SOX Whistleblowers Protection

SOX WHISTLEBLOWER PROTECTED ACTIVITY.

 A STOCK ANALYST’S STATEMENT AT A REVIEW MEETING THAT SHE WOULD REFUSE TO CHANGE A STOCK RATING WAS NOT PROTECTED ACTIVITY WHERE SHE DID NOT VOICE A BELIEF THAT A CHANGE WOULD VIOLATE A SECURITIES LAW AND SHE WAS NOT DIRECTED TO CHANGE THE RATING

In Getman v. Administrative Review Board, USDOL, No. 07-60509 (5th Cir. Feb. 13, 2008) (unpublished), the Fifth Circuit Court of Appeals  affirmed the ARB’s holding that the Complainant employee, a research analyst for a securities company, had not engaged in protected activity under SOX when she refused to recommend a high rating for a stock she reported on. A review committee had questioned her rating and asked for her reasoning. At the end of the meeting, the Complainant told the committee that they could change the rating but that she would not sign on to the change. She did not, however, inform the committee that she believed that changing the rating would violate any securities law. Moreover, none of the committee members told her to change the rating.

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REPORTING WITHIN JOB DUTIES IS SUFFICIENT;

THE SOX WHISTLEBLOWER DOES NOT HAVE TO EXPRESSLY  IDENTIFY THE COMPLAINED OF ACTIONS AS ILLEGAL

In Deremer v. Gulfmark Offshore Inc., 2006-SOX-2 (ALJ June 29, 2007), the Respondent contended that the Complainant’s SOX whistleblower complaint was barred because his allegations fell within his job responsibilities and because he failed to communicate to the Respondent that he believed the conduct to be illegal. In support of the first contention, the Respondent cited several decisions in which it was found that finding irregularities as part of one’s job duties cannot constitute protected activity and  that the employer must be put on notice that the reporting is being done to expose illegal acts rather than merely warning of the consequences of its conduct. The ALJ distinguished the decisions as arising under other laws with different contexts, and returned to the purposes of SOX in interpreting the respondent’s knowledge element of protected activity. The ALJ concluded that restricting protected activity to exclude job duties would be contrary to Congressional intent. The ALJ pointed out that the legislative history of SOX explicitly discusses the case of Sherron Watkins, whose job responsibilities at Enron arguably included reporting accounting fraud. The ALJ also pointed out that, to be actionable, a SOX whistleblower complaint requires the respondent’s knowledge of protected activity, and an adverse job action to which protected activity is a contributing factor. 

As to the employer’s second contention that SOX Whistleblowers  must expressly state that he considers the conduct to be illegal, the ALJ found that an examination must be made of the context in which and to whom the statements were made. the ALJ focused on the fact that the statements were made to the controller, auditors, and an investigating law firm, all of whom should logically have recognized fraudulent behavior if the Complainant described it to them, and that publishing of fraudulent statements with the SEC was illegal. Thus, the ALJ found that the Complainant was not required to specifically state to the Respondent that the activity of which he complained was illegal.

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In January, 2008, President Bush signed into law the National Defense Authorization Act for Fiscal Year 2008 (H.R. 4986), which includes a provision protecting employees of defense contractors who blow the whistle on contracting fraud.  Section 846 amends 10 U.S.C. § 2409 to protect employees who disclose to Congress, an Inspector General, the Government Accountability Office, or  a Department of Defense employee responsible for contract oversight or management “information that the employee reasonably believes is evidence of gross mismanagement of a Department of Defense contract or grant, a gross waste of Department of Defense funds, a substantial and specific danger to public health or safety, or a violation of law related to a Department of Defense contract (including the competition for or negotiation of a contract) or grant.” A complainant must be filed with the Inspector General (IG) of an agency, and unless the IG determines that the complaint is frivolous, the IG will conduct an investigation.  Once the complainant exhausts administrative remedies, the complainant may bring a de novo action in federal court and is entitled to a jury trial.  Remedies at the administrative level and in federal court include reinstatement, back pay, compensatory damages, and attorney fees and costs.

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The SEC recently announced that it’s giving another delay to the implementation of Sarbanes-Oxley to smaller public companies.

Now the small companies won’t have to comply with an internal-controls audit requirement until December 15, 2009. Some wonder if the compliance date will ever actually arrive. 

 The SEC has also announced it is going to commence a  cost-benefit analysis of Sarbanes-Oxley section 404 for small businesses including a look at  cost and benefit data. The delay has earned praise from the US chamber of Commerce which said it was an important step for business, particularly in this economic climate.

Senator  Olympia Snowe stated  ”When you consider that businesses that employ fewer than 20 people spend more than $2000 per employee in regulatory compliance costs than [larger]  businesses ….  it’s painfully clear that we could be doing more to help small businesses succeed. I am pleased that the SEC has taken steps today to help address and rectify this discrepancy,” 

One should question how many publicly trade companies actually have so few employees and why a company with only twenty (20) employees should really benefit from “going public”. Let’s hope that the current downturn in the economy is not somehow blamed on SOX regulations and that the true benifit of courageous SOX Whistleblowers is not diminished by such an unsupported conclusion.

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In Mahony v. Keyspan Corp, No. 06CV00554 (E.D.N.Y. Mar. 12, 2007) (case below 2004-SOX-24) the Federal Court  found that SOX includes an illustrative list of the types of special damages that may be recovered rather than an exhaustive list. The court indicated that it agreed with the reasoning of the court in Hanna v. WCI Communities, Inc., 348 F.Supp.2d 1332 (S.D.Fla.2004), where the court held that the SOX whistleblower provision includes damages for loss of reputation. SOX whistleblowerswhistleblowers helpwhistleblowers protectionwrongful termination

Allen v. ARB is not all bad for Whistleblowers. In fact it should provide some help for the whistleblowers effort to get the claim heard by his or her peers.  While the Fifth Circuit’s opinion last week is being touted as a victory for publicly traded companies, the opinion does shed important light on the scope of protected activity, including a finding that typically the question of whether the whistleblower had a subjective reasonable belief will be a question of fact.  This is will enable the whistleblower to argue that his or her case should be determined by a jury trial. This will hopefully force the publicly traded company to try its case in front of the last people it wants to consider its actions — a jury of the whistleblower’s peers!SOX whistleblowerswhistleblowers helpwhistleblowers protectionwrongful termination

PROTECTED ACTIVITY; ALLEGED FRAUDULENT POLICY OF SINGLE STORE FOUND NOT TO HAVE BEEN OF SUFFICIENT MAGNITUDE TO MATTER TO A REASONABLE INVESTOR

In Frederickson v. The Home Depot, U.S.A., Inc., 2007-SOX-13 (ALJ July 10, 2007), the ALJ found that the Complainant failed to establish a prima facie case of a SOX whistleblower complaint where he did not, under the facts presented, show that he had a reasonable belief of actionable fraudulent activity. Specifically, the Complainant maintained that he had a reasonable belief of fraud relating to the recording of items as damaged rather than for “store use,” whereby refunds for such merchandise were wrongfully extracted from vendors (the Complainant had used some hooks in his department, and was instructed to record them in the store computer as damaged). The ALJ found, however, that the Complainant had no reasonable basis to believe that this policy extended beyond the store at which he worked, and that such an alleged fraudulent policy, isolated to a single store, even if true, would not have been of sufficient magnitude to believe that a reasonable investor would rely on such information.

 Moral of story — to be covered by SOX your complaint has to be of a magnitude that it affects the financial condition of the entire company.  

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Could this lead to much needed  SOX Whistleblowers Reforms?

In December the  United States  Senate approved Senate Bill 274.   The purpose of the  legislation is to restore and strengthen the Whistleblower Protection Act (WPA) for federal government workers. Like SOX, the original law had been gutted and discredited by 13 years of hostile court rulings, which made it nearly impossible to qualify for protection under the law.

 The legislation restores the mandate of the Whistleblower Protection Act (WPA), which was unanimously passed by Congress in 1989 and unanimously strengthened in 1994, but which since has been gutted by judicial activism that undermined congressional intent to protect for any lawful disclosure of misconduct. The amendment also strengthens the due process enforcement structure for WPA paper rights, and applies them to a broader set of harassment scenarios, such as security clearance actions, retaliatory investigations and gag orders.

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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.

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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SOX also requires that information presented by protected whistleblowers be investigated by an “Independent” Audit Committee. While this is an excellent requirement, it is unfortunately susceptible to much abuse. If you have or are contemplating blowing the whistle on your publicly traded employer, please be mindful that the members of the company’s management team more than likely hired the “independent” audit committee members probably speak with the audit committee on a very regular basis.

MORAL OF THIS BLOG POST: If you are blowing the whistle on one of the higher ups at your publicly traded employer, chances are that your allegation and your identity will probably be known within hours. Get Help First.

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The initial statistics are not favorable for a Sarbanes Oxley protected whistle-blower. Recent reports from the Department of Labor (”DOL”) indicate that SOX whistle blowers prevail only about ten percent of the time.

 Why? 

Many explanations come to mind. First, the more egregious cases are settled and resolved before the courts rule on the complaint.  Second,  SOX whistleblower protection is still relatively new and everyone continues to learn  what is and is not a “protected activity” or what constitutes discriminatory conduct against the SOX whistleblower.

What can a protected employee do?  That will be the subject of a later post, but the most important tip would be to protect him or herself. Don’t let an employer set you up and turn the investigation towards you instead of the truly culpable party.

Blaming the victim is the oldest trick in the book!

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Once a case is filed, OSHA reviews the allegations in the complaint to determine whether the claim should be investigated.

If, on the basis of the investigation, OSHA determines that the employee was subjected to retaliation, OSHA must order the employer to provide a complete “make whole” remedy to the employee.

If OSHA determines that the claim is without merit, OSHA must dismiss the action. Either an employee or employer may appeal the investigative findings. The appeal is completely de novo. If appealed, the parties are entitled to an on-the-record hearing before the DOL’s Office of Administrative Law Judges (OALJ). Although a case is held de novo before the OALJ, a preliminary order of reinstatement issued by OSHA is immediately enforceable. Thus, if OSHA orders an employee reinstatement on the basis of an investigation alone, the employee must be immediately reinstated pending the appeal of the OSHA ruling.

The OALJ procedures for adjudicating whistleblower cases, codified at 29 C.F.R. Part 18, are very similar to the Federal Rules of Civil Procedure. Parties are entitled to discovery and may file standard pretrial motions. Upon the completion of pretrial proceedings, the DOL ALJ conduct formal bench trials, where each party is permitted to call and cross-examine witnesses.

The Federal Rules of Evidence are not directly applicable, and the cases are tried before a single judge, who will issue findings of fact and conclusions of law.

The ALJ’s decision is appealable to the DOL’s Administrative Review Board (“ARB”). The ARB was given the authority to issue final administrative orders on behalf of the Secretary of Labor. ARB orders are reviewable in the U.S. Courts of Appeal for the circuit in which the violation arose.

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The whistleblower provisions of SOX prohibit a covered employer from discharging, demoting, suspending, threatening, harrassing, or “in any other manner” discriminating against an employee who has taken actions protected by the act. 

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You may still have a claim under SOX but you should  include the parent,  publicly traded company, as a Respondant in your OSHA claim.

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