Judge: Private Suits Not Allowed Under Section 304 of SOX

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A federal judge has ruled that private shareholders cannot file derivative lawsuits under Section 304 of the Sarbanes-Oxley Act.

Under Section 304, corporate executives can be forced to give back profits and bonuses gained in alleged accounting scandals. U.S. District Judge Stewart Dalzell took on the question of whether Section 304 creates an implied private right of action, according to Law.com, and found that Congress “explicitly created a private right of action in only one place, and that is in Section 306.” That provision bars corporate officers from buying or selling securities during a pension fund blackout period. Only the Securities and Exchange Commission can enforce Section 304, the judge found.

"Because Congress explicitly created a private right of action in Section 306 and did not do so in Section 304, the natural inference is that Congress did not intend to create a private right of action in Section 304," Dalzell concluded.

The ruling stems from a lawsuit filed last year by Ronald Jeffrey Neer after the logistics company Stonepath Group Inc. announced it needed to restate previous financial statements. The suit alleged that the most recent restatement will reduce reported revenue for 2001 through 2004 by $16.3 million.

Dalzell wrote that the case could be taken to Delaware state court. Stonepath is headquartered in Philadelphia, but it was incorporated in Delaware.

"We believed from the beginning that this case had no foundation and we are extremely pleased to have won our motion to dismiss," said Dennis L. Pelino, chairman of Stonepath, in a statement.

The dismissal of the derivatives lawsuit does not affect a pending class-action case also before Judge Dalzell. Lead plaintiff Globis Capital Partners contends that Stonepath executives “knew, or recklessly disregarded that Stonepath was plagued by internal control deficiencies that caused the company to consistently understate its most significant operating cost. As a result, the financial benchmarks cited by defendants as the most useful measures of the company's performance were materially overstated."

Recent media reports suggest that companies may be better off settling lawsuits than fighting them in court. Companies accused of wrongdoing in court receive tax deductions for the payments they make to settle investor claims.

Rachel Beck, national business columnist for The Associated Press, wrote that Time Warner, for example, will pay $2.4 billion to certain shareholders who claim they were cheated in the 2001 merger of Time Warner and America Online. The majority of that figure will be tax deductible. That's because companies are allowed to write off payments to cover private litigation if the actions that led to the lawsuits took place during the “normal course of business.”

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