No IN THE SUPREME COURT OF THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION BRIAN BOSCO; JASMINE LEE; RONALD PRINCE

Transcription

1 No IN THE SUPREME COURT OF THE UNITED STATES SECURITIES AND EXCHANGE COMMISSION V. BRIAN BOSCO; JASMINE LEE; RONALD PRINCE ON WRIT OF CERTIORARI TO THE UNITED STATES COURT OF APPEALS FOR THE FOURTEENTH CIRCUIT BRIEF FOR THE PETITIONER Team P7 Counsel of Record for Petitioner

2 TABLE OF CONTENTS TABLE OF CONTENTS i TABLE OF AUTHORITIES iii QUESTIONS PRESENTED vi STATEMENT OF THE CASE STATEMENT OF FACTS SUMMARY OF THE ARGUMENT ARGUMENT I. THE FOURTEENTH CIRCUIT ERRED IN CONCLUDING THAT RULE 13A-14 OF THE SARBANES-OXLEY ACT DOES NOT REQUIRE A SHOWING OF MENTAL CULPABILITY IN ORDER TO FIND CEOs AND CFOs LIABLE FOR FALSE CERTIFICATIONS... 8 A. This Court should adopt an aider and abettor theory in determining CEO and CFO liability under Rule 13a B. Bosco and Lee are not liable of a Rule 13a-14 violation under an aiding and abetting theory because the SEC cannot satisfy the three-prong test set forth in Ponce C. Even if this Court does not adopt an aiding and abetting theory of liability, Bosco and Lee are not liable of a securities violation under Rule 13a-14 because the SEC cannot demonstrate they acted with scienter D. Even if this Court allows recklessness to satisfy scienter, Bosco and Lee are not liable of a 13a-14 violation because their conduct does not satisfy any circuit s recklessness standard. 16 II. THE AS A RESULT OF MISCONDUCT PORTION OF SECTION 304 OF THE SARBANES-OXLEY ACT OF 2002 IS INTENTIONALLY BROAD IN ORDER TO REQUIRE PERSONAL MISCONDUCT OF THE CEO AND CFO FOR DISGORGEMENT REMEDIES A. Whether as a result of misconduct is in reference to the misconduct of the CEO and CFO or the issuer is unsettled.. 18 i

3 B. The legislative intent behind Section 304 of the Sarbanes-Oxley Act of 2002 is to require misconduct by the CEO and CFO for disgorgement remedies C. Petitioners case presents a unique approach to the original three element relief test under SOX 304, illustrating the differences between petitioners case and previous disgorgement cases in a way that questions the constitutionality of SOX 304 entirely III. THE FIVE-YEAR STATUTE OF LIMITATIONS IN 28 U.S.C APPLIES TO DISGORGEMENT CLAIMS, AND THEREFORE THE SEC SHOULD BE BARRED FROM THE DISGORGEMENT OF MONEY ACQUIRED BY PETITONERS BETWEEN JANUARY 2008 AND JANUARY A. In determining whether SEC disgorgement actions constitute a forfeiture, this Court should analyze the ordinary meaning of both terms B. The SEC s use of disgorgement has a punitive purpose, and is therefore in conformity with the punitive forfeitures, fines, and penalties in C. Allowing the SEC to use disgorgement beyond five years creates a significant potential for future abuse CONCLUSION ii

4 TABLE OF AUTHORITIES Cases Abrams v. Baker Hughes, Inc., 292 F. 3d 424 (5th Cir. 2002) Asgrow Seed Co. v. Winterboer, 513 U.S. 179 (1995) Banco Industrial de Venez., C.A. v. CDW Direct L.L.C., 888 F.Supp.2d 508 (S.D.N.Y. 2012) Blue Shield of Va. v. McCready, 457 U.S. 371 (2005) Clark v. Martinez, 543 U.S. 371 (2005) Consol. Bank, N.A. v. United States Dep't of the Treasury, Office of the Comptroller of the Currency, 118 F.3d 1461 (11th Cir. 1997) Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976) , 15 Gabelli v. SEC, 133 S. Ct (2013) Gompers v. Buck s Stove & Range Co., 221 U.S. 418 (1911) Graham v. SEC, 222 F.3d 994 (D.C. Cir. 2000) , 15 Hollinger v. Titan Capital Corp., 914 F.2d 1564 (9 th Cir. 1990) , 18 Howard v. Everex Sys., Inc., 228 F.3d 1057 (9 th Cir. 2000) , 16 In re Telsey, 144 B.R. 563 (Bankr. S.D. Fla. 1992) In the Matter of WSF Corp., 2002 SEC LEXIS 3584, 2002 WL (SEC, May 8, 2002) , 15 Johnson v. SEC, 87 F.3d 484 (D.C. Cir. 1996) , 28 Kouichi Taniguchi v. Kan Pac. Saipan, Ltd., 566 U.S. 560 (2012) Levine v. Diamanthuset, Inc., 950 F.2d 1478 (9 th Cir. 1991) iii

5 Phillips v. LCI Int l Inc., 190 F.3d 609 (4 th Cir. 1999) , 18 Ponce v. SEC, 345 F.3d 722 (9 th Cir. 2003) PASSIM SEC v. Arthur Young & Co., 590 F.2d 785 (9 th Cir. 1979) SEC v. BankAtlantic Bancorp, Inc., 2012 U.S. Dist. LEXIS (S.D. Fla. May 29, 2012) , 16 SEC v. Egan, 994 F.Supp.2d 558 (S.D.N.Y. 2014) SEC v. Espuelas, 579 F. Supp.2d 461 (S.D.N.Y. 2008) SEC v. Fehn, 97 F.3d 1276 (9 th Cir. 1996) SEC v. Graham, 823 F.3d 1357 (2016) SEC v. Kalvex, Inc., 425 F.Supp. 310 (S.D.N.Y. 1975) , 13 SEC v. Kokesh, 834 F.3d 1158 (2016) , 25, 27 SEC v. Life Partners Holdings, Inc., 71 F.Supp.3d 615 (W.D. Tex. 2014).. 20, 22 SEC v. Retail Pro, Inc., 673 F. Supp. 2d 1108 (S.D. Cal. 2009) SEC v. Saltsman, 2016 U.S. Dist. LEXIS (E.D.N.Y. Aug. 2, 2016). 12, 15 SEC v. Tome, 833 F.2d 1086 (2d Cir. 1987) SEC v. Treadway, 430 F.Supp.2d 293 (S.D.N.Y. 2006) SEC v. Zwick, 2007 U.S. Dist. LEXIS (S.D.N.Y. 2006) United States SEC v. Brown, 740 F.Supp.2d 148 (D.C. Cir. 2010) United States SEC v. Jensen, 835 F.3d 1100 (9 th Cir. 2016) PASSIM United States v. Ursery, 518 U.S. 267 (1996) Ward v. United States 448 U.S. 242 (1980) Zacharias v. SEC, 569 F.3d 458 (D.C. Cir. 2009) , 27 iv

6 Statutes 15 U.S.C. 78j(b) U.S.C ( Rule 13a-14 ) PASSIM 15 U.S.C. 7243(a) , U.S.C PASSIM Other Authorities Certification of Disclosure in Companies Quarterly and Annual Reports, Exchange Act Release No. 8124, 78 SEC Docket 875, 2002 WL (Aug. 28, 2002) [ Release 8124 ] Committee on Banking, Housing and Urban Affairs, S No (March 6, 2002) Committee on Rules, H. Rep. No (April 23, 2002) Webster s Dictionary Rules Fed. R. Civ. P Regulations Sarbanes-Oxley Act of PASSIM Securities Exchange Act of PASSIM 17 C.F.R b ( Rule 10(b) ) PASSIM v

7 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 limitations authorized by 28 U.S.C applies to disgorgement claims. vi

8 STATEMENT OF THE CASE On January 1, 2016, the Securities and Exchange Commission ( SEC or Commission ) brought suit against Brian Bosco, Jasmine Lee, and Ronald Prince (together, the Petitioners ) in the United States District Court for the District of Fordham. (R. at 6). The SEC sued Bosco and Lee under Rule 13a-14 and Section 304 of the Sarbanes-Oxley Act of 2002 ( Rule 13a-14 and SOX 304 respectively). (R. at 6). The SEC charged Prince under Section 10(b) of the Securities Exchange Act of 1934 (the Exchange Act ), 15 U.S.C. 78j(b) and 17 C.F.R b-5 ( Rule 10b-5 ). (R. at 6). Bosco and Lee moved for summary judgment pursuant to Rule 56 of the Federal Rules of Civil Procedure ( Rule 56 ). In response, the SEC filed for summary judgment against all Petitioners. (R. at 6). The district court granted the SEC s motion against Bosco and Lee, holding that a Rule 13a-14 cause of action exists against CEOs and CFOs who certify false financial statements regardless of whether they knew of the falsity, and that SOX 304 requires officers to disgorge gains even if their conduct did not cause the securities violation. (R. at 7). The SEC ordered Bosco and Lee to disgorge $600,000 and $475,000, respectively. (R. at 7). The district court also granted the SEC s motion against Prince, rejecting his 28 U.S.C ( 2462 ) statute of limitations defense and ordering him to disgorge $1,770,000. Upon appeal, the Fourteenth Circuit affirmed both of the District Court s rulings. (R. at 11, 14, 21). The U.S. Supreme Court granted the Petitioner and the SEC s petition for a writ of certiorari on February 1, (R. at 32). 1

9 STATEMENT OF THE FACTS Burlingham Inc. is a microchip manufacturer with a strong presence in the smartphone industry. (R. at 1). By 2007, Burlingham s smartphone business held a 42% market share and accounted for 52% of the company s net income. (R. at 2). In 2009, under the guidance of CEO Veronice Uchekwe, Burlingham entered into a contract to provide microchips for a computer tablet manufacturer. (R. at 3). The deal proved successful, and each Burlingham executive received a $45,000 bonus as a result. (R. at 3). In 2011, Uchekwe retired as CEO, and Brian Bosco was named her successor. (R. at 3). Soon thereafter, Bosco selected Jasmine Lee to serve as the company s new CFO. (R. at 4). Under their helm, Burlingham continued to successfully expand into the Asian smartphone market. (R. at 4). As part of their responsibilities as CEO and CFO, Bosco and Lee certified the company s financial statements. (R. at 4). In October 2014, Bosco and Lee attended a technology conference on behalf of Burlingham. (R. at 4). While there, Bosco and Lee were each approached by the CEO of a major Japanese smartphone manufacturer who hoped to amend his company s contract with Burlingham to include unilateral termination rights. (R. at 4). Bosco and Lee found this strange because, to the best of their knowledge, Burlingham did not offer such provisions in their contractual agreements with smartphone manufacturers. (R. at 4). Bosco and Lee discussed their encounters with the Japanese CEO, but reasonably concluded it did not warrant any further investigation. (R. at 4). 2

10 Burlingham s operations continued normally until March 2015, when Bosco and Lee were blind-sided: five purchasers they had contracted with notified Burlingham that they wished to exercise their unilateral termination rights based on a 2.5% decline in the United Kingdom s GDP. (R. at 4-5). Bosco and Lee took a hands-on approach, moving quickly to determine the validity of the purchasers termination rights, launching an investigation into the contracts, and informing Burlingham s Chairman of the Board of the situation. (R. at 5). Upon investigation, it was revealed that Ronald Prince who served as Burlingham s Executive Vice President, overseeing the Communications division, since 2002 was responsible for the unilateral termination agreements. (R. at 2,5). The only other executive manager in the Communications Division at the time was Henrietta Conrad. (R. at 2). Prince had previously expressed frustration to Conrad regarding his compensation, which he claimed to be inadequate because it was not directly tied to the smartphone business success. (R. at 2). Burlingham s Compensation Committee determined discretionary bonuses by analyzing the company s financial and operating results and applying the metrics of revenue, profit, market share, retention of employees, and integration of acquired businesses. (R. at 2). The inadequacy of this system, as argued by Prince, prohibited him from directly compensating from the smartphone business. (R. at 2). Beginning in 2008, three years before Bosco and Lee s respective appointments as CEO and CFO, Prince had begun secretly entering into side 3

11 letters with various purchasers. (R. at 3). These side letters offered the purchasers unilateral termination rights upon the occurrence of the triggering event, a decline in the UK s GDP. (R. at 3). In exchange for offering the purchasers these rights, Prince was paid $25,000 up front, with an additional $50,000 due to him if any of the termination rights were exercised. (R. at 3). The investigation revealed that Prince engaged in this kickback scheme from January 2008 until January 2010, and again from January 2014 to January (R. at 3-4). These findings came as a surprise to Bosco and Lee, who worked to correct the harm the side letters had caused. As a result of the findings, Burlingham filed a restated 10-K for the fiscal year (R. at 5). 4

12 SUMMARY OF THE ARGUMENT Rule 13a-14 of the Sarbanes-Oxley Act requires the SEC to establish mental culpability on the behalf of CEOs and CFOs in order to hold them liable for false certifications. The Fourteenth Circuit s holding that Rule 13a-14 violations do not require the SEC to establish mental culpability is inconsistent with the statutory scheme of securities fraud violations, textual analysis of Rule 13a-14, linguistic analysis, and case law. As an issue of first impression, this Court should adopt an aider and abettor theory in order to determine CEO and CFO liability for 13a-14 violations. Under such a theory, Bosco and Lee would not be liable because the SEC cannot satisfy the threeprong test set forth in Ponce. If the Court declines to adopt an aider and abettor theory, it must still require the SEC to establish scienter in order to hold Bosco and Lee liable under 13a-14. Again, SEC would also fail: it cannot establish scienter because Bosco and Lee did not act with an intent to deceive, manipulate, or defraud. Some courts allow recklessness to satisfy scienter, and other courts have held that, at the very least, individuals must act with reckless mental state in order to establish their culpability under 13a-14. Even under this less stringent test, Bosco and Lee would not be liable of a 13a-14 violation because their actions were not highly unreasonable in a way that suggests an extreme departure from the ordinary standards of care. The As a Result of Misconduct portion of Section 304 of the Sarbanes-Oxley Act of 2002 is intentionally broad in order to require personal misconduct of the CEO and CFO for disgorgement remedies. 5

13 Section 304 of the Sarbanes-Oxley Act of 2002 states [i]f an issuer is required to prepare 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, the chief executive officer and chief financial officers of the issuer shall reimburse the issuer for. 15 U.S.C. 7243(a). As a result of misconduct should be interpreted as requiring the misconduct of both the CEO and the CFO due to the legislative intent behind Section 304 of the SOX Act, the constitutionality of requiring CEOs and CFOs to be strictly liable for any misconduct within their company that leads to filing a restatement, and the differing fact patterns of petitioner s case compared to previously cited cases. The funds earned by Burlingham employees from January 2008 to January 2010 are not subject to SEC disgorgement, as this action was brought after the five-year statute of limitations had tolled. 28 U.S.C states that the enforcement of any civil fine, penalty, or forfeiture, pecuniary or otherwise must be brought within five years of the illegal action s occurrence. Utilizing an erroneous analysis, the Fourteenth Circuit held that disgorgement is distinguishable from forfeiture, and therefore beyond the purview of In analyzing whether the SEC s requested disgorgement constitutes a forfeiture this Court should look first to the ordinary, contemporary meanings of these words. Modern dictionaries define these remedies in nearly identical 6

14 terms, and therefore disgorgement is merely a type of forfeiture subject to the statute of limitations found in Furthermore, this court should look to the purpose of disgorgement both broadly and in the context of this action. The lower court held that disgorgement is remedial, however the scope and application of the remedy in this scenario suggests a punitive purpose. Therefore, when acknowledged as a punitive action, disgorgement is homogenous with the fines, penalties, and forfeitures limited by Finally, allowing the SEC to prevail on this issue would open the flood gates, allowing this agency to pursue previously barred actions under the cloak of disgorgement. This expansion in power creates uncertainty and fosters evidentiary problems. 7

15 ARGUMENT I. THE FOURTEENTH CIRCUIT ERRED IN CONCLUDING THAT RULE 13A-14 OF THE SARBANES-OXLEY ACT DOES NOT REQUIRE A SHOWING OF MENTAL CULPABILITY IN ORDER TO FIND CEOs AND CFOs LIABILE FOR FALSE CERTIFICATIONS The Fourteenth Circuit relies on stretched linguistic construction and cursory consideration of a sole administrative proceeding to conclude a showing of mental culpability is not required to find executive officers liable for false certifications under Rule 13a-14. In doing so, the Fourteenth Circuit incorrectly interprets Rule 13a-14 as a strict liability statute. The statutory scheme of securities fraud violations, textual analysis of Rule 13a-14, linguistic analysis, and case law clearly demonstrate that Rule 13a-14 contains a mental state requirement. The SEC s own interpretation of securities fraud violations group Sections 13(a), 10(b) and 18 of the Exchange Act together under a category labeled Liability for False Certification. Certification of Disclosure in Companies Quarterly and Annual Reports, Exchange Act Release No. 8124, 78 SEC Docket 875, 2002 WL , at *9 (Aug. 28, 2002) [ Release 8124 ]. A finding of scienter is required to prove violations under 10(b). Ernst & Ernst v. Hochfelder, 425 U.S. 185 (1976). In the context of 10(b) securities violations, scienter refers to a mental state embracing intent to deceive, manipulate, or defraud. Id. Similarly, an executive will not be held liable for a 18 securities fraud violation if he can prove he acted in good faith, that is, without knowledge of the false or fraudulent behavior or misrepresentations giving rise to the fraud allegations. United States SEC v. Jensen, 835 F.3d 1100, 1121 (9th 8

16 Cir. 2016) (Bea, J., concurring). As these three sections of the Exchange Act are grouped together in the SEC s own interpretation of its securities laws, it follows that violations of 13(a) have also been found to require a culpable mental state. See Ponce v. SEC, 345 F.3d 722, 737 (9th Cir. 2003) (an officer must act with, at least, a reckless mental state in order to be held liable for false certification under 13(a)). Thus, it is clear that the Fourteenth Circuit erred in summarily construing Rule 13a-14 as a strict liability statute. The text of Rule 13a-14 also indicates a mental culpability requirement. 15 U.S.C. 7241, which sets out Rule 13a-14, states that an individual must certify documents based on the officer s knowledge. Additionally, the Fourteenth Circuit s conclusion that Bosco and Lee are liable under 13a-14 because they both certified a false statement is inconsistent with the meaning of the word false. (R. at 11). As the Ninth Circuit clarified, the concept of falsity embodies a mental element. Jensen, 835 F.3d at Courts have interpreted Rule 13a-14 to include a mental state requirement. See United States SEC v. Brown, 740 F.Supp.2d 148, 164 (D.C. Cir. 2010) (explaining that Rule 13a-14 certifications are based on the certifying individual s knowledge ); see also SEC v. Retail Pro, Inc., 673 F. Supp. 2d 1108, 1143 (S.D. Cal. 2009) (holding that the SEC s motion for summary judgment pursuant to a Rule 13a-14 claim denied when there was an issue of fact as to whether an officer s certifications were false based on his knowledge ). 9

17 A. This Court should adopt an aider and abettor theory in determining CEO and CFO liability under Rule 13a-14 Aider and abettor theory is widely utilized to determine whether executive officers are liable for the securities fraud of their issuing companies under the Exchange Act. See SEC v. Fehn, 97 F.3d 1276, 1288 (9th Cir. 1996) (utilizing an aiding and abetting theory to evaluate a cause of action against an executive for an issuer s violation of 15(d)); see also Graham v. SEC, 222 F.3d 994, 1000 (D.C. Cir. 2000) (establishing a test for aiding and abetting liability under 10(b)); see also SEC v. Arthur Young & Co., 590 F.2d 785, 786 (9th Cir. 1979) (acknowledging aider and abettor liability for 13(a) violations); see also SEC v. Kalvex, Inc., 425 F.Supp. 310, 316 (S.D.N.Y. 1975) (recognizing aider and abettor liability for 13(a) violations). As an issue of first impression, we urge the Court to adopt an aiding and abetting theory in determining CEO and CFO liability for 13(a) violations. The Ninth Circuit has applied such a theory to evaluate an individual officer s liability under 13(a) when that officer s issuer violates the securities laws: Our finding that [the issuing company] violated Exchange Act Section[] 13(a)... does not end our inquiry with respect to [the individual officer s] liability... Although there is apparently no circuit law articulating the requirements for aider and abettor liability for Section 13 violations, we are guided by cases finding aider and abettor liability of other securities laws violations. In order to find [the officer] aided and abetted [the issuing company s] violation of federal securities laws, it must be found that: (1) [The issuing company] violated the relevant securities laws; (2) [The individual officer in question] had knowledge of the primary violation and of his or her own role in furthering it; and (3) [The individual officer in question] provided substantial assistance in the primary violation. 10

18 Ponce, 345 F.3d at 737. Because the text of Section 13(a) focuses on the issuer s conduct, the Ponce court s articulation of an aiding and abetting theory for officer liability under 13(a) has been interpreted as holding that: [T]he only way to hold a CEO or CFO liable for a Section 13(a) violation is through aider and abettor liability, which requires knowledge of the falsity of the statement certified. Thus, our precedent leaves no room for doubt that a CEO or CFO cannot be held liable for an issuer s violation of Section 13(a) without a showing that he acted with knowledge of such falsity... Thus, to prevail on a cause of action for false certification in violation of Rule 13a-14, the SEC must show that the CEO or CFO who certified as true a financial statement which contained materially false or misleading information acted with some mental culpability Jensen, 835 F.3d at , n.3 (Bea, J., concurring). B. Bosco and Lee are not liable of a Rule 13a-14 violation under an aiding and abetting theory because the SEC cannot satisfy the three-prong test set forth in Ponce If this Court adopts an aiding and abetting theory for individual officer liability, it is clear that Bosco and Lee are not liable for a 13(a) violation because the SEC cannot satisfy the three-prong Ponce test. Petitioners concede that the first prong is met, as Burlingham the issuing company violated the securities laws by filing materially false financial statements. However, the SEC s claim fails on both the second and third prongs of the Ponce test. As to the second prong, Ponce unambiguously held that... [the SEC is required] to establish both knowledge of both the primary violation and the aider and abettor s own role in furthering that violation. Jensen, 345 F.3d at 1119, n.3 (Bea, J., concurring). Other courts have also implied that lack of 11

19 knowledge constitutes a defense to a 13(a) violation. See SEC v. Egan, 994 F.Supp.2d 558, 568 (S.D.N.Y. 2014) (recognizing a financial officer s lack of knowledge defense in a 13a-14 proceeding, but denying it because the SEC sufficiently showed the officer to have knowledge of the underlying fraud). Further, knowledge in this context should be construed to mean actual knowledge. See Levine v. Diamanthuset, Inc., 950 F.2d 1478, 1483 (9th Cir. 1991) (interpreting knowledge to mean actual knowledge in order to establish aiding and abetting liability in a securities fraud context); see also SEC v. Saltsman, 2016 U.S. Dist. LEXIS , *76 (E.D.N.Y. Aug. 2, 2016) ( it would be nonsensical to find that [officer] somehow lacked knowledge of conduct for which he himself was responsible ). Here, it is undisputed that neither Bosco nor Lee had actual knowledge of the primary violation, as Prince never informed them of his side letter scheme. While a Japanese CEO approached Bosco and Lee in October 2014 about the possibility of amending Burlingham s contract with his company to include unilateral termination rights, this did not give them explicit knowledge of any underlying fraud or securities violations. Furthermore, the SEC cannot establish the role either Bosco or Lee played in furthering the violation. The side letter scheme was executed solely by Prince. The Fourteenth Circuit held that an officer s signature represents the fact that he believes the statements in the document are true and hence, if an individual certifies a false document, that individual is liable for any false statements therein. However, this is inconsistent with the meaning of the word false, given that the concept 12

20 of falsity embodies a mental element and there can be no mental culpability here given the fact that Bosco and Lee did not have any knowledge of the inaccurate statements contained in the 10-Ks. Jensen, 835 F.3d at Thus, the SEC cannot satisfy the second prong of the Ponce test needed to establish aiding and abetting liability for a CEO or CFO under Rule 13(a). Nonetheless, the SEC s claim would also fail on the third prong of the Ponce aiding and abetting test. The third prong requires the SEC to show that the CEO or CFO in question provided substantial assistance in the primary violation. Ponce, 345 F.3d at 737. To demonstrate substantial assistance, the SEC must show that the aider and abettor s conduct was a substantial causal factor in the perpetuation of the underlying violation. SEC v. Espuelas, 579 F. Supp.2d 461, 471 (S.D.N.Y. 2008) (citing SEC v. Zwick, 2007 U.S. Dist. LEXIS 19045, at *49 (S.D.N.Y. Mar. 16, 2007). In addition, the SEC must also show that the acts of the aider and abettor proximately caused the primary violation. Espuelas, 579 F.Supp.2d at 471 (citing SEC v. Treadway, 430 F.Supp.2d 293, 339 (S.D.N.Y. 2006)). When considering whether knowledge was a necessary element of the third (substantial assistance) prong, the Ponce court concluded that the SEC had assumed that it was. Jensen, 835 F.3d at 1119 (Bea, J., concurring). Additionally, courts have held that an officer who provided assistance and encouragement to conduct patently in violation of the securities laws was responsible as an aider and abettor. Kalvex, Inc., 425 F.Supp. at

21 Here, the SEC cannot meet any of these requirements. Bosco and Lee s conduct was not a substantial causal factor in the underlying violation. They were appointed as CEO and CFO in 2011, three years after Prince had begun his side letter kickback scheme. Furthermore, Bosco and Lee could not have proximately caused the primary violation because they had no knowledge of the fraud until the purchasers sought to exercise their unilateral termination rights and an investigation was conducted. Finally, the SEC cannot show that Bosco and Lee provided assistance or encouragement to Prince s conduct, because they had no knowledge of it. Thus, it is clear that under an aider and abettor theory of liability, Bosco and Lee are not liable for securities violations for false certifications under Rule 13a-14 C. Even if this Court does not adopt an aiding and abetting theory of liability, Bosco and Lee are not liable of a securities violation under Rule 13a-14 because the SEC cannot demonstrate they acted with scienter Even if this Court declines to adopt an aider and abettor theory of liability for CEO and CFO Rule 13a-14 liability, it must still find that Bosco and Lee acted with scienter in order to hold them in violation of securities fraud under Rule 13a-14. There has only been one SEC administrative proceeding in which the SEC did not require a showing of scienter in order to demonstrate a 13(a) violation. Jensen, 835 F.3d at 1119 (Bea, J., concurring) (citing In the Matter of WSF Corp., 2002 SEC LEXIS 3584, 2002 WL , at *3 (SEC, May 8, 2002)). In WSF Corp, the SEC ruled that the issuing company had violated 13(a) and that no showing of scienter on behalf of the company was required to hold them liable. WSF Corp., 2002 SEC LEXIS 3584, at *2. As the concurrence 14

22 in Jensen points out however, there is a critical distinction between this lone case and many other 13(a) cases, ours included. WSF Corp. was about issuer liability, not individual officer (or aider and abettor) liability. Jensen, 835 F.3d at 1119 (Bea, J., concurring). In addition, other cases indicate that scienter is required for Rule 13a-14 violations. See SEC v. BankAtlantic Bancorp, Inc., 2012 U.S. Dist. LEXIS 73891, *68 (S.D. Fla. May 29, 2012) (holding that the CEO s conviction under Rule 13a-14 may stand because the SEC s allegations demonstrated the requisite scienter ). While this all tends to point to the fact that scienter is required to establish Bosco and Lee s liability under 13(a), it should also be noted that the other securities violations with which 13(a) was grouped in the SEC s Release 8124 require scienter. See Hochfelder, 425 U.S at 194 (holding that 10(b) violations require scienter); Graham, 222 F.3d at 1000 (explaining that scienter is the third requirement aider and abettor liability for individuals under 10(b)). The term scienter refers to a mental state embracing intent to deceive, manipulate or defraud. Hochfelder, 425 U.S. at 194 (defining scienter for 10(b) violations). Courts take different views when it comes to satisfying the scienter requirement. See Howard v. Everex Sys., Inc., 228 F.3d 1057, 1063 (9th Cir. 2000) (scienter can be shown by demonstrating knowledge or recklessness as to the false, misleading, or fraudulent statements); see also Saltsman, 2016 U.S. Dist. LEXIS at *76 ( both actual knowledge and conscious avoidance are sufficient to plead scienter ); see also Banco Industrial de Venez., C.A. v. CDW Direct L.L.C., 888 F.Supp.2d 508, 514 (S.D.N.Y. 2012) 15

23 ( knowledge in the scienter context refers to actual knowledge; constructive knowledge does not suffice); see also BankAtlantic Bancorp, Inc., 2012 U.S. Dist. LEXIS at *49-50 (scienter found when officer knowingly made material misrepresentations and omissions). The facts in the present case do not support a finding of scienter under any of these tests. Bosco and Lee had no actual knowledge of the underlying fraudulent kickback scheme being carried out solely by Prince. Accordingly, it also follows that Bosco and Lee s conduct does not constitute conscious avoidance because they were not aware of the side letters being offered by Prince. In order to be conscious of something, you must have knowledge of it. In this context, the Japanese CEO s inquiry as to unilateral termination rights is not sufficient to prove knowledge that would allow Bosco and Lee to be conscious of the fraud, because the knowledge must be actual, not constructive. Banco Industrial de Venez., C.A, 888 F.Supp.2d at 514. D. Even if this Court allows recklessness to satisfy scienter, Bosco and Lee are not liable of a 13a-14 violation because their conduct does not satisfy any circuit s recklessness standard Some circuits allow recklessness to satisfy scienter. See Howard, F.3d at 1063 (scienter can be shown by demonstrating knowledge or recklessness ); see also BankAtlantic Corp., 2012 U.S. Dist. LEXIS at *49 (suggesting that severe recklessness can satisfy scienter). Other courts have indicated that, at a minimum, the SEC must prove recklessness in order to establish liability for a 13(a) violation. Jensen, 835 F.3d at 1119, n.3 (Bea, J., concurring) (explaining that at least recklessness as 16

24 to the falsity of a certification is required to hold an officer liable in violation of Section 13(a) by falsely certifying the statement is true and that the binding holding of Ponce in fact forecloses any argument that an individual could be held liable for a Section 13(a) [sic] without a showing that he acted with at least recklessness ). Thus, it is clear the SEC must prove at least that Bosco and Lee acted with recklessness in order to hold them liable under 13(a). The Ninth Circuit has defined recklessness as a highly unreasonable omission, involving not merely simple, or even inexcusable negligence, but an extreme departure from the standards of ordinary care. Hollinger v. Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990). The Fifth Circuit enables scienter to be demonstrated by a showing of severe recklessness, the definition of which is substantially similar to the Ninth Circuit s definition of recklessness. Abrams v. Baker Hughes, Inc., 292 F.3d 424, 430 (5th Cir. 2002). The Fourth Circuit, which has suggested that scienter can be established by recklessness, has defined recklessness as an act so highly unreasonable and such an extreme departure from ordinary care as to present a danger of misleader to the extent that the danger was either known to the defendant or so obvious that the defendant must have been aware of it. Phillips v. LCI Int l, Inc., 190 F.3d 609, 620 (4th Cir. 1999). Bosco and Lee s conduct in the present case does not satisfy any of the aforementioned recklessness standards. Bosco and Lee did not participate in the conduct that resulted in the underlying fraud, nor did they have actual knowledge of it. Their actions in certifying the inaccurate 10-Ks were not 17

25 highly unreasonable because they did not know, or have reason to know, about Prince s side letter scheme. The Japanese CEOs inquiry does not support a finding that the danger was either known to the defendant or so obvious that the defendant must have been aware of. Phillips, 190 F.3d at 620. His inquiry into unilateral termination rights could reasonably be dismissed as a negotiating tactic in an effort to secure his company a better deal. The fact that this did not cause Bosco and Lee to discover Prince s scheme could hardly be seen to establish such an extreme departure from ordinary care, as Bosco and Lee are likely approached often by representatives from other companies they do business with. Hollinger, 914 F.2d at II. THE AS A RESULT OF MISCONDUCT PORTION OF SECTION 304 OF THE SARBANES-OXLEY ACT OF 2002 IS INTENTIONALLY BROAD IN ORDER TO REQUIRE PERSONAL MISCONDUCT OF THE CEO AND CFO FOR DISGORGEMENT REMEDIES. A. Whether as a result of misconduct is in reference to the misconduct of the CEO and CFO or the issuer is unsettled Section 304 of the Sarbanes-Oxley Act of 2002 states [i]f an issuer is required to prepare 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, the chief executive officer and chief financial officers of the issuer shall reimburse the issuer for. 15 U.S.C. 7243(a). The portion of this statement at issue, as a result of misconduct, has lead courts to question whether the misconduct must be done by the CEO and CFO in question, or if it can be misconduct by the issuer, in order to charge the CEO and CFO with disgorgement remedies. SEC v. Jensen was the 18

26 first circuit court to address this issue, proving it to be unsettled. Jensen, 835 F.3d at 1115 (2016). B. The legislative intent behind Section 304 of the Sarbanes- Oxley Act of 2002 is to require misconduct by the CEO and CFO for disgorgement remedies As the dissent in the Fourteenth Circuit noted, SOX 304 does not plainly express whose misconduct must cause an accounting restatement in order to trigger the reimbursement requirement. Congress included the term issuer when referring to the material noncompliance, and further included the chief executive officer and chief financial officer when discussing who shall reimburse the issuer as a result of misconduct. 15 U.S.C. 7243(a). However, Congress did not include the term issuer, or the terms chief executive officer and chief financial officer when discussing the misconduct that results in disgorgement. Id. This would imply a requirement of personal misconduct by the CEO and CFO, as the statute specifies that the CEO and the CFO must reimburse the issuer for all qualifying compensation, implying further that the misconduct was on the part of the CEO and CFO. Furthermore, the legislative history of House Bill 3763, heard in the Committee on Rules indicates that the original House Bill included earnings obtained by an officer or director if such officer or director engaged in misconduct resulting in, or made or caused to be made in, the filing of a financial statement. Jensen, 835 F.3d at 115 (citing Committee on Rules, H. Rep. No at 31, 2002 WL (April 23, 2002)). The Senate version of this bill, S. 2673, was discussed in the Banking, Housing and Urban Affairs 19

27 Committee before going to the floor for a vote. Committee on Banking, Housing and Urban Affairs, S No at 53 (March 6, 2002). The Committee noted that CEOs and CFOs must disgorge bonuses... if the non-compliance results from misconduct. Id. The discrepancy between the House and the Senate version of the Bill indicates that Congress did intend to require misconduct by CEOs and CFOs, as it was explicitly written in the House companion bill and not explicitly denied in the final Senate bill. C. Petitioners case presents a unique approach to the original three element relief test under SOX 304, illustrating the differences between petitioners case and previous disgorgement cases in a way that questions the constitutionality of SOX 304 entirely At the district court level, in order to obtain relief under SOX, the SEC must meet three elements. SEC v. Life Partners Holdings, Inc., 71 F.Supp.3d 615, 625 (W.D. Tex. 2014)). This test requires that 1) the issuer was required to issue a restatement because of non-compliance with reporting requirements, 2) the noncompliance was caused by misconduct within, and 3) the CEO received incentive pay within the relevant time period[]. Jensen, 835 F.3d at (2016) (citing Life Partners Holdings, Inc., 71 F.Supp.3d at 625). The first element of Life Partners specifies that the issuer was required to issue a restatement and the third element of this test specifies that the CEO and CFO must issue a disgorgement. Id. However, the second element is left ambiguous as to whose misconduct is in question. Interpreting this more broadly is necessary, as interpreting this element strictly would make CEOs and CFOs strictly liable for any restatement filed to correct any misconduct 20

28 within their company. The ambiguity in the second element of the Life Partners test should be viewed in the best light to avoid questions about the statute s constitutionality. See Clark v. Martinez, 543 U.S. 371, 381 (2005). To hold CEOs and CFO strictly liable would be to question the constitutionality of the statute. Therefore, this Court should require that the misconduct must be done by the CEO and CFO in order to hold them responsible for disgorgement because of the filed restatement. Further, Life Partners holds that SOX 304 would hold CEOs and CFOs responsible for establishing internal controls for financial reporting, allowing them to catch any misconduct that results in a restatement. Id. This element seems to be the overarching goal of the statute, which petitioners corporate structure upholds. Petitioners are the CEO and CFO of a large microchip manufacturer that conducts approximately half of their business within the smartphone industry. R. at 2. Petitioners were hands-on managers and examined each division s cash flow and cost structure. R. at 4. It wasn t until the unilateral termination rights were triggered that Bosco and Lee were put on notice of the financial discrepancies, despite their rigorous corporate structure. R. at 5. As soon as this misconduct was realized, petitioners immediately acted to determine the validity of the unilateral termination agreements. Id. Not only did Bosco inform the chairman of Burlingham s board, but she also placed Prince on an indefinite leave of absence. Id. These facts illustrate that the did Petitioners not participate in misconduct, as the statute requires, and they also 21

29 acted swiftly upon the disclosure of Prince s misconduct to comply with the underlying premise of SOX 304. The third element from Life Partners, the CEO receiv[ing] incentive pay within the relevant time period, is also not met in this case. Life Partners, 71 F.Supp.3d at 625. At no point was Bosco, Lee, or any other employee s compensation tied directly to the smartphone business. R. at 2. Burlingham s compensation system has a discretionary component that determines the executive s compensation by analyzing Burlingham s financial and operating results, applying five metrics to Burlingham on a consolidated basis and then to each of Burlingham s divisions individually. R. at 2. The metrics used in the year in question were revenue, profit, market share, retention of employees, and integration of acquired businesses. R. at 2. Therefore, even if this Court holds that issuer misconduct is sufficient, Petitioners did not directly benefit from the smartphone business misconduct. In both Life Partners and Jensen, the CEO was not only being charged with disgorgement, but was also the employee who committed the misconduct. Jensen, 835 F.3d at 1105; Life Partners, 71 F.Supp.3d at These cases differ from Bosco and Lee s situation, as neither of these executives participated in misconduct nor did they have knowledge of the misconduct during the year in question. Prince served as the Executive Vice president and had direct managerial responsibility for the Communications division, where the smartphone business was housed. R. at 2. Prince was given this position in 2002 and it wasn t until 2008 that Prince began his backdoor dealing. R. at 2-22

30 3. The time period between Prince s employment with Bosco and Lee and his misconduct exemplifies that it was not unreasonable for Bosco and Lee to depend on Prince to run the Communications department, specifically the smartphone business. III. THE FIVE-YEAR STATUTE OF LIMITATIONS IN 28 U.S.C APPLIES TO DISGORGEMENT CLAIMS, AND THEREFORE THE SEC SHOULD BE BARRED FROM THE DISGORGEMENT OF MONEY ACQUIRED BY PETITIONERS BETWEEN JANUARY 2008 AND JANUARY The five-year statute of limitations set out in 28 U.S.C applies to any civil fine, penalty, or forfeiture, pecuniary or otherwise. Currently circuit courts are split as to whether SEC disgorgement claims are within the scope of this statutory language. In SEC v. Graham the Eleventh Circuit held that the statute of limitations did apply as forfeiture and disgorgement are effectively synonyms. 823 F.3d 1357, 1363 (2016). Alternatively, the Tenth Circuit has held that disgorgement is neither a penalty nor a forfeiture, and therefore this remedy can be sought without temporal restriction. SEC v. Kokesh, 834 F.3d 1158 (2016). A. In determining whether SEC disgorgement actions constitute a forfeiture, this Court should analyze the ordinary meaning of both terms. When the ordinary meanings of forfeiture and disgorgement are considered, the SEC s desired remedy constitutes a subset of forfeiture limited by See Graham, 823 F.3d at Forfeiture is not explicitly defined in the language of 2462, and therefore this court must look beyond the statute to determine the 23

31 Congressional intent behind this term. Looking back over 200 years at the statutory origins of this limitation, the lower court held that forfeiture refers only to a narrow set of remedies aimed at recovering property. Alternatively, this Court has held that [w]hen a term goes undefined in a statute, we give the term its ordinary meaning. Kouichi Taniguchi v. Kan Pac. Saipan, Ltd., 566 U.S. 560, 566 (2012) (citing Asgrow Seed Co. v. Winterboer, 513 U.S. 179, 187 (1995)). In determining ordinary meaning circuit courts have previously looked primarily to modern dictionary definitions. See Graham, 823 F. 3d at In Webster s Third Int l Dictionary forfeiture is defined broadly as the divesting of the ownership of particular property of a person of on account of the breach of a legal duty and without any compensation to him. (2002). Black s Law Dictionary similarly defines forfeiture as the the loss of a right, privilege, or property because of a crime, breach of obligation, or neglect of duty. (10 th ed. 2014). Disgorgement is defined as [t]he act of giving up something (such as profits illegally obtained) on demand or by legal compulsion. Id. Acknowledging the similarities of these contemporary definitions, the Tenth Circuit concluded there is no meaningful difference between SEC disgorgement and forfeiture. Graham, 823 F.3d at The similarities of these definitions are also evident in past decisions by this Court, some of which have used these terms interchangeably. See United States v. Ursery, 518 U.S. 267, 284 (1996). In the bankruptcy context the SEC itself has asserted that disgorgement constitutes a non-dischargeable forfeiture. In re Telsey, 144 B.R. 563 (Bankr. S.D. Fla. 1992). The bankruptcy 24

32 court accepted this definition holding that the deterrent purpose of a disgorgement order is sufficiently penal to characterize a disgorgement debt as a forfeiture. Id. at 565. This Court should not permit the SEC to utilize different definitions based merely on their desired outcome. The broader definition of forfeiture considered in Graham supports the idea that forfeiture describes a range of actions. Under Graham forfeiture can encompass both the historical actions considered by the lower court, and the modern action of disgorgement. Adopting a narrower definition for the SEC in this case could lead to uncertainty across industries as the statute of limitations found in 2462 applies to suits brought by other agencies. See Consol. Bank, N.A. v. United States Dep't of the Treasury, Office of the Comptroller of the Currency, 118 F.3d 1461, 1462 (11th Cir. 1997)). B. The SEC s use of disgorgement has a punitive purpose, and is therefore in conformity with the punitive forfeitures, fines, and penalties in Both the lower court and the Tenth Circuit in Kokesh predicated their holdings on the notion that disgorgement is purely remedial. See Kokesh, 834 F.3d at While this may be the case for disgorgement in other contexts, the SEC s use of the remedy in this instance is clearly punitive. The relevance of distinguishing between punitive and remedial sanctions is relevant as a punitive remedy is more homogeneous with the fines, penalties, and forfeitures within the purview of Furthermore, this Court has held that the character and purpose of the statutory language should be 25

33 considered in defining terms. See Gompers v. Buck s Stove & Range Co., 221 U.S. 418, 441 (1911). In deciding whether a remedy is punitive the court must consider a variety of factors including the degree and extent of the consequences to the subject of the sanction. Johnson v. SEC, 87 F.3d 484, 488 (D.C. Cir. 1996). As applied to the requested remedy, the D.C. Circuit has held that SEC remedial disgorgement is limited to a reasonable approximation of the profits causally connected to the violation. Zacharias v. SEC, 569 F.3d 458, 473 (D.C. Cir. 2009). In the immediate case the SEC s approximation is clearly unreasonable, as it extends to funds earned legally by other Burlingham employees. The $45,000 bonus distributed by Burlingham in 2010 best illustrates both the unreasonableness of the approximation, and the lack of causal connection. This bonus was distributed in response to a successful computer tablet sale, while Prince s side deals were executed exclusively with smartphone manufacturers. Furthermore, the unreasonableness is exacerbated as all of the disgorged funds are subject to prejudgment interest, some of which has been tolling for over seven years. The inclusion of $250,000 in bonuses awarded to Conrad also suggests a punitive purpose. The facts indicate that Burlingham distributed the majority of their executive compensation in the form of discretionary bonuses. These bonuses were determined by a compensation committee that considered financial success in addition to the department s market share, retention of employees, and integration of acquired businesses. The facts do not suggest 26

34 that Burlingham would have been any less profitable or successful in 2010 without Prince s illegal conduct. While the bonuses could be partly attributable to the side letters, they were also based on the success of other deals, and aspects of the business completely unrelated to Prince s Chinese smartphone deals. Furthermore, according to the facts no other executives ever took part in the illegal practices central to this case, nor did they know they were occurring. The lower court s ruling also puts Burlingham s executives at an inherent disadvantage in that they would have been able to keep their money if the corporation had opted to compensate them using a traditional salary. The scope of the requested remedy in this case is also distinguishable from SEC disgorgements ruled permissible by the circuit courts. In Zacharias the court held that the defendant s had the right to deduct legally earned funds from the disgorgement. See 569 F.3d at 473. In this case no effort was made to distinguish between bonuses and funds earned legally. Kokesh also presents a different scenario as the defendant took $34.9 million directly from investors. 834 F. 3d at This is different from the immediate case in that a significant portion of the requested funds bear only a tangential relation to Prince s conduct. Furthermore, Kokesh can be distinguished by the scale of the stolen funds, and the fact that the entirety of the illegal conduct occurred more than five years prior to the suit. Id. These facts likely influenced the Kokesh court s decision, as barring disgorgement would have deprived the SEC of the ability to seek any relief from the defendant. 27