May 17, 2004

9th Circuit Overturns Frozen Termination

Last week, the 9th Circuit – in SEC v. Gemstar-TV Guide Int’l, No. 03-56129 (9th Circuit, May 12, 2004) – overturned a district court in a 2-1 decision by holding that the SEC had not produced suffient evidence to prove that the termination payments to high-level corporate officials were “extraordinary” – and thus such payments should not be subject to involuntary retention in an escrow account under Section 1103 of Sarbanes-Oxley. This is the first court case to deal with Section 1103.

The SEC had frozen $37.6 million in termination pay and bonuses negotiated by two top officials of Gemstar while they were under suspicion of cooking the company’s books. These officers are awaiting trial, set for August, on civil fraud charges of overstating revenue by $223 million.

From the decision, it looks like the two judges that overturned the district court wanted more evidence that $37.6 million was extraordinary for severance payments – basically perpetuating the survey/benchmarking practices that helped send compensation levels into the strasophere over the past decade.

As a result of the 9th Circuit’s decision, the outstanding escrow order was vacated and the case was remanded to allow the SEC to produce more evidence. The SEC is examining its options; it could ask the full appeals court for a rehearing or appeal to the U.S. Supreme Court.

Updated Internal Controls Proposed for Financial Institutions

On Friday, the SEC and all the federal bank regulators (Fed Reserve, FDIC, Comptroller and OTS) put out a proposed statement describing updated internal controls and risk management procedures for financial institutions with complex structured finance transactions.

The interagency statement refers to risks to a financial institution where a customer uses a complex structured finance transaction to “circumvent regulatory or financial reporting requirements, evade tax liabilities, or further other illegal or improper behavior.” The Statement emphasizes the critical role of the board and senior management in establishing a corporate-wide culture that fosters integrity, compliance with law and overall good business ethics. The Statement would represent a policy statement for institutions supervised by the SEC, and supervisory guidance for institutions supervised by the four banking agencies.