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In the first legal challenge to the Sarbanes-Oxley Act, a sweeping securities law passed by Congress last summer, two executives have sued the Securities and Exchange Commission, the federal agency charged with administering the new statute. Henry Yuen, former chief executive of Gemstar-TV Guide International Inc., and Elsie Leung, the company’s former chief financial officer, are accusing the SEC of illegally withholding more than $37 million in severance payments they claim they are owed by the company. There may be more lawsuits to come, experts say. The SEC has been playing things fast and loose, they say, buoyed by the powerful new enforcement tools of Sarbanes-Oxley and a political climate impatient with corporate wrongdoing. In the complaint filed last week in U.S. District Court for the Central District of California, the two executives claim that the agency, which is investigating Gemstar for accounting irregularities, “injected itself” into severance negotiations they were conducting with their employer, a leading supplier of on-screen TV programming guides. They allege that the SEC then impounded the money and put it into escrow, in violation of their constitutional due process rights. They seek dissolution of the escrow account. The plaintiffs’ lawyer, Stanley Arkin of Arkin Kaplan, says the complaint addresses the “unlawful, arrogant and high-handed conduct” of the SEC toward Yuen and Leung. SEC spokesman John Nester declined to comment on the lawsuit. ‘EXTRAORDINARY’ PAYMENTS The SEC’s authority to freeze the assets of executives such as Yuen and Leung derives from Section 1103 of Sarbanes-Oxley, which gives the agency the right to escrow assets of companies and executives it is investigating for possible securities law violations. To do so, it must petition the court. Assets may be frozen for up to 90 days. If the SEC brings a lawsuit in that time, the freeze may be extended indefinitely. Only “extraordinary” payments may be frozen, although the SEC has yet to define what that means. One lawyer familiar with the legislative history of the act says that Congress contemplated the type of illegal payout made to an executive once a government investigation has already started, such as a special bonus. The SEC previously had authority to freeze assets of companies under investigation if it could show both a legitimate concern that the assets would be dissipated and a basis to infer wrongdoing. It used this power to impound assets of the bankrupt telecom company WorldCom Corp. Section 1103 expanded the commission’s already substantial power in this arena. But Yuen and Leung claim that the SEC went even further than what is permitted by the new law, making an end run around its due process safeguards. They say that instead of seeking a court order as required, the SEC used Gemstar as a proxy to strong-arm them into agreeing to the asset freeze. Gemstar came under federal scrutiny last summer after it failed to certify the accuracy of its financial statement. Its stock had suffered severely from the burst of the high-tech bubble, questions about its accounting practices, and court rulings that undermined its patent claims. At the time, Yuen was 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 his longtime colleague Leung agreed to cede control to Murdoch, in return for severance packages worth about $30 million and $8 million, respectively. Shortly after the SEC learned of the agreement, it told both sides that it wanted to escrow the payments under its new Section 1103 authority. The two executives rejected the SEC’s request. They submitted a brief arguing that any attempt to freeze the payments would be illegal because they had not been accused of any wrongdoing. The payments, they argued, related to long-standing contractual rights, not the last-minute grab of corporate funds that the provision was intended to thwart. PRESSURED BY GEMSTAR Yuen and Leung claim that the SEC then switched tacks and pressured Gemstar, through subpoenas and the threat of sanctions, to promise to lock up the severance payments for six months. Gemstar presented this demand to the two executives, who, seeing no alternative, reluctantly agreed, provided that the SEC agreed to discuss with them the release of any “non-extraordinary” payments. But the SEC subsequently refused to do so, they claim, instead telling them in late January that it would not release any of the escrowed money. Section 1103 is not the only area where the agency has been accused of overreaching under Sarbanes-Oxley. Late last year, it caused a huge uproar in the legal community when it proposed that lawyers be required to inform the commission when they learned of securities violations by their clients serious enough to warrant their resignation. The so-called noisy withdrawal provision spurred an onslaught of lobbying by the bar, and the SEC backed off, substituting a proposal that would require the company, rather than the lawyer, to inform the agency of violations. The rules have yet to be made final. Roberta Karmel, a former SEC commissioner who is now a professor at Brooklyn Law School, says this lawsuit may be a harbinger of things to come. She says that, in general, the SEC is engaging in extremely aggressive enforcement actions, behaving much like it did in the wake of the insider trading scandals of the late 1970s. “The SEC has a lot more power because of Sarbanes-Oxley and the current political climate, in which any public company is presumed to be guilty before proven innocent,” Karmel says. “I think the SEC has to be very cautious, or it will get caught up in situations in which it is accused of overreaching,” she adds. This article was distributed by the American Lawyer Media News Service. Tamara Loomis is a staff reporter at the New York Law Journal.

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