Monday, September 27, 2004
Ninth Circuit to Reconsider En Banc Whether Amount Of Gemstar Executive Buyout Was ‘Extraordinary’
From Staff and Wire Service Reports
An en banc panel of the Ninth U.S. Circuit Court of Appeals will revisit the issue of when payments to departing executives by a company under investigation by the Securities and Exchange Commission are “extraordinary,” justifying placing them in escrow under legislation adopted in 2002, the court said Friday.
In a brief order, Chief Judge Mary M. Schroeder said a majority of the court’s unrecused, active judges had voted to reconsider the May decision of a three-judge panel in Securities and Exchange Commission v. Gemstar-TV Guide International, Inc., 03- 56129. In a 2-1 decision, the three-judge panel overturned a ruling by Senior U.S. District Judge Wm. Matthew Byrne Jr. of the Central District of California allowing approximately $38 million to be held in involuntary escrow under a provision of the Sarbanes-Oxley Act.
The provision allows such an escrow during investigation and prosecution of securities fraud cases where it “is likely” that an issuer of securities “will make extraordinary payments” to its “directors, officers, partners, controlling persons, agents, or employees.”
After the SEC launched an investigation into Gemstar’s accounting practices, leading the restatement of some $55.8 million in revenues, the company agreed to pay $38 million to Henry Yuen, its chief executive officer, and Elsie Ma Leung, its chief operating officer and chief financial officer. In return for the payments, Yuen and Leung agreed to their termination as executives, though both were to remain company employees.
When the SEC invoked the escrow provision, Yuen and Leung brought a court challenge arguing that the statute was vague and that the termination payments did not qualify as extraordinary.
Writing for himself and Judge Johnnie B. Rawlinson, Judge Carlos T. Bea said Byrne erred in rejecting the challenge based on a record that did not include evidence bearing on what type of compensation would be normal for executives under similar circumstances. He noted that the Sarbanes-Oxley Act does not define the term “extraordinary payments.”
“There is no evidence in the record of what similarly placed officers and board members of corporations of similar revenues and worth are paid upon termination. Such payments may be called ‘golden parachutes’ or ‘golden handshakes’ in the press, but purple prose is not enough to prove a statutory requirement in court. For enforcement of the securities laws of the United States, evidence of what is ‘usual’ under the same or similar circumstances is necessary to distinguish ‘extraordinary payments’ and to order their impoundment in an escrow....”
Bea noted that Byrne “found it significant” that Gemstar had reported the termination agreement in an SEC filing as a “substantial event.”
“But,” the appellate jurist explained, “a discretionary corporate disclosure is not an admission that the company has paid an ‘extraordinary’ amount. In any case, 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. A ‘substantial event’ may or may not coincide with an ‘extraordinary payment.’ Only evidence of comparable events and circumstances can tell us.”
“Instead of objective evidence, what we have here is the district court’s conjecture as to what would have been ‘ordinary’ or ‘usual’ negotiations for termination payments, conjecture as to what the size should have been of such payments and conclusions drawn from filings made under different standards.”
Judge Stephen S. Trott dissented, arguing that the payments were extraordinary since they were made outside the course of Gemstar’s ordinary business activities.
“There is no need necessarily to engage in metaphysical inquiries about what is ordinary in another company or to look to some sort of an industry standard to ascertain the meaning of this provision,” Trott asserted. “One can simply look at the business of the issuer and determine whether the payments under scrutiny directly advance the issuer’s normal business objectives, or whether the payment reasonably appears to be in the nature of damage control, hush money, taking financial advantage of the fraud, cover-up, looting, etc.”
Byrne, Trott said, “correctly focused on the nature, purpose, and circumstances of the payments and determined that they had nothing to do with Gemstar’s ordinary business.”
“[T]he negotiated Termination Agreement payments here are five and six times greater than Yuen’s and Leung’s base salary, the component amounts that make up the lump sum payments are different than the amounts due under their employment agreements, the termination fees are different from what they may have been entitled to under existing agreements, the bonuses are fruit of the alleged fraudulent financial results, and the vacation pay item did not exist under their contracts. One would not expect benefits like these to be flowing from corporate assets to executives resigning under fire. This scenario is not business as usual. It appears to be looting.”
The type of evidence required by the majority, Trott said, should not be necessary to invoke the statute.
“If these mega-suspicious payments were not ‘extraordinary,’ the word needs either to be redefined or to be taken out of our dictionaries,” he remarked.
The dissenting jurist queried:
“Do we really expect the government to offer evidence of what constitutes ‘usual or ordinary payments to a CEO and a CFO under same or similar circumstances,’ i.e., under threat of delisting, in a fight with its independent auditor, and under investigation for having misstated revenues, cooked the books, defrauded investors, employees and the market, and possibly committed a basket full of crimes? Why would this be necessary? On reflection, the idea that a court needs somehow to have evidence of a ‘norm for corporate decisionmaking of this type,’ i.e., rampaging fraud and a world of trouble, seems off the mark.”
Attorney Michelle Rice of the New York firm Arkin Kaplan, who represented Yuen and Leung, cautioned against viewing the vote to review the ruling en banc as “evidencing a particular outcome.”
En banc review “neither means they will affirm nor reverse,” Rice said. Instead, she suggested, the vote in favor of en banc review probably reflects the importance of the issue and the fact that the Ninth Circuit is the first court to rule on it.
The court’s judges may just “want to make sure they get it right,” Rice declared.
She noted that the SEC settled a securities fraud case against Gemstar. The case against Yuen and Leung is in the discovery stage, with a trial before U.S. District Court Judge Mariana R. Pfaelzer of the Central District of California scheduled for January, she said.
In mid-2003, the Securities and Exchange Commission accused Yuen and Leung of a widespread scheme to inflate company ad and licensing revenues by at least $248 million over three years to show Gemstar-TV Guide was meeting ambitious growth projections.
Because Yuen and Leung’s compensation was tied to the company’s performance, the alleged fraud would have increased their income.
Copyright 2004, Metropolitan News Company