Interpretations And Implementation Of The Whistleblower Provisions Of The Sarbanes-Oxley Law

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Cameron Fowler
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1 Interpretations And Implementation Of The Whistleblower Provisions Of The Sarbanes-Oxley Law Irvin B. Nathan and Yue-Han Chow A. History Of The Sarbanes-Oxley Whistleblower Provision 1. Drafted principally by plaintiffs organizations to encourage and protect whistleblowers in reporting financial fraud by public companies, the Sarbanes-Oxley ( SOX ) whistleblower provisions were designed to prevent recurrences of the Enron debacle and similar threats to the nation s financial markets. 148 Cong. Rec. S7419, S7420 (daily ed. July 26, 2002). a. Ostensibly because corporate employees who report fraud [were] subject to the patchwork and vagaries of current state laws, even though most publicly traded companies do business nationwide, id. at S7420, Congress chose to enact these liberalized whistleblower provisions. Irvin B. Nathan is a senior litigation partner at Arnold & Porter LLP in Washington, D.C., who has defended a number of whistleblower suits brought under the Sarbanes-Oxley Act. Yue-Han Chow is a litigation associate in Arnold & Porter s New York office who has worked with Mr. Nathan in defense of those suits. A complete set of the course materials from which this outline was drawn may be purchased from ALI-ABA by calling CLE-NEWS and asking for customer service. (Have the order code SL027 handy.) Or order online at 5

2 6 ALI-ABA Business Law Course Materials Journal October 2006 b. As a recently enacted statute, many of the key provisions of SOX have yet to be interpreted by the Courts of Appeals. There are, however, a growing number of decisions by Administrative Law Judges ( ALJs ) in the Department of Labor ( DOL ) and by district courts that provide guidance for litigators. As can be expected, some of these de novo decisions are not completely consistent. 2. The statute, 18 U.S.C. 1514A, is largely based on the Wendell H. Ford Aviation Investment and Reform Act for the 21st Century ( AIR21 Act ) and regulations promulgated under it, although a few unique features have been added to it. The SOX regulations can be found at 29 C.F.R. Pt The statute is stacked in favor of purported whistleblowers, making it difficult for companies to defend employment actions. There are a number of unique features in the law. a. Adverse employment actions are more than ultimate employment actions: they can include a hostile work environment, loss of job responsibilities, and placement on a lay-off list before lay-offs occur. b. Employees need only prove that the protected activity was a contributing factor to the employer s decision to take adverse employment action. This is based on the Whistleblower Protection Act, 5 U.S.C. 1221(e)(1) (1989), which applies only to Federal employees. Before the passage of the Whistleblower Protection Act, an employee had to prove that his protected conduct was a significant, motivating, substantial, or the predominant factor in a personnel action. See Marano v. Dep t of Justice, 2 F.3d 1137, 1140 (Fed. Cir. 1993). c. Companies have a heavier burden of proving by clear and convincing evidence that they would have taken the same adverse employment action absent the protected activity. Employees need only prove by a preponderance of the evidence that the protected activity was a contributing factor to the adverse employment action. SOX follows the AIR21 Act in this respect. d. SOX allows the complainant to bring an action for de novo review in district court if there is no final decision within 180 days of filing the complaint. No other whistleblower statute allows for this. i. This is a very short and improbable amount of time for OSHAand the DOL to come to a final determination about the case. By a final order, the

3 SOX Whistleblower Provisions 7 statute apparently means the completion of a preliminary investigation, the ALJ proceeding, and a decision on any appeal accepted by the Administrative Review Board ( ARB ). ii. By the end of the 180 days, it is possible that the parties will have wasted a great deal of resources on the administrative proceeding, only to litigate in another forum. iii. A final decision is any decision made by the ARB or by the investigator or ALJ that has not been appealed or challenged. It is possible that an investigator will have rendered preliminary findings, an ALJ granted a hearing request, the ALJ heard the case and made a decision, the ARB accepted the case for review, and the parties will be waiting for the ARB s decision when the 180 days expire. Because there is no final decision, the complainant will be allowed to file an action in district court for de novo review, ignoring any determinations and decision made during the administrative process. This provision appears to be in urgent need of revision by Congress. 4. Appropriate Expertise? Though OSHA has experience with adjudicating whistleblower claims, determining whether an employee reported SOX violations is particularly tricky, because it involves allegations of financial malfeasance. a. As a Wall Street Journal article points out, OSHA investigators have been trained in health and safety issues. Deborah Solomon, Risk Management: For Financial Whistle-Blowers, New Shield Is an Imperfect One, Wall Street Journal, Oct. 4, 2004, at A1. The 13 other whistleblower statutes that OSHA enforces involve violations of federal laws concerning pollution, energy, nuclear power plant operations, and transportation. b. OSHA has not increased its staff of investigators to include those with a finance background; instead, the investigators received written materials on securities laws. B. Which Employers Are Covered? 1. Companies with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 781) or that [are] required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)) are covered under the SOX whistleblower provision. 18 U.S.C. 1514A(a).

4 8 ALI-ABA Business Law Course Materials Journal October 2006 a. Subsidiaries, though they may not be publicly traded companies, may be liable under the SOX whistleblower provision if their parent companies are covered. Some ALJs have evaluated whether the subsidiary and the parent companies have a shared management and function, and an ALJ permitted a complainant to amend the complaint to include the parent when it found that there had been a mistake in identifying the responsible party. The same ALJ found that Congress intended to provide whistleblower protection to employees of subsidiaries of publicly traded companies, and there was a cause of action sufficient to withstand a motion for summary decision. See Gonzalez v. Colonial Bank, 2004-SOX-39 (ALJ Aug. 20, 2004); Morefield v. Exelon Services, Inc., 2004-SOX-2 (ALJ Jan. 28, 2004). b. If the complaint fails to name the public parent corporation, then an ALJ may dismiss the complaint. Despite the apparent legislative intent to attach liability to publicly traded companies who surround themselves by other entities under their control, it does not seem the Act provides a cause of action directly against the [non-public] subsidiary alone. Klopfenstein v. PCC Flow Technologies Holdings, Inc., 2004-SOX-11 (ALJ July 6, 2004) (rejecting argument that the holding company was an agent of the parent company); Powers v. Pinnacle Airlines, Inc., 2003-AIR-12 (ALJ Mar. 5, 2003) (ALJ found that the complainant did not justify piercing the corporate veil and that any complaint filed against the parent company would be untimely). c. A company that did not have a class of securities registered under section 12 of the Securities Exchange Act of 1934, and filed only reports required by section 15(d) of that Act owing to an indenture agreement with its lenders, was not covered by the SOX whistleblower provision. Flake v. New World Pasta Co., 2003-SOX-18 (ALJ July 7, 2003). d. Even if a company filed a registration statement with the SEC pursuant to the Securities Exchange Act of 1933, if it sought to withdraw its registration and did not consummate an IPO, then it cannot be considered a registered issuer and is not subject to the SOX whistleblower provision. Roulett v. American Capital Access, 2004-SOX-78 (ALJ Dec. 22, 2004). i. If a company filed a registration statement with the SEC, but it had not become effective at the time of the adverse action, it is not considered a publicly traded company and is not subject to the SOX whistleblower provision. Stalcup v. Sonoma College, 2005-SOX-114 (ALJ Feb. 7, 2006).

5 SOX Whistleblower Provisions 9 e. If an employer became a publicly traded company only after it took adverse employment action against the employee, the SOX whistleblower provision cannot be applied to it retroactively. Roulett v. American Capital Access, 2004-SOX-78 (ALJ Dec. 22, 2004). i. There is no retroactive application of the SOX whistleblower provision. See McIntyre v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 2003-SOX-23 (ALJ Jan. 16, 2004); Gilmore v. Parametric Technology, 2003-SOX-1 (ALJ Feb. 6, 2003); Kunkler v. Global Futures & Forex, Ltd., 2003-SOX-6 (ALJ Apr. 24, 2003). f. However, if the adverse employment action was taken after the SOX Act became effective, then it will be covered, even if the whistleblowing activity happened before the SOX Act was passed. Lerbs v. Buca Di Beppo, Inc., 2004-SOX-8 (ALJ June 15, 2004). 2. Any officer, employee, contractor, subcontractor, or agent of such company who takes adverse action against a whistleblower can cause the company to be liable. 18 U.S.C. 1514A(a). a. OSHA stated that a respondent may be liable for its contractor s or subcontractor s adverse action against an employee in situations where the respondent acted as an employer with regard to the employee of the contractor or subcontractor whether by exercising control of the work product or by establishing, modifying, or interfering with the terms, conditions, or privileges of employment. 69 Fed. Reg. at 52,107 (Aug. 24, 2004). b. Individuals are also potentially liable for discriminatory action. 29 C.F.R. Pt c. When the publicly traded parent company has the authority to affect the employment of its subsidiary s employees or the subsidiary was a mere instrumentality of the parent company owing to its large amount of control, then the complainant is a covered employee. Collins v. Beazer Homes USA, Inc., 334 F. Supp. 2d 1365 (N.D. Ga. 2004); Platone v. Atlantic Coast Airlines, 2003-SOX-27 (ALJ Apr. 30, 2004). d. Employees of a non-publicly traded company who hold management positions and have the authority to hire and fire employees of a public traded company are considered officers of the publicly traded company under SOX. Kalkunte v. DVI Financial Services, Inc., 2004-SOX-56 (ALJ July 18, 2005).

U.S. Department of Labor

U.S. Department of Labor Administrative Review Board 200 Constitution Avenue, N.W. Washington, D.C. 20210 In the Matter of: ANTONIO ANDREWS, ARB CASE NO. 06-071 NIQUEL BARRON, COMPLAINANTS, ALJ CASE NOS.