Question

True or False questions

Michael Baker and Michael Gluk were the CEO and CFO of ArthroCare Corporation, a public company. Due to fraud committed by two senior vice presidents of ArthroCare, John Raffle and David Applegate, ArthroCare misstated its earnings in various SEC filings from 2006 to 2008. Pursuant to the clawback provisions of §§ 302 and 304 of Sarbanes-Oxley Act and acting on behalf of ArthroCare, the SEC sought recovery from Baker and Gluk in the amount of cash bonuses, incentives, and equity-based compensation that Baker and Gluk earned during the affected periods. The SEC argued that Baker and Gluk were liable because they were the CEO and CFO at the time and thus signed the filings that required restatements. Baker and Gluk argued that they did not commit any conscious wrongdoing, did not themselves commit any violation of securities law, and should not be required to disgorge their compensation.

1. Under §§ 302 and 304 of Sarbanes-Oxley, Baker and Gluk as CEO and CFO are required to be diligent to insure internal controls prevented misdeeds by the two senior vice presidents, and must disgorge their compensation if they knowingly committed any conscience wrongdoing or violate securities law.
2. The Sarbanes-Oxley Act creates a cause of action permitting the SEC to pursue a derivative lawsuit to disgorge the compensation of CEOs and CFOs for failure to maintain sufficient internal controls.
3. §§ 302 and 304 of Sarbanes-Oxley impose fiduciary duties on CEOs and CFOs to be vigilant in insuring adequate internal controls and accuracy of financial statements.
4. Baker and Gluk are appointed to their respective posts as CEO and CFO by the Board of Directors and serve at their pleasure. The shareholders of Arthrocare appoint the directors by voting for them at the annual meeting or a special shareholder meeting called for that purpose.
5. The executive vice presidents who misstated ArthroCare Corporation earnings in various SEC filings from 2006 to 2008 are not liable for fraud under Rule 10b-5.

Answer 1

1. TRUE

As per section 302(4)(A) of Sarbanes-Oxley, the signing officers are responsible for establishing and maintaining internal control.

And as per section 304 of Sarbanes-Oxley regarding forfeiture of certain bonus and profits, 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 CEO and CFO 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.

However as per section 304(b) The Commission may exempt any person from the application of subsection (a), as it deems necessary and appropriate.

2. TRUE

Most courts have held that GAAP violations and internal control deficiencies are, standing alone, insufficient to support the "strong inference" of fraudulent conduct required to state a federal Rule 10b-5 securities fraud claim. On the other hand, cases involving large restatements and particularized allegations that specific executives knew of specific undisclosed problems at specific times can survive dismissal. Accounting restatements that affect the financial information in registration statements and prospectus materials for public offerings can also give rise to claims under Section 11 and 12(a)(2) of the Securities Act, which do not require the plaintiff to establish fraudulent intent or reliance and are thus more likely to survive an initial motion to dismiss. The existence of an SEC enforcement proceeding can also increase private litigation risk by attracting civil suits and increasing the settlement value of existing cases.  

3. TRUE

As per section 302(4)(A) The signing officers are responsible for establishing and maintaining internal control. It is the fiduciary duty of CEO and CFO to ensure adequate internal control and accuracy of financial statements.

4.TRUE

Baker and Gluk are appointed to their respective posts as CEO and CFO by the Board of Directors and they are responsible for establishing and maintaining internal control. The shareholders of Arthrocare appoint the directors by voting for them at the annual meeting or a special shareholder meeting called for that purpose.

5. TRUE

Rule 10b-5 talks about Insider trading laws apply to private as well as to public companies, and to transactions with employees and employee stock plans as well as with third-party shareholders. Moreover, this case emphasizes that the SEC will prosecute cases involving private companies and employee shareholders.