Ninth circuit hold no private right of action under SOX 304

By Cydney Posner

The 9th circuit case , In re Digimarc Corp., attached below for your reading pleasure, confirms that there is no private right of action under SOX 304. As you may recall, SOX 304 provides for the forfeiture of certain bonuses and profits by a CEO and CFO when there is a restatement due to the material noncompliance of the issuer, as a result of misconduct, with any financial reporting requirement under the securities laws. There are a number of ambiguities that arise under this provision, one of them being the question of who can enforce it.

In 2004, Digimarc, a supplier of personal ID systems, announced that, due to accounting errors, the corporation had likely overstated earnings for the previous six quarters primarily as a result of improper capitalization of internal software development costs. The plaintiff then filed a shareholder derivative action, asserting breach of fiduciary duty, abuse of control, gross mismanagement, waste of corporate assets, unjust enrichment and claims for disgorgement under SOX 304 (although there seems to be an implicit suggestion that the SOX claim was really just a pretext to secure federal question jurisdiction). The court held that SOX 304 does not explicitly create a private right of action because nothing in the text of the section makes any mention of a cause of action; in contrast, other sections of SOX demonstrate how Congress expressly creates private rights of action. As a result, any private right of action within SOX 304 must be implied from the statute’s language, structure, context and legislative history. While no circuit court had yet addressed the issue, except in dicta, several district courts had all held that no private right existed under SOX 304.

In Cort v. Ash, the Supreme Court created a four-factor test for determining the existence of an implied private right of action: (1) whether the plaintiff is "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) whether "there [is] any indication of legislative intent, explicit or implicit, either to create such a remedy or to deny one"; (3) whether the cause of action is "consistent with the underlying purposes of the legislative scheme"; and (4) whether "the cause of action [is] 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." Here, the court focused on legislative intent. Plaintiff analogized to SOX 303, arguing that SOX 304 did not have an express prohibition on a private right as there was under SOX 303. Appellees pointed to SOX 306, which explicitly created a private right. The court found that "congressional intent weighs decisively against finding a private right of action," arguing that it "would turn Cort on its head to hold that by making clear it did not intend to create a private right of action in sections 303 and 804, Congress affirmatively intended to create rights of action in sections where it omitted such an express denial." Accordingly, the court concluded that SOX 304 does not create a private right of action.