legislative history supports the understanding that SOX 304 requires personal misconduct, the opposing interpretation is not one that Congress would have sanctioned. Chevron, U.S.A., Inc. v. Natural Resources Defense Council, Inc., 467 U.S. 837, 844 (1984). SOX 304 must require personal misconduct otherwise it would be void for vagueness. Without a requirement for personal misconduct SOX 304 would be so broad and unclear that it would not provide fair notice as to which conduct is prohibited and it would be susceptible to arbitrary enforcement. FCC v. Fox TV Stations, Inc., 132 S. Ct. 2307, 2309 (2012). Further, without a requirement of personal misconduct SOX 304 would punish CEOs and CFOs for the misconduct of another, thus the punishment would be grossly disproportionate compared to the gravity of the offense. United States v. Bajakajian, 524 U.S. 321, 328 (1998). Such is a due process violation of the most basic sort. Bordenkircher v. Hayes, 434 U.S. 357, 363 (1978). Since it is assumed that Congress enacts constitutional statutes SOX 304 must require personal misconduct. Skilling v. United States, 561 U.S. 358, 412 (2010). Further, even if one reason Congress enacted SOX 304 was to motivate CEOs and CFOs to implement robust internal control systems, this does not defeat the requirement for personal misconduct. SEC v. Baker, 2012 WL , at *5 (W.D. Tex. 2012). The SEC must show that the officers 8

16 knowingly circumvent[ed] or knowingly fail[ed] to implement a system of internal accounting controls to hold executives liable for misconduct within the corporation. 15 U.S.C. 78m. Even the most robust an internal control system will not catch every error. Thus to hold CEOs and CFOs liable would be unreasonable. Here, Bosco and Lee were not involved in Prince s misconduct and so the SEC cannot substantiate a SOX 304 claim against them. (R. at 3-4). To punish them for Prince s fraud scheme would amount to a grossly disproportional fine and trample upon their constitutional protections. Bajakajian, 524 U.S. at 32; (R. at 7). Moreover, Bosco and Lee did not knowingly circumvent or knowingly fail to implement internal control systems. 15 U.S.C. 78m. Rather, they maintained Burlingham s internal controls in compliance with [SOX]. (R. at 4). Therefore, SOX 304 requires personal misconduct to trigger disgorgement. (R. at 7, 9). With respect to Prince s disgorgement order, this Court should find that disgorgement falls within the meaning of 2462, thus barring the SEC s claims for the years 2008 through The Fourteenth Circuit s holding allows the SEC to unfairly label its relief as a disgorgement to avoid the time bar of Notably, this Court has not addressed whether disgorgement constitutes a penalty or forfeiture under See Gabelli v. SEC, 133 S. Ct. 1216, 1220 (2013) (applying 2462 to statutory penalties imposed in SEC enforcement actions, but declining to address if disgorgement falls within 2462 s ambit). While disgorgement is an equitable remedy, which seeks to return the 9

17 wrongdoer back to the status quo ante, it can also be punitive in its effect. See Zacharias v. SEC, 569 F.3d 458, (D.C. Cir. 2009); see also Johnson v. SEC, 87 F.3d 484, 491 n.11 (D.C. Cir. 1996). If a disgorgement order is punitive, then it is a penalty or forfeiture under 2462 and thus qualifies under the five-year statute of limitations. Prince s disgorgement order was overly broad because it included amounts outside and unrelated to his conduct, which he never controlled directly or indirectly. To require Prince to disgorge these amounts would not be the compensatory remedy proscribed by disgorgement and would in fact be punitive within the meaning of ARGUMENT I. UNDER RULE 13A-14 THERE IS NO CAUSE OF ACTION AGAINST CEOS AND CFOS WHO CERTIFY FALSE FINANCIAL STATEMENTS WHERE THEY DID NOT HAVE ACTUAL KNOWLEDGE OF THE FALSITY, AND THE DISGORGEMENT REMEDY UNDER 304 OF THE SARBANES-OXLEY ACT OF 2002 REQUIRES PERSONAL MISCONDUCT OF CEOS AND CFOS. A. Rule 13a-14 does not provide a cause of action against certifying officers where they did not have actual knowledge of the falsity because both direct and aiding abetting liability require actual knowledge. A proper understanding of whether Rule 13a-14 provides a cause of action against chief executive officers and chief financial officers who certify financial statements without actual knowledge of falsity requires an understanding of SOX 302, the law under which Rule 13a-14 was promulgated. 15 U.S.C. 7241; 17 C.F.R a 14; Jensen, 835 F.3d at SOX 302 directs the SEC to create rules under Sections 13(a) or 15(d) of the Exchange Act requiring publicly traded companies to submit periodic 10

18 reports. 15 U.S.C. 7241; 17 C.F.R a 14. Thus, SOX 302 acts as a guide for the way in which Congress intended Rule 13a-14 to function. 15 U.S.C. 7241; 17 C.F.R a 14; Jensen, 835 F3d at Rule 13a-14 requires principal executive and financial officers to sign certifications to be filed along with financial documents. 17 C.F.R a 14. Under SOX 302, the signing officer certifies that, based on the officer s knowledge, the report does not contain any untrue statement... in light of the circumstances under which such statements were made. 15 U.S.C To substantiate an action for direct liability under SOX 302 the SEC is required to prove basic elements of fraud, including knowledge. Hollinger, 914 F.2d at (finding that an officer who personally committed the wrong is primarily liable, based on proof of his actions or omissions, and on scienter ); SEC v. Fehn, 97 F.3d 1276, 1289 (9th Cir. 1996) (to prove a violation under Section 10(b) of the Exchange Act, the SEC must show a misstatement or omission of material fact, made with scienter ); Hochfelder, 425 U.S. at 185. When an officer signs a document, the officer attests to its accuracy and one cannot certify a fact about which one is ignorant or which one knows is false. Jensen, 835 F.3d at 1113 (emphasis added). However, not every inaccurate certification is false. Id. at 1117 (Bea, J., concurring). False means intentional perversion of truth or intend[ing] to mislead. Id. Officers may certify financial statements without knowing they contain false information. Id. at When there is no knowledge of the 11

19 falsity, a certification is inaccurate but it is not false, therefore there is no cause of action under Rule 13a-14. Id. The SEC itself embraced knowledge as a requirement for liability under a fraudulent filing claim in Release No Release No at *9. Release No cites to Section 18 of the Exchange Act as a basis for imposing direct liability on officers who falsely certify financial statements. Jensen, 835 F.3d at However, in addition to delineating when certifying officers are liable, Section 18 also provides an affirmative defense for a certifying officer who prove[s] that he acted in good faith and had no knowledge that such statement was false or misleading. 15 U.S.C. 78r (emphasis added). Release No states that as an alternative to direct liability, the SEC may seek redress against certifying officers who aid or abet violations. Release No at *9. To state a claim of aiding and abetting securities fraud, one must plead (1) the existence of an independent primary wrong, (2) actual knowledge or reckless disregard by the alleged aider and abettor of the wrong and of his or her role in furthering it, and (3) substantial assistance in the wrong. Ponce, 345 F.3d at 726 (emphasis added) (defendant was overvaluing products and preparing, certifying and submitting reports containing these overvaluations, which caused misleading annual and quarterly reports in contravention of Rule 13(a) by willfully aiding and abetting the principal s scheme); Levine v. Diamanthuset, Inc., 950 F.2d 1478, 1483 (9th Cir. 1991) (defendant found liable for reckless disregard under aiding and 12

20 abetting liability because he sent dishonest acknowledgments to investors stating he certified the value of their investments and they were insured). Violations occur only when the aider and abettor knowingly provides substantial assistance in the violation of antifraud statutes. Fehn, 97 F.3d at 1283 (emphasis added) (defendant substantially assisted by knowingly altering financial statements to create a material omission). If the SEC cannot prove actual knowledge it must, at least, show recklessness to substantiate a claim for aiding and abetting liability under 13(a). Ponce, 345 F.3d at 737. Recklessness for the purpose of securities fraud has been defined as, a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care, and which presents a danger of misleading buyers or sellers that is either known to the defendant or is so obvious that the actor must have been aware of it. Id. (emphasis added) (quoting Hollinger, 914 F.2d at 1569). In Hollinger the court held that defendant was reckless for posing an unreasonable and obvious risk to investors because after learning that a registered securities broker had been previously suspended for felony forgery, defendant did not terminate the broker, nor did he disclose the information. Id. ( Such was an extreme departure for the standards of ordinary care. ). Further, since other statues governing fraudulent SEC filings such as 10(b) and 15(d) both require knowledge, 13(a) must also require knowledge. Id. at 737. For example, in Ponce the court used the aiding and abetting test 13

21 designed for 10(b) and 15(d) to hold the defendant liable under 13(a). Id.; Hochfelder, 425 U.S. at 185. Additionally, section 15(d) and 13(a) are both incorporated into SOX 302, therefore it follows that both sections should have a knowledge requirement. Fehn, 97 F.3d at Finally, like direct liability, aiding and abetting liability also includes an affirmative defense for officers who acted in good faith and did not induce the act or acts constituting the violation. 15 U.S.C. 78t; Everex Systems, Inc., 228 F.3d at 1065 ( [A] defendant is entitled to a good faith defense if he can show no scienter and an effective lack of participation. ). In this case, Bosco and Lee are innocent certifying officers, as they had no knowledge of Prince s side deals until March 2015, two months after filing Burlingham s 2014 annual 10-K. (R. at 4-5). Since Bosco and Lee were not personally involved in the fraud, the SEC cannot substantiate a claim for primary liability against them. Hollinger, 914 F2d at ; (R. at 3). Further, it is undisputed that Bosco and Lee did not have knowledge of the falsity, thus their certification was inaccurate but it was not false. Jensen, 835 F.3d at 1117; (R. at 7). The SEC also cannot substantiate an aiding and abetting cause of action against Bosco and Lee. (R. at 3). Bosco and Lee did not recklessly disregard or willfully aid and abet Prince s fraud, nor did they knowingly provide substantial assistance. Ponce, 345 F.3d at 737. Although they did not further investigate the Japanese CEO s inquiries about unilateral termination rights, 14

22 this does not rise to the level of reckless disregard delineated by the court in Hollinger. (R. at 4); Hollinger, 914 F.2d at Finally, Bosco and Lee are vindicated under the good faith defense, as they had no knowledge of the fraud and lacked effective participation. 15 U.S.C. 78t; Everex Systems, Inc., 228 F.3d at Their good faith is further established by their immediate and comprehensive response to news regarding Princes fraud. (R. at 4 5). Therefore, the Appellate Court erred in upholding the District Courts ruling that Rule 13a-14 provides a cause of action against officers who certify false statements, even when the officers were unaware of the falsity. (R. at 6 7, 9). B. The disgorgement remedy under 304 of the Sarbanes-Oxley Act requires personal misconduct of CEOs and CFOs. 1. According to basic rules of statutory interpretation and legislative history, disgorgement under 304 requires personal misconduct of CEOs and CFOs, and an opposing interpretation would render 304 unconstitutional. Because the plain language of SOX 304 is ambiguous, whether it requires personal misconduct of CEOs and CFOs depends largely on basic cannons of statutory interpretation. SEC v. Jenkins, 718 F.Supp.2d 1070, 1074 (D. Ariz., 2010). When a statute is ambiguous the starting point for interpretation is always the ordinary, contemporary, common meaning of the statute. Alvarado v. Cajun Operating Co., 588 F.3d 1261, 1268 (9th Cir. 2009); Perrin v. United States, 444 U.S. 37, 42 (1979). SOX 304 states that if an issuer is required to prepare an accounting restatement due to material noncompliance of the issuer, as a result of misconduct, with any financial 15

23 reporting requirement... the CEO and CFO of the issuer shall reimburse the issuer. 15 U.S.C The most patent ambiguity of SOX 304 is that it does not specify which individual s misconduct triggers the disgorgement. For example, it could be the misconduct of the CEO or CFO, other officers, employees, outside agents and representatives, or third party vendors. The Jenkins court stated that Congress says in the statute what it means and means in the statute what it says. Jenkins, 718 F.Supp.2d at However, both Jenkins and Jensen argue that the statute refers to issuer misconduct. See Jenkins, 718 F.Supp.2d at 1076; see also Jensen, 835 F.3d at Such an understanding necessarily requires adding the word issuer to SOX 304 where Congress left a vacancy. 15 U.S.C These courts could just have easily added the words CEO and CFO before misconduct. Because the unadulterated words of the statute are unclear, to determine their meaning it is appropriate to look to the entire statutory scheme. Daas, 198 F.3d at 1174; Hochfelder, 425 U.S. at 206 (quoting SEC v. National Securities, Inc., 393 U.S. 453, 466 (1969) ( [T]he interdependence of the various sections of the securities laws is certainly a relevant factor [in statutory interpretation]. ). Other antifraud securities statutes such as sections 13(a), 15(d), 10(b), 14(a) and 12(2), require culpability, or at minimum provide a good faith defense. 15 U.S.C. 77o & 78t; SEC v. Shanahan, 646 F.3d 536, 545 (8th Cir. 2011). Further, in the preceding statute, SOX 302, Congress states that CEOs and CFOs must certify that based on the officer s knowledge the corporate 16

24 financial statements are not misleading. 15 U.S.C (emphasis added). SOX 302 explicitly requires CEOs and CFOs to have acted with actual knowledge or at the very least recklessness in order to be held liable. 15 U.S.C It would be inconsistent with the statutory scheme to assume that SOX 304 does not require the same level of culpability. Hochfelder, 425 U.S. at 206. Thus, it cannot be the case that this statute imposes liability of CEOs and CFOs for the misconduct of the issuer. SOX 304 must apply to the personal misconduct of CEOs and CFOs. Legislative history further supports the notion that SOX 304 is not a strict liability statute. Rather it requires personal misconduct of CEOs and CFOs to trigger disgorgement. Rutti v. Lojack Corp., Inc., 596 F.3d 1046, 1052 (9th Cir. 2010). Although Senate Report No does not shed any light on whose misconduct SOX 304 refers to, House Report No clarifies that disgorgement is required only in cases where the Commission can prove extreme misconduct on the part of that officer or director. S. REP , 26; H.R. REP , 44 (emphasis added). Considering the abovementioned statutory interpretation and legislative history, SOX 304 clearly requires personal misconduct to trigger disgorgement. Therefore, the SEC s contrary strict liability interpretation of SOX 304 is unreasonable, manifestly contrary to the statute, and not one that Congress would have sanctioned. Chevron, U.S.A, 467 U.S. at 844; U.S. v. Shimer, 367 U.S. 374, 383 (1961). 2. SOX 304 must require personal misconduct of CEOs and CFOs, otherwise it is rendered an unconstitutional violation of the Due Process Clause. 17

25 The SEC s opposing interpretation of SOX 304 would render it void for vagueness. This doctrine is crucial because vague statutes are susceptible to arbitrary enforcement, and fail to give fair and adequate notice of the type of conduct prohibited, which would necessarily result from interpreting SOX 304 as a strict liability statute. Fox TV Stations, Inc., 132 S. Ct. at 2309; Kolender v. Lawson, 461 U.S. 352, 355 (1983). Because courts should avoid constitutional difficulties by adopting a limiting interpretation of such construction if fairly possible, SOX 304 must require personal misconduct of CEOs and CFOs to trigger disgorgement. Skilling 561 U.S. at 412 (quoting Boos v. Barry, 485 U.S. 312, 331 (1988)). Additionally, the rule of lenity requires resolving any ambiguities in the defendant's favor. SEC v. Mercury Interactive, LLC, 2009 WL , at *7 (N.D. Cal. 2009) (rejecting the SEC's broad interpretation of SOX 304 in favor of a narrower interpretation to protect the due process right to fair notice). The Due Process Clause provides that laws are vague when persons of common intelligence must necessarily guess their meaning and application. Women's Med. Ctr. v. Bell, 248 F.3d 411, 421 (5th Cir. 2001). Further, the SEC may not sanction pursuant to a substantial change in its enforcement policy that was not reasonably communicated to the public. Upton v. SEC, 75 F.3d 92, 98 (2d Cir. 1996). SOX 304 s vague plain language in the face of (1) the other antifraud securities statues, (2) SOX 302, and (3) legislative history all support a narrow interpretation of SOX 304 with respect to a personal 18

26 misconduct requirement. Fox TV Stations, Inc., 132 S. Ct. at 2309; Baker, 2012 WL , at *3. Additionally, considering that the Commission has been historically reluctant to utilize 304 in the ten years since SOX was enacted, and any broad strict liability interpretation violates fair notice. While broad discretionary statutes are occasionally deliberate, [t]he constitution does not permit a legislature to set a net large enough to catch all possible offenders, and leave it to the courts to determine who should be penalized. City of Chicago v. Morales, 527 U.S. 41, 56 (1999) (quoting United States v. Reese, 92 U.S. 214, 221 (1876)). SOX 304 must require personal misconduct because a broad and standardless strict liability understanding undoubtedly renders the statute unconstitutionally susceptible to arbitrary enforcement. Fox TV Stations, Inc., 132 S. Ct. at 2309; Lawson, 461 U.S. at 355; Morales, 527 U.S. at 59. The danger of arbitrary enforcement is further supported by SOX 304 s discretionary language allowing the SEC to exempt any person from the application... as it deems necessary and appropriate. Baker, 2012 WL , at *9; see also 15 U.S.C SOX 304 must require personal misconduct of CEOs and CFOs, otherwise it is rendered unconstitutional for the imposition of excessive fines. The SEC s strict liability interpretation for SOX 304 contains serious constitutional infirmities under the Excessive Fines Clause of the Eighth Amendment and the Due Process Clause. TXO Prod. Corp. v. Alliance Res. Corp., 509 U.S. 443, 453 (1993). SOX 304 is titled Forfeiture of Certain Bonuses and Profits, forfeitures constitute fines, which serve at least in part, 19

27 to punish the owner. Austin v. United States, 509 U.S. 602, 618 (1993); Bajakajian, 524 U.S. at 328. Since SOX 304 is used to punish and deter CEOs and CFOs it allows for the possibility of a remedy that is punitive in nature, and constitutional concerns are necessarily implicated. In re ibasis, Inc. Derivative Litigation, 532 F.Supp.2d 214, 224 (D. Mass. 2007); 15 U.S.C Punitive forfeitures cannot be grossly disproportional they must bear some relationship to the gravity of the offense, thus such fines should be based on the degree of reprehensibility. Bajakajian, 524 U.S. at 328; BMW of North America, Inc. v. Gore, 517 U.S. 559, 575 (1996). Punishing citizens who did not engage in unlawful conduct is a due process violation of the most basic sort. Bordenkircher, 434 U.S. at 363. The SEC s broad interpretation for SOX 304 is a clear violation of these constitutional principles as it seeks to punish CEOs and CFOs for the misconduct of others, and without requiring personal misconduct SOX 304 imposes a grossly disproportionate punishment. Bajakajian, 524 U.S. at 328; Gore, 517 U.S. at 575; Hayes, 434 U.S. at 363. The SEC s interpretation ventures beyond claw[ing] back illgotten gains received as a result of misconduct, requiring disgorgement of all bonuses, incentive and equity based compensation received during the year following the issuance, as well as all profits realized from securities sales during that year. SEC. v. Life Partners Holdings, Inc., 2013 WL , at *3 (W.D. Tex. 2013) (emphasis added); 15 U.S.C Since it is assumed that 20

28 Congress enacts constitutional statutes SOX 304 must require personal misconduct. Skilling, 561 U.S. at 412. Under SOX 302, the preceding section,... CEO[s] and CFO[s] certify that they are responsible for the existence, design, and operation of effective internal controls... [SOX] 304 provides an incentive for CEOs and CFOs to be rigorous in their creation and certification of internal controls. Jenkins, 718 F.Supp.2d at It ensures that executives have skin in the game, so they too will feel the impact of their cheating or willful ignorance... by claw[ing] back ill-gotten gains. Life Partners Holdings, Inc., 2013 WL , at *3 (emphasis added). While motivating CEOs and CFOs to catch misconduct may be one reason Congress enacted SOX 304, it does not defeat the requirement for personal misconduct. Baker, 2012 WL , at *5. SOX 302 requires officers to certify that based on the officer s knowledge there are no weaknesses in compliance systems. 15 U.S.C Officers must certify only that internal control systems provide reasonable assurance regarding reliability of financial reporting. 17 C.F.R (emphasis added). Further, the SEC shows that the executives knowingly circumvent[ed] or knowingly fail[ed] to implement a system of internal accounting controls to hold executives liable for any errors. 15 U.S.C. 78m; SEC v. Retail Pro, Inc., 2010 WL , at *3 (S.D. Cal. 2010) (finding that showing that a person misled company auditors can substantiate a claim for knowing circumvention of internal control systems). However, even the most robust internal control systems cannot possibly catch every error. Therefore, 21

29 punishing executives who implement and maintain control systems in good faith for misconduct that escapes detection is unreasonable. In light of the abovementioned statutes the SEC s severe interpretation of SOX 304 is not one that Congress would have sanctioned. Chevron, 467 U.S. at 844. Accordingly, SOX 304 requires personal misconduct to trigger disgorgement. Since SOX 304 requires personal misconduct, the SEC cannot substantiate a claim against Bosco and Lee based on the facts of this case. (R. at 3). Because Bosco and Lee were not involved in Prince s misconduct, to punish them for Prince s fraud scheme would trample upon their constitutional protections. (R. at 3 4); Hayes, 434 U.S. at 363. The SEC endeavors to capture all of Bosco s and Lee s bonuses, incentive and equity based compensation, and all profits received from Burlingham s securities sales; accounting for over seventy five percent of their annual pay. (R. at 2, 7). Exercising SOX 304 here is grossly disproportional and excessive as it is undisputed that the directors were not involved in the misconduct that caused the restatement. Bajakajian, 524 U.S. at 32; (R. at 7). It is undisputed that Bosco and Lee maintained Burlingham s internal controls in compliance with [SOX]. (R. at 4). Although they did not investigate the Japanese CEO s comments regarding unilateral termination rights, unlike in Retail Pro, Inc., they did not knowingly circumvent or knowingly fail to implement internal control systems, rather they sustained what was required by law. 15 U.S.C. 78m; (R. at 4); Retail Pro, Inc., 2010 WL , at *3. For these reasons, the Appellate Court erred in upholding the District Court s 22

30 ruling that SOX 304 requires a CEO and CFO to disgorge incentive-based compensation regardless of the directors non-involvement in the misconduct. II. THE SEC S DISGORGEMENT CLAIM CONSTITUTES A PENALTY OR FORFEITURE WITHIN THE MEANING OF 2462 S FIVE-YEAR STATUTE OF LIMITATIONS The Fourteenth Circuit erroneously held that disgorgement claims do not fall within the meaning of 28 U.S.C Specifically, the five-year statute of limitations pursuant to 2462 states, in part, that: [A]n action, suit or proceeding for the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise, shall not be entertained unless commenced within five years from the date when the claim first accrued. 28 U.S.C (emphasis added). As such, courts have interpreted the statute of limitations to apply to only punitive sanctions. See e.g. SEC v. Kokesh, 834 F.3d 1158, 1164 (10th Cir. 2016) (finding disgorgement constituted an equitable remedy, which was remedial rather than punitive since it did not influence punishment and only deprived wrongdoer of the benefits of wrongdoing). However, as the court acknowledged in Johnson, [i]t is clearly possible for a sanction to be remedial in the sense that its purpose is to protect the public, yet not be remedial because it imposes a punishment going beyond the harm inflicted by the defendant. Johnson, 87 F.3d at 491 n.11. Moreover, the purpose of disgorgement is not to inflict punishment but to prevent an unjust enrichment. Sheldon v. Metro-Goldwyn Pictures Corp., 309 U.S. 390, 399 (1940). Therefore, disgorgement may be ordered in an 23

31 amount casually related to the wrongdoing but may not be used punitively. SEC v. First City Financial Corp., F.2d 1215, 1231 (D.C. Cir. 1989). Here, the SEC s disgorgement order is punitive and thus acts as a penalty or a forfeiture. The disgorgement order seeks a $45,000 bonus paid to all executives, which is collateral to the fraudulent conduct. (R. at 7). Additionally, it seeks $250,000 in compensation provided to Conrad, which Prince never directly or indirectly received or controlled. Id. Accordingly, the disgorgement of these amounts is punitive and squarely within the meaning of A. The SEC s disgorgement claim is punitive in effect and thus acts as a penalty The SEC s disgorgement claim punishes Prince rather than returning him to the status quo ante. This Court has defined a penalty as something imposed in a punitive way for an infraction of a public law. Meeker v. Lehigh Valley R.R. Co., 236 U.S. 412, 423 (1915). A penalty goes beyond compensation, are intended to punish, and label defendants wrongdoers. Gabelli, 133 S. Ct. at 1223; see also Johnson, 87 F.3d at 488 (A penalty goes beyond remedying the damage caused to the harmed parties by the defendant s action. ). The Fourteenth Circuit, along with certain other appeals courts, distinguish disgorgement from penalties and forfeitures because of disgorgement s remedial rather than punitive purpose. See e.g. SEC v. Tambone, 550 F. 3d 106, 148 (1st Cir. 2008) (finding that disgorgement is 24

32 equitable relief and thus not a penalty under 2462); see also Riordian v. SEC, 627 F.3d 1230, 1234 (D.C. Cir. 2010) (holding that disgorgement orders were not penalties because disgorged amount was casually related to wrongdoing). However, when determining the punitive nature of a remedy, courts look not only to the label of relief, but also the purpose or effect of the remedy. United States v. Ward, U.S. 242, 249 (1980). Similar to a penalty, the SEC s disgorgement claim is punitive because it goes beyond the compensatory purpose of disgorgement by demanding funds that are unrelated to the relevant conduct and never acquired or controlled by Prince. In the present matter, the disgorgement amount includes a $45,000 bonus, which was distributed to all executive board members as a result of a lucrative contract with a computer tablet manufacturer, and because of Prince s fraudulent scheme. (R. at 3). The bonus was also provided to each executive in accordance with the compensation board s metrics and bears no correlation to Prince s work within the Division. Additionally, the disgorgement order seeks $250,000 from Conrad, which represents the total amount of bonuses Conrad earned during the relevant time periods. (R. at 7). These funds were never directly or indirectly provided to Prince, and thus requiring this payment is in effect punitive. The amount requested is outside the scope of disgorgement, which seeks to prevent unjust enrichment and ill-gotten gains. See SEC v. MacDonald, 699 F.2d 47, 54 (1st Cir. 1983) ( The court s power to order disgorgement extends only to the amount with interest by which the defendant profited from his wrongdoing. Any further would 25

33 constitute a penalty assessment. ) (quoting SEC v. Blatt, 583 F.2d 1325, 1335 (5th Cir. 1978)); see also United States v. Contorinis, 692 F.3d 136, 148 (2d Cir. 2012) (finding that court ordered disgorgement punitive because it contained profits never possessed or controlled by the defendant or others acting in concert with him did not return the defendant back to the status quo ante). The Fourteenth Circuit s reliance on Platforms Wireless, is unfounded because neither Prince nor Conrad s compensation were directly tied to the success of Burlingham s smartphone business and thus did not trickle[] down to others as a result of his own action. (R. at 18); see SEC v. Platforms Wireless Int l Corp., 617 F.3d 1072, 1098 (9th Cir. 2010). In fact, the reason Prince began executing side letters with the unilateral termination agreements was to make supplemental money. (R. at 2). Any bonus paid out as a result of business that occurred because of the side letters constituted only a small portion of any executive s compensation. Thus, the disgorgement order of $250,000 is unfairly punitive. See SEC v. Warde, 151 F.3d 42 (2d Cir. 1998) (finding that disgorgement would impermissibly operate as a penalty rather than a release of unjust gain because a portion of the ordered disgorgement belonged to third parties). B. Forfeiture and disgorgement are effectively synonyms and thus are time barred under 2462 Nothing in the statutory text supports the Fourteenth Circuit s narrow reading of forfeiture. In Graham, the court held that for the purposes of 26

34 2462 forfeiture and disgorgement are effectively synonyms. SEC v. Graham, 823 F.3d 1357, 1363 (11th Cir. 2016). Specifically, the court compared the ordinary meaning of both forfeiture and disgorgement and found no meaningful difference in the definitions of disgorgement and forfeiture. SEC v. Graham, 823 F.3d 1357, 1363 (11th Cir. 2016). For example, Black s Law Dictionary defines disgorgement as [t]he act of giving up something on demand or by legal compulsion. Disgorgement, Black s Law Dictionary (10th ed. 2014). Similarly, Black s Law Dictionary defines forfeitures as [t]he loss of a right, privilege, or property because of a crime, breach of obligation, or neglect of duty. Forfeiture, Black s Law Dictionary (10 th ed. 2014). As such, both terms refer to the same basic principle of losing property as a result of misconduct or breach. 1. The primary purpose of both disgorgement and forfeiture is deterrence Disgorgement and civil forfeiture serve the same purpose of forcing a defendant to forfeit or to disgorge what he had wrongfully gained. Contorinis, 743 F.3d at 310; see also SEC v. Manor Nursing Ctrs., Inc., 458 F.2d 1082, 1104 (2d Cir. 1972) ( [T]he deterrent effect of an SEC enforcement action would be greatly undermined if securities law violators were not required to disgorge illicit profits. ); see also First City Fin. Corp., 890 F.2d at 1232 n.24 ( [I]n the context of an SEC enforcement suit deterrence is the key objective. ). Furthermore, in Telsey a bankruptcy court agreed with the SEC s argument that the SEC s disgorgement order was not dischargeable in a 27