Has the legal community declared war on Sarbanes-Oxley? Probably not.

But, there is some evidence that they are either beginning to chip away at the nearly two-year-old legislation, or at least willing to challenge some of its provisions.

“It’s easier to attack it than a year ago,” asserts David Katz, partner at Wachtell, Lipton, Rosen & Katz. “No one wanted to be in the mode of attacking it” when major corporate problems were hogging the headlines.

The first successful shot was fired a month or so ago when the 9th Circuit Court of Appeals ruled that two former top executives of Gemstar-TV Guide International Inc. may seek to collect $37.6 million in severance payments that had been blocked by the SEC.

A number of observers say the ruling could make it much harder for the Securities and Exchange Commission to freeze executive compensation under the Sarbanes-Oxley Act.

The deciding issue came down to what constitutes "extraordinary payments" as it relates to Section 1103 of the Act. Under Section 1103, the SEC can petition a district court to require a company subject to an investigation of possible securities fraud to escrow “extraordinary payments” to directors, officers or employees for up to 90 days, Wachtell, Lipton explains in a recent report sent to clients.

Under Section 1103, if the Commission charges the company or a director, officer or employee with a violation of the federal securities laws during the initial escrow period, the escrow could remain in effect until the conclusion of the proceedings.

The problem is that Sarbanes-Oxley does not specifically define “extraordinary” payments and the SEC has yet to issue regulatory guidance on this provision.

In October 2002, the SEC began investigating Gemstar after the company announced that it would restate its financials from July 1999 through March 2002.

The following month, the company announced it had reached termination agreements with chief executive officer Henry Yuen and chief financial officer Elsie Leung, which called for them to be paid nearly $38 million. Last year, the SEC persuaded a federal judge to block the payments.

However, the 9th Circuit reversed that ruling. “According to the majority opinion, the SEC could not establish the extraordinary nature of the termination payments because it had failed to introduce any evidence of what would constitute an ordinary payment under comparable circumstances,” Wachtell, Lipton explained.

The 9th Circuit is believed to be the first appellate court to review the extraordinary payment issue.

“The absence of statutory or rulemaking guidance regarding the meaning of the phrase ‘extraordinary payments’ promises to generate future challenges to SEC efforts to enforce the escrow provision,” Wachtell, Lipton wrote in its analysis. It added that boards of directors must “carefully consider the ramifications of approving or permitting ‘extraordinary payments’ in the context of an investigation of possible securities fraud.”

The Scrushy Test

Then there is the case of Richard Scrushy, the former chief executive officer of HealthSouth Corp.

His lawyers have asked a judge to throw out three of the 85 criminal charges against their client that relate to the Sarbanes-Oxley Act. These provisions are related to the requirement that the CEO and CFO sign off on a company’s financials, calling them vague and their use in this case unconstitutional.

When he initially filed his motion back in April, Scrushy attorney Thomas Sjoblom argued that the part of Sarbanes-Oxley being used by the prosecutors against the former CEO violates basic constitutional law. The reason? It makes criminal the most ordinary and non-intentional acts of corporate officials, maintained Sjoblom—like signing their name to lengthy SEC reports prepared by others—when the statute fails to specify the state of mind required and the conduct proscribed.

"Section 906 of Sarbanes-Oxley imposes criminal liability on a corporate officer who certifies that his company's periodic reports comply with certain specific reporting regulations imposed by federal securities law, regardless of whether violations of those very regulations would give rise to criminal liability in their own right," added Sjoblom. "And, to make matters worse, corporate officers face liability for inaction, i.e., for not signing the required certification, even if the underlying financials are precisely accurate."

"Several of the provisions of Sarbanes-Oxley ... are so vague that they fail to provide ordinary people with an understanding of what conduct is prohibited and place no limitation on the discretion of government officials to curtail arbitrary and discriminatory enforcement," wrote Scrushy’s defense attorneys.

For example, whether the SEC report "fairly presents," the information, or even "fairly presents, in all material respects," may lie in the eye of the beholder, added the attorneys. Sarbanes-Oxley, they continued, "is unconstitutional as being so vague that no corporate officer can possibly know what actions he or she can or cannot take without risking going to jail for up to 20 years."

In December, when the possibility was first raised that Scrushy's attorneys would challenge the 2002 act, U.S. attorney Alice Martin, the lead prosecutor on the case, told Reuters, "Sarbanes-Oxley is a new law, and it is to be expected that there would be a challenge."

Indeed, although there are currently no other major provisions being challenged, many lawyers wouldn’t be surprised to see another case arise soon. “Good, aggressive lawyers always knew they could chip away at it,” says Cathy Fleming, partner with Edwards & Angell and chairperson of white collar and corporate integrity.

However, don’t expect anyone to overturn all or a large portion of Sarbanes-Oxley. Says Gordon Kaiser, partner and head of the corporate practice at Squire, Sanders & Dempsey, “No one has come up with a serious flaw in the core of the act—the core being the federalization of corporate governance standards.”

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