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What makes a corporate executive’s pay “extraordinary”? It all depends, the 9th U.S. Circuit Court of Appeals said Tuesday — but the combined $37 million planned for two executives at Gemstar-TV Guide International certainly fit the bill. Former Chief Executive Officer Henry Yuen and former Chief Financial Officer Elsie Leung have been fighting a U.S. district judge’s order that put their planned severance packages into escrow two years ago. At the time, the Securities and Exchange Commission was investigating the leaders of the company to see if they’d overstated revenues and misled stockholders. Their case hinges on how the courts interpret a part of the Sarbanes-Oxley Act that lets the SEC force “extraordinary payments” for employees into escrow while their company is under investigation. Although district court judges have interpreted the law several times as the SEC has sought court orders, the 9th Circuit is the first federal appellate court to interpret what kinds of payments qualify as extraordinary, said Richard Humes, an associate general counsel with the SEC. Yuen and Leung have argued that the district court’s interpretation of “extraordinary” was wrong, and that the law’s wording is unconstitutionally vague. A divided three-judge panel at the 9th Circuit agreed, but this week, an en banc majority rejected both arguments. Two of the judges from the original panel were among the judges sitting en banc. The en banc’s majority author, Senior Judge Stephen Trott, was the three-judge panel’s dissenter. Judge Carlos Bea, who had written the original majority opinion, wound up being the lone en banc dissent. For a law that aims to protect third-party creditors and corporate investors once the SEC begins an investigation of corporate malfeasance, Trott wrote, “‘out of the ordinary’ means a payment that would not typically be made by a company in its customary course of business.” And Yuen and Leung’s planned severance packages were “anything but ordinary,” Trott concluded, noting that they were five and six times greater than their base salaries, and that the size of their bonuses appeared tied to the allegedly fraudulent financial reporting at the heart of the SEC investigation. In general, the court should look at factors like the size of the payment, its purpose and the circumstances surrounding it, or even deviation from an industry standard, Trott wrote. But there shouldn’t be a specific litmus test. “To do so for all possible situations would be next to impossible.” Two concurring judges took a more absolute stance. All “substantial non-routine” payments to top corporate officials of a company under investigation should be considered extraordinary, Judge Stephen Reinhardt wrote, joined by Judge Susan Graber. In his dissent, Judge Bea said he would vacate U.S. District Judge William Matthew Byrne Jr.’s order but give the SEC a chance to present stronger evidence on remand. He said he thinks the SEC should have to show a payment was extraordinary relative to payments made by other comparable companies that aren’t under investigation by the SEC. Comparing a payment to the normal course of business at the same company is unworkable, Bea asserted, because in that light, “ any payment made under any situation novel to that company is now subject to escrow.” That includes, he added, “the first time a company under SEC investigation gives a departing executive not a golden parachute, but a mere gold watch (or, even, a gold-plated watch).” Humes, the SEC lawyer, said Tuesday that it would be too onerous to investigate a company’s alleged securities fraud while trying to gather information on other companies’ pay at the same time. “We are pleased, not only because we won but because the court adopted the standard that we had urged,” he said. “The court should look at a flexible standard.” Trott defended the court order for escrow as reasonable, noting that the money goes into an interest-bearing account for up to 45 days. Bea proclaimed that “at best, a naive view.” If executives are subsequently charged with a securities violation, the escrow order remains in effect until those proceedings are over, he pointed out. That’s what happened to Yuen and Leung. The SEC sued them for securities fraud about a month after the court order that put their pay into escrow, so their money remains locked in escrow. The case is Securities and Exchange Commission v. Gemstar-TV Guide International Inc., 05 C.D.O.S. 2421.

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