Ninth Circuit Becomes the First Circuit Court to Rule That There Is No Private Cause of Action Against Executive Officers Under Section 304 of Sarbanes-Oxley
The Ninth Circuit handed down a decisive victory to corporate officers in December, holding that there is no private right of action under the Sarbanes-Oxley Act for an officer's failure to comply with securities law reporting requirements. In re Digimarc Corporation Derivative Litigation, --- F.3d. ---, 2008 WL 5171347 (9th Cir. Dec. 11, 2008). This was the first such decision by a Circuit Court in the country.
Plaintiff was a shareholder of Digimarc Corporation, which overstated earnings for six quarters allegedly due to "accounting errors." Plaintiff filed a derivative action in the District Court for the District of Oregon, asserting California state law claims and a claim under Section 304 of Sarbanes-Oxley, which requires chief executive officers or chief financial officers to forfeit profits, bonuses and other incentive-based compensation if the company fails to comply with securities law reporting requirements. The Section 304 claim was the sole basis for Plaintiff's assertion of federal question jurisdiction.
Defendants moved to dismiss the complaint based on lack of jurisdiction. The District Court granted the motion, holding that Section 304 did not create a private cause of action and, thus, the court lacked subject matter jurisdiction over the only federal law claim asserted. The Ninth Circuit affirmed.
Section 304 does not expressly create a private right of action by, for example, providing that an action to recover the forfeiture penalty "may be instituted at law or in equity." Thus, the court held that any private cause of action existing in Section 304 must be implied.
In analyzing whether Congress intended to create a private right of action, the Ninth Circuit relied on the four-factor test enunciated by the Supreme Court for determining the existence of an implied right of action: (1) is the plaintiff "one of the class for whose especial benefit the statute was enacted - that is, [whether] the statute create[s] a federal right in favor of the plaintiff; (2) is there "any indication of legislative intent, explicit or implicit, either to create such a remedy or to deny one"; (3) is a private right of action "consistent with the underlying purposes of the legislative scheme"; and (4) is "the cause of action one traditionally relegated to state law, in an area basically the concern of the States, so that it would be inappropriate to infer a cause of action based solely on federal law." The court emphasized that the second factor is "the key inquiry in this calculus."
The court concluded that "congressional intent weighs decisively against finding a private right of action." The court emphasized that other provisions of Sarbanes-Oxley expressly provide for private rights of action, including Section 306 which - similarly to Section 304 - requires disgorgement of profits by officers and directors who engage in insider trading during pension fund blackout periods. The court emphasized that it "must consider ‘the entire statutory scheme provided by Congress in determining if a private cause of action exists, noting that analogous provisions expressly providing for private causes of action can imply congressional intent not to create an implied cause of action." Because Section 306 does expressly provide for a private right of action, while Section 304 is silent, the court concluded that Congress' intent was clear that no private right of action exists under Section 304.
Although the Ninth Circuit was the first Circuit Court to rule on the issue, it is likely that other Circuit Courts will reach the same conclusion. See, e.g., Pirelli Armstrong Tire corp. Retiree Med. Benefits Trust v. Raines, 534 F.3d 779, 793 (D.C. Cir. 2008) (holding that defendant directors' decision not to bring suit under Section 304 was within the business judgment rule, since Section 304 "does not create a private right of action").
In light of the strict securities law reporting requirements contained in Sarbanes-Oxley, and the reality that failure to comply with them may be unintentional, the In re Digimarc decision should come as a welcome relief to corporate officers.