October 8, 2010 | Posted By
Second Circuit Holds That No Private Right Of Action Exists Under Section 304 Of The
Sarbanes-Oxley Act
In Cohen v. Viray, 2010 WL 3785243 (2d Cir. Sept. 30, 2010), the United States Court of Appeals for the
Second Circuit held that no private right of action exists under Section 304 of the Sarbanes Oxley Act, 1 5
U.S.C. § 7243 (“Section 304”), to recover from chief executive officers (“CEOs”) and chief financial officers
(“CFOs”) any bonus or similar compensation, or any profits realized from stock sales, they may have
received during the twelve-month period prior to a restatement of company financial statements due to
misconduct. The Second Circuit concluded further that because only the Securities & Exchange Commission
(“SEC”) may enforce Section 304, a settlement agreement between a shareholder derivative plaintiff and a
CEO and CFO may not purport to indemnify or release those senior corporate executives from liability under
Section 304. This decision follows that of the Ninth Circuit on the question of whether a private right of
action exists under Section 304.
The facts in Cohen were straightforward. DHB Industries, Inc. (“DHB”) is a manufacturer of body armor used
by the military. In 2005, the price of DHB’s stock “plummeted” when it was revealed that the metal used i n
DHB’s body armor “contained an inferior material prone to rapid deterioration.” Thereafter, several
shareholder derivative lawsuits were filed, each naming as defendants David H. Brooks (“Brooks”), DHB’s
former Chairman and CEO, and Dawn M. Schlegel (“Schlegel”), DHB’s former CFO. The derivative suits were
consolidated in the United States District Court for the Eastern District of New York. Plaintiff shareholders
subsequently settled the lawsuit.
As part of the settlement agreement, plaintiff shareholders agreed to release Brooks and Schlegel “from any
liability” under Section 304 and to “indemnify them against any liability” they might incur under Section
304. Another DHB shareholder, David Cohen, intervened and objected to the settlement, arguing that the
“indemnification and relief provisions violate [the Sarbanes-Oxley Act] and public policy because Congress
vested authority to exempt CEOs and CFOs from application of § 304(a) solely in the SEC, and did not grant
such discretion to the public companies themselves, . . . and because the indemnification and release
provisions would nullify the right and remedy that Congress expressly provided in the
statute.” Subsequently, the United States objected as well, asserting that the derivative action settlement
“(i) limited the remedies available to the government in pending criminal cases against” Brooks and Schlegel
and “(ii) undermined efforts by the SEC to hold the individual defendants liable for disgorgement under
§ 304.”
