SOX Whistleblowers Protection

In Deremer v. Gulfmark Offshore Inc., 2006-SOX-2 (ALJ June 29, 2007), the ALJ reviewed the still evolving law on what constitutes protected activity under SOX. The ALJ started by observing that the law includes a “reasonable belief” test, which must be scrutinized under both subjective and objective standards: the complainant must have actually believed that the employer was in violation of the relevant law or regulations, and that belief must be reasonable. Reasonable belief is determined based on the knowledge available to a reasonable person in the circumstances with the employee’s training and experience. The ALJ then observed that fraud is an integral element under the SOX whistleblower provision, which in the securities area, may include dissemination of false information in to the market on which a reasonable investor may rely. The intent to deceive is implicit. The ALJ noted a split in authority over whether SOX whistleblower protection is limited to fraud “against shareholders,” and after reviewing the nature of that split, found that his conclusion was consistent with that of the ARB B that an allegation of “shareholder fraud” is an essential element of a cause of action under SOX. The ALJ concluded, therefore, that materiality was required for alleged conduct to rise to the level of shareholder fraud.

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The ALJ wrote: Therefore, under subjective and objective standards, Complainant must actually and reasonably believe, based on the knowledge available to a reasonable person, that Respondent intentionally acted fraudulently, and that such conduct was sufficiently material so as to constitute fraud against the shareholders. In cases where allegations of shareholder fraud are based on potential or actual dissemination of fraudulent information, there must exist a “substantial likelihood” that the disclosure of the omitted or misstated information would have been viewed by the reasonable investor as having significantly altered the ‘total mix’ of information made available. Slip op. at 50.

In response to a recent post, the question was asked: is Federal Court the better forum to help a SOX Whistleblower obtain relief for wrongful termination because he blew the whistle on accounting corruption in a publicly traded corporation?

 We think that the answer is yes and no. It does appear that SOX Whistleblowers do enjoy a more expansive interpretation of what constitutes a ”protected activity” in Federal Court BUT the costs and time delays in Federal Court should also be considered.   The technicalities of presenting a case in Federal Court will require the help of an attorney and the time to resolve your your claim will be much longer.

Before jumping into the Federal Court system the SOX Whistleblower should also consider these factors.

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The case discussed below may show that a SOX Whistleblower may have more success redressing corporate coruption in Federal Courts than with Administrative Judges.   Smith v. Corning, Ltd, Inc., No. 06-CV-6516 (W.D.N.Y. July 12, 2007) is a Federal District Court case which may indicate that Federal Courts may have a more expansive view of what constitutes protected activity. 

 In Smith v. Corning, Inc. the New York Federal District court found that the Whistleblower’s contention that a software application, was being implemented in a way that was not correctly reporting financial data with resultant impact on the integrity of quarterly reports may possibly be a report of fraud against shareholders. The court rejected the Defendants’ contention that the complaint was deficient because it did not allege an actual fraud against shareholders. The court found that § 1514A only requires a plaintiff to have a reasonably believed that the problem constituted a violation of a provision of Federal law relating to fraud against shareholders. The court found that the SOX Whistleblower’s complaint met this standard insofar as it alleged that the Plaintiff reasonably believed that the company was violating 15 U.S.C. § 78m(b)(2)(B)(ii), and that he believed that § 78m(b)(2)(B)(ii) was related to fraud against shareholders.

The New York District Court also indicated that the submission of quarterly reports that were not prepared in accordance with GAAP would also violate a SEC rule, namely 17 C.F.R. § 210.4 01(a)(1), citing Richards v. Lexmark Int’l, Inc., 2004-SOX-49 (ALJ June 20, 2006). The court also rejected the Defendants’ contention that the Whistleblower’s complaints were not protected because they involved an internal accounting dispute, and only pertained to a potential for fraud occurring in the future. The court found that the Whistleblower had alleged that the Defendants repeatedly refused to address a problem that was resulting in incorrect financial information being reported to the company’s general ledger B.   The Court then found that this  allegation would survive the Motion to Dismiss Finally, the court rejected the Defendants’ contention that the Whistleblower’s complaint was deficient because he only complained about the software application, and therefore could not allege a basis for reasonably believing that the company’s entire system of accounting controls was so inadequate as to violate § 78m(b)(2), which speaks to systems rather than portions of accounting systems. The court found that based on facts alleged in the complaint and at this stage in the litigation, it could not say as a matter of law that it was unreasonable for the Plaintiff to believe that the company was violating § 78m(b)(2)(B)(ii) when it refused to address problems with the Software. 

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No matter how you you look at it or where you look, the answer is the same. The best way to fight corruption in corporate america is to enable whistleblowers! Protection for whistleblowers is the first step. While SOX may have many pitfalls and hidden traps, it is still an important vehicle for you.

This blog is dedicated to the understanding of SOX and the protection of the whistleblower. Don’t let corrupt managment discredit and retaliate against you.

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PROTECTED ACTIVITY; CFO’S COMPLAINT OF INSUFFICIENT ACCESS TO AN OUTSIDE AUDITOR

In Welch v. Cardinal Bankshares Corp., ARB No. 05 064, ALJ No. 2003-SOX-15 (ARB May 31, 2007), the Complainant B who was the Respondent’s CFO complained that he had been denied sufficient access to an outside auditor, who instead chose to communicate with the company’s CEO. The ARB found that such complaints were not protected activity under SOX. The ARB wrote: “But Welch did not prove by a preponderance of evidence how his unhappiness about access to [theoutside auditor] constituted a reasonable belief that Cardinal was violating or might violate the enumerated fraud statutes, any SEC rule or regulation, or any federal law relating to fraud against shareholders. To be protected, an employee’s SOX complaint must definitively and specifically relate to the listed categories of fraud or securities violation.” USDOL/OALJ Reporter at 13 (footnote omitted).

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PROTECTED ACTIVITY; REPORTS OF MAIL OR WIRE FRAUD NEED NOT BE LINKED TO FRAUD AGAINST SHAREHOLDERS TO BE PROTECTED UNDER THE SOX

In Reyna v. Conagra Foods, Inc., No. 3:04-CV-00039 (M.D.Ga. June 11, 2007), the Plaintiffs (who were employees in the Defendant’s HR Department) contended that the Defendant violated the whistleblower provision of the Sarbanes Oxley Act when they were terminated for reporting two incidents of fraud: (1) a fraudulent insurance scheme in which a supervisor falsely requested that individuals he identified as his wife and son (who were in fact his sister and nephew) be added to his company provided health insurance as dependents, and (2) an instance in which a HR supervisor and a benefits coordinator provided a fake social security card for an employee in order to satisfy the I 9 requirements of the immigration law. The Plaintiffs contended that these fraudulent activities necessarily involved the use of mail or the internet, and thus the reporting of the activities was protected under the SOX. The Defendant filed a motion for summary judgment arguing that the reporting was not protected activity because the reports of mail fraud and wire fraud did not relate to “fraud against shareholders.” Employing principles of statutory interpretation, the court denied summary judgment, holding: The statute clearly protects an employee against retaliation based upon that employee’s reporting of mail fraud or wire fraud regardless of whether that fraud involves a shareholder of the company. The Court rejects Defendants’ interpretation that the last phrase of the provision, “relating to fraud against shareholders,” modifies each of the preceding phrases in the provision. Defendants seek to redraft the statute to read that the employee is protected only if he reasonably believes that the conduct constitutes a “violation of section 1341 [mail fraud] ‘relating to fraud against shareholders,’ section 1343 [wire fraud] ‘relating to fraud against shareholders,’” etc.Slip op. at 39.

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Does a Whistleblower complaint that results in an internal investigation constitute a protected activity?

 Yes under the facts of this case at least.

In Johnson v. Stein Mart, Inc., No. 3:06-CV-00341 (M.D.Fla. June 20, 2007) (case below 2006-SOX-52), the Plaintiff had been hired as a Buyer at the Defendant’s corporate headquarters, and was later promoted to be a Planner, in which capacity she complained to management about (1) the collection of markdown allowances from vendors, (2) the changing of season codes on older inventory, and (3) the accounting for the value of inventory. The Employer, Stein Mart,  argued that the Plaintiff failedto establish a prima facie case on the element of protected activity because she did not have a reasonable belief that these practices were illegal because she had no accounting background and had no knowledge of the Defendant’s accounting practices. Stein Mart  argued that its vendor markdown allowances and season code changes were in line with general industry practices. The district court rejected this argument because Stein Martt had treated the Plaintiff’s complaints reasonable enough to have warranted an internal investigation.

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One of the factors that has contributed to the  disappointing results for many employees submitting SOX Whistleblower Retaliation claims has been the lack of understanding of  what constitutes protected activity under the Act. While there are two different sections on protected activity in the Act, the first section is the one  overwhelmingly used by employees presenting SOX Whistleblower claims. This Section provides that reporting conduct that the employee reasonably believes constituted a violation of securities, mail, bank or wire fraud is a protected activity.  

 The next few posts will explore recent rulings on this critical element of a  Sox Whistleblower claim. 

 Welch v. Cardinal Bankshares Corp., ARB No. 05 064, ALJ No. 2003-SOX-15 (ARB May 31, 2007)  is one of the most recent rulings on the issue of what is required to establish  that a Complainant had a “reasonable basis” to believe he was reporting a violation of securities laws. In Welch, the  ARB  wrote: “The “reasonable belief” standard requires Welch to prove both that he actually believed that the SEC report overstated income and that a person with his expertise and knowledge would have reasonably believed that as well. The ARB found that an experienced CPA/CFO like the Complainant could not have reasonably believed that the quarterly SEC report presented a misleading picture of the Respondent’s financial condition because whether reported as income or as a credit to expenses, the fact remained that the Respondent had $195,000 that it previously did not have.  The ARB also found that reporting violations of accounting standards is not “ipso facto” reporting a violation of securities laws.

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Several recent decisions from the Department of Labor have discussed what is and what is not a Protected Activity under SOX.  Below is a discussion of two of these recent cases.

In Johnson v. Stein Mart, Inc., No. 3:06-CV-00341 (M.D.Fla. June 20, 2007) (case below 2006-SOX-52), the Plaintiff had been hired as a Buyer at the Defendant’s corporate headquarters, and was later promoted to be a Planner, in which capacity she complained to management about (1) the collection of markdown allowances from vendors, (2) the changing of season codes on older inventory, and (3) the accounting for the value of inventory. The Defendant argued that the Plaintiff failedto establish a prima facie case on the element of protected activity because she did not have a reasonable belief that these practices were illegal because she had no accounting background and had no knowledge of the Defendant’s accounting practices. The Defendant argued that its vendor markdown allowances and season code changes were in line with general industry practices. The district court rejected this argument because the Defendant had treated the Plaintiff’s complaints reasonable enough to have warranted an internal investigation.

In Reyna v. Conagra Foods, Inc., No. 3:04-CV-00039 (M.D.Ga. June 11, 2007), the Plaintiffs (who were employees in the Defendant’s HR Department) contended that the Defendant violated the whistleblower provision of the Sarbanes Oxley Act when they were terminated for reporting two incidents of fraud: (1) a fraudulent insurance scheme in which a supervisor falsely requested that individuals he identified as his wife and son (who were in fact his sister and nephew) be added to his company provided health insurance as dependents, and (2) an instance in which a HR supervisor and a benefits coordinator provided a fake social security card for an employee in order to satisfy the I 9 requirements of the immigration law. The Plaintiffs contended that these fraudulent activities necessarily involved the use of mail or the internet, and thus the reporting of the activities was protected under the SOX. The Defendant filed a motion for summary judgment arguing that the reporting was not protected activity because the reports of mail fraud and wire fraud did not relate to “fraud against shareholders.” Employing principles of statutory interpretation, the court denied summary judgment, holding: The statute clearly protects an employee against retaliation based upon that employee’s reporting of mail fraud or wire fraud regardless of whether that fraud involves a shareholder of the company. The Court rejected Defendants’ interpretation that the last phrase of the provision, “relating to fraud against shareholders,” modifies each of the preceding phrases in the provision. Defendants seek to redraft the statute to read that the employee is protected only if he reasonably believes that the conduct constitutes a “violation of section 1341 [mail fraud] ‘relating to fraud against shareholders,’ section 1343 [wire fraud] ‘relating to fraud against shareholders,’” etc.Slip op. at 39.

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In response to a recent post, the question was asked where should a Sox Whistleblower turn for help.  The answer is not that easy. Potential Whistleblowers must be make sure that they protect themselves as well as the shareholders of the publicly traded company at issue.

Other officers of the company and/or its legal counsel or auditors are potential sources of assistance.  Representatives of the SEC may be able to assist you and lawyers that are specialize in the area are potential sources of help.  Other Whistleblowers would also be a good group to consider.   But,

Do not expect that other officers of the company or its “independent” audit committee will be looking out for you.  One would hope that they would and they might, but do not be so naive as to rely on their good faith and devotion to “truth, justice, and the American way”. 

PROTECT YOURSELF.

If you are asked to do something and it doesn’t feel right to you, it probably isn’t. Don’t fall for the rationalization that everyone has been doing it for years. That may be the case but that argument won’t help you that much if you are being set up this time.

Paper your file with hard copies of confirming emails. Do not expect that your soft copies will be readily available to you if you blow the whistle. While the statute mandates the preservation of email communications, my experience is that they are not always voluntarily provided  by the company.  

Be mindful that you may not retain access to your sent emails under your companies data organization structure. To be safe, copy your self on your emails so you can retain a copy and remember to print out hard copies of all important correspondence.

Remember that when it gets right down to it, you may be the only one you can trust in your organization.   

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