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Sarbanes-Oxley Escrow of Extraordinary Payments Proper

In a rare en banc decision, the 9th U.S. Circuit Court of Appeals held that one-time payments by a corporation to its CEO and CFO were "extraordinary" and were properly subject to escrow under Section 1103 of the Sarbanes-Oxley Act. The appellate court affirmed a district court finding that the payments were to be made during an SEC investigation and were extraordinary in nature.

The court stated that "the facts and circumstances of this case provide a textbook example of the problem," as the two officers received large one-time payments after resigning from their positions following the disclosure of serious accounting problems. The CEO received a cash payment of almost $30 million, while the CFO received more than $8 million in cash. Both officers also received grants of stock and options.

The court initially noted that "the determination of whether a payment is 'extraordinary' will be a fact-based and flexible inquiry," and added that "a nexus between the suspected wrongdoing and the payment itself may further demonstrate that the payment is extraordinary, although such a connection is not required." In this case, the appellate court determined that the district court had properly avoided any "litmus test" and instead looked in context at 1) the circumstances of the payments, 2) the purpose of the payments and 3) the size of the payments.

The payments were nearly five to six times greater than the officers' regular base salary, noted the court, and the component amounts used in determining the lump sum payments were different than the amounts due under their employment agreements. The termination fees were different from what the officers might have been entitled to under existing agreements, noted the court, and the bonuses appeared to be fruit of the alleged fraudulent financial results. "One would not expect benefits like these to be flowing from corporate assets to executives resigning under fire from key management positions," stated the court. The court also concluded that the statute was not unconstitutionally vague. According to the court, "Congress' use of the term 'extraordinary' in Section 1103 in connection with payments being made by a company to insiders during an investigation for potential securities fraud read in the light of the remedial purposes of federal securities laws does not constitute a legal or a constitutional infirmity." The statutory provision also did not present any constitutional free speech issues.

In a concurring opinion, two judges agreed with the result but differed on the proper approach to determining what payments should be considered extraordinary. "I do not believe, however, that Congress intended courts to apply a vague and multi-faceted test that requires consideration of the purpose, circumstances, and size of the benefits, as well as other more complex factors, when determining whether to grant a temporary order escrowing such one time payments for a short period of time while the SEC makes its decision regarding the filing of formal charges," wrote Judge Reinhardt. He concluded that "employing a well established meaning of the word 'extraordinary,' I would hold that all severance packages due top corporate officers and officials, and any other substantial non routine payments to which they may be entitled, constitute 'extraordinary payments' that the district court may order placed in escrow temporarily." SEC v. Yuen (9thCir) is reported at Fed Sec L Rep ¶93,135.