ANOTHER SOX 304 STRICT LIABILITY ACTION
The Commission filed another strict liability, SOX 304 action, seeking to clawback certain CEO and CFO compensation. This time the defendants are Michael Baker and Michael Gluck, respectively, the CEO from 1997 through February 2009, and CFO from May 2006 through December 2008, of ArthroCare Corporation. SEC v. Baker, Case No. 1:12-cv-00285 (W.D. Tx. Filed April 2, 2012).
ArtroCare is an Austin, Texas based manufacturer of medical devices whose shares are traded on NASDAQ. From 2006 through the first quarter of 2008 two company sales executives, John Raffle and David Applegate, engaged in a channel stuffing scheme which resulted in the improper inflation of company revenue and earnings. Specifically, during that time period the two salesmen shipped certain products to distributors even though they often did not need, or have the ability to pay for, them. As a result for 2006, 2007 and the first quarter of 2008 revenues were overstated by, respectively 7.9%, 14.1% and 17.4% totaling almost $72.3 million. For the same period net income was overstated by 14.5% in 2006, 8,694.3% for 2007 and 315.2% for the first quarter of 2008, totaling about $53.7 million. As a result the company was required to restate its financial statements.
The Commission previously brought an enforcement action against the two salesmen. SEC v. Raffle, Civil Action No. 1:11-cv-540 (W.D. Tx. Filed June 27, 2011). Mr. Applegate settled that action. Lit. Rel. No. 22027 (July 5, 2011).
Most of the Commissionâ€™s complaint details the fraudulent conduct of the two salesmen. It notes at the outset, however, that â€œThe Commission does not allege that Banker and Gluk participated in the wrongful conduct.â€ Rather, the complaint seeks the repayment of cash bonuses, incentive and equity-based compensation and profits from the sale of company stock under SOX 304 during the 12 month periods following the issuance of the quarterly and annual financial statements later restated. The amount of the compensation and stock sale revenue to be clawedback is not specified.
This is not the first strict liability clawback action brought by the SEC. That case is SEC v. Jenkins, CV 09-01510 (D.Arix. Filed July 22, 2009) brought against the former CEO of CSK Auto. That case ultimately settled following the rejection by the Commission of a settlement offer of partial repayment. See also SEC v. Oâ€™Dell, Civil Action No. 1:10-CV-00909 (D.D.C. Filed June 2, 2010). While it is clearly debatable as to whether a strict liability interpretation constitutes good enforcement policy, the Commissionâ€™s position has been sustained by the Second Circuit. Cohen v. Viray, Case No. 3860-cv (2nd Cir. Sept. 30, 2010).