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9th Circuit: Sarbanes-Oxley Payment Escrow Reversed

Termination payments to a former executive officer were improperly placed in escrow under Section 1103 of the Sarbanes-Oxley Act. This section allows the SEC to request a district court to place " extraordinary" payments made to insiders during the course of an SEC investigation in an escrow account under court supervision for an initial 45-day period. In the first review of this section by a federal appeals court, a 9th Circuit panel held that the payments were improperly characterized as "extraordinary" because the district court did not require "proof by admissible objective evidence of what is ordinary."

In this case, a magazine publisher announced that 2001 revenues and related amortization for certain business sectors had been overstated by approximately $40 million. The company negotiated a termination agreement with its CEO and its chief operating officer. Pursuant to the agreement, the CEO was to receive a " termination fee" of more than $22 million, in addition to unpaid salary, bonuses and vacation pay and a grant of restricted stock. The COO received a smaller package, including salary, bonuses, vacation pay and stock grants, with a termination payout of approximately $6.9 million.

In the course of its investigation, the SEC requested that the payments be placed in escrow subject to Section 1103. The district court (CD Cal) found the payments to be "extraordinary" and ordered the escrow. Subsequently, the Commission initiated a civil action against the officers.

The appellate panel initially noted that neither Congress nor the SEC has defined what constitutes an "extraordinary" payment. According to the court, the fact that the payments were the result of extensive negotiations between several parties and that the amounts to be paid were quite large did not establish necessarily that these were extraordinary payments. The disclosure of the payouts in a Form 8-K filing was also not determinative, as "a discretionary corporate disclosure is not an admission that the company has paid an extraordinary amount." The court also noted that "there was also no evidence of whether other issuers had made similar reports for similar sums paid to similarly departing upper management under the same or similar circumstances." Because the district court based its conclusion on conjecture rather than objective evidence, the 9th Circuit panel vacated the escrow and remanded the case.

Circuit Judge Stephen S. Trott argued in dissent stated that Section 1103 is " extraordinarily narrow, well defined and utterly clear," and "applies only to insiders making shadowy payments to insiders." According to Judge Trott, the district court properly concluded that the payments were not made in the ordinary course of business.

¨ SEC v. Yuen (9thCir) is reported at ¶92,811 .