U.S. Securities & Exchange Commission v. Jensen , 835 F.3d 1100 ( 2016 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
U.S. SECURITIES & No. 14-55221
EXCHANGE COMMISSION,
Plaintiff-Appellant, D.C. No.
2:11-cv-05316-R-AGR
v.
PETER L. JENSEN; OPINION
THOMAS C. TEKULVE, JR.,
Defendants-Appellees.
Appeal from the United States District Court
for the Central District of California
Manuel L. Real, District Judge, Presiding
Argued and Submitted February 10, 2016
Pasadena, California
Filed August 31, 2016
Before: Jerome Farris, Richard R. Clifton,
and Carlos T. Bea, Circuit Judges.
Opinion by Judge Clifton;
Concurrence by Judge Bea
2 U.S. SEC V. JENSEN
SUMMARY*
Securities and Exchange Commission
The panel vacated the district court’s judgment in favor
of defendant-corporate officers of the now-defunct Basin
Water, Inc., in an enforcement action filed by the Securities
and Exchange Commission (“SEC”) alleging that the
defendants participated in a scheme to defraud Basin
investors by reporting millions of dollars in revenue that were
never realized; and remanded for further proceedings.
The panel reversed the district court’s rulings interpreting
Rule 13a-14 of the Securities Exchange Act and Section 304
of the Sarbanes-Oxley Act. The panel held that Rule 13a-14
provided the SEC with a cause of action not only against
Chief Executive Officers and Chief Financial Officers who
did not file the required certifications, but also against CEOs
and CFOs who certified false or misleading statements. The
panel further held that the disgorgement remedy authorized
under Section 304 of the Sarbanes-Oxley Act applied
regardless of whether a restatement was caused by the
personal misconduct of an issuer’s CEO and CFO or by other
issuer misconduct.
The panel reversed the district court’s bench trial order,
vacated the judgment, and remanded for a jury trial. The
panel held that the SEC was entitled to a jury trial and did not
consent to defendant officers’ withdrawal of their jury
demand. The panel also held that the SEC did not waive its
*
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
U.S. SEC V. JENSEN 3
right to a jury trial when it objected consistently and
repeatedly before trial to the district court’s decision to hold
a bench trial.
The panel approved the district court’s grant of
defendants’ motion in limine to exclude evidence about the
SEC injunction against Basin’s Director of Finance because
the evidence was both unfairly prejudicial and not particularly
probative.
Judge Bea generally concurred in the panel’s analysis and
disposition, but wrote separately to clarify the intended scope
of the new legal rules announced in the panel’s opinion.
COUNSEL
Paul G. Alvarez (argued), Senior Counsel; Benjamin L.
Schiffrin, Senior Litigation Counsel; Jacob H. Stillman,
Solicitor; Michael A. Conley, Deputy General Counsel; U.S.
Securities & Exchange Commission, Washington, D.C.; for
Plaintiff-Appellant.
David C. Scheper (argued), William H. Forman, and Annah
S. Kim, Scheper Kim & Harris, Los Angeles, California, for
Defendant-Appellee Peter L. Jensen.
Seth Aronson (argued), Carolyn Kubota, and Alec Johnson,
O’Melveny & Myers, Los Angeles, California, for
Defendant-Appellee Thomas C. Tekulve, Jr.
4 U.S. SEC V. JENSEN
OPINION
CLIFTON, Circuit Judge:
The Securities and Exchange Commission appeals from
a district court judgment in favor of Peter Jensen and Thomas
Tekulve, the former Chief Executive Officer and Chief
Financial Officer of the now-defunct Basin Water, Inc. The
SEC filed suit against Defendants in 2011 alleging that they
had participated in a scheme to defraud Basin investors by
reporting millions of dollars in revenue that were never
realized. The district court granted partial summary judgment
to Defendants on the SEC’s claim under Rule 13a–14 of the
Securities Exchange Act (Exchange Act), which requires that
an issuer’s CEO and CFO certify the accuracy of the issuer’s
financial reports. 17 C.F.R. § 240.13a–14. The court held
that the rule requires CEOs and CFOs to certify certain
financial statements but does not provide a cause of action
against officers who certified false statements. The court
held a bench trial on the SEC’s remaining claims and found
for Defendants on all counts.
On appeal, the SEC challenges the district court’s grant of
partial summary judgment, its grant of Defendants’ motion to
withdraw their demand for a jury trial, its decision to exclude
evidence at trial about a 1995 SEC injunction against Basin’s
Director of Finance, and the substance of several factual
findings and legal conclusions the court reached at trial.
Among the legal conclusions challenged is the district court’s
interpretation of Section 304 of the Sarbanes-Oxley Act
(SOX 304). See 15 U.S.C. § 7201 et seq. The district court
held that SOX 304 requires CEOs and CFOs to disgorge
incentive- and equity-based compensation if their companies
issue an accounting restatement because of the officers’ own
U.S. SEC V. JENSEN 5
misconduct, but not if the restatement was caused by issuer
misconduct in which the officers were not directly involved.
We reverse the district court’s rulings interpreting
Exchange Act Rule 13a–14 and SOX 304. Rule 13a–14
provides the SEC with a cause of action not only against
CEOs and CFOs who do not file the required certifications,
but also against CEOs and CFOs who certify false or
misleading statements. The disgorgement remedy authorized
under SOX 304 applies regardless of whether a restatement
was caused by the personal misconduct of an issuer’s CEO
and CFO or by other issuer misconduct.
We also reverse the district court’s bench trial order,
vacate the judgment, and remand for a jury trial. The SEC
was entitled to a jury trial and did not consent to Jensen and
Tekulve’s withdrawal of their jury demand. Nor did the SEC
waive its right to a jury trial when it objected consistently and
repeatedly before trial to the district court’s decision to hold
a bench trial.
Anticipating that the issue may arise again on remand, we
approve the district court’s grant of Defendants’ motion in
limine to exclude evidence about the injunction against
Basin’s Director of Finance.
The judgment of the district court is vacated and the case
is remanded for further proceedings.
I. Background
Peter Jensen founded Basin Water in 1999 to manufacture
water treatment units that would provide municipalities with
clean drinking water. In 2004, Jensen hired Thomas Tekulve
6 U.S. SEC V. JENSEN
as CFO. Tekulve created a finance and accounting
department at Basin and put in place accounting procedures
and internal controls intended to position the company to go
public,1 which it did in May 2006.
The SEC alleges that, beginning in Basin’s first quarter as
a public company and ending with the end of the 2007 fiscal
year, Jensen and Tekulve engaged in a scheme to fraudulently
overstate the company’s financial results. The alleged
scheme involved what the SEC viewed as Basin’s failure to
comply with Generally Accepted Accounting Principles
1
Public reporting companies (with the exception of some foreign
issuers) are required to prepare their publicly filed financial statements in
accordance with Generally Accepted Accounting Principles (GAAP)
(though they may also prepare additional reports using non-GAAP
principles). See, e.g., 15 U.S.C. § 78m; 17 C.F.R. § 229.10 (providing
that, if a publicly registered company chooses to present non-GAAP
financial measures, it must include a “presentation, with equal or greater
prominence, . . . of the most directly comparable financial measure or
measures calculated and presented in accordance with Generally Accepted
Accounting Principles (GAAP) . . . .”); 17 C.F.R. § 229.601(b)(31)
(requiring CEOs and CFOs to certify, in accordance with Rule 13a–14,
“exactly” as follows: “The registrant’s other certifying officer(s) and I are
responsible for establishing and maintaining disclosure controls and
procedures . . . and internal control over financial reporting . . . and have
. . . [among other things] [d]esigned such internal control over financial
reporting . . . to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles
. . . .” (emphasis added)). Since 1973, the SEC has entrusted the
maintenance of GAAP to the Financial Accounting Standards Board,
which periodically updates or revises GAAP in light of new accounting
and legal developments. However, “GAAP is not the lucid or
encyclopedic set of pre-existing rules . . . . Far from a single-source
accounting rulebook, GAAP ‘encompasses the conventions, rules, and
procedures that define accepted accounting practice at a particular point
in time.’” Shalala v. Guernsey Mem’l Hosp., 514 U.S. 87, 101 (1995).
U.S. SEC V. JENSEN 7
(GAAP) in financial reports to the SEC. The agency pointed
to two general types of transactions that it viewed as violating
GAAP: (1) Basin recognized revenue from sales that were
contingent or had not yet been finalized, and (2) Basin
recognized sales revenue from loans made to Special Purpose
Entities (SPEs), which used that money to purchase water
treatment units from Basin with no reasonable expectation
that the SPEs would ever repay such loans. In its complaint,
the SEC also alleged that Jensen and Tekulve each received
several hundred thousand dollars of incentive-based
compensation, in the form of salary and bonuses, and equity-
based compensation, in the form of shares of Basin stock,
during the period in which they were allegedly causing Basin
to inflate its revenues fraudulently. The complaint also
asserted that Jensen had sold his Basin stock based on
material nonpublic information, realizing some $9,000,000 in
profit.
After Jensen and Tekulve left the company in 2008, Basin
restated its financial statements for 2006 and 2007. Basin’s
stock price fell substantially after the company’s
announcement that restatement might be necessary.
Thereafter, the SEC brought this enforcement action
against Jensen and Tekulve. In November 2012, the district
court granted partial summary judgment for Defendants on
the SEC’s claims under Exchange Act Rule 13a–14 and
denied all other motions and cross-motions for summary
judgment. After a bench trial beginning on October 15, 2013,
the district court found in favor of the defendants on all
remaining counts, concluding that “revenue was properly
recognized” on all the transactions at issue, and that they “had
economic substance.” The court also found that the SEC had
8 U.S. SEC V. JENSEN
failed to show that Jensen had sold any of his Basin shares in
reliance on insider information. This appeal followed.
II. The SEC’s entitlement to a jury trial
Because it affects the largest number of issues, we start by
taking up the question of whether the SEC was improperly
denied a jury trial. We review entitlement to a jury trial de
novo. Palmer v. Valdez, 560 F.3d 965, 968 (9th Cir. 2009).
We conclude that the issues should have been tried to a jury,
that the district court erred in proceeding with a bench trial,
and that the results of that bench trial must be vacated.
A. The right to a jury trial
As a preliminary issue, we note that the SEC had a right
to a jury trial on most of its claims against Defendants.
Parties have a right to a jury trial in lawsuits seeking legal
remedies. Legal remedies are distinct from equitable
remedies in that they are “intended to punish culpable
individuals, as opposed to those intended simply to extract
compensation or restore the status quo.” Tull v. United
States, 481 U.S. 412, 422 (1987).
Although much of the relief sought by the SEC was
equitable, for which there is not a right to a jury, the SEC
requested legal relief in the form of civil penalties for six of
the seven claims asserted in its complaint.2 See 15 U.S.C.
2
The claimed violations arose under the following provisions of the
Securities and Exchange Acts: (1) Section 17(a) of the Securities Act
(fraud); (2) Section 10(b) of the Exchange Act and Exchange Act Rule
10b–5 (fraud); (3) Section 13(a) of the Exchange Act and Exchange Act
Rules 12b–20, 13a–1 and 13a–13 (failure to include material information
U.S. SEC V. JENSEN 9
§ 77t(d) (granting the SEC the power to seek civil penalties
for violations of the Securities Act); 15 U.S.C. § 78u(d)
(granting the SEC the power to seek civil penalties for
violations of the Exchange Act). For only one claim did the
SEC request exclusively equitable relief. That was for a
claim, identified as Claim Seven, which arose under Section
304 of the Sarbanes-Oxley Act (SOX 304). See SEC v.
Jasper, 678 F.3d 1116, 1130 (9th Cir. 2012) (“Ninth Circuit
law is clear that the reimbursement provision of SOX 304 is
considered an equitable disgorgement remedy and not a legal
penalty.”).
That the SEC, in addition to seeking civil penalties, also
requested equitable relief for Claims One through Six does
not undercut its entitlement to a jury. Where, as here, “a
‘legal claim is joined with an equitable claim, the right to jury
trial on the legal claim, including all issues common to both
claims, remains intact.’” Tull, 481 U.S. at 425.
B. The SEC did not waive its right to a jury trial
The SEC did not request a jury trial in its complaint.
Rather, the first party to request trial by jury was Tekulve,
whose answer to the SEC’s complaint included a jury demand
“as to all issues which are triable by jury.” Accordingly, the
district court entered an order on December 8, 2011 setting
the case for a jury trial.
on annual and quarterly reports); (4) Section 13(b)(5) of the Exchange Act
and Exchange Act Rule 13b2–1 (falsifying books and records);
(5) Exchange Act Rule 13b2–2 (making false statements to accountants);
(6) Exchange Act Rule 13a–14 (false certification), and (7) Sarbanes-
Oxley Section 304 (violation of financial reporting requirements).
10 U.S. SEC V. JENSEN
Almost a year and a half later, on March 29, 2013, Jensen
and Tekulve filed a notice withdrawing the jury demand and
waiving their right to a jury trial. The SEC responded on the
same day by filing a response stating its lack of consent to the
withdrawal of the jury trial demand, noting that Defendants’
filing did not comply with Rule 38(d) of the Federal Rules of
Civil Procedure (which requires all parties to consent to the
withdrawal of a jury demand), and asking the court to
disregard Defendants’ notice.
Despite the SEC’s objection, the court granted
Defendants’ request and set the case for a bench trial,
reasoning that “only the defendants timely requested a jury
trial.” The court’s order was dated April 1, 2013, but due to
a error by the clerk’s office it was not docketed or served
until June 4, 2013.
The SEC did not state any further objection on the record
until the parties’ jointly proposed Amended Final Pretrial
Conference Order, submitted on September 5, 2013, in which
the SEC again requested that the case be tried by a jury. At
the pretrial conference a few days later, the district court
reiterated its intention to hold a bench trial because the SEC
“didn’t ask for a jury trial in the first place.”
This decision was erroneous. The rules provide that a
jury demand can be withdrawn “only if the parties consent.”
Fed. R. Civ. P. 38(d). It does not matter whether the party
that filed for waiver was the same party that demanded a jury
in the first place; other parties “are entitled to rely” on the
original jury demand, “and need not file their own demands.”
Fuller v. City of Oakland, 47 F.3d 1522, 1531 (9th Cir. 1995).
Moreover, the Federal Rules provide a specific procedure for
withdrawal of a jury demand: As long as there is a federal
U.S. SEC V. JENSEN 11
right to a jury trial, “trial on all issues so demanded must be
by jury unless . . . the parties or their attorneys file a
stipulation to a nonjury trial or so stipulate on the record.”
Fed. R. Civ. P. 39(a). It is uncontested that the SEC did not
so stipulate here. To the contrary, the SEC stated its
objection to a bench trial multiple times, beginning on the
very same day that Defendants purported to withdraw the jury
demand.
In its Findings of Fact and Conclusions of Law after trial,
the district court repeated its position that a bench trial was
appropriate, but by that point its reasoning had changed. The
court concluded, and Defendants argue on appeal, that the
SEC waived its right to a jury trial by failing to object to the
district court’s order setting the case for a bench trial between
June 4, 2013, when the agency received notice of the order,
and September 5, 2013, when it filed its Amended Pretrial
Conference Order.
We have recognized a limited exception to the
requirements of Rules 38 and 39 “when the party claiming the
jury trial right is attempting to act strategically—participating
in a bench trial in the hopes of achieving a favorable
outcome, then asserting lack of consent to the bench trial
when the result turns out to be unfavorable for him.” Solis v.
Cty. of Los Angeles, 514 F.3d 946, 955 (9th Cir. 2008).
However, this exception is narrow. “Because the right to a
jury trial is a fundamental right guaranteed to our citizenry by
the Constitution, . . . courts should indulge every reasonable
presumption against waiver.” Id. at 953 (quoting Pradier v.
Elespuru, 641 F.2d 808, 811 (9th Cir. 1981)). “Reluctant
participation in a bench trial does not waive one’s Seventh
Amendment right to a jury trial.” Id. at 956.
12 U.S. SEC V. JENSEN
In White v. McGinnis, 903 F.2d 699 (9th Cir. 1990), we
found waiver where the appellant “sat through the entire
bench trial and never once objected to the absence of a jury
while his counsel vigorously argued his case to the judge.”
Id. at 700. “Nor did appellant notify the court of its mistake
before it entered judgment against him.” Id. “Nor did he file
a motion for a new trial after judgment.” Id. This case is
nothing like that. Here, the SEC maintained the consistent
position that it did not consent to the withdrawal of the jury
demand, beginning on the day the demand withdrawal was
filed. It then stated its objection to the court’s order setting
the matter for bench trial more than a month before trial. A
few days before trial commenced, the SEC submitted
proposed jury instructions. This is a far cry from the type of
“vigorous participation in a bench trial, without so much as
a mention of a jury” that we have previously held to
constitute waiver. White, 903 F.2d at 703. The SEC’s
repeated objections prior to trial preserved its right to contest
the district court’s erroneous bench trial order.
C. The district court’s error was not harmless
Even though we have concluded that the district court
erred in conducting a bench trial, Defendants argue that
remand for a jury trial is not necessary because the error in
denying the SEC a jury trial was harmless. “The denial will
be harmless only if ‘no reasonable jury could have found for
the losing party, and the trial court could have granted a
directed verdict for the prevailing party.’” Solis, 514 F.3d at
957 (quoting Fuller, 47 F.3d at 1533). “If reasonable minds
could differ as to the import of the evidence, however, a
verdict should not be directed.” Anderson v. Liberty Lobby,
Inc., 477 U.S. 242, 250–51 (1986). We conclude that a
directed verdict would not have been appropriate based on the
U.S. SEC V. JENSEN 13
evidence offered in this case, so the erroneous denial of a jury
trial was not harmless.
The SEC’s claims focused generally on Basin’s
transactions with a group of investors called Opus Trust, a
company called Thermax, and two Special Purpose Entities
(SPEs). With regard to each of the six transactions at issue in
this case, the district court resolved key issues of fact in favor
of Defendants that a jury could have resolved in the SEC’s
favor. This is particularly clear in the context of the district
court’s credibility determinations, which are “the exclusive
function of the jury.” Donoghue v. Orange Cty., 848 F.2d
926, 932 (9th Cir. 1987). The court discounted the testimony
of three of the SEC’s fact witnesses outright,3 some of whom
3
The court discounted the testimony of James Sabzali, Lloyd Ward, and
Michael Stark. Sabzali’s testimony was discounted on the ground that he
lied about a prior felony conviction and was impeached at trial, as well as
on the basis of his general “demeanor and attitude during his testimony.”
The court gave “little weight” to the testimony of Lloyd Ward (the
attorney who set up the SPE deals) due to Lloyd’s demeanor and attitude,
as well as evidence that Ward had committed numerous recent legal and
ethical violations: His license to practice law had been suspended for
eleven months as of the date of trial; he admitted that he was subject to a
2011 cease and desist order by the Connecticut Banking Commission for
providing illegal debt relief services and had been ordered to pay a
$500,000 fine; and he was subject to a final judgment in Kansas for
providing illegal debt services and had been ordered to pay a $100,000
fine there. Lastly, the district court found “Stark’s credibility to have been
impeached” by evidence that directly contradicted his trial testimony on
material issues. Stark testified that he did not have a close relationship
with Charles Litt, who was involved in setting up the SPE transactions,
and that Stark had never before done a deal with Litt. However, e-mail
correspondence revealed that, at the time he began work at Basin, Stark
had just returned from a three-week vacation in Italy with Litt and his
wife. Moreover, Litt’s wife was Stark’s wife’s cousin, and Stark had
testified in his deposition that he considered Litt a member of the family.
14 U.S. SEC V. JENSEN
presented testimony that materially contradicted other
witnesses favorable to Defendants.4 “A directed verdict is
improper when there is conflicting testimony raising a
question of witness credibility.” Id.
The district court also credited statements made by other
witnesses despite evidence in the record that a reasonable jury
could conclude contradicted their testimony. For instance,
the district court’s determination that Basin properly
Stark was also confronted on cross-examination with a May 12, 2007 e-
mail to a business colleague in which Stark identified Litt as his “financial
guy who does all [his] deals.”
4
The court also discounted the testimony of the SEC’s expert because
she “did not sufficiently take into consideration the role of professional
judgment in accounting for transactions and relied excessively on
hindsight in evaluating the accounting issues in this case, rather than
viewing the facts as they existed at the time.” This determination
doubtless affected the verdict, as the key issue in many of the SEC’s
claims was whether revenue had been properly recognized under GAAP,
a subject on which the district court accepted Defendants’ expert’s
testimony in full.
Defendants argue on appeal that, were this case tried before a jury, the
district court would have been obligated to bar the jury from hearing the
SEC’s expert witness altogether because the court found her methodology
“unreliable.” It is true that “the Federal Rules of Evidence impose a
‘gatekeeping’ duty on the district court, requiring the court to ‘screen[ ]’
the proffered evidence to ‘ensure that any and all scientific testimony or
evidence admitted is not only relevant, but reliable.’” United States v.
Alatorre, 222 F.3d 1098, 1100–01 (9th Cir. 2000) (quoting Daubert v.
Merrell Dow Pharmaceuticals, Inc., 509 U.S. 579, 597 (1993)). However,
under this standard, the district court’s critiques of the SEC’s expert’s
methodology in its Findings of Fact and Conclusions of Law, by
themselves, would not have given it proper grounds to bar the expert from
testifying before a jury. We do not need to resolve this issue, because
there are enough other conflicts to foreclose a directed verdict.
U.S. SEC V. JENSEN 15
recognized revenue from the Opus Trust transaction was
dictated by its assessment of Tekulve’s credibility as a
witness. In the initial letter agreement between Opus and
Basin, dated December 2005, Opus agreed to purchase a five
percent stake in a Basin subsidiary and two 1,000 gpm
(gallons per minute) ion exchange units for a total price of
$1.5 million. Basin’s auditors advised the company that the
revenue from that deal could not be recorded based on the
letter agreement because the agreement did not specify the
items sold. At trial, Tekulve testified that Basin identified the
specific units sold to Opus in March 2006, at which point
Basin’s auditors gave their approval for the revenue to be
recorded.
The district court credited Tekulve’s testimony and found
that the revenue from the Opus sale had been properly
recorded as of March 2006. But other evidence in the record
suggests that the identity of the units sold to Opus may not
have been finalized until late June 2006. An e-mail sent by
Tekulve on June 16, 2006 stated that Opus would have to
identify for Basin’s auditors that “the units [Opus] owns are
the Salinas Well 06 and 20 units,” which had a respective
gpm of 500 and 600, but the formal purchase agreement,
signed later that month, identified the units sold to Opus as
Salinas Units Nos. 15 and 108, which had a gpm of 700 and
1,100. While Defendants argue that the June 16 e-mail “only
notes that the [final agreement] should reflect the identity of
the units sold”—essentially, that the units named were
meaningless placeholders—it would not be unreasonable for
a jury to read the e-mail to show that the units sold were not
agreed upon until June 2006, and thus to conclude that the
sale price should not have been recognized as revenue in the
first quarter of 2006.
16 U.S. SEC V. JENSEN
Similarly, the district court’s decision to credit Jensen’s
testimony over potentially contradictory evidence affected its
verdict on the SEC’s claim that Basin prematurely recognized
revenue in the Thermax transaction. In September 2006,
Thermax representative James Sabzali e-mailed Jensen
stating his intent to purchase two controlled softening
modules from Basin. The e-mail attached a letter that
included several terms and conditions (T&Cs), including an
escape clause providing that Thermax’s purchase order was
contingent on Thermax receiving an order for controlled
softening modules from PDVSA, a state-owned petroleum
company in Venezuela, by November 30, 2006. Sabzali
asked Jensen to confirm agreement with the T&C by reply e-
mail. At trial, Sabzali testified that Jensen provided him with
oral consent to Thermax’s T&Cs in a later phone
conversation. Jensen, in contrast, testified that he called
Sabzali and told him that he would reject the offer unless
Thermax sent him a non-contingent purchase order.
On September 28, 2006, Thermax’s Finance Unit sent
Jensen a purchase order for two controlled softening modules
at a total cost of $860,320. The purchase order did not
contain the T&Cs or the escape clause that had been included
in Sabzali’s prior e-mail, but stated only “TBA[:] Agreed that
the T&C to Basin will reflect the T&C’s on PDVSA’s to
Thermax Inc.” Jensen testified that he understood this
purchase order to be non-contingent. Based on this
understanding, Basin began construction on the modules and,
over the next four quarters, recorded revenues from the
transaction totaling $642,000. Having discredited Sabzali’s
testimony to the contrary, the district court found that Jensen
had properly rejected Thermax’s T&Cs and that Basin
recognized revenue in accordance with GAAP based on the
U.S. SEC V. JENSEN 17
purchase order from Thermax’s Finance Unit.5 But had a jury
credited Sabzali’s testimony instead of Jensen’s, it could have
concluded that collectibility was not reasonably assured on
the Thermax transaction, and that as a result Basin’s
accounting had not complied with GAAP.
The other transactions at issue in this case involved the
two SPEs, VL Capital, LLC (VLC) and Water Services
Solutions (WSS), which the SEC alleged had been
established at Basin’s direction. According to the SEC, the
transactions Basin entered into with the SPEs were without
“economic substance,” because “Basin essentially paid [the
SPEs] to purchase the system[s]” and then reported those
purchases as revenue without reasonably expecting to receive
repayment of the purchase price. At trial, Defendants
countered that the decision to recognize revenue from these
transactions complied in full with GAAP because at the time
it recognized revenue, Basin thought the SPEs could secure
financing.
One of the requirements under GAAP is that collectibility
of reported revenue is reasonably assured. At trial,
5
Whether Basin’s recognition of revenue comported with SEC Release
(Staff Accounting Bulletin) No. 104 (“SAB 104”) was a significant point
of contention at trial. A Staff Accounting Bulletin is a periodic
publication from the SEC that offers “interpretive guidance” regarding
how the SEC thinks GAAP’s broad principles (as well as applicable SEC
rules and regulations) should be applied with respect to a particular
accounting issue or in a particular situation. SAB 104, 81 SEC Docket
2848, 2003 WL 22971049, at *1 (Dec. 17, 2003). SAB 104 provides that
the SEC “believes that revenue generally is realized or realizable and
earned when all of the following criteria are met: [1] Persuasive evidence
of an arrangement exists, [2] Delivery has occurred or services have been
rendered, [3] The seller’s price to the buyer is fixed or determinable, and
[4] Collectibility is reasonably assured.” Id. at *4.
18 U.S. SEC V. JENSEN
Defendants’ expert testified that preliminary financing
arrangements between VLC and CCH, a Danish bank, and
between WSS and National City Energy Capital, an
American bank, provided evidence of collectibility in the SPE
transactions. The district court’s conclusion that collectibility
for the SPE transactions was reasonably assured relied at least
in part on this testimony. But the early arrangements with
CCH and National City were never finalized, and both banks
dropped out of the transactions before formal contracts
between Basin and the SPEs were signed. The district court
did not acknowledge this, and Defendants’ expert testified
that it was an “important” part of the collectibility analysis
that the preliminary financing arrangement with National City
allowed the bank “to not fulfill [the loan] at their own
discretion.” Because a reasonable jury could have viewed the
lack of outside financing as having undermined collectibility,
a directed verdict would not have been appropriate regarding
the SPE transactions.
The examples above are not intended to provide a
comprehensive list of the potential issues on which a jury
could reach a different result than the judge did. Rather, they
point to evidence as to all transactions at issue that “presents
a sufficient disagreement to require submission to a jury.”
Anderson, 477 U.S. at 251–52. Because the court could not
have granted Defendants a directed verdict, the court’s error
in concluding that the SEC waived its right to a jury trial was
not harmless. We reverse the bench trial order and remand
for a jury trial. See Solis, 514 F.3d at 957.
U.S. SEC V. JENSEN 19
D. Remand moots the SEC’s challenges to the findings of
fact
For the most part, our decision that the order setting the
case for a bench trial was erroneous moots the SEC’s
remaining challenges to the district court’s findings of fact
and conclusions of law on appeal. As noted above, the right
to a jury trial exists only for legal and not equitable claims,
but the jury serves as the finder of fact for “issues common to
both claims.” Tull, 481 U.S. at 425. Therefore, the SEC’s
Claims One through Six must be tried to a jury. This
conclusion vacates the district court’s findings of fact as to
those claims and, on remand, the district court may consider
equitable relief for Claims One through Six only “after the
jury renders its verdict.” See Beacon Theatres, Inc. v.
Westover, 359 U.S. 500, 508 (1959) (holding that in cases for
both legal and equitable relief, the legal claims must be tried
to a jury before the court can grant equitable relief). To the
extent that the SEC’s challenges to the district court’s legal
conclusions depended on the court’s application of the law to
the facts, those challenges are moot as well.
SEC’s Claim Seven for relief under SOX 304 presents a
more challenging question. As noted above, this claim
requests only equitable relief, so it does not trigger the right
to a jury trial. However, it involves the same set of facts that
the jury will be required to find in order to resolve Claims
One through Six. The key issue in determining Jensen and
Tekulve’s liability under Claim Seven, which we discuss in
greater detail below, is whether Basin’s restatements resulted
from misconduct. Claims One through Six all involve
allegations of misconduct, including fraud, falsifying books
and records, and false certification. As a result, a finding that
Jensen and Tekulve committed a violation of securities laws
20 U.S. SEC V. JENSEN
under any of Claims One through Six would necessarily
require the jury to consider the same issues that the court is
called upon to determine in Claim Seven.
In cases that involve both legal and equitable claims, the
Supreme Court has cautioned against “trying part to a judge
and part to a jury.” Id. at 508. When a plaintiff brings legal
and equitable claims “based on the same facts, the Seventh
Amendment requires the trial judge to follow the jury’s
implicit or explicit factual determinations in deciding the
legal claim.” Miller v. Fairchild Industries, Inc., 885 F.2d
498, 507 (9th Cir. 1989). Therefore, even though it is
uncontested that Claim Seven is purely equitable, it is
necessary to vacate the district court’s judgment as to that
claim. In ruling on Claim Seven on remand, the district court
“will be bound by all factual determinations made by the
jury” in the process of deciding Claims One through Six. Id.
III. Rule 13a–14
Prior to trial, the district court granted summary judgment
to Defendants on the claim that their certification of false
financial statements violated Rule 13a–14 of the Exchange
Act. The SEC challenges that decision. We review a district
court’s grant of summary judgment de novo. Oswalt v.
Resolute Indus., Inc., 642 F.3d 856, 859 (9th Cir. 2011).
Rule 13a–14 requires that for every report filed under
Section 13(a) of the Exchange Act, including Form 10–Q and
10–K financial reports, each principal executive and principal
financial officer of the issuer must sign a certification as to
the accuracy of the financial statements within the report.
17 C.F.R. §240.13a–14. The rule was adopted in 2002, as
directed by Section 302 of the Sarbanes-Oxley Act (SOX
U.S. SEC V. JENSEN 21
302). 15 U.S.C. § 7241. The rule in relevant part reads as
follows:
Each report, including transition reports, filed
on Form 10–Q, Form 10–K, Form 20–F or
Form 40–F . . . under Section 13(a) of the Act
. . . must include certifications in the form
specified in the applicable exhibit filing
requirements of such report and such
certifications must be filed as an exhibit to
such report. Each principal executive and
principal financial officer of the issuer, or
persons performing similar functions, at the
time of filing of the report must sign a
certification.
17 C.F.R. § 240.13a–14(a). In accordance with SOX 302, the
certification must provide, among other things, that “the
signing officers . . . are responsible for establishing and
maintaining internal controls,” and that those controls “ensure
that material information relating to the issuer . . . is made
known to such officers.” 15 U.S.C. § 7241(a)(4). The
signing officers are also required to certify that, “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.” Id. § 7241(a)(2).
Defendants argue that this rule creates a cause of action
against CEOs and CFOs who do not sign or file certifications
but does not create a cause of action based on false
certifications independent of the existing provisions in the
Exchange Act that prohibit fraudulent statements. The
22 U.S. SEC V. JENSEN
district court agreed with Defendants and dismissed the
SEC’s Rule 13a–14 claim.
We disagree. “[S]igners of documents should be held
responsible for the statements in the document.” Howard v.
Everex Sys., Inc., 228 F.3d 1057, 1061 (9th Cir. 2000).
“[T]he affixing of a signature is not a mere formality, but
rather signifies that the signer has read the document and
attests to its accuracy.” Id. (quoting United States v. Gomez-
Gutierrez, 140 F.3d 1287, 1289 (9th Cir. 1998)).
The wording of Rule 13a–14 supports the conclusion that
a mere signature is not enough for compliance. The
dictionary definition of “certify” is “1. to testify by formal
declaration, often in writing; to make known or establish (a
fact)”; or “3. to guarantee the quality or worth of; vouch for
[something].” Webster’s New Twentieth Century Dictionary
of the English Language, Unabridged, 297 (Jean L.
McKechnie ed., 2d ed. 1979). Thus, by definition, one cannot
certify a fact about which one is ignorant or which one knows
is false.
While we have not previously had the opportunity to
define the scope of Rule 13a–14, we have in the past
concluded that other, similar rules include an implicit
truthfulness requirement. Rule 13a–14 is promulgated under
the authority of Exchange Act Section 13(a), which requires
companies to file with the SEC annual and quarterly reports
as well as such “information and documents . . . as the
Commission shall require to keep reasonably current the
information and documents required to be included in or filed
with an application or registration statement.” United States
v. Berger, 473 F.3d 1080, 1097 (9th Cir. 2007) (quoting
15 U.S.C. § 78m(a)). In Ponce v. SEC, 345 F.3d 722 (9th Cir.
U.S. SEC V. JENSEN 23
2003), we concluded that Rule 13a–13, which is also
promulgated under the authority of Section 13(a), “requires
the filing of quarterly reports that are not misleading,” id. at
735, even though the rule itself states only that issuers are
required to file such reports without specifying whether they
must be truthful, see 17 C.F.R. § 240.13a–13. We also
upheld the SEC’s determination that the defendant had
violated Rule 13a–1, which requires issuers to file annual
reports, by filing reports that contained misleading
information. Ponce, 345 F.3d at 735–36 (quoting 17 C.F.R.
§ 240.13a–1).
Other circuit courts have also read rules promulgated
under Section 13 to create liability for false statements even
when the rules did not explicitly require truthfulness. For
example, Rule 13d–1, promulgated under Exchange Act
Section 13(d), requires certain stockholders to file a form
called a Schedule 13D with the SEC within a certain period
of time after taking possession of their stock. 17 C.F.R.
§ 240.13d–1. The rule does not explicitly require that the
Schedule 13D be accurate. Nonetheless, in GAF Corp. v.
Milstein, 453 F.2d 709 (2d Cir. 1971), the Second Circuit
concluded that “the obligation to file truthful statements is
implicit in the obligation to file with the issuer.” Id. at 720.
It held that Rule 13d–1 created a cause of action against a
stockholder who filed a false Schedule 13D and not merely
against one who failed to file a Schedule 13D altogether. In
so holding, the court explicitly rejected the argument that
false filings violated only “the penal provision on false filings
. . . or one of the antifraud provisions” within the Exchange
Act. Id; see also Dan River, Inc. v. Unitex Ltd., 624 F.2d
1216, 1227 (4th Cir. 1980); SEC v. Savoy Indus., Inc.,
587 F.2d 1149, 1165 (D.C. Cir. 1978) (“Sections 13(d)(1) and
24 U.S. SEC V. JENSEN
13(d)(3) and the rules promulgated thereunder undoubtedly
create the duty to file truthfully and completely.”).
We agree and conclude that Rule 13a–14, like other rules
promulgated under Section 13 of the Exchange Act, includes
an implicit truthfulness requirement. It is not enough for
CEOs and CFOs to sign their names to a document certifying
that SEC filings include no material misstatements or
omissions without a sufficient basis to believe that the
certification is accurate. We reverse the district court’s
decision to the contrary and remand the SEC’s Rule 13a–14
claim.6
6
We decline to reach the question of the mental state required for a
violation of Rule 13a–14. The parties have not presented arguments on
that issue, which confirms that a rule on mental state is not needed to
resolve the case before us. Moreover, as the concurrence notes, our only
precedent on this issue expressly declines to reach the question of the
mental state required for a violation of a rule promulgated under Section
13. Ponce, 345 F.3d at 741 (noting that “in at least one proceeding the
SEC has held that a scienter requirement is not necessary [for a violation
of Rules 13a–1 and 13a–13] since Section 13(a) violations do not require
scienter”). In addition, at least one other circuit has concluded that rules
promulgated under Section 13—including rules that apply to persons and
not to the issuers themselves—do not incorporate a scienter requirement.
See SEC v. McNulty, 137 F.3d 732, 740–41 (2d Cir. 1998) (holding that
there is “no scienter requirement inserted in SEC Rule 13b2–1 . . . because
§ 13(b) of the 1934 Act ‘contains no words indicating that Congress
intended to impose a ‘scienter’ requirement.’”) (internal citations omitted).
To be sure, we do not express an opinion on whether or not the standard
suggested by the concurrence is correct. Rather, we recognize that this
issue is not properly before us and observe the “cardinal principle of
judicial restraint—if it is not necessary to decide more, it is necessary not
to decide more.” Ventress v. Japan Airlines, 747 F.3d 716, 724 (9th Cir.
2014) (Bea, J., concurring in part) (quoting PDK Labs. Inc. v. DEA,
362 F.3d 786, 799 (D.C. Cir. 2004) (Roberts, J., concurring in part and
concurring in the judgment)).
U.S. SEC V. JENSEN 25
IV. Sarbanes-Oxley Section 304
The SEC also raises a substantive challenge to the district
court’s legal analysis of Section 304 of the Sarbanes-Oxley
Act, commonly referred to as SOX 304. We review de novo
the district court’s conclusions of law following a bench trial.
Lentini v. California Ctr. for the Arts, Escondido, 370 F.3d
837, 843 (9th Cir. 2004).
SOX 304 provides, in relevant part:
If 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
officer of the issuer shall reimburse the issuer
for—
(1) any bonus or other incentive-based or
equity-based compensation received by that
person from the issuer during the 12-month
period following the first public issuance or
filing with the Commission (whichever first
occurs) of the financial document embodying
such financial reporting requirement; and
(2) any profits realized from the sale of
securities of the issuer during that 12-month
period.
15 U.S.C. § 7243(a). The district court held that Jensen and
Tekulve did not violate SOX 304 because “Basin’s
26 U.S. SEC V. JENSEN
misstatement was not issued due to any misconduct on the
part of Defendants.” SEC argues that this conclusion was
legally erroneous because SOX 304 is concerned not with
individual misconduct on the part of the CEO and the CFO,
but rather with the misconduct of the issuer. Because this is
a purely legal issue that may arise again on remand, we
address it here.
The SEC’s interpretation of SOX 304 is consistent with
the plain language of the statute, which is the first thing we
look to when interpreting statutes. See King v. Burwell,
135 S. Ct. 2480, 2489 (2015). SOX 304 provides for
reimbursement to issuers 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.” 15 U.S.C. § 7243(a)
(emphasis added). The clause “as a result of misconduct”
modifies the phrase “the material noncompliance of the
issuer,” suggesting that it is the issuer’s misconduct that
matters, and not the personal misconduct of the CEO or CFO.
This conclusion is bolstered by the history of the statute.
The report from the Senate Committee on Banking, Housing,
and Urban Affairs on the bill that became the law indicated
that the disgorgement remedy was developed with the broad
goal of addressing concerns “about management benefitting
from unsound financial statements.” S. Rep. No. 107–205 at
26, 2002 WL 1443523 (July 3, 2002). That report echoed
then-President George W. Bush’s recommendations that
“‘CEOs or other officers should not be allowed to profit from
erroneous financial statements,’ and that ‘CEO bonuses and
other incentive-based forms of compensation [sh]ould be
disgorged in cases of accounting restatement and
misconduct.” Id. It also emphasized that the disgorgement
U.S. SEC V. JENSEN 27
remedy was intended as a significant expansion of the SEC’s
enforcement powers:
For a securities law violation, currently an
individual may be ordered to disgorge funds
that he or she received “as a result of the
violation.” Rather than limiting disgorgement
to these gains, the bill will permit courts to
impose any equitable relief necessary or
appropriate to protect, and mitigate harm to,
investors.
Id. at 27.
Congress’s intent to craft a broad remedy that focused on
disgorging unearned profits rather than punishing individual
wrongdoing is particularly apparent when comparing the
legislative history of the Senate bill, S. 2673, with the
legislative history of its House of Representatives
counterpart, H.R. 3763. One proposed version of H.R. 3763
would have provided for disgorgement of all salary,
commissions, and other 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.” Committee on Rules, H. Rep. No.
107–418 at 31, 2002 WL 704333 (April 23, 2002). The
contrast between that language and the “as a result of
misconduct” language in the final statute suggests that
Congress knew how to draft a statute that would limit the
disgorgement remedy to cases of officer or director
misconduct, and chose not to do so.
While we are aware of no circuit court that has addressed
this issue, most district courts to have examined it have
28 U.S. SEC V. JENSEN
concluded that SOX 304 does not require CEOs or CFOs to
have personally engaged in misconduct before they are
required to disgorge profits under that statute. As a court in
the District of Arizona has observed, “[a] CEO need not be
personally aware of financial misconduct to have received
additional compensation during the period of that misconduct,
and to have unfairly benefitted therefrom.” SEC v. Jenkins,
718 F. Supp. 2d 1070, 1075 (D. Ariz. 2010); see also SEC v.
Baker, No. A-12-CA-285-SS, 2012 WL 5499497, at *4
(W.D. Tex. Nov. 13, 2012) (“Jenkins persuasively rejected
similar attempts by the officer defendant to read into the
statute a requirement of misconduct by the officer.”); SEC v.
Geswein, No. 5:10CV1235, 2011 WL 4541303, at *3 (N.D.
Ohio Sept. 29, 2011) (“[I]f [the issuer] had to prepare an
accounting restatement because of its material noncompliance
with financial reporting securities laws, and if that
noncompliance was caused by [the issuer’s] misconduct, then
the CEO or CFO must provide certain reimbursements to [the
issuer].”); SEC v. Life Partners Holdings, Inc., 71 F. Supp. 3d
615, 625 (W.D. Tex. 2014) (holding that, in order to secure
relief under SOX 304, the SEC was required to demonstrate
that 1) the issuer was required to issue a restatement because
of non-compliance with reporting requirements, 2) “the non-
compliance was caused by misconduct within [the issuer],”
and 3) the CEO received incentive pay within the relevant
time period).
In accordance with its text and legislative history, we hold
that SOX 304 allows the SEC to seek disgorgement from
CEOs and CFOs even if the triggering restatement did not
result from misconduct on the part of those officers. This is
consistent with our conclusion elsewhere that the
reimbursement provision is an equitable and not a legal
remedy. See Jasper, 678 F.3d at 1130. “[A]mple authority
U.S. SEC V. JENSEN 29
supports the proposition that the broad equitable powers of
the federal courts can be employed to recover ill gotten gains
for the benefit of the victims of wrongdoing, whether held by
the original wrongdoer or by one who has received the
proceeds after the wrong.” SEC v. Colello, 139 F.3d 674, 676
(9th Cir. 1998). Here, disgorgement is merited to prevent
corporate officers from profiting from the proceeds of
misconduct, whether it is their own misconduct or the
misconduct of the companies they are paid to run.7
V. Exclusion of evidence
The final issue we address, as it is likely to appear again
on remand, is whether the district court properly excluded
evidence about an SEC injunction against Doug Hansen,
whom Tekulve hired as Basin’s Director of Finance in the
period before the company went public. Evidentiary rulings
are reviewed for abuse of discretion, and reversed only if the
decision below was both erroneous and prejudicial. Orr v.
Bank of Am., NT & SA, 285 F.3d 764, 773 (9th Cir. 2002).
In 1994 Hansen was the target of an SEC action alleging
violation of Section 10(b) and Rules 10b–5 and 13b2–1 of the
Exchange Act. “[W]ithout admitting or denying the
allegations” against him, Hansen entered into a consent
decree in which he agreed to a permanent injunction
prohibiting him from committing securities fraud, an
administrative order prohibiting him from practicing in front
of the SEC, and other relief. The SEC argues that the district
7
We decline to reach the issue of the meaning of “misconduct” under
SOX 304. Once again, this issue was not presented or argued before us
on appeal, and it goes significantly beyond what is needed to resolve the
dispute before us.
30 U.S. SEC V. JENSEN
court erred in excluding evidence of the injunction at trial
because the evidence was relevant and not unduly prejudicial.
We affirm the district court’s decision to exclude that
evidence. Under Rule 403 of the Federal Rules of Evidence,
a court may exclude evidence “if its probative value is
substantially outweighed by a danger of . . . unfair prejudice,
confusing the issues, [or] misleading the jury.” Fed. R. Evid.
403. Here, there is a clear risk of unfair prejudice. The
consent decree was not evidence of culpability, but admitting
the settlement into evidence would run the risk of
“permitt[ing] the jurors to succumb to the simplistic
reasoning that if the defendant was accused of the conduct, it
probably or actually occurred.” United States v. Bailey,
696 F.3d 794, 801 (9th Cir. 2012).
Moreover, evidence of the two-decades-old injunction
would be minimally probative at best. While there is no clear
time bar on evidence of civil settlements, the Federal Rules
of Evidence and the SEC’s own internal policies both suggest
that the probative value of prior bad acts is diminished after
ten years. Under the Federal Rules, evidence that a witness
in a civil or criminal trial has been convicted of a felony must
be admitted within ten years of the conviction; after ten years,
the conviction is admissible only if its probative value,
“supported by specific facts and circumstances, substantially
outweighs its prejudicial effect.” Fed. R. Evid. 609(b)(1).
Similarly, the SEC’s own regulations on reporting for public
companies require that directors and officers disclose legal
proceedings “material to an evaluation of . . . ability and
integrity” only from the last ten years. 17 C.F.R. 229.401(f).
Because evidence of the injunction against Hansen was both
unfairly prejudicial and not particularly probative, the district
court’s decision to exclude it was not error.
U.S. SEC V. JENSEN 31
VI. Conclusion
We reverse the district court’s decision to hold a bench
trial in spite of the SEC’s repeated objections in the months
before trial that it had not consented to the withdrawal of the
jury demand. As a result, we vacate the district court’s bench
trial judgment and remand for proceedings consistent with
this opinion.
We also reverse the court’s interpretations of Exchange
Act Rule 13a–14 and SOX 304. Rule 13a–14 provides a
cause of action against CEOs and CFOs who file false
certifications as well as those who do not file certifications at
all. SOX 304 allows the SEC to pursue a disgorgement
remedy against CEOs and CFOs of issuers required to
prepare an accounting restatement as a result of misconduct,
even if the officers did not engage in the relevant misconduct
themselves.
We agree with the district court’s exclusion of evidence
regarding Hansen’s consent decree and injunction.
We decline the request by the SEC that we order that the
case be reassigned on remand to a different district judge.
All parties shall bear their own costs.
VACATED and REMANDED.
32 U.S. SEC V. JENSEN
BEA, Circuit Judge, concurring:
I generally concur in the panel’s analysis and disposition.
I write separately only to clarify the intended scope of the
new legal rules we announce today.
A. Rule 13a–14
I turn first to our holding that Rule 13a–14, a regulation
promulgated pursuant to the Exchange Act of 1934
(“Exchange Act”), permits a cause of action against a Chief
Executive Officer (“CEO”) or Chief Financial Officer
(“CFO”) for “false” certification of a financial report.1 Maj.
Op. at 5, 21–24. I agree that the district court erred to the
extent it recognized a cause of action under Rule 13a–14 only
for the failure to file any certification at all, and granted
summary judgment to Defendants Peter Jensen (“Jensen”)
and Thomas Tekulve (“Tekulve”) (collectively,
“Defendants”) on that basis. I therefore concur in the panel’s
reversal of the district court’s grant of summary judgment to
Defendants on this claim. Maj. Op. at 24.
Nevertheless, I would emphasize that not every inaccurate
certification is “false” within the meaning of the rule we
announce. Maj. Op. at 5, 21–24. Rather, the concept of
falsity embodies a mental element. Merriam-Webster defines
“false,” as “intentionally untrue” (e.g., “false testimony”),
1
Rule 13a–14 provides: “Each report, . . . filed on Form 10–Q, Form
10–K [etc.] . . . under Section 13(a) of the Act . . . must include
certifications . . . as an exhibit to such report. Each principal executive
and principal financial officer of the issuer, or persons performing similar
functions, at the time of filing of the report must sign a certification.”
17 C.F.R. § 240.13a–14.
U.S. SEC V. JENSEN 33
and as “intended or tending to mislead” (e.g., “a false
promise”). False, Merriam-Webster (last visited Aug. 9,
2016). 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.
Specifically, I would hold that liability for false
certification under Rule 13a–14 may lie only where a CEO or
CFO acts with knowledge or at least recklessness as to the
falsity of a certification. I find support for this rule in the
plain meaning of the word “false.” But should some
imaginative person claim “false” is somehow an ambiguous
term, I also find support in the SEC’s official release in
connection with the final version of Rule 13a–14. See
Certification of Disclosure in Companies’ Quarterly and
Annual Reports, Release No. 8124, 78 S.E.C. Docket 875,
2002 WL 31720215, at *9 (Aug. 28, 2002) [“Release No.
8124”].2 As an agency’s interpretation of its own regulation,
Release No. 8124 is entitled to “substantial deference.”
Thomas Jefferson Univ. v. Shalala, 512 U.S. 504, 512 (1994);
see also Chase Bank USA, N.A. v. McCoy, 562 U.S. 195,
208–09 (2011) (With the exception of “post hoc
rationalization[s]” taken by an agency “as a litigation
position,” or interpretations that are “plainly erroneous or
inconsistent with the regulation,” courts generally “defer to
an agency’s interpretation of its own regulation.”).
2
That release commences with the following preamble: “As directed by
Section 302(a) of the Sarbanes-Oxley Act of 2002, we are adopting rules
to require an issuer’s principal executive and financial officers each to
certify the financial and other information contained in the issuer’s
quarterly and annual reports.” Id. at *1.
34 U.S. SEC V. JENSEN
SEC Release No. 8124 envisions that liability for a
“false” certification will require at least recklessness on the
part of the certifying officer. Under a section entitled
“Liability for False Certification,” Release No. 8124
provides:
An issuer’s principal executive and financial
officers already are responsible as signatories
for the issuer’s disclosures under the
Exchange Act liability provisions [citing
Sections 13(a) and 18 of the Exchange Act]
and can be liable for material misstatements
or omissions under general antifraud
standards [i.e. under Exchange Act Section
10(b) and Rule 10(b)-5] and under our
authority to seek redress against those who
cause or aid or abet securities law violations
[citing various sections of the Exchange Act
which impose reporting requirements on the
issuer]. An officer providing a false
certification potentially could be subject to
Commission action for violating Section 13(a)
or 15(d) of the Exchange Act and to both
Commission and private actions for violating
Section 10(b) of the Exchange Act and
Exchange Act Rule 10b-5.
Release No. 8124, at *9. I address each of the provisions
listed in Release No. 8124 as a basis for liability for false
certification in turn.
Section 13(a) of the Exchange Act, codified at 15 U.S.C.
§ 78m, requires “‘every issuer having securities registered’
with the SEC to file annual [and quarterly] reports including
U.S. SEC V. JENSEN 35
certain financial information.” Ponce v. S.E.C., 345 F.3d
722, 734 (9th Cir. 2003). Because the text of Section 13(a)
focuses on the issuer’s conduct, an aiding and abetting theory
is necessary to hold the CEO or CFO liable for a Section
13(a) violation. In the securities context, aiding and abetting
liability requires the SEC to establish “(1) the existence of an
independent primary wrong [by the issuer], (2) actual
knowledge or reckless disregard by the alleged aider and
abettor of the wrong and of his or her role in furthering it, and
(3) substantial assistance in the wrong.” Levine v.
Diamanthuset, Inc., 950 F.2d 1478, 1483 (9th Cir. 1991)
(emphasis added) (setting forth the elements of a prima facie
cause of action for aiding and abetting securities fraud); see
also Ponce, 345 F.3d at 734 (SEC must prove the same
elements in order to prevail on a claim that the defendant
aided and abetted an issuer’s violation of Section 13(a) by
causing the issuer to file false annual and quarterly reports).
In sum, at least recklessness as to the falsity of a certification
is required to hold an officer liable for aiding and abetting an
issuer’s issuance of a false or misleading financial statement
in violation of Section 13(a) by falsely certifying the
statement as true.3
3
My colleagues incorrectly suggest that our precedent leaves open the
possibility that Section 13 may permit the imposition of liability on an
individual defendant without a showing of mental culpability. See Maj.
Op. at 24 n.6. This misconception appears to stem from a misreading of
a footnote in Ponce. The binding holding of Ponce in fact forecloses any
argument that an individual could be held liable for a Section 13(a)
without a showing that he acted with at least recklessness. In Ponce, we
specifically held that a finding that an issuer had violated Section 13(a)
“does not end our inquiry with respect to [an individual’s] liability,”
because Section 13(a) applies only to issuers of securities. Ponce,
345 F.3d at 737. Ponce was a certified public accountant who had
prepared and certified the issuer’s financial statements. Id. at 725–26. To
hold Ponce liable, the SEC was required to establish the additional
36 U.S. SEC V. JENSEN
Section 15(d) of the Exchange Act imposes an analogous
elements necessary for “aider and abettor liability.” Id. Accordingly, we
instructed that “it must be found that . . . (2) Ponce had knowledge of the
[issuer’s] primary violation and of his or her own role in furthering it; and
(3) [that] Ponce provided substantial assistance in the primary violation.”
Id. (emphasis added). Then, in a footnote, we queried whether knowledge
was a necessary element of the “third prong” (i.e., the substantial
assistance prong) of aider and abettor liability, noting that the SEC had
assumed that it was. We cited “one [administrative] proceeding” in which
the SEC had held that scienter was not a necessary requirement to
establish a Section 13(a) violation. Id. at 737 n.10 (citing In the Matter of
WSF Corp., 2002 WL 917293, at *3 (SEC, May 8, 2002)).
But the case we cited, In the Matter of WSF Corp., was about issuer
liability—not aider and abettor liability. 2002 WL 917293, at *2, 6
(holding that an issuer, WSF Corporation, had violated Section 13(a) by
virtue of its failure to file various mandatory annual and quarterly reports;
holding that no showing of scienter on the part of WSF Corporation was
required). Thus, the administrative proceeding we cited was, in fact,
irrelevant to the question in Ponce—whether aider and abettor liability
requires a showing of recklessness or knowledge. And even conceding
that our dicta in Ponce created some ambiguity as to whether the “third
prong” of aider and abettor liability incorporates a scienter requirement,
Ponce unambiguously held that the second prong of a Section 13(a) aider
and abettor theory requires the SEC to establish both “knowledge” of both
“the primary violation” and the aider and abettor’s “own role in
furthering” that violation. In short, the 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. But cf. Levine, 950
F.2d at 1483 (suggesting that recklessness is sufficient). Accordingly, I
would make clear that the SEC may not attempt to circumvent our
precedent, or to take a position in this litigation contrary to its prior,
official position with respect to officer liability for false certifications,
simply because we today adopt a more expansive view of Rule 13a–14 as
permitting yet another cause of action against CEOs and CFOs who
falsely certify financial reports.
U.S. SEC V. JENSEN 37
reporting requirement on the issuer. See 15 U.S.C. § 78o(d)
(“Each issuer [of registered securities] . . . shall file with the
Commission, in accordance with such rules and regulations
as the Commission may prescribe . . . such supplementary
and periodic information, documents, and reports as may be
required pursuant to section 78m of this title [i.e., Section
13(a)] in respect of a security registered [with the SEC].”).
In S.E.C. v. Fehn, 97 F.3d 1276 (9th Cir. 1996), this Circuit
recognized that a cause of action may lie against an executive
for an issuer’s violation of Section 15(d)—again under an
aiding and abetting theory. Id. at 1288. We concluded that
the elements were similar to those required for aiding and
abetting under Section 10(b) (securities fraud): “(1) the
existence of an independent primary violation; (2) actual
knowledge by the alleged aider and abettor of the primary
violation and of his or her own role in furthering it; and
(3) ‘substantial assistance’ in the commission of the primary
violation.” Id. Thus, under our precedent, the SEC must
establish knowledge to hold a CEO or CFO liable under
Section 15(d) for falsely certifying a financial report as true.
A CEO or CFO could also be held liable, either directly
or through an aiding and abetting theory, under the Exchange
Act’s anti-fraud provisions. Liability for securities fraud
under Exchange Act Section 10(b) and its implementing
regulation, Rule 10b-5 (which collectively prohibit fraud in
the purchase or sale of securities),4 requires a showing of
4
“Section 10(b), the central antifraud provision of the Securities
Exchange Act, 15 U.S.C. § 78j(b), makes it unlawful ‘for any person,
directly or indirectly’:
To use or employ, in connection with the purchase or
sale of any security registered on a national securities
exchange or any security not so registered, any
38 U.S. SEC V. JENSEN
“scienter.” Id. at 1289 (“To prove a primary violation of
Section 10(b) of the Securities Exchange Act, the SEC was
required to ‘show that there has been a misstatement or
omission of material fact, made with scienter.’” (citation
omitted)). We have held that “[k]nowledge or recklessness
[as to whether statements made in connection with the sale of
securities are false or misleading] is required for a finding of
scienter under § 10(b).” Howard v. Everex Sys., Inc.,
228 F.3d 1057, 1063 (9th Cir. 2000). Sitting en banc, we
have previously defined “recklessness” for purposes of
Section 10(b) violations as “a highly unreasonable omission,
involving not merely simple, or even inexcusable negligence,
but an extreme departure from the standards of ordinary care,
and which presents a danger of misleading buyers or sellers
manipulative or deceptive device or contrivance in
contravention of such rules and regulations as the
Commission may prescribe as necessary or appropriate
in the public interest or for the protection of investors.
Rule 10b–5 further defines the conduct prohibited under Section 10(b),
making it unlawful:
(a) [t]o employ any device, scheme, or artifice to
defraud,
(b) to make any untrue statement of a material fact or to
omit to state a material fact necessary in order to make
the statements made, in the light of the circumstances
under which they were made, not misleading, or
(c) to engage in any act, practice, or course of business which
operates or would operate as a fraud or deceit upon any person,
in connection with the purchase or sale of any security.
S.E.C. v. Fehn, 97 F.3d 1276, 1289 (9th Cir. 1996) (quoting 15 U.S.C.
§ 78j(b); 17 C.F.R. § 240.10b–5).
U.S. SEC V. JENSEN 39
that is either known to the defendant or is so obvious that the
actor must have been aware of it.” Id. (quoting Hollinger v.
Titan Capital Corp., 914 F.2d 1564, 1569 (9th Cir. 1990) (en
banc)). In other words, direct liability under Section 10(b)
and Rule 10b-5 would also require the SEC to establish that
the CEO or CFO acted either knowingly or with “inexcusable
negligence” in certifying a financial report as true when the
report in fact contained false or misleading statements.
Alternatively, aiding and abetting liability for the issuer’s
commission of securities fraud would require a showing that
the CEO or CFO knowingly or recklessly aided the issuer’s
commission of securities fraud by falsely certifying as true a
financial report that in fact contained false or misleading
statements. See Levine, 950 F.2d at 1483.
Finally, SEC Release No. 8124 cites Section 18 of the
Exchange Act as a basis for imposing liability on a CEO or
CFO who falsely certifies a financial statement as true.
Section 18 imposes direct liability on “[a]ny person who . . .
make[s] or cause[s] to be made any statement in any
application, report, or document . . . which . . . at the time and
in the light of the circumstances under which it was made
false or misleading with respect to any material fact.”
15 U.S.C. § 78r(a). Plainly, a false certification is a
“statement” which is “false or misleading with respect to any
material fact”—namely, that the certified financial statement
is accurate. Though mental culpability is not an element of
a prima facie Section 18 violation, that section contains a
“defense of good faith”: A person who makes a false or
misleading statement is not liable under Section 18 if that
person can “prove that he acted in good faith and had no
knowledge that such statement was false or misleading.” Id.
(emphasis added). Though the burden rests on the defendant
under Section 18 rather than on the SEC as it does under
40 U.S. SEC V. JENSEN
related securities laws, Section 18—like the other provisions
discussed above—ultimately requires the fact-finder to
conclude that the CEO or CFO had knowledge of the falsity
of a certification in order for the SEC to prevail on a claim for
false certification.
From consideration of the sources cited, I conclude
that—simultaneously with its issuance of Rule 13a–14—the
SEC explicitly considered and listed various mechanisms
through which an officer may be held liable for a false
certification. Each of the enforcement mechanisms listed
requires the executive to have acted with knowledge or
recklessness as to the falsity of a certification in order to be
held liable for it. We may therefore reasonably infer that the
SEC, in promulgating Rule 13a–14, intended any cause of
action brought thereunder to require a showing of
recklessness or knowledge. The SEC’s official position on
this issue is entitled to deference, Thomas Jefferson Univ.,
512 U.S. at 512, particularly given that it is consistent with
the plain meaning of the word, “false,” as explained above.
B. SOX 304
I also concur in today’s holding that Section 304 of the
Sarbanes-Oxley Act (“SOX 304”) permits the SEC to seek
disgorgement of executive compensation whenever an issuer
is required to restate a financial report because of the issuer’s
misconduct—personal misconduct on the part of the CEO or
CFO is not required. Maj. Op. at 27.5 I therefore concur in
5
SOX 304 provides:
“If an issuer is required to prepare an accounting
restatement due to the material noncompliance of the
U.S. SEC V. JENSEN 41
the panel’s reversal of the district court’s interpretation of
SOX 304 as requiring the SEC to establish personal
“misconduct” on the part of the CEO and CFO. Maj. Op. at
31. However, the panel’s rule fails to provide sufficient
instruction to the district court judge on remand, who will be
required to determine whether the jury’s findings with respect
to the SEC’s Claims One through Six, coupled with other
relevant record evidence, establish that Basin Water, Inc.
committed “misconduct.”6 Neither we, nor the SEC, have
previously explained what qualifies as “misconduct” as
necessary to trigger disgorgement under SOX 304, and thus
issuer, as a result of misconduct, with any financial
reporting requirement under the securities laws, the
chief executive officer and chief financial officer of the
issuer shall reimburse the issuer for . . . any bonus or
other incentive-based or equity-based compensation
received by that person from the issuer during the 12-
month period following the first public issuance or
filing with the Commission (whichever first occurs) of
the financial document embodying such financial
reporting requirement; and . . . any profits realized from
the sale of securities of the issuer during that 12-month
period.”
15 U.S.C. § 7243(a) (emphasis added).
6
As explained fully in the panel’s opinion, Claims One through Six
sought both legal and equitable relief, and the SEC was therefore entitled
to a jury trial on those claims. See Maj. Op. at 8 & n.2 (summarizing the
seven causes of action brought by the SEC); Tull v. United States,
481 U.S. 412, 422 (1987). We have previously held, however, that a
claim for disgorgement under SOX 304 is purely equitable, and therefore
the SEC has no right to demand a jury trial for its claims seeking
disgorgement pursuant to SOX 304. S.E.C. v. Jasper, 678 F.3d 1116,
1130 (9th Cir. 2012).
42 U.S. SEC V. JENSEN
further clarification regarding the meaning of “misconduct”
is warranted here.
I would adopt a plain language understanding of the word,
which Merriam Webster defines as “1. mismanagement” or
“2. intentional wrongdoing; specifically: deliberate violation
of a law or standard . . . .” Misconduct, Merriam-Webster
(last visited Aug. 10, 2016). In my view, “misconduct”
requires an intentional violation of a law or standard (such as
GAAP) on the part of the issuer, which can be shown by
evidence that any employee of the issuer (not only the CEO
or CFO), acting within the course and scope of that
employee’s agency, intentionally violated a law or corporate
standard.
Such an understanding is consistent with the statutory
scheme of which SOX 304 is a part, as well as the case law to
date. SOX 302, entitled “Corporate responsibility for
financial reports,” requires CEOs and CFOs to “certify in
each annual or quarterly report” that the officers have
reviewed the report and, based on their knowledge, the report
does not contain any false or misleading statements or
omissions of material fact. 15 U.S.C. § 7241(a). More
importantly, the signing officers must certify that they have
“designed . . . internal controls to ensure that material
information relating to the issuer . . . is made known to such
officers by others within [the issuer], particularly during the
period in which the periodic reports are being prepared,” and
the officers “have evaluated the effectiveness of the issuer’s
internal controls as of a date within 90 days prior to the
report.” Id. (emphasis added).
In short, SOX 302 (in conjunction with other securities
rules and regulations) imposes a management obligation on
U.S. SEC V. JENSEN 43
CEOs and CFOs to maintain internal controls that will be
effective in ensuring that other agents of the issuer are—for
purposes of the present case—recording income in a manner
that produces accurate and complete financial statements in
accord with GAAP. See id.; see also 17 C.F.R.
§ 229.601(b)(31) (requiring CEOs and CFOs to certify, in
accordance with Rule 13a–14, “exactly” as follows: “The
registrant’s other certifying officer(s) and I are responsible
for establishing and maintaining disclosure controls and
procedures . . . and internal control over financial reporting
. . . and have . . . [among other things] [d]esigned such
internal control over financial reporting . . . to provide
reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for
external purposes in accordance with generally accepted
accounting principles . . . .” (emphasis added)); Maj. Op. at
6 n.1.
In turn, SOX 304 encourages vigorous compliance with
SOX 302 by making CEOs and CFOs subject to
disgorgement if their internal controls fail to prevent (or to
detect prior to the publication of a false or misleading
financial report) intentional wrongdoing by any authorized
agent of the issuer. When the internal controls fail to
detect such wrongful behavior, a CEO or CFO (and thus,
by extension, the issuer itself) has committed
“mismanagement”—i.e., the first definition of “misconduct.”7
7
The definition I propose would also be consistent with the handful of
lower court decisions which have considered the circumstances under
which CEOs may be subject to disgorgement under SOX 304. Compare,
e.g., SEC v. Jenkins, 718 F. Supp. 2d 1070, 1072, 1077 (D. Ariz. 2010)
(holding that the SEC’s allegations that a CFO, Chief Operating Officer,
and other employees intentionally attempted to conceal losses from write
offs of uncollected receivables would, if proven, establish “misconduct”
44 U.S. SEC V. JENSEN
In sum, the district court should consider on remand
whether the evidence establishes that Basin was required to
restate its financial reports as a result of an intentional
violation of any law or standard by any Basin employee
acting within the course and scope of that employee’s agency.
* * *
Our holdings today with respect to both Rule 13a–14 and
SOX 304 resolve difficult and complex issues of first
impression. My colleagues would prefer to announce broad,
but unclear rules and to leave for another day important
questions—questions which will likely be determinative on
remand of this case—about the precise scope of the rules we
announce. While I am generally in accord with the notion
that we should decide only that which is strictly necessary to
decide, I disagree with my colleagues’ suggested course in
this particular case.8 What is culpably “false” and what
for purposes of SOX 304), with e.g., SEC v. Life Partners Holdings, Inc.,
71 F. Supp. 3d 615, 618, 625 (W.D. Tex. 2014) (finding no “misconduct”
within the meaning of SOX 304—notwithstanding a jury finding that the
issuer had filed numerous false or misleading financial statements in
violation of Exchange Act Rule 13(a) and related regulations—because
those who prepared the inaccurate financial statements had reasonably
relied on the issuer’s outside auditor, Ernst & Young, in good faith, and
the mistakes which ultimately required restatement and upon which the
securities violations were predicated were discovered only after-the-fact
and corrected).
8
Even Chief Justice Roberts, a great proponent of judicial restraint, has
acknowledged: “[W]hile it is true that ‘[i]f it is not necessary to decide
more, it is necessary not to decide more,’ . . . , sometimes it is necessary
to decide more. There is a difference between judicial restraint and
judicial abdication.” Citizens United v. Fed. Election Comm’n, 558 U.S.
U.S. SEC V. JENSEN 45
constitutes “misconduct” are central to the disposition of this
case. We have discretion to decide those issues to guide this
case on remand. We ought to do so. Cf. Singleton v. Wulff,
428 U.S. 106, 121 (1976) (“The matter of what questions may
be taken up and resolved for the first time on appeal is one
left primarily to the discretion of the courts of appeals, to be
exercised on the facts of individual cases.”).
It is well-established that where we “undertake[] to decide
[a] claim” that “is properly before th[is] court, [we] [are] not
limited to the particular legal theories advanced by the
parties, but rather retain[] the independent power to identify
and apply the proper construction of governing law.” Kamen
v. Kemper Fin. Servs., Inc., 500 U.S. 90, 99 (1991); cf.
Engquist v. Oregon Dep’t of Agric., 478 F.3d 985, 996 n.5
(9th Cir. 2007) (“[W]here an issue is purely legal, and the . . .
part[ies] would not be prejudiced, we can consider an issue
not raised below.”), aff’d sub nom. Engquist v. Oregon Dep’t
of Agr., 553 U.S. 591 (2008).
Having properly undertaken to answer the broader
question whether Rule 13a–14 requires CEOs and CFOs only
to certify financial reports, or whether it requires them to do
so truthfully, we act well within our discretion when we
clarify precisely what we mean when say that Rule 13a–14
permits a cause of action against CEOs and CFOs who
“falsely” certify a financial statement (regardless of the
parties’ failure specifically to brief that nuance). Whether a
cause of action includes a mental element is a purely legal
question that, for reasons of judicial economy, we are far
better situated than the district court to resolve: Our mandate
310, 375 (2010) (Roberts, C.J., concurring) (second alteration in original)
(citation omitted).
46 U.S. SEC V. JENSEN
specifically directs the district court to apply our newly
minted rule on remand, no prior precedent has addressed what
it means for a certification to be “false” (reasonably so, as we
have not previously recognized this cause of action), and this
issue is likely to be determinative to the SEC’s claim.9
The same analysis applies with respect to our new
interpretation of SOX 304. We announce today that CEOs
and CFOs may be subject to disgorgement not only when they
commit “misconduct,” but also when any agent of the issuer
(acting within the course and scope of his agency) commits
“misconduct” on behalf of the issuer. Given the lack of any
definition of “misconduct” in the securities laws and
regulations, or in our own precedent, the district court will be
hard-pressed on remand to determine whether, for example,
evidence of an accounting error qualifies as “misconduct”
within the meaning of the rule we announce, absent some
clarification regarding what “misconduct” for purposes of
SOX 304 actually means. The clarification provided herein
answers purely legal questions and in no way opines on the
factual issues the district court must resolve in the first
instance on remand (e.g., whether the SEC has adduced
evidence sufficient to establish that Defendants committed
misconduct on the record before the court).
Lastly, I suggest the panel bear in mind that, due to the
district court’s improvident decision to proceed with a bench
9
Because Basin did, in fact, restate information in some financial reports
certified by Defendants, there will be little dispute on remand that the
certifications were in some sense “incorrect.” Thus, the critical question
will likely be what more the SEC must show to establish that the
certifications were also “false”—i.e., what mental state is required to make
an incorrect certification a “false” one?
U.S. SEC V. JENSEN 47
trial in the initial proceedings, our holding today vacates a
host of factual and legal conclusions that were, unfortunately,
the product of significant resource investment by all parties
involved. To remand this case for application of new legal
rules that are so woefully vague as to virtually guarantee
another appeal to this Court and remand—after yet another
significant resource investment—would be the paradigm of
judicial inefficiency.
Subject to these additional clarifications, I concur in the
panel’s opinion.