On June 20, 2003, the Securities and Exchange Commission ("SEC") announced that it had filed securities fraud charges against the Henry Yuen, the former chief executive officer ("Yuen"), and Elsie Leung, the former chief financial officer ("Leung"), of Gemstar-TV Guide International, Inc. ("Gemstar"). The charges against Yuen and Leung include lying to Gemstar's auditors, falsifying the company's books and records, and aiding and abetting the company's reporting, record-keeping, and internal controls violations. The SEC also announced that it was seeking to have the court continue a previous forty-five-day order, pursuant to § 1103 of the Sarbanes-Oxley Act (the "Act"), requiring Gemstar to place into escrow any "extraordinary payments" to any of its directors or officers, including nearly $38 million in cash severance payments that the company had previously agreed to pay Yuen and Leung.
Section 1103 of the Act
Under § 1103 of the Act, the SEC now has the authority to seek a judicial freeze of "extraordinary payments" to certain specified individuals, including "directors, officers, partners, controlling persons, agents, or employees" of a company, where it is investigating possible securities laws violations by the company or any of the listed individuals. Pursuant to § 1103, the SEC can petition the court for a "temporary order" requiring a company to "escrow, subject to court supervision," "extraordinary payments (whether compensation or otherwise)" to any of the listed individuals. Section 1103(a)(3)(A)(i). Such a temporary order is limited to forty-five days, unless extended by the court for an additional forty-five days "upon good cause shown." Section 1103(a)(3)(A)(iii) and (iv). Furthermore, if the SEC charges the company or one of the listed individuals "with any violation of the corporate securities laws before the expiration of the effective period of a temporary order, ... the order shall remain in effect, subject to court approval, until the conclusion of any legal proceedings related thereto." Section 1103(a)(3)(B)(i).[1]
The statute does not set forth any factual showing that the SEC is required to make to obtain such an order. Rather, § 1103 merely requires that the SEC demonstrate that it is conducting a "lawful investigation" and that it "shall appear to the [SEC] that it is likely" that extraordinary payments will be made. Moreover, there is no definition of exactly what is an "extraordinary payment," although there is some suggestion that in enacting § 1103, Congress contemplated payouts made to an executive during a government investigation, and that the purpose of the statute was to ensure "that corporate assets are not improperly taken [for] an executive's personal benefit." 148 Cong. Rec. S 6524, S 6545 (comments of Sen. Lott). However, as demonstrated in the Gemstar case, the SEC appears to be taking an aggressive position on the scope of the definition of "extraordinary payments."
The Gemstar Facts
In the summer of 2002, Gemstar came under scrutiny when it failed to certify the accuracy of its financial statements. At that time, Yuen and Leung were battling for control of the company with Rupert Murdoch, the owner of TV Guide, which had merged with Gemstar in 2000. By mid-2002, Yuen and Leung agreed to leave Gemstar in exchange for severance packages totaling almost $38 million.
The severance packages included a number of different forms of compensation, including a multiple of annual salary, a payout of sixty-days worth of vacation time, "'catch-up' salary payments" for the period between a raise being determined and actually implemented, and bonuses earned the prior year. See 2003 Extra LEXIS 13 (March 31, 2003). Yuen and Leung claimed that the severance package contained the same categories of payments that their employment contracts, executed years earlier, required in the event of a "termination without cause," but that the revised payments were "substantially reduced from the amounts [they] would have received had their former employment contracts remained in force." Id. at *8-9.
According to Yuen and Leung, when the SEC learned of the severance packages, it pressured Gemstar to promise to lock up the severance payments for six months. Id. at *12-15. Yuen and Leung claim that they reluctantly agreed to the escrow, provided that the SEC agreed "to release a portion of the [escrowed funds] once it had determined what portion of the [severance package] allegedly were properly subject to escrow as 'extraordinary payments.'" Id. at *15-16. Yuen and Leung claim that the SEC subsequently refused to do so. Id.
In response to the SEC's motion for a temporary freeze under § 1103, the Central District of California on May 12, 2003, granted the SEC's request under § 1103 to impose a forty-five-day court-supervised escrow. See SEC v. Gemstar-TV Guide Int'l, Inc. (In re An Application for a Temp. Order Pursuant to Section 1103 of the Sarbanes-Oxley Act), 2003 U.S. Dist. LEXIS 8707 (C.D. Cal. May 12, 2003). The court's opinion granting the SEC's motion is remarkably and unfortunately sparse. In fact, the opinion provides no reasoning whatsoever, but rather simply grants the SEC's motion and denies Yuen and Leung's cross motions for relief from the previously implemented escrow. Id.
In opposition to the SEC's request, Yuen and Leung argued that the term "extraordinary payments" "should properly be construed to mean abnormal or unusual payments that (i) are made without proper corporate approval, or (ii) cannot be traced to identifiable legal obligations or well-established corporate policies existing at the time the SEC commenced its investigation." 2003 U.S. Dist. LEXIS 8197 at *12 (May 8, 2003). Yuen and Leung claimed that, under their proposed definition, the payments at issue were not "extraordinary"; rather, the payments represented payment of unpaid salary, bonuses, and vacation due under their employment agreements, executed in 1998, and termination payments, which also were based upon employment agreements. Id. at *10.
In opposition, the SEC apparently argued that the plain meaning of the term "extraordinary" encompassed the payments at issue here. The SEC apparently advanced two arguments. First, that the payments were extraordinary because they pertained to extraordinary corporate events. Second, the payments were extraordinary due to the size of the payments. Id. at *11. From the court's ruling, it agreed with the SEC that the payments were "extraordinary," although, it did not articulate the grounds for that decision. Now that the SEC has actually commenced an action against Yuen and Leung, it has requested the court to continue the freeze under § 1103(a)(3)(B)(i).
The Gemstar case suggests that the SEC is going to exercise vigorously its power under § 1103. Indeed, in Gemstar, the SEC initially avoided entirely even the minimal statutory safeguards found in § 1103 by pressuring the company into agreeing to a six-month escrow of payments. Further, the SEC seems determined to expand to the fullest extent possible the definition of "extraordinary payments." In Gemstar, whether the payments at issue were in fact "extraordinary" was subject to significant dispute by the defendants. Obviously, the court agreed with the SEC that the payments were "extraordinary," though it unfortunately did not provide any reasoning for its conclusions or guidance for future matters. But, it is clear from the arguments presented to the court, that the SEC argued that the size of a payment is a factor in determining whether the payment is "extraordinary."
[1] The SEC has long had the ability to seek to freeze a defendant's assets through a court-issued temporary restraining order ("TRO"), followed by a motion for a preliminary injunction. See, e.g., SEC v. Montle, 2003 U.S. App. LEXIS 4612 at *8 (2d Cir. March 13, 2003). A TRO is harder to obtain than a § 1103 order, but more expansive. For a TRO, the SEC would be required to demonstrate, at least, that it has a likelihood of success on the merits. Id. However, if the SEC meets that standard, it can freeze assets already in the hands of the defendant, and not just "extraordinary payments" about to be made.