## Facts

- DHB Industries, Inc., a public body-armor company, suffered a sharp stock decline in late 2005 after reports that certain products used Zylon, an inferior material.
- Shareholders brought consolidated derivative and class actions against DHB and former officers and directors, including CEO David H. Brooks and CFO Dawn M. Schlegel, alleging securities and fiduciary misconduct.
- In December 2006, the parties reached a proposed global settlement of the derivative litigation.
- The settlement required DHB to indemnify Brooks and Schlegel for any amounts they might be required to reimburse to DHB under Sarbanes–Oxley Act § 304, and it included releases related to § 304 exposure.
- While settlement approval was pending, DHB restated financial results for 2003, 2004, and part of 2005, potentially triggering § 304 reimbursement duties for the CEO/CFO.
- Shareholder D. David Cohen intervened to object; the United States (DOJ in consultation with the SEC) also objected, arguing the settlement interfered with the SEC’s exclusive authority under § 304.
- The district court approved the settlement over the objections, including the § 304 indemnification and release provisions.
- Cohen appealed the approval order.

## Issues

1. Whether a shareholder-derivative settlement may release or require the issuer to indemnify its CEO/CFO against reimbursement obligations arising under Sarbanes–Oxley Act § 304, given the SEC’s exclusive statutory authority to enforce and exempt.
2. Whether the district court erred in approving settlement terms that effectively insulated the CEO/CFO from § 304 liability by shifting any reimbursement back to the issuer.
3. What remedy is required when unlawful § 304 indemnification/release provisions are included in an approved settlement.

## Decision

- The Second Circuit vacated the district court’s order approving the settlement and remanded.
- The court held that the settlement could not be approved to the extent it provided for indemnification and release of § 304 claims.
- The court concluded that a derivative settlement may not release or indemnify corporate officers from liability arising under § 304.
- The court reasoned that indemnification would allow the officers to retain compensation Congress intended them to repay and would shift the repayment burden to the corporation and shareholders.
- The court credited the federal government’s objection that the settlement would interfere with the SEC’s ability to obtain § 304 reimbursement and would function as an unauthorized exemption.

## Legal Principles

- Sarbanes–Oxley Act § 304 establishes a reimbursement scheme for certain CEO/CFO compensation following a restatement due to material noncompliance with financial-reporting requirements, enforceable by the SEC.
- Only the SEC may exempt any person from § 304’s reimbursement obligation; private parties and courts approving private settlements may not create de facto exemptions.
- A corporation may not indemnify its CEO/CFO for § 304 reimbursement amounts, because indemnification would defeat § 304’s purpose by shifting the statutory repayment obligation from the officers to the issuer and its shareholders.
- Settlement releases or indemnities that foreclose or substantially impair potential § 304 enforcement conflict with federal law and cannot be approved.

## Conclusion

The Second Circuit held that shareholder-derivative settlements cannot release or indemnify CEOs or CFOs from Sarbanes–Oxley § 304 reimbursement obligations, vacated the settlement approval, and remanded for further proceedings consistent with preserving the SEC’s exclusive enforcement and exemption authority.


Cohen v. Viray ex rel. DHB Indus., Inc., 622 F.3d 188 (2d Cir. 2010)