No BRIAN BOSCO, JASMINE LEE, and RONALD PRINCE, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent. BRIEF FOR THE PETITIONER

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1 No IN THE SUPREME COURT OF THE UNITED STATES BRIAN BOSCO, JASMINE LEE, and RONALD PRINCE, Petitioners, v. SECURITIES AND EXCHANGE COMMISSION, Respondent. ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FOURTEEN CIRCUIT BRIEF FOR THE PETITIONER Team P5 Counsel of Record for Respondent

2 Table of Contents Table of Authorities... ii Questions Presented... v Statement of the Case... 1 Statement of Facts... 3 Summary of the Argument... 7 Argument... 9 I. OFFICERS ARE NOT LIABLE FOR CERTIFYING FALSE FINANCIAL STATEMENTS UNLESS THE OFFICER POSSESSES SOME KNOWLEDGE OF THE FALSITY A. The text and legislative history of Rule 13a-14 indicate that an officer s violation requires knowledge B. The SEC s enforcement of Rule 13a-14 indicates that scienter is required for an officer to be found liable C. The cases cited in the court below for support are distinguishable II. OFFICERS ARE NOT LIABLE FOR DISGORGEMENT OF BONUSES UNLESS THEY PERSONALLY COMMITTED THE MISCONDUCT LEADING TO THE DISGORGEMENT A. Universal liability for any misconduct implicates constitutional questions that can be avoided by a narrower construction B. Alternatively, limiting the scope of misconduct to only that which occurs within the scope of employment avoids the constitutional obstacles III. DISGORGEMENT CLAIMS ARE SUBJECT TO THE STATUTE OF LIMITATIONS UNDER 28 U.S.C A. Disgorgement functions as a penalty B. Alternatively, disgorgement in this context also serves as forfeiture C. If 28 U.S.C does not apply, then disgorgement actions would not be subject to any statute of limitations Conclusion i

3 TABLE OF AUTHORITIES CASES Clark v. Martinez, 543 U.S. 371 (2005) Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976)...9, 10, 12 Gabelli v. SEC, 133 S. Ct (2013) GAF v. Milstein, 453 F.2d 709 (2d Cir. 1971) Gompers v. Buck s Stove & Range Co., 221 U.S. 418 (1911) Howard v. Everex Sys., Inc., 228 F.3d 1057 (9th Cir. 2000) Hughes Aircraft Co. v. Jacobson, 525 U.S. 432 (1999)... 9 In re Am. Int l Grp., Inc., 965 A.2d 763 (Del. Ch. 2009) In re Caremark Int l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996) In re Gold Resource Corp. Securities Litigation, 776 F.3d 1103 (10th Cir. 2015) MCI Telecommunications Corp. v. AT&T, 512 U.S. 218 (1994) Ponce v. SEC, 345 F.3d 722 (9th Cir. 2003)... 13, 17 Riordan v. SEC, 627 F.3d 1230 (D.C. Cir. 2010) SEC v. Bilzerian, 29 F.3d 689 (D.C. Cir. 1994) SEC v. Brown, 740 F.Supp.2d 148 (D.D.C. 2010) SEC v. Contorinis, 743 F.3d 296 (2d Cir. 2014) SEC v. Das, 723 F.3d 943 (8th Cir. 2013) SEC v. Egan, 994 F.Supp.2d 558 (S.D.N.Y 2014) SEC v. e-smart Technologies, Inc., 31 F.Supp.3d 69 (D.D.C. 2014) SEC v. First City Financial Corp., 890 F.2d 1215 (D.C. Cir. 1989) SEC v. Goldstone, 952 F.Supp.2d 1060 (D.N.M 2013)... 13, 15 SEC v. Graham, 823 F.3d 1357 (11th Cir. 2016)... 26, 27, 28 SEC v. Jackson, 908 F.Supp.2d 834 (S.D. Tex. 2012) SEC v. Jenkins, 718 F.Supp.2d 1070 (D. Ariz. 2010)... 19, 21 SEC v. Jensen, 835 F.3d 1100 (9th Cir. 2016)... 13, 14, 17, 18 ii

4 SEC v. Keller Industries, Inc., 342 F.Supp. 654 (S.D.N.Y. 1972) SEC v. Kokesh, 834 F.3d 1158 (10th Cir. 2016)... 23, 25 SEC v. Life Partners Holdings, Inc. No. 12-cv-00033, 2013 WL (W.D. Tex. Nov. 19, 2013) SEC v. Life Partners Holdings, Inc., 71 F.Supp.3d 615 (W.D. Tex. 2014)... 9, 14 SEC v. Pitters, No. 09-cv-20957, 2010 WL (S.D. Fla. Mar. 5, 2010)... 14, 15 SEC v. Spongetech Delivery Systems Inc., No. 10-cv-2031, 2015 WL at *7 (E.D.N.Y. Sept. 30, 2015) Siris v. SEC, 773 F.3d 89 (D.C. Cir. 2014) Zacharias v. SEC, 569 F.3d 458 (D.C. Cir. 2009) Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981 (9th Cir. 2009) STATUTES 15 U.S.C U.S.C , U.S.C. 78j U.S.C. 78m U.S.C. 78o U.S.C. 78r U.S.C passim Sarbanes-Oxley Act (SOX) of 2002, Pub. L , 116 Stat REGULATIONS 17 C.F.R a C.F.R a-14 (2009)... passim 17 C.F.R. 13d iii

5 CONSTITUTIONAL PROVISIONS U.S. Const. amend XIV U.S. Const. amend. V OTHER AUTHORITIES Allison List, Note, The Lax Enforcement of Section 304 of Sarbanes-Oxley: Why is the SEC Ignoring Its Greatest Asset in the Fight Against Corporate Misconduct?, 70 Ohio St. L.J. 195, 226 (2009) Certification of Disclosure in Companies' Quarterly and Annual Reports, Release No. 8124, 78 S.E.C. Docket 875, 2002 WL , at *3 (Aug. 28, 2002)... 11, 12 Disgorgement, Black s Law Dictionary (10th ed. 2014) Disgorgement, Webster s Third New Int l Dictionary (2002) Forfeiture, Black s Law Dictionary (10th ed. 2014) Forfeiture, Oxford English Dictionary (2d ed. 1989) Forfeiture, Webster's Third New Int'l Dictionary (2002) Restatement (Third) of Agency 2.01 (Am. Law Inst. 2006) Restatement (Third) of Agency 2.03 (Am. Law Inst. 2006) WSF Corp., SEC Release No. 204, 2002 WL (ALJ May 8, 2002)... 9 iv

6 QUESTIONS PRESENTED 1. Whether a cause of action exists under Rule 13a-14 against chief executive officers and chief financial officers who certify false financial statements where they did not have actual knowledge of the falsity and whether the disgorgement remedy authorized under Section 304 of the Sarbanes-Oxley Act of 2002 requires personal misconduct of chief executive officers and chief financial officers. 2. Whether the five-year statute of limitation authorized by 28 U.S.C applies to disgorgement claims. v

7 STATEMENT OF THE CASE On January 1, 2016, the U.S. Securities and Exchange Commission ( SEC ) filed a civil action against Brian Bosco, Jasmine Lee, and Ronald Prince (together, the Petitioners ) in the District of Fordham. (R. at 6). The SEC alleged that Prince had participated in a scheme to defraud Burlingham investors by reporting millions of dollars of unearned revenue. (R. at 6). With respect to Petitioners Bosco and Lee, the SEC alleged that Bosco and Lee violated Rule 13a-14 by certifying Burlingham s false and misleading financial statements for the fiscal year (R. at 6). Further, the SEC asserted that the financial restatements resulting from the false certification triggered a disgorgement remedy pursuant to Section 302 of the Sarbanes- Oxley Act (SOX) of 2002 for the 10-K filing filed on January 1, (R. at 6). With respect to Petitioner Prince, the complaint alleged violations of the Section 10(b) of the Securities Exchange Act (Exchange Act) of 1934, 15 U.S.C. 78j(b) and Rule 10b-5, 17 C.F.R b-5. (R. at 6). The SEC also requested disgorgement of gains during the periods of January 2008 to January 2010 and January 2014 to January (R. at 6). In June 2016, following limited discovery, Bosco and Lee filed for summary judgment under Rule 56. (R. at 6). The SEC filed a cross-motion for summary judgment against Bosco and Lee, and a motion for summary judgment against Prince. (R. at 6). The District Court granted the SEC s cross-motion, ruling that a cause of action exists under Rule 13a-14 against CEOs and CFOs who certify false 1

8 financial statements, even when they did not have knowledge of the falsity. R. at 6-7). The District Court further held that under SOX 304, a CEO and CFO must disgorge incentive-based and equity-based compensation if their company issues an accounting restatement, even when the CEO and CFO were not involved in the misconduct that caused the restatement and had no knowledge of the same. (R.at 7). Pursuant to this, the District Court ordered Bosco to disgorge $600,000 and Lee to disgorge $475,000 for all bonuses, incentive-based and equity-based compensation, and profits from the sale of Burlingham securities from January 1, 2015 to January 1, (R. at 7) With respect to Prince, the District Court granted the SEC s motion, finding Prince liable under Rule 10b-5 and holding that since disgorgement did not constitute a penalty or forfeiture under 2462, the statute of limitations did not apply to the SEC s request for disgorgement for the period of January 2008 to January (R. at 7). The District Court ordered disgorgement of the following amounts: (1) $1,025,000 earned from forty-one side letters; (2) $495,000 for all bonuses and other discretionary compensation received during the periods of January 2008 through January 2010 and January 2014 through January 2015, including a bonus of $45,000 in 2010 for a successful deal with a major producer of computer tablets; and (3) $250,000 representing the total amount of bonuses that Henrietta Conrad, another manager, earned during these periods. (R. at 7). Petitioners filed an appeal to the United States Court of Appeals for the Fourteenth Circuit. (R. at 7). The Fourteenth Circuit affirmed both of the 2

9 District Court s holdings. (R. at 14, 21). The U.S. Supreme Court granted Petitioners petition for a writ of certiorari on February 1, STATEMENT OF FACTS Burlingham Inc., founded in 1981, is a microchip manufacturer that has its roots in providing inventory to computer manufacturers in Japan. (R. at 1). Burlingham made its initial common stock offering in (R. at 1). In 2001, Veronica Uchekwe, the founder and CEO, added smartphone microchips to Burlingham s product lines. (R. at 1). By 2007, the smartphone business attained forty-two percent market-share and earned fifty-two percent of Burlingham s net income. (R. at 2). Ronald Prince was named Executive Vice President of Burlingham in 2002 and as part of that role, maintained direct managerial responsibility for the Communication Division, which included Burlingham s smartphone business. (R. at 2). Through Prince s leadership, Burlingham expanded into the growing market for the sale of smartphone microchips in China to meet the demand of smartphones in the UK. (R. at 2). Despite the success of smartphone business, Prince s compensation remained somewhat unreliable due to the compensation system in place at Burlingham. (R. at 2). Henrietta Conrad, the other Executive Manager of the Communications Division, acknowledged Prince s frustration and was of the belief that Burlingham s compensation system was atypical of Burlingham s peer companies. (R. at 2). 3

10 At Burlingham, discretionary bonuses were determined by the Compensation Committee, who analyzed the company s financial and operating results, and applied five metrics to both Burlingham as a whole, then to each division individually. (R. at 2). The committee then used the results of those measurements to determine each individual manager s compensation. (R. at 3). In January 2008, Prince began negotiating concessions into Burlingham s purchase agreements with select Chinese smartphone manufacturers without the knowledge or consent of Uchekwe or any other executive at Burlingham. (R. at 3). Under the terms of Prince s side agreements, select purchasers would enjoy unilateral termination rights that would allow them to terminate their agreements with Burlingham in the event of a projected decline of over two percent in the UK s GDP. (R. at 3). The rights would automatically terminate two years after the effective date of the side letter. (R. at 3). Standard purchase agreements at Burlingham contained termination rights limited to an event of force majeure negatively impacting the UK s smartphone market. (R. at 3). Prince received $25,000 for each side letter containing unilateral termination rights, and under the terms of the letter, would be entitled to an additional $50,000 if the purchaser chose to exercise those rights. (R. at 3). Prince executed these letters on behalf of Burlingham without disclosing their existence to Uchekwe, Burlingham s auditors, or attorneys. (R. at 3). From January 2008 through January 2010, Prince executed thirty side letters. (R. at 3). None of the purchasers exercised their unilateral termination 4

11 rights, and by February 2010, Prince felt financially comfortable enough to stop executing the letters. (R. at 3). In March 2010, Burlingham entered into a hugely successful contract with a major producer of computer tablets. (R. at 3). At the end of 2010, each executive was awarded a $45,000 bonus due to this deal. (R. at 3). In 2011, Uchekwe retired, and the board of directors named Brian Bosco as her replacement. (R. at 3). Under Bosco s leadership, Jasmine Lee was selected at CFO. (R. at 4). Bosco and Lee maintained Burlingham s internal controls in compliance with the Sarbanes-Oxley Act of (R. at 4). Pursuant to this, Bosco and Lee signed certifications of Burlingham s financial statements at each filing with the SEC. (R. at 4). In October 2014, Bosco, Lee, and Prince attended a technology conference. (R. at 4). While at the conference, both Bosco and Lee were approached, separately, by the CEO of a major Japanese smartphone manufacturer, who inquired about amending his company s agreement with Burlingham to include rumored deal sweeteners such as unilateral termination rights. (R. at 4). Bosco and Lee each initially brushed off the rumors, but upon learning that each had been asked individually, they considered looking into the source of the rumor. (R. at 4). Ultimately they did not pursue any investigation. (R. at 4). In January 2014, Prince began executing side letters again. (R. at 4). From January 2014 to January 2015, Prince executed eleven new side letters. (R. at 4). 5

12 The unilateral termination rights were triggered in March 2015, when there was a 2.5% decline in UK GDP. (R. at 4). Five of the eleven purchasers with side letters executed their termination rights, while the others continued to maintain the relationship under the other terms of the agreement. When the parties attempted to exercise their termination rights, Bosco and Lee acted to determine the validity of these rights. (R. at 5). Bosco also called the chairman of the board, informed him of the side letters and that they would likely have a material adverse impact on Burlingham s 2015 financial condition, its results of operations, and its first quarter financial results. (R. at 5). Additionally, Bosco placed Prince on an indefinite leave of absence. (R. at 5). The following week, the board of directors met for a special board meeting, where they appointed a committee of outside directors (the Special Committee ) to conduct an investigation into Prince s alleged side deals with Chinese smartphone manufacturers. (R. at 5). The Special Committee s preliminary findings indicated that Prince had been operating his scheme from 2008 through 2010, and in (R. at 5). The Special Committee eventually found that Prince s scheme substantially affected the company s financial statements for the fiscal year 2014, and that the correction required reclassification of some income items related to the contracts with the Chinese microchip manufacturers. 1 (R. at 5). The company filed a restated 10-K for fiscal year (R. at 5). 1 Uchekwe and the SEC reached a settlement agreement concerning Burlingham filings from January 2008 through January The parties 6

13 SUMMARY OF THE ARGUMENT The United States Court of Appeals for the Fourteenth Circuit s holdings should be reversed. No cause of action exists under Rule 13a-14 against chief executive officers and chief financial officers who certify false financial statements where they did not have any knowledge of the falsity. 17 C.F.R a-14 (Rule 13a- 14) (2009). Rule 13a-14 must be read to include a scienter element. The text of the rule and its authorizing statute clearly express that the rule can only be applied where some knowledge exists. However, even if this court requires more than the text of Rule 13a-14 to evaluate the question, the history of enforcement actions using the rule, not to mention the SEC s own interpretations of the rule, demands that scienter is required. Similarly, the disgorgement remedy authorized under Section 304 of the Sarbanes-Oxley Act (SOX 304) of 2002 requires personal misconduct of chief executive officers and chief financial officers in order to avoid questions about the constitutionality of the statute. SOX 304 is ambiguous; some readings, however, provoke questions about the constitutionality of the law. To avoid these questions, in accordance with canons of statutory interpretation, this Court should construe SOX 304 narrowly. Alternatively, this Court can resolve this case without considering the constitutional issues, by requiring misconduct to be within the scope of the actor s employment at the company. stipulate that the only restated filing at issue is the 10-K filing for fiscal year (R. at 5). 7

14 Finally, the five-year statute of limitation authorized by 28 U.S.C applies to disgorgement claims because disgorgement of ill-gotten gains from alleged violations of securities law constitutes either a penalty or punitive forfeiture. Section 2462 imposes a five-year statute of limitations for any civil fine, penalty, or forfeiture, pecuniary or otherwise. 28 U.S.C (2016). The disgorgement ordered by the District Court at the request of the SEC constitutes a penalty under Courts have distinguished between penalties and remedial actions by finding that the primary purpose of penalties is to punish culpable individuals, while remedial measures are designed to return culpable individuals to the status quo prior to the crime. In the present case, the disgorgement order goes further than returning Prince to the status quo, rather it includes an order to disgorge money from a bonus wholly unrelated to Prince s misconduct, and an order to disgorge the amount of bonuses awarded to another employee. This order thus goes beyond the scope of a remedial measure, and functions as a penalty. Alternatively, disgorgement constitutes forfeiture under 2462 in that the terms function as synonyms. At the very least, disgorgement is a subset of forfeiture. The Court should reverse the rulings of the Court of Appeals for the Fourteenth Circuit in their entirety. Without this, corporate managers will be subject to endless liability beyond their control and disgorgement actions will be subject to no statute of limitations. 8

15 ARGUMENT I. OFFICERS ARE NOT LIABLE FOR CERTIFYING FALSE FINANCIAL STATEMENTS UNLESS THE OFFICER POSSESSES SOME KNOWLEDGE OF THE FALSITY. Rule 13a-14 was promulgated after the passage of the Sarbanes-Oxley Act (SOX) of 2002, Pub. L , 116 Stat. 745 (codified at 15 USC 7201 et seq). It is undisputed that Congress intended the law to rein[] in corporate fraud and impose[] a number of important disclosure and control-related duties on corporate officers and their companies. SEC v. Life Partners Holdings, Inc., 71 F.Supp.3d 615, 625 (W.D. Tex. 2014). However, while corporate violations of the regulations promulgated under SOX require no scienter, the application of the regulations to individual corporate officers requires a showing of at least recklessness. See WSF Corp., SEC Release No. 204, 2002 WL , at *6 (ALJ May 8, 2002) (noting that corporate violations of securities laws do not require a finding of scienter); Ernst & Ernst v. Hochfelder, 425 U.S. 185, (1976) (noting that officer liability under Section 13a requires scienter like that required under Rule 10b-5 knowing or reckless). With this background, the SEC promulgated Rule 13a-14 in A. The text and legislative history of Rule 13a-14 indicate that an officer s violation requires knowledge. Analysis of any statute or regulation begins with the text itself. See Hughes Aircraft Co. v. Jacobson, 525 U.S. 432, 438 (1999) (stating our analysis begins with the language of the statute... [a]nd where the statutory language provides a clear answer, it ends there as well (internal quotations 9

16 omitted)). It is a maxim in administrative law that agency rules may not expand beyond the scope of the power delegated by Congress. See Ernst & Ernst, 425 U.S. at (stating the rulemaking power granted to an administrative agency charged with the administration of a federal statute is not the power to make law. Rather, it is the power to adopt regulations to carry into effect the will of Congress as expressed by the statute. (internal quotations omitted)). See also MCI Telecommunications Corp. v. AT&T, 512 U.S. 218, 229 (1994) (stating an agency s interpretation of a statute is not entitled to deference when it goes beyond the meaning that the statute can bear ). The text of Rule 13a-14 and the related statutes indicate that an officer s violation of the regulation requires knowledge. The rule states that the principal executive and financial officers in a corporation must certify the accuracy of both the yearly and periodic financial statements of the corporation. See 17 CFR a-14(a)-(b). There is no mention of a knowledge requirement within the regulation itself. However, Rule 13a-14 is authorized by Section 302 of SOX which states in relevant part: The Commission shall, by rule, require... that [the officers] certify in each annual or quarterly report... that-- (1) the signing officer has reviewed the report; (2) based on the officer s knowledge, the report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading; (3) based on such officer's knowledge, the financial statements, and other financial information included in the report, fairly present in all material respects the financial condition and results of operations of the issuer as of, and for, the periods presented in the report; 10

17 15 U.S.C (2002) (emphasis added). The text of the statute authorizing Rule 13a-14 requires that regulations under 7241 contemplate the officer s knowledge when imposing liability for violations of the statute. Courts have stated just that that facts need to be plead (and later proven) that illustrate an individual officer had knowledge of, or was recklessly disregarding, the falsity of statements he/she was certifying. See In re Gold Resource Corp. Securities Litigation, 776 F.3d 1103, (10th Cir. 2015) (holding that a showing of scienter is necessary to hold officers liable for securities fraud); Zucco Partners, LLC v. Digimarc Corp., 552 F.3d 981, (9th Cir. 2009) (holding that a SOX-required certification on a false financial statement was not enough to show adequate scienter for securities fraud). Because the text of the authorizing statute requires the certifications to be based on the officer s knowledge, and because the rules written pursuant to the statute cannot expand liability beyond that intended by Congress, Rule 13a-14 requires at least some knowledge of the falsity or reckless disregard of the same. Agency understandings of the regulation contemporaneous with its promulgation is equally favorable to the assertion that Rule 13a-14 requires knowledge of the underlying falsity. In the press release accompanying the issuance of Rule 13a-14 in 2002, the SEC reiterated that 13a-14 certifications were based on [the officer s] knowledge. Certification of Disclosure in Companies' Quarterly and Annual Reports, Release No. 8124, 78 S.E.C. Docket 875, 2002 WL , at *3 (Aug. 28, 2002). The release takes up the issue 11

18 of liability for false statements for officers. Under the heading Liability for False Certification, the SEC states that officers are liable for certifying false statements, through private or public civil action, under Sections 10(b), 13(a), 15(d), 18, and of the Securities and Exchange Act. Id. at *9. See 15 U.S.C. 78j(b), 78m(a), 78o(d), 78r (2010). Aiding and abetting liability under 15 U.S.C. 20 et seq. (2010) is also mentioned. The SEC does not contemplate, however, individual liability under Rule 13a-14 itself at all, though courts quickly found an independent cause of action under the regulation which the SEC could use to enforce the rule. See SEC v. Brown, 740 F.Supp.2d 148, (D.D.C. 2010) (holding that Rule 13a-14 supported a separate cause of action against former employee who knowingly concealed information from a financial statement). To bring this judicially-created cause of action into line with other SEC actions, it should require similar scienter to the statutes mentioned as sources of liability. More simply, the SEC intended Rule 13a-14 to be enforced in the manner prescribed by the above-named sections of the Exchange Act. Under each of the sections referenced, courts have demanded a showing of at least negligence to find director liability, and have required knowing intent to deceive in some. See Siris v. SEC, 773 F.3d 89 (D.C. Cir. 2014) (holding that knowing intent satisfied for civil liability under Section 15); SEC v. Das, 723 F.3d 943 (8th Cir. 2013) (holding that civil liability under Section 13 requires a showing of negligence); Ernst & Ernst, 425 U.S. at 194 (holding that a violation of Section 10(b) requires intent to deceive, manipulate, or defraud ); SEC v. Keller Industries, Inc., 342 F.Supp. 654 (S.D.N.Y. 1972) (holding that civil 12

19 liability under of Section 18 requires a showing of at least reckless negligence). Aiding and abetting liability also requires knowing scienter. See also Ponce v. SEC, 345 F.3d 722 (9th Cir. 2003) (holding that aiding and abetting liability for false securities reporting requires knowledge of the violation and substantial assistance in causing it). The SEC stated that liability for false certifications could follow from any of these statutes. Construing Rule 13a-14 in line with them best articulates the intent and understanding the agency had at the time. Thus, requiring the plaintiff to prove at least some level of scienter is required for civil liability under Rule 13a-14. B. The SEC s enforcement of Rule 13a-14 indicates that scienter is required for an officer to be found liable. Until 2011, the SEC had never pursued a case under Rule 13a-14 against an officer that did not also allege some level of scienter for the defendant. See SEC v. Jensen, 835 F.3d 1100, 1104 (9th Cir. 2016). Until last year, no court had considered the possibility that Rule 13a-14 could be satisfied without some level of scienter. See Id. Even in cases where the court noted that an officer s signature was enough to impose liability, it was always accompanied by an allegation of scienter - sometimes reckless disregard, but more often actual knowledge. See, e.g., SEC v. e-smart Technologies, Inc., 31 F.Supp.3d 69 (D.D.C. 2014) (holding that a CEO s organization of a scheme to hide stock issuances as loans was sufficient knowledge for Rule 13a-14 liability); SEC v. Goldstone, 952 F.Supp.2d 1060 (D.N.M 2013) (allowing suit 13

20 under Rule 13a-14 when the SEC alleged that the officers had prior knowledge of numbers that would prove the financial statements wrong). Until Jensen, Rule 13a-14 claims had overwhelmingly always been litigated with a corresponding 10(b) claim, requiring scienter. Indeed, since Rule 13a-14 was enacted there have been only four reported opinions (and one unreported) that find an officer violated of Rule 13a-14 without a 10(b) violation, including Jensen. See 835 F.3d at 1100; Life Partners Holdings, 71 F.Supp.3d 615; SEC v. Egan, 994 F.Supp.2d 558 (S.D.N.Y 2014); SEC v. Jackson, 908 F.Supp.2d 834 (S.D. Tex. 2012); SEC v. Pitters, No. 09-cv-20957, 2010 WL (S.D. Fla. Mar. 5, 2010). Even in those cases, the court still premises liability on the finding of scienter. In Life Partner Holdings, a complete failure to implement controls was sufficient to demonstrate knowledge, or at least reckless disregard of the truth for a CEO who certified a false financial statement. 71 F.Supp.3d at In Egan, the CEO had actual knowledge that the company s financial statements, that he certified, had misstated the return of a leased property as income. 994 F.Supp.2d at 563. In Jackson and Pitters, similarly, the certifying officers had actual knowledge of side payments to the Nigerian government and of bogus revenue records respectively, neither of which were reflected in the financial statements. Jackson, 908 F.Supp.2d at ; Pitters, 2010 WL , at 2 Other areas of law consider the total failure to install review procedures to be an indication of, or stand in for, knowledge. Most notably, Delaware corporate law holds directors of a corporation liable for losses when they either know of misconduct or completely fail to install reporting or oversight controls. See In re Caremark Int l Inc. Derivative Litig., 698 A.2d 959 (Del. Ch. 1996). 14

21 *3. In other cases, the scienter for the 10(b) claim is used to find knowledge for the Rule 13a-14 claim. See Goldstone, 952 F.Supp.2d 1060, 1242 (refusing to dismiss a claim of a violation of Rule 13a-14 when the SEC alleged that the certifying officers had knowledge sufficient to know that certain accountings in the financial statement were false). These enforcement action indicate that Rule 13a-14 liability should only be imposed where some measure of scienter is found. In the present case, none of the Petitioners had knowledge of Prince s side letters or secret negotiations. (R. at 3, 5). Neither Bosco or Lee had any knowledge that secret deals had been negotiated until the unilateral termination rights were triggered in March 2015, after the 10-K at issue here was already filed. (R. at 4). Nor did they have information that could have indicated there was a problem. Id. Burlingham also had internal compliance controls that complied with the requirements in SOX. (R. at 4). To hold Bosco or Lee liable for misconduct any earlier than March 2015 then, goes against years of precedent requiring at least some knowledge on the part of the party being punished or a complete lack of internal controls. C. The cases cited in the court below for support are distinguishable. The Fourteenth Circuit relied heavily on dicta in various cases and the recent unprecedented opinion in Jensen to hold that Rule 13a-14 liability for officers requires no showing of knowledge. However, each of these cases is distinguishable from the present case. 15

22 For the proposition that signatures bear an inherent truth value, the court cites: when a corporate officer signs a document on behalf of the corporation, that signature will be rendered meaningless unless the officer believes that the statements in the document are true. Howard v. Everex Sys., Inc., 228 F.3d 1057, 1061 (9th Cir. 2000). However, Howard was a class action under 10(b) where the court was merely overturning the defense s motion to dismiss. In doing so, the court noted that the defendant s possible motive, combined with the red flags of [the company s] financial condition are sufficient to withstand a motion to dismiss. Id at Further evidence was necessary to prove liability at trial. Id. The court also addressed the certification further stating that there is evidence indicating [the defendant] signed financial statements in the face of potentially alarming information concerning [the company s] financial condition. Id. This analysis is closer to the willful blindness or reckless disregard standard in other cases, and not a strict liability regime like the government would argue here. The court below also analogizes 13a-14 to other rules promulgated under Section 13 of the Securities and Exchange Act namely 13a-13 and 13d C.F.R a-13, 13d-1 (2010) Neither of these provisions are authorized by the same statute as Rule 13a-14 but are instead rules directly under the Exchange Act. Because of that, 13a-13 and 13d-1 are not limited by the same language as Rule 13a-14. Whereas 13a-14 is promulgated under a statute requiring liability based on the officer s knowledge, these other rules have no 16

23 similar requirement. Thus, it makes sense that 13a-13 and 13d-1 would have a different scienter requirement from that of 13a-14. Additionally, the court employs cases to analogize to Rule 13a-14 that still include reference to a scienter requirement. In Ponce v. SEC, the court does note an implicit truthfulness requirement for 13a-13 claims, but does so in the context of an aiding and abetting claim against the corporation s auditor. 345 F.3d at 734. To make out that claim, the SEC proved that the auditor willfully provided substantial assistance to violate the regulation. Scienter was necessary to the claim. Similarly, scienter was required in GAF Corp. v. Milstein, when a corporation alleged a conspiracy to violate Section 13D by lying about one s intentions to acquire more stock. 453 F.2d 709, 719 (2d Cir. 1971). Liability would only follow if the members conspired to pool their securities interests for one of the stated purposes. Id. Even the allegedly analogous rules require a showing of scienter for individual officer liability. Finally, the court rests on the opinion in Jensen as affirmative evidence that Rule 13a-14 does not require a showing of scienter because certification implicitly includes it. R. at 10. This assertion, however, misinterprets Jensen. There the court reversed a summary judgment finding that 13a-14 necessarily required knowledge. Jensen, 835 F.3d at The court ruled that there was an implicit truthfulness requirement in Rule 13a-14 that certification was an implicit guarantee of truth but explicitly refused to state what mental state is necessary to prove an individual violation of the Rule. Id. at 1113 n.6. In concurrence however, one judge suggested that proof of a false certification 17

24 under Rule 13a-14 requires showing at least recklessness. Id. at (Bea, J, concurring) (quoting Merriam-Webster defines false, as intentionally untrue (e.g. false testimony ), and as intended or tending to mislead (e.g. a false promise ). False, Merriam Webster (last visited Aug. 9, 2016)(emphasis added)). The judge also alludes to the SEC Release about Rule 13a-14, as evidence that the SEC intends the rule to require mental culpability. Jensen, 835 F.3d at 1118 (quoting Release No. 8124, 2002 WL ). To the extent that Jensen departs from the historical requirement of scienter for Rule 13a-14 violations, it does so by suggesting only that the defendant may not need absolute knowledge of a statement s falsity. A total lack of scienter evidence cannot sustain liability for a certifying officer under Rule 13a-14. II. OFFICERS ARE NOT LIABLE FOR DISGORGEMENT OF BONUSES UNLESS THEY PERSONALLY COMMITTED THE MISCONDUCT LEADING TO THE DISGORGEMENT. SOX 304 requires that a CEO or CFO reimburse the company for any bonus or incentive-based compensation they received if they must file an accounting restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws. 15 U.S.C (SOX 304) (2002). The circuit court here found that any misconduct in the company, no matter who committed it, that results in noncompliance, triggers the statute. (R. at 12-13). 18

25 A. Universal liability for any misconduct implicates constitutional questions that can be avoided by a narrower construction. Imposing broad liability for any conduct outside one s control raises questions about the statute s constitutionality. Namely, the requirement that officers forfeit all incentive compensation runs aground of the Due Process Clause of the Fifth and Fourteenth Amendments. U.S. Const. amend. V; U.S. Const. amend XIV. SOX 304, as written, provides insufficient notice as to the conduct required to constitute a violation and thus provides no notice of the methods officers can take to avoid liability. Due process requires that laws give the person of ordinary intelligence a reasonable opportunity to know what is prohibited. SEC v. Life Partners Holdings, Inc. No. 12-cv-00033, 2013 WL (W.D. Tex. Nov. 19, 2013) (quoting Grayned v. City of Rockford, 408 U.S. 104, 108 (1972)). SOX 304 merely prescribes misconduct that requires an accounting restatement. 15 U.S.C To date, the SEC has provided no guidance on what precisely requires a restatement beyond the text of the original Exchange Act; no case has defined the parameters of what required means, because the SEC has only enforced SOX 304 against officers of companies who have already refiled their statements. See Allison List, Note, The Lax Enforcement of Section 304 of Sarbanes-Oxley: Why is the SEC Ignoring Its Greatest Asset in the Fight Against Corporate Misconduct?, 70 Ohio St. L.J. 195, 226 (2009) (discussing the lack of guidance on the meaning of required in the statute). See, e.g., SEC v. Jenkins, 718 F.Supp.2d 1070, 1075 (D. Ariz. 19

26 2010) (holding the SEC may enforce SOX 304 against an officer of a corporation that has already refiled its 10-K). Because there is no guidance on exactly what conduct leads to liability, the statute is unconstitutionally broad. The canon of constitutional avoidance demands that the court chose an interpretation of an ambiguous statute that avoid questions about the constitutionality of a statute. See Clark v. Martinez, 543 U.S. 371, 381 (2005) (explaining the canon of constitutional avoidance as the presumption that Congress intended a constitutional meaning of a statute over one that raises doubts about constitutionality). Here, Congress left SOX 304 ambiguous by omitting whose misconduct is required. As the lower court dissent noted here, Congress could have modified the statute to merely add the word issuer or officer misconduct to clear up the ambiguity. (R. at 27 (Khatibifar, J. dissenting)). In light of the ambiguity, this Court should choose the alternative construction that does not subject officers to near unlimited liability in violation of the Due Process Clause, and hold that there must be personal officer misconduct before disgorgement of incentive pay is allowable. B. Alternatively, limiting the scope of misconduct to only that which occurs within the scope of employment avoids the constitutional obstacles. Even if this Court is unwilling to impose a strict personal misconduct reading on SOX 304, the statute should at least be limited by ensuring that CEOs and CFOs are only liable when the misconduct leading to refiling is within the scope of the actor s employment. In SEC v. Jenkins, while dismissing the argument that SOX 304 requires personal wrongdoing, the court noted that 20

27 a corporation acts through its officers, agents or employees and is liable for the actions of such persons acting within the scope of their agency. 718 F.Supp.2d at 1075 (emphasis added). The court bases this view on traditional norms in corporate law that impute liability onto corporations for actions taken by a corporation s officers or employees within the scope of their employment. See In re Am. Int l Grp., Inc., 965 A.2d 763, 823 (Del. Ch. 2009) (noting that liability is only imputed when wrongdoing is on behalf of the corporation and in the course of business ). This language mirrors traditional agency principles. Under the common law doctrine of agency, an agent s actions transmit to the principal when done within the agent s actual authority. Restatement (Third) of Agency 2.01 (Am. Law Inst. 2006). Even under the more expansive view of apparent authority an actors actions must be traceable to the principal s manifestations. Id Here, Bosco and Lee have given no instructions or consent to Prince that he can or should negotiate unilateral termination rights. Prince s actions in hiding the negotiations from them also illustrates this. Thus, because the actions here were outside of Prince s authority under his relationship with Burlingham, the liability for his misconduct should not be imputed to anyone further in the corporation including the CEO or CFO. Because Prince s misconduct here was not within either the actual or apparent authority he had through the corporation, his misconduct cannot be imputed to the CEO or CFO for their personal liability. 21

28 III. DISGORGEMENT CLAIMS ARE SUBJECT TO THE STATUTE OF LIMITATIONS UNDER 28 U.S.C The Securities Act of 1933 and the Exchange Act do not provide a statute of limitations applicable to SEC enforcement actions. (R. at 15). Given this, the standard five-year statute of limitations authorized by 28 U.S.C. 2462, which applies to any civil fine, penalty, or forfeiture, pecuniary or otherwise. 28 U.S.C (2016) must apply to the disgorgement claim requested by the SEC and ordered by the District Court. Focusing on the formal label of disgorgement leads to an incorrect assessment of whether or not disgorgement constitutes a penalty or forfeiture under Instead, the focus should be placed on the character and purpose of the action. Gompers v. Buck s Stove & Range Co., 221 U.S. 418, 441 (1911) (finding that the court should look to character and purpose to distinguish between actions that are remedial, and actions that are punitive). The character and purpose of the disgorgement order at issue is undoubtedly intended to function as a penalty, or alternatively, forfeiture. The Court should find that the SEC is barred under 2462 from bringing this enforcement action. A. Disgorgement functions as a penalty. The disgorgement ordered by the District Court at the request of the SEC constitutes a penalty under Courts have distinguished between penalties and remedial actions by finding that the primary purpose of penalties 22

29 is to punish culpable individuals, while remedial measures are designed to return culpable individuals to the status quo prior to the crime. The District of Columbia Circuit has held that disgorgement orders are not penalties, at least so long as the disgorged amount is causally related to the wrongdoing. Riordan v. SEC, 627 F.3d 1230, 1234 (D.C. Cir. 2010). Other courts have reached similar conclusions. See, e.g., Zacharias v. SEC, 569 F.3d 458, (D.C. Cir. 2009); SEC v. Bilzerian, 29 F.3d 689, 696 (D.C. Cir. 1994); SEC v. First City Financial Corp., 890 F.2d 1215, 1231 (D.C. Cir. 1989) (finding that the amount of disgorgement ordered was causally related to the wrongdoing, and did not go farther so as to constitute a punitive measure). In Riordan, the defendant was ordered to disgorge all commissions and bonuses derived from his fraudulent dealings, as well as prejudgment interest on the disgorged funds. Riordan, 627 F.3d at The amount of disgorgement ordered thus went no farther than the amount related to defendant s conduct, and to go farther would have led to a finding that the amount was in fact punitive. In Kokesh, the Tenth Circuit distinguished disgorgement from a penalty by reasoning that: [p]roperly applied, the disgorgement remedy does not inflict punishment. The object of restitution [in the disgorgement context]... is to eliminate profit from wrongdoing while avoiding, so far as possible, the imposition of a penalty. Restatement (Third) of Restitution and Unjust Enrichment 51(4) (Am. Law Inst. 2010). Disgorgement just leaves the wrongdoer in the position he would have occupied had there been no misconduct. Id. 51 cmt. K. 23

30 SEC v. Kokesh, 834 F.3d 1158, 1164 (10th Cir. 2016) (citing Restatement (Third) of Restitution and Unjust Enrichment 51(4)(Am. Law Inst. 2010)). Restitution in the disgorgement context does not serve the traditional common law function of restitution. Instead, it focuses on depriving the wrongdoer of any illicitly gained profits, and not necessarily on compensation of victims of the wrongdoing. See, SEC v. Spongetech Delivery Systems Inc., No. 10-cv-2031, 2015 WL at *7 (E.D.N.Y. Sept. 30, 2015) ( [Disgorgement] operates to make the illicit action unprofitable for the wrongdoer, disgorgement need not serve to compensate the victims of the wrongdoing. ) (citing FTC v. Bronson Partners LLC, 654 F.3d 359, 374 (2d Cir. 2011)). In the present case, the disgorgement amount is not causally related to the wrongdoing, thus it goes beyond the scope of the D.C. Circuit s reasoning in Riordan. It also fails to avoid the imposition of a penalty under Kokesh. The amount to be disgorged includes two distinct amounts that push the order past a return to the status quo, and to the zone constituting a penalty. First, the amount of bonuses and discretionary income to be disgorged includes the $45,000 bonus from (R. at 7). This bonus was awarded as a result of a hugely successful deal with a producer of tablets, was entirely unrelated to Prince s side letter scheme, and was awarded to all executives that year. (R. at 3). Further, there is no indication that Burlingham s computer tablet business was even housed within the Communications Division, so Prince may not have even exercised any managerial responsibility over the deal. By including the amount of this totally unrelated bonus, the disgorgement goes 24

31 further than returning Prince to the status quo, and leaves Prince worse off than he would have been absent any misconduct. This order thus goes beyond the scope of a remedial measure, and functions as a penalty. The inclusion of the $250,000 representing the bonuses that Henrietta Conrad earned during the relevant periods in the disgorgement order also demonstrates that the disgorgement is intended to serve as a penalty. Under Kokesh, the Tenth Circuit found that there is nothing punitive about requiring a wrongdoer to pay for all the funds he caused to be improperly diverted to others as well as to himself. Kokesh, 834 F.3d at (emphasis added). In Kokesh, the defendant was advising the treasurer of the fund to pay bonuses and salaries of executives (including to the defendant himself). Id. at Thus, the Tenth Circuit found that it proper for the disgorgement order to include the amount of those funds diverted to others, since it was under the defendant s direct control. Id. at By contrast, Prince exercised no such control over the amount of bonuses that Conrad received during the relevant periods. At Burlingham, discretionary bonuses were determined by the Compensation Committee, who analyzed the company s financial and operating results, applied five metrics to Burlingham as a whole and to each division individually, and then used the results of that process to determine each individual manager s compensation. (R. at 2-3) (emphasis added). Prince did not serve on the compensation committee, and thereby had no direct tie to the amount of discretionary compensation due to Conrad during these periods. The argument that Prince should be held liable for the amount of bonuses that 25

32 Conrad received is thus tenuous at best. Prince had no role in determining the amount of Conrad s compensation, in stark contrast to Kokesh, where defendant himself was giving the directions as to how much money should be diverted to specific officers. Kokesh, 834 F.3d at Prince s lack of involvement in setting Conrad s discretionary compensation demonstrates that the disgorgement order goes further than returning him to the position he would have occupied had there been no misconduct and thus surpasses the Tenth Circuit s construction of what constitutes disgorgement. The disgorgement order at issue operates as a penalty. B. Alternatively, disgorgement in this context also serves as forfeiture. Alternatively, disgorgement constitutes forfeiture under 2462 in that in the modern legal lexicon, disgorgement and forfeiture function as synonyms. In determining how to interpret the terms disgorgement and forfeiture, courts should look to the terms ordinary meaning. SEC v. Graham, 823 F.3d 1357, 1360 (11th Cir. 2016) (citing Taniguchi v. Kan Pac. Saipan, Ltd., 132 S. Ct. 1997, 2002 (2012)) (stating that to determine whether 2462 applies to certain types of relief, the court must look to the ordinary meaning of the term penalty ). Common usage defines forfeiture as an action through which a person or entity must turn over property or money due to some wrong they committed. See, e.g., Forfeiture, Webster's Third New Int'l Dictionary (2002) (defining 26

33 forfeiture as [t]he divesting of the ownership of particular property of a person on account of the breach of a legal duty and without any compensation to him ); Forfeiture, Oxford English Dictionary (2d ed. 1989) (defining forfeiture as [t]he fact of losing or becoming liable to deprivation of (an estate, goods, life, an office, right, etc.) in consequence of a crime, offence, or breach of engagement ). Disgorgement is defined as to give up (as illegally gained profits) on request, under pressure, or by court order especially to prevent unjust enrichment. Disgorgement, Webster s Third New Int l Dictionary (2002). Black s Law Dictionary provides similar definitions for their legal usage. Black s defines forfeiture 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 (10th ed. 2014). Disgorgement is defined as [t]he act of giving up something (such as profits illegally obtained) on demand or by legal compulsion. Disgorgement, Black s Law Dictionary (10th ed. 2014). Additionally, the court in Graham points out that this court has used the terms interchangeably. Graham, 823 F.3d at 1363 (Citing United States v. Ursery, 518 U.S. 267, 284 (1996) ( Forfeitures serve a variety of purposes, but are designed primarily to confiscate property used in violation of the law, and to require disgorgement of the fruits of illegal conduct. ). Some circuit courts have followed the Supreme Court s lead and used the terms interchangeably as well. See SEC v. Contorinis, 743 F.3d 296, 310 (2d Cir. 2014) ( Both forfeiture and disgorgement seek to force a defendant to give up- that is, to forfeit or disgorge- what he has wrongfully gained. ). 27