Whistleblowing, Sarbanes-Oxley, and Retaliation Claims |
|
ALI-ABA Course of Study
ADVANCED EMPLOYMENT LAW AND LITIGATION
November 29-December 1, 2007
by
Debra S. Katz 1
Katz, Marshall & Banks, LLP
Washington, D.C.
I. Sarbanes-Oxley: Whistleblower Protection
A. Introduction
Undoubtedly the most widely discussed federal whistleblower statute is the enacted provision of the Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204 (July 30, 2002) that protects certain corporate whistleblowers who report financial or securities-related wrongdoing.2 As of March 21, 2006, 714 Sarbanes-Oxley whistleblower cases had been filed with the Department of Labor (285 of those coming in FY2005, an increase of 101 over FY2004). Six hundred nineteen cases have been completed, resulting in 642 determinations (the difference in number is due to the fact that some cases have multiple complainants, each of whom receives a separate determination). Of these, the Occupational Safety and Health Administration reports that 454 were dismissed, 92 were withdrawn, and 96 were determined to have merit (resulting in 81 settlements).3 Given increased media exposure and employee education about this law, and the breadth of the coverage and protections afforded, one can only anticipate a proliferation in the number of cases filed.
B. What Whistleblowing is Covered?
This statute provides a new civil remedy to employees of publicly traded companies who allege that they were retaliated against because they provided information about, or participated in an investigation relating to, what they reasonably believed to be violations of securities statutes and regulations. See Pub. L. No. 107-204, § 806, codified at 18 U.S.C. § 1514A.
The investigation prong protects those who provide, or cause to be provided, information or otherwise participate in an investigation regarding any conduct that the employee reasonably believes constitutes a violation of specified federal securities and fraud law. The information or assistance must have been provided to, or the investigation must be conducted by, (1) a federal regulatory or law enforcement agency; (2) a member of Congress or any committee of Congress; (3) a person with supervisory authority over the employee; or (4) a person working for the employer who has the authority to investigate, discover, or terminate the misconduct.
The proceedings prong protects those who file, cause to be filed, testify, participate in, or otherwise assist in a proceeding filed, or about to be filed, relating to an alleged violation of federal securities and fraud laws. The Department of Labor has historically interpreted "proceedings" broadly to encompass internal reports to management, and potentially employee leaks to the media, on the grounds that such contacts were a "preliminary step" towards causing a proceeding to be filed or initiated.
C. What Employers are Covered Under SOX?
1. Companies
SOX whistleblower provisions apply to publicly traded companies with a class of securities registered under Section 12 of the Securities Exchange Act of 1934 ("Exchange Act") (15 U.S.C. § 78l) or subject to the periodic reporting requirements of Section 15(d) (e.g., required to file forms 10-K and 10-Q). (15 U.S.C. § 78o(d)). See 18 U.S.C. 1514A(a).
a. Domestic
The Act applies to all companies that have obtained a listing in the United States or have registered securities with the SEC. However, coverage under the whistleblower provisions is narrower than coverage under SOX Section 402 (enhanced conflict of interest provisions) in that it does not cover companies that have filed a registration statement but do not yet have a class of securities registered under Section 12 or report under Section 15(d) of the Exchange Act.
The requirement that a respondent be subject to the registration or reporting requirements of the Exchange Act has been strictly construed. For example, in Flake v. New World Pasta Co., 2003-SOX-18 (ALJ July 7, 2003), aff'd, ARB No. 03-126 (ARB Feb. 25, 2004), an ALJ addressed the issue of whether the respondent was a company subject to jurisdiction under Section 806. It was undisputed that the respondent had no publicly traded securities. Therefore, the only issue was whether it was required to file reports under Section 15(d) of the Exchange Act. The ALJ found that the respondent fell within an exception to Section 15(d)'s reporting requirements because its public debt had been held by less than 300 persons in each year since its registration and offering. According to the ALJ, the fact that the respondent voluntarily filed some reports required by Section 15(d) in order to comply with a contractual agreement did not transform it into an issuer "required to" make such filings. Therefore, the ALJ granted the respondent's motion for summary decision. See also SEC Division of Corporation Finance, Sarbanes-Oxley Act of 2002 - FAQ #1 (Nov. 8, 2002) (company that voluntarily files reports under the Exchange Act but is not required to because it had fewer than 300 security holders of record at the beginning of its fiscal year is not an "issuer" within the meaning of SOX).
In Stevenson v. Neighborhood House Charter Sch., 2005-SOX-87 (ALJ Sept. 7, 2005), complainant argued that respondent, a non-publicly traded charter school, should be covered under Section 806 because it was subject to reporting under SEC Rules 10b5 and 15c2-12, had a retirement plan with benefits subject to reporting and disclosure requirements under ERISA, and received funds from public companies. The ALJ rejected these arguments, reasoning that whether or not a company is covered by Section 806 "is determined solely by whether the company has a class of stock registered under Section 12 of the [Exchange Act] or whether it is required to make reports pursuant to Section 15(d)."
See also Paz v. Mary's Center for Maternal & Child Care, 2006-SOX-7 (ALJ Dec. 12, 2005) (dismissing complaint against non-profit health organization which neither had a class of securities registered under Section 12 of the Exchange Act nor was required to file reports under Section 15(d)); Fiedler v. Compass Group USA, Inc., 2005-SOX-38 (ALJ July 15, 2005); Gibson-Michaels v. Federal Deposit Ins. Corp., 2005-SOX-53 (ALJ May 26, 2005) (FDIC is not a covered employer under Section 806); Weiss v. KDDI America, Inc., 2005-SOX-20 (Feb. 11, 2005); Roulett v. American Capital Access, 2004-SOX-78 (ALJ Dec. 22, 2004) (respondent not covered under Section 806 where it withdrew its registration before any approval by an exchange or the SEC was effected and, therefore, never registered a class of securities under Section 12); Ionata v. Nielsen Media Research, Inc., 2003-SOX-29 (ALJ Oct. 2, 2003) (ALJ lacked jurisdiction because the respondents were not companies "with a class of securities registered under Section 12 of the Securities Exchange Act of 1934").
Consistent with this strict construction of the requirement that the respondent be subject to the registration or reporting requirements of the Exchange Act, an ALJ in Gallagher v. Granada Entertainment USA, 2004-SOX-74 (ALJ Apr. 1. 2005), found no liability where the employer was not subject to the requirements of Sections 12 or 15(d) at the time the adverse employment action was taken. The ALJ reasoned that the adverse action occurred on January 22, 2004, but the company did not become subject to Section 12 until after a merger on February 2, 2004.
b. Foreign
The Act's whistleblower protections apply to foreign private issuers (as defined by Rule 36-4(c) of the Exchange Act) subject to SEC reporting and registration obligations. Foreign issuers that are exempt from SEC filing requirements under Rule 12g3-2(b) of the Exchange Act are excluded from coverage under SOX.
Foreign corporations doing business in the United States are subject to Section 806 whistleblower provisions. See Ward v. W & H Voortman, Ltd., 685 F. Supp. 231, 232 (M.D. Ala. 1988). Whether SOX whistleblower provisions apply to U.S. residents working abroad has been an open issue. Statutory whistleblower provisions generally do not apply extraterritorially absent clear language by Congress in the statute to extend the statute's protections abroad. See, e.g., EEOC v. Arabian American Oil Co., 499 U.S. 244, 248 (1991); Mendonca v. Tidewater, Inc., 2001 U.S. Dist. LEXIS 3486, at *7 (E.D. La. Mar. 4, 2001). Still, courts have held that U.S. courts do, in certain circumstances, have jurisdiction over violations of the Exchange Act, although the violations take place outside the U.S. See, e.g., Leasco Data Processing Equip. Corp. v. Maxwell, 468 F.2d 1326, 1336-37 (2d Cir. 1972) (statute applicable when foreigner made substantial misrepresentations in the United States for transactions executed in England); Schoenbaum v. Firstbrook, 405 F.2d 200, 208 (2d Cir. 1968). In its Final Rule, OSHA declined to clarify this issue, despite requests by commentators, on the ground that the purpose of the regulations is procedural and not to interpret the statute. 69 Fed. Reg. 52104, 52105 (Aug. 24, 2004).
Nonetheless, most courts and ALJs have refused to afford SOX whistleblower protection to employees working outside the United States. For instance, in Carnero v. Boston Scientific Corp., 2004 U.S. Dist. LEXIS 17205 (D. Mass. Aug. 27, 2004), the court refused to apply Section 806 to a foreign national working for Argentinean and Brazilian subsidiaries. According to the court, "[n]othing in Section 1514A(a) remotely suggests that Congress intended it to apply outside of the United States." The court noted, as well, that application of Section 1514A overseas might conflict with foreign laws, particularly where a plaintiff seeks reinstatement. The First Circuit, citing the presumption against the extraterritorial application of Congressional statutes, affirmed. Carnero v. Boston Scientific Corp., 433 F.3d 1 (1st Cir. 2006). See also O'Mahony v. Accenture Ltd., 2005-SOX-72 (ALJ Jan. 20, 2006) ("[a]s a matter of statutory construction, the whistleblower provision of the Act applies only to employees who work within the United States"); Ede v. Swatch Group, 2004-SOX-68 & 69 (ALJ) (Jan. 14, 2005) (SOX does not apply extraterritorially to employees working outside of the United States); Concone v. Capital One Finance Corp., 2005-SOX-6 (ALJ Dec. 3, 2004) (no applicability to persons employed outside the United States).
However, in Penesso v. LLC International, Inc., 2005-SOX-16 (ALJ Mar. 4, 2005), respondent, citing Carnero and Concone, moved for summary decision on the grounds that Section 806 does not have extraterritorial application. The ALJ denied summary decision and distinguished Carnero and Concone, finding "this case has a substantial nexus to the United States, and it is appropriate for the complainant to bring this claim under § 1514A of the Sarbanes-Oxley Act." The ALJ reasoned that the complainant was a U.S. citizen, much of the protected activity took place in the U.S. when complainant came to respondent's U.S. headquarters to inform corporate officers of the financial improprieties he believed were taking place in Italy, and at least one of the alleged retaliatory actions took place in the U.S.
c. Extraterritorial Application Prohibited
In the first Circuit Court decision issued on the whistleblower protections under the Sarbanes-Oxley Act, the First Circuit Court of Appeals recently held that the whistleblower provision of the SOX applies only to employees who work within the United States. See Carnero v. Boston Scientific Corp., 433 F.3d 1 (1st Cir. 2006) (case below 2004-SOX-18), (denying coverage where complainant was an Argentinian citizen resident in Brazil working for two Brazilian subsidiaries.) See also Ede v. The Swatch Group, Ltd., ARB No. 05-053, ALJ Nos. 2004-SOX-68 and 69 (ARB June 27, 2007) (denying coverage where complainants were working for the Swatch Group subsidiaries in Switzerland, Hong Kong, and Singapore, but never worked for any subsidiary in the United States); O'Mahony v. Accenture Ltd., 2005-SOX-72 (ALJ Jan. 20, 2006). But see Penesso v. LLC International, Inc., 2005-SOX-16 (ALJ Mar. 4, 2005) (finding SOX jurisdiction where the US citizen complainant was employed in Italy by the Italian subsidiary of a corporation headquartered in McLean, Virginia, and distinguishing Carnero on the basis of a substantial nexus to the United States, where protected activity and at least one retaliatory act occurred in the US).
2. Agents/Contractors
SOX whistleblower provisions cover not only publicly traded companies, but also "any officer, employee, contractor, subcontractor or agent" of a covered company. 18 U.S.C. § 1514A(a). Therefore, private companies that are not publicly traded, as well as other entities or individuals, that serve as "agents" or "contractors" of the publicly traded employer, may be subject to the whistleblower provisions. OSHA specifies that a small accounting firm acting as a contractor of a publicly traded company could be liable for retaliation against an employee who provides information to the SEC regarding a violation of SEC regulations (e.g., accounting irregularities). OSHA Whistleblower Investigations Manual (2003), at 14-1 ("OSHA Manual").
SOX also might be found to apply to publicly traded companies for acts committed by them against employees of their agents or contractors. In an environmental whistleblower case, the ARB held that a government agency could be subject to a discrimination charge filed by the employee of a private-sector government contractor when the agency banned the contractor's employee from entering the government workplace. Stephenson v. NASA, ARB No. 96-080, ALJ No. 94-TSC-5 (ARB Feb. 3, 1997). In its Final Rule, OSHA, citing Stephenson, confirmed 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 by exercising control of the work product or by establishing, modifying or interfering with the terms, conditions, or privileges of employment." "Conversely," OSHA added, "a respondent will not be liable for the adverse action taken against an employee of its contractor or subcontractor where the respondent did not act as an employer with regard to the employee." 69 Fed. Reg. at 52017.
The analysis used in Stephenson suggests that the scope of SOX may apply freely across contractual arrangements. Yet, the scope of contractor or agent coverage generally has been limited to cases where the contractor or agent is acting in such a role with respect to the complainant's employment relationship. See, e.g., Brady v. Calyon Securities (USA), 2005 U.S. Dist. LEXIS 27130 (S.D.N.Y. Nov. 8, 2005); Brady v. Direct Mail Mgmt., Inc., 2006-SOX-16 (ALJ Jan. 5, 2006); Roulett v. American Capital Access, 2004-SOX-78 (ALJ Dec. 22, 2004); Judith v. Magnolia Plumbing Co., Inc., 2005-SOX-99 & 100 (ALJ Sept. 20, 2005).
The scope of contractor or agent coverage also has generally been limited to cases where the complainant was employed by the publicly traded company, not by the agent or contractor. For example, in Minkina v. Affiliated Physician's Group, 2005-SOX-19 (ALJ Feb. 22, 2005), appeal dismissed, ARB No. 05-074 (ARB July 29, 2005), an ALJ, interpreting SOX's "any officer, contractor, subcontractor or agent" language, concluded that, although a privately held entity could engage in discrimination prohibited by Section 806 with regard to an employee of a publicly traded company when acting in the capacity as an agent of the publicly traded company, Section 806 does not protect employees of the privately-held contractors, subcontractors and agents from discrimination. See also Goodman v. Decisive Analytics Corp., 2006-SOX-11 (ALJ Jan. 10, 2006) (employee of a private contractor or subcontractor of a publicly traded company is not afforded SOX whistleblower protection); Kalkunte v. DVI Financial Servs. Inc., 2004-SOX-56 (ALJ July 18. 2005).
3. Subsidiaries
The Act's retaliation provisions have been applied to private subsidiaries of publicly traded companies, but not under all circumstances. The cases have addressed three distinct, albeit often intertwined, inquiries: (1) whether the employee of the subsidiary is a covered "employee" under SOX; (2) if so, whether the subsidiary/employer is a covered entity subject to suit; and (3) if the employee names the parent as a respondent, whether the existence of separate corporate identities insulates the parent from liability.
4. Whether The Employee Of The Subsidiary Is A Covered "Employee"
The first inquiry - whether the employee of the subsidiary is a covered "employee" under SOX - has been consistently answered in the affirmative. For example, in Platone v. Atlantic Coast Airlines Holdings Inc., 2003-SOX-27 (ALJ Apr. 30, 2004), an ALJ held that an employee of a non-publicly traded subsidiary was a covered "employee" where the company's parent/holding company was publicly traded. The ALJ in Platone reasoned that, under the facts of the case, the holding company was the alter ego of the subsidiary and that it certainly had the ability to affect the complainant's employment. In Collins v. Beazer Homes USA, Inc., 334 F. Supp.2d 1365 (N.D. Ga. 2004), the first reported federal district court decision on point, a federal district court in Georgia held that where the officers of a publicly traded parent company had the authority to affect the employment of the employees of the subsidiary, an employee of the subsidiary was a "covered employee" within the meaning of the SOX whistleblower provision. Both Platone and Collins looked to the interrelatedness of the corporate structures to ultimately conclude the employee of the subsidiary was a covered "employee."
An ALJ in Morefield v. Exelon Servs. Inc., 2004-SOX-2 (ALJ Jan. 28, 2004), held that the Vice President-Finance of a non-publicly traded subsidiary of a publicly traded company was covered under SOX, regardless of the parent company's role in affecting the employment of the subsidiary's employees. The ALJ concluded that, based on the legislative intent and purpose of SOX, the term "employee of publicly traded company," within the meaning of SOX, "includes all employees of every constituent part of the publicly traded company, including, but not limited to, subsidiaries and subsidiaries of subsidiaries which are subject to its internal controls, the oversight of its audit committee, or contribute information, directly or indirectly, to its financial reports."
Similarly, in Gonzalez v. Colonial Bank, 2004-SOX-39 (ALJ Aug. 20, 2004) (Gonzalez III), an ALJ concluded that Congress intended to provide whistleblower protection to employees of subsidiaries of publicly traded companies. Therefore, the ALJ held that the complainant, an employee of a non-publicly traded subsidiary of a publicly traded bank holding company, set forth a cause of action sufficient to withstand a motion for summary decision. The ALJ also reasoned that evidence reflected that the holding company's actions affected the complainant's employment and shared management and function with the subsidiary.
In Klopfenstein v. PPC Flow Technologies Holdings, Inc., 2004-SOX-11 (ALJ July 6, 2004), an ALJ, citing Morefield, agreed with the complainant that employees of non-public subsidiaries of publicly traded companies can be covered by the SOX whistleblower provisions.
In Carnero v. Boston Scientific Corp., 433 F.3d 1 (1st Cir. 2006), the First Circuit suggested that an employee of a subsidiary of a publicly traded company could be a covered employee not only due to the parent company's role in affecting the employment of the subsidiary's employees but also because the subsidiary could be considered an "agent" of the parent. Therefore, the court opined, "the fact that [complainant] was employed by [the parent's] subsidiaries may be enough to make him a BSC 'employee' for purposes of seeking relief under the whistleblower statute." However, the court ultimately held that Section 806 did not protect the plaintiff foreign national due to its lack of extraterritorial effect.
5. Whether A Non-Publicly Traded Subsidiary Is A Covered Entity
The second inquiry - whether a subsidiary of a publicly traded parent company, standing alone, is a covered entity subject to suit - is a much debated issue.
In Klopfenstein, 2004-SOX-11 (ARB May, 31, 2006) (remanding the case to the ALJ for further findings based on erroneous legal analysis as to the standards used for determining who is covered by SOX provisions), an executive of a subsidiary of a non-publicly traded holding company that, in turn, was owned by a publicly traded parent company filed a complaint naming only the holding company and a vice president of the subsidiary as respondents. Initially, the ALJ held that the non-publicly traded subsidiary was not a proper respondent, because SOX does not "provide[] a cause of action directly against such subsidiary alone." On review, however, the ARB found that the ALJ's holding was erroneous. The ARB held that it was necessary to that particular case to discuss whether SOX provisions covered non-public subsidiaries of its public parent. Instead, the ARB emphasized that "whether a particular subsidiary or its employee is an agent of a public parent for purposes of the SOX employee protection provision should be determined according to principles of the general common law of agency." Because the legal concept of agency relies on the underlying factual elements, the ARB made a point to charge the ALJ with the function of determining whether an agency relationship exists based on the specific facts in that case.
Notably, the ARB in Klopfenstein specifically rejected the ALJ's reasoning that the named respondents did not fall within the scope of agency principles. It was previously unclear what position the DOL would take on this issue, as the SOX whistleblower provision prohibits retaliation not only by publicly traded companies, but also by "any officer, employee, contractor or agent" of a covered company. 18 U.S.C. § 1514A(a). The Klopfenstein ALJ had found that the subsidiary holding company did not fall within the category because the compnay was more than an "agent" of the parent within the meaning of SOX. The ARB, however, disagreed and found that because there were overlapping officers between them, and the PCC officers and employees were involved in overseeing the named respondents' investigation, it was more probable that an agency relationship existed "because one characteristic of an agent is that it acts on behalf of the principal."
In its amicus brief filed in Ambrose v. U.S. Foodservice, Inc., ALJ No. 2005-SOX-105, ARB Case No. 06-096, the Secretary of Labor for OSHA took a strong position on this issue. It clearly recommended the "integrated employer" test for determining whether employees of subsidiaries of publicly traded companies are protected under the SOX whistleblower provisions. In cases under labor and employment statutes, federal courts have used this test to determine if "two or more companies may be considered so interrelated that they constitute a single employer subject to liability or coverage under the particular statute." Amicus Curiae Br. of the Secretary of Labor for OSHA In Matter of: John Ambrose v. U.S Foodservice, Inc., ARB Case No. 06-096, p. 15 (XXXX). The four factors used to make this determination include: "(1) the interrelation of operations; (2) centralized control of labor or employment decisions; (3) common management; and (4) common ownership or financial control." Id. The Secretary emphasized that this is a case-by-case factual determination and that "[n]one of these factors are conclusive, and all four need not be met in every case." Id.
On the other hand, an ALJ in Powers v. Pinnacle Airlines Corp., 2003-AIR-12 (ALJ Mar. 5, 2003), dismissed a complaint brought against the employer, a non-publicly traded subsidiary of a non-publicly traded subsidiary of a publicly traded airline, on the basis that the subsidiary was not a proper respondent under SOX. The appeal of this decision was dismissed in Powers v. Pinnacle Airlines, Inc., ARB No. 04-035, ALJ No. 2003-AIR-12 (ARB Sept. 28, 2004). Citing Klopfenstein and Powers, the respondent in Gonzalez v. Colonial Bank, 2004-SOX-39 (ALJ Aug. 17, 2004) (Gonzalez II), moved for summary decision on the ground that it was not a publicly traded company. However, the issue did not have to be decided as the ALJ permitted the complainant to amend his complaint to include as a respondent the publicly traded holding company.
In Dawkins v. Shell Chemical, LP, 2005-SOX-41 (ALJ May 16, 2005), the ALJ granted summary decision for the employer because the complaint identified only the employer, a non-publicly traded subsidiary, as respondent and did not name the parent companies. The ALJ noted that there was no evidence that the parent companies were sufficiently involved in the management and employment relations of the respondent to justify piercing the corporate veil. However, it does not appear that the ALJ considered this factor in deciding whether the complainant could proceed against the subsidiary, but rather addressed this issue only in relation to whether the complainant successfully could have pursued the parent companies if they had been properly included or were added as respondents.
In contrast to the above cases, an ALJ in Hughart v. Raymond James & Associates, Inc., 2004-SOX-9 (ALJ Dec. 17, 2004) suggested that a case under Section 806 may proceed solely against a subsidiary if the parent company and its wholly owned subsidiary are "so intertwined as to represent one entity." Ultimately, the ALJ dismissed the complaint because the two corporate entities had a sufficient degree of separation such that they "were not one entity for consideration of the applicability of SOX."
In Grant v. Dominion East Ohio Gas, 2004-SOX-63 (ALJ Mar. 10, 2005), an ALJ rejected the reasoning in Hughart and concluded (consistent with what appears to be the majority view) that the plain language of Section 806 provides no cause of action against a non-public subsidiary standing alone, regardless of whether complainant could produce evidence to justify piercing the corporate veil. The ALJ reasoned that even if complainant could establish that the parent company was liable for the acts of its subsidiary, this "does not cure the deficiency of not naming a company covered by the Act as Respondent. In other words, neither the doctrine of piercing the corporate veil, nor agency law principles generally, operate to pull a parent company into litigation if the parent company is not named as a party in the first place."
6. Whether The Existence Of Separate Corporate Identities Insulates The Parent From Liability
The third inquiry - whether the existence of separate corporate identities insulates the parent corporation from liability for acts of the subsidiary - has proven a more difficult issue for ALJs, requiring evaluation of specific facts to determine whether piercing the corporate veil or some other basis for ignoring corporate separateness is warranted.
For instance, in Powers, 2003-AIR-12, an ALJ dismissed a SOX complaint where the employee was employed by a non-publicly traded subsidiary of a non-publicly traded subsidiary of a publicly traded airline. The ALJ reasoned that the complainant's attempt to hold the parent liable "ignores the general principle of corporate law that a parent corporation is not liable for the acts of its subsidiaries. In other words, the mere fact of a parent-subsidiary relationship between two corporations does not make one company liable for the torts of its affiliate." The ALJ continued that the complainant had not alleged any facts that would justify piercing the corporate veil and ignoring the separate corporate entities. Specifically, the ALJ noted that the subsidiary's impact on the parent was "questionable at best."
Likewise, in Hasan v. J.A. Jones-Lockwood, 2002-ERA-5 (ALJ Sept. 17, 2002), an ALJ held that a parent company was not an "employer" under the analogous ERA retaliation provision merely because it was the parent of another company that employed a complainant. The ALJ reasoned that no evidence showed that the parent had the power to hire, promote, discipline or give raises or had input in those decisions.
In contrast, in Platone, 2003-SOX-27, an ALJ held that the parent/holding company was a proper respondent in an action by an employee of a non-publicly traded subsidiary where the ALJ found the subsidiary to be a "mere instrumentality" of the holding company. The ALJ reasoned that the holding company had no employees; the companies disregarded the separate identity of the subsidiary in its dealings with the public, the SEC, and its employees; there was a great degree of commonality between the senior management of the two corporate entities, including those responsible for labor relations within the subsidiary; and the holding company had the ability to affect the complainant's employment, including making the ultimate termination decision.
Likewise, in Gonzalez III, 2004-SOX-39, the complainant, an employee of a non-publicly traded subsidiary, was permitted to amend his complaint to add the publicly traded holding company as a respondent. The ALJ denied summary decision for the holding company because evidence suggested that the holding company had shared management and function with the subsidiary and that the holding company's actions affected the complainant's employment.
Similarly, in McIntyre v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 2003-SOX-23 (ALJ Sept. 4, 2003), the ALJ permitted complainant to amend his complaint to include as a respondent the publicly traded parent company. The ALJ reasoned that complainant had alleged facts regarding commonality of management and operations which arguably justified piercing the corporate veil. The ALJ also noted that there was a genuine issue of material fact as to whether the subsidiary and parent company constituted a "joint employer." See also Clemmons v. Ameristar Airways, Inc., 2004-AIR-11 (ALJ Jan. 14, 2005) (in AIR21 case, finding joint employment based on interrelation of operations, common management, centralized control of labor relations and common ownership).
In Mann v. United Space Alliance, LLC, 2004-SOX-15 (ALJ Feb. 18, 2005), Boeing and Lockheed Martin established the employer USA as a joint venture. All three entities were named as respondents. The ALJ, citing Gonzalez, Platone, and Morefield, found that "shared management and control and unity of operations have been key factors in holding the parent company and its subsidiary to be covered by the Act." Finding a lack of such shared functions, the ALJ concluded that USA was not a covered respondent under the Act. The ALJ reasoned that neither Boeing nor Lockheed affected, nor was USA acting as an agent with respect to, the complainant's employment. The ALJ also found that Boeing and Lockheed Martin could not be held liable for any violation of the Act by USA.
In Bothwell v. American Income Life, 2005-SOX-57 (ALJ Sept. 19, 2005), an ALJ granted summary decision on the grounds that complainant's employer, a non-public subsidiary of a publicly traded company, was not a covered employer subject to SOX's whistleblower provisions. The complainant failed to name the parent company in the complaint, and the ALJ refused to permit an amendment to add the parent because the parent was not given notice of the action prior to expiration of the 90-day statute of limitations. The ALJ further ruled that, even if the parent had been timely named, complainant was unable to provide sufficient evidence of commonality of management and purpose to justify piercing the corporate veil and holding the parent liable for the subsidiary's actions. The ALJ reasoned that there was no indication that the subsidiary was acting as an agent for its parent company "with respect to employment practices towards Complainant or any other employee," e.g., the parent took no part in hiring or terminating complainant and had no role in payment of complainant's salary, and complainant had no interaction with the parent's employees.
7. Individual Liability
Section 806's prohibition of retaliation by "officers, employees, contractors, subcontractors or agents of covered companies" could be construed as providing for individual liability for wrongful retaliation. This conclusion is supported by the summary and discussion in the Final Rule, which provides "the definition of 'named person' will implement Sarbanes-Oxley's unique statutory provisions that identify individuals as well as the employer as potentially liable for discriminatory action." 69 Fed. Reg. 52104, 52105 (Aug. 24, 2004).
However, in Williams v. Lockheed Martin Energy Systems, Inc., 1995-CAA-10 (ARB Jan. 31, 2001), a case dealing with liability under CERCLA (Comprehensive Environmental Response, Compensation, and Liability Act, 42 U.S.C. § 9610) and SDWA (Safe Drinking Water Act, 42 U.S.C. § 300j-9(I)), the ALJ dismissed individual supervisors from the case because they were not the complainant's employer despite statutory language providing that no "person" shall discriminate against whistleblowers. The complainant did not appeal, nor did the ARB decision address this issue.
The only decision to date addressing this issue under SOX found that Section 806 does provide for individual liability. In Gallagher v. Granada Entertainment USA, 2004-SOX-74 (ALJ Oct. 19, 2004), an ALJ, citing the above Federal Register quote, permitted amendment of the complaint to add as respondents the executives who terminated the complainant's employment. However, the ALJ rejected complainant's effort to join "any person or business entity . . . whose acts in concert with or at the direction of the Employer . . . lead to" his termination. The ALJ reasoned that "[o]nly individuals who were Complainant's superiors . . . could discriminate against him 'in the terms or conditions of his employment' . . ." The ALJ concluded that "[t]he availability of damages does not convert this statutory proceeding into a common law tort action, permitting joinder of persons or entities who were not the Complainant's superiors as if they were joint tortfeasors."
D. What Employees are Covered Under SOX?
29 C.F.R. § 1980.101 defines "employee" as "an individual presently or formerly working for a company or . . . an individual applying to work for a company or . . . whose employment could be affected by the company. . . ." As discussed in Section III.B., supra, courts and ALJs generally have included employees of subsidiaries within this definition. Whether the following other categories of persons fall within Section 806's definition of "employee" also has been addressed:
1. Former Employees
In Robinson v. Shell Oil Co., 519 U.S. 337 (1997), the U.S. Supreme Court held that the term "employees" as used in Title VII's retaliation provisions includes former employees. There is no reason to believe this holding will not be adopted under SOX.
Yet, in Harvey v. The Home Depot, Inc., 2004-SOX-36 (ALJ May 28, 2004), the ALJ refused to allow a complaint by a former employee to proceed where the protected activity occurred after plaintiff's termination. The complaint alleged that the employer violated SOX's whistleblower provision where, after the complainant had filed a professional responsibility complaint against the company's attorney, the attorney's representative filed a response to the state committee contending that the complainant's grievances were "part of an ongoing campaign by Mr. Harvey to harass Home Depot and its employees." The complainant no longer was employed by the company when this statement was made. The ALJ found that "with the exception of blacklisting or other active interference with subsequent employment, the SOX employee protection provisions essentially shelter an employee from employment discrimination in retaliation for his or her protected activities, while the complainant is an employee of the respondent." (Emphasis in original; footnote omitted). Compare Anderson v. Jaro Transp. Serv., 2004-STA-2 & 3 (ARB Nov. 30, 2005) (assuming that blacklisting in retaliation for protected activity which occurred while complainant was employed by respondent is prohibited under the STAA, but rejecting claim where complainant provided no evidence that his employer had provided information to a potential employer).
2. Independent Contractors
In Bothwell v. American Income Life, 2005-SOX-57 (ALJ Sept. 19, 2005), respondent argued that complainant was not protected under Section 806 because he was an independent contractor, not an employee. In evaluating whether complainant was an independent contractor, the ALJ adopted the common law agency test, which, as set forth in Nationwide Mutual Ins. Co. v. Darden, 503 U.S. 318 (1992), focuses on the hiring party's right to control the manner and means by which the product is accomplished. The ALJ refused to grant summary decision for the respondent on this issue because complainant presented evidence demonstrating that respondent retained control over the means by which his work was performed. For instance, there was evidence that complainant was required to report to his superiors every day at a specific time, was given a specific list of daily contacts and appointments, was not allowed to alter his sales presentation or decide how to accomplish any tasks without first receiving input, had no control over his work hours or appointment schedule, and was required to complete all of his work at respondent's office.
3. Officers and Directors
In Vodicka v. DOBI Medical Int'l, Inc., 2005-SOX-111 (ALJ Dec. 23, 2005), respondent moved for summary decision on the grounds that complainant was a member of its board of directors and therefore was not an employee protected under Section 806. The ALJ noted that, although corporate officers have been held to be employees under SOX, whether directors are "employees" under SOX was an issue of first impression. While an "interesting and difficult issue," the ALJ was able to resolve the case on other grounds.
4. Third Parties
In Davis v. United Airlines, Inc., 2001-AIR-5 (ALJ Apr. 23, 2002), an ALJ denied derivative protection to spouses of whistleblowers based solely upon their status as a spouse.
E. What Constitutes Protected Activity?
1. Scope of Protected Activity
The scope of protected activity under the statute has been narrowly construed. In Marshall v. Northrup Gruman Synoptics, 2005-SOX-0008 (ALJ June 22, 2005), the Administrative Law Judge granted summary judgment against a plaintiff who had complained about violations of internal ethics policies and financial accounting methods. The ALJ interpreted the statute to mean that "an element of intentional deceit that would impact shareholders or investors is implicit" in a claim. Id. at 4. Thus, since the complainant had failed to raise any issues of fraud (but only violations of internal policies), he had not engaged in protected activity under the statute. Id. at 4-5. In Getman v. Southwest Securities, Inc., ARB Case No. 04-059 (ARB July 29, 2005), the Administrative Review Board reversed a finding that the Respondent had retaliated against the complainant. The ARB held that an equity research analyst had not engaged in protected activity by refusing to change a recommendation on a stock. Id. at 9. Rather, because she never complained that she had been pressured to change her recommendation, she did not engage in "whistleblowing." Id.
"General inquires" have been found insufficient to support a claim for protected activity under the statute. See Lerbs v. Buca Di Beppo, Inc., 2004-SOX-8 (ALJ June 15, 2004), at 11. See generally Fraser v. Fiduciary Trust Co., 2006 WL 399468 (S.D.N.Y.) (Feb. 16, 2006). In Fraser, the court found that certain emails and memos written and distributed by complainant involving financial losses to the company that he believed could have been avoided were mere complaints that his advice or recommendations were not followed. Since the complainant failed to specify allegations of conduct that would alert Defendants that he believed the company was violating any federal rule or law related to fraud on shareholders the court found these complaints inadequate. In contrast, the court found that other complaints by the same plaintiff, though they did not particularly specify concerns about illegality, when taken in context, were sufficient to constituted protected activity. Fraser v. Fiduciary Trust Co., 2006 WL 399468 (S.D.N.Y.) (Feb. 16, 2006).
Efforts to bring complaints about a company's employment practices under the protection of the statute have failed. In a recent case the ALJ found that an employees complaints about longstanding institutional discriminatory practices, accompanied by warnings that if corrective action was not taken the employee would report the company to the EEOC, Department of Labor and other agencies, did not constitute protected activity because it was not a violation of federal law directly related to fraud against shareholders. Smith v. Hewlett Packard, 2005-SOX-88 to 92 (ALJ Jan. 19, 2006). See also Harvey v. The Home Depot, Inc., 2004 SOX 20 (ALJ May 28, 2005) (finding that neither general allegations of a violation of federal labor law, nor specific allegations of racial discrimination, are covered by the Act). In another case, the ALJ held that a plaintiff seeking protection for complaints that his salary did not comply with the requirements of the Fair Labor Standards Act did not constitute protected activity under the Act. Harvey v. Safeway Inc., 2004 SOX 21 (ALJ Feb. 11, 2005). However, the ALJ in this case also noted that, "complaints of systemic violations of the FLSA might reach the necessary magnitude to effectively perpetrate a fraud on shareholders because of the potential for influencing shareholder value." Id.
In May 2007, the ARB determined that an employee who reported his employer's deviation from generally accepted accounting practices (GAAP) and other industry standards was not necessarily engaging in protected activity under SOX because such deviations are not inherently violations of securities laws. Welch v. Cardinal Bankshares Corporation, ARB No. 05-064, ALJ No. 2003-SOX-15 (ARB May 31, 2007)
David Welch, a certified public accountant and MBA, who served the Chief Financial Officer of Cardinal Bankshares Corp. brought a SOX claim against the company. Welch believed that Cardinal violated GAAP and rules set forth by the Federal Financial Institutions Examination Council (FFIEC) because the company allowed employees with no special accounting skills to make ledger entries. GAAP standards provide that only individuals with accounting expertise should be permitted to make ledger entries. Welch also had concerns that during the second and third quarters of 2001, Cardinal's CEO, Ronald Moore, recorded two loan recoveries, totaling $195,000, as forms of income. Welch believed that this also violated GAAP and the FFIEC rules. As a result of this accounting entry, the company's third quarter 10-QSB report to the SEC included this $195,000 in year-to-date income. In addition, Welch complained that the CEO had generally been rejecting his accounting advice and excluding him from important meetings with the outside auditor where accounting issues were discussed. Welch himself was investigated for improper conduct and eventually terminated.
Welch then filed a SOX whistleblower complaint. The Occupational Safety and Health Administration investigated his complaint and determined that it had no merit. Welch requested a hearing before a Labor Department ALJ who concluded that Cardinal had violated SOX and recommended that Welch be reinstated and receive back pay and other relief. Cardinal appealed this decision to the Labor Department's Administrative Review Board.
The ARB reversed the ALJ's conclusion holding that Welch had not engaged in protected activity. The ARB based its decision on the following four conclusions:
1) An experienced CFO could not have reasonably believed that Cardinal's third quarter SEC report presented potential investors with a misleading picture of the company's financial condition.
2) Welch's complaint about his lack of access to the outside auditor did not constitute protected activity under SOX. The ARB emphasized that Welch failed to demonstrate that the complaint related in any way to fraud statutes, any SEC rule or regulation, or any federal law relating to fraud against shareholders.
3) Cardinal's rejection of Welch's recommendations on accounting matters was not inherently a violation of federal securities laws. Again pointing to the lack of legal authority and failure to establish how the complaints about inadequate internal controls could reasonably be held to implicate federal securities laws, the ARB concluded that Welch's allegations did not constitute protected activity.
4) Welch's concerns about the fact that Cardinal misclassified loan recoveries as income and allowed employees without accounting expertise to make financial transaction entries violated GAAP accounting standards and accounting rules by the FFIEC did not, in itself, violate SOX. The ARB rejected this contention because SOX's section 1514A expressly provides that SOX protects whistleblowers who report employer conduct that specifically violates federal fraud statutes, SEC rules or regulations or federal laws relating to shareholder fraud. The ARB also pointed to the intent of Congress in passing SOX by maintaining that if Congress had intended for standards such as GAAP and rules promulgated by the FFIEC to be included in SOX's employee protection provisions, it would have articulated such an intent in the law.
In light of this decision, accounting professionals should be aware that without a showing of a reasonable belief that federal fraud statutes and/or SEC rules are being violated by their employer, protesting an employer's accounting practices and failure to follow GAAP or other related codes of conduct in the accounting and finance industry may not be deemed to be protected under SOX.
This narrowing scope of protected activity under the whistleblower provision of SOX extends beyond the accounting industry. On August 20, 2007, a federal judge in the Southern District of New York dismissed a SOX retaliation lawsuit brought by a project manager who complained that his employer failed to comply with a Consent Decree issued by the Food and Drug Administration ("FDA") and various other federal regulations governing good manufacturing practices ("GMP") generally accepted in the pharmaceutical industry. Portes v. Wyeth Pharmaceuticals, Inc., Slip Copy, 2007 WL 2363356 (S.D.N.Y. 2007).
Portes involved a Consent Decree that had been issued by the FDA in 2000 against Wyeth Pharmaceuticals, Inc. for failing to comply with various federal regulations, as well as GMP for the production of pharmaceutical and biological products. To comply with the Consent Decree, the company implemented a program called the Sustainable Compliance Initiative ("SCI") to improve its operations. In September 2003, Wyeth hired Portes as a principal project manager for the SCI department in one of its facilities. Id. at *1. In this capacity, Portes discovered several problems that led him to believe that Wyeth's operations were in violation of the Consent Decree, federal regulations, EU regulations and provisions of the Barr Mandate. Id.
Portes complained about these possible violations to Wyeth's Director of Quality, but was berated for raising these concerns, placed on a Performance Improvement Plan, and eventually terminated. Id., at *2. Portes filed a SOX whistleblower complaint with OSHA in March 2005. Because the Department of Labor made no final determination on his claim within 180 days, Portes availed himself of SOX's "kick out" provision and filed his claim in federal court. The court concluded that Portes' allegations that Wyeth violated the Consent Decree, FDA regulations, EU regulations and other drug manufacturing guidelines were not sufficiently related to shareholder fraud.
The court determined that there was no way to derive Portes' concern for potential fraud against Wyeth shareholders from his actual allegations, the circumstances of his disclosures to the company or his position at the company. Portes' allegations were exclusively concerns with violations of regulations and guidelines pertaining to the manufacture of pharmaceuticals; the circumstances of his disclosures did not suggest that he was concerned that such violations could lead to or demonstrate fraud against investors but rather that the company was not adhering to standards promulgated by the FDA. Further, the court emphasized that Portes was employed as a chemist and project manager, not an investment analyst, which led the court to conclude that no inference that Portes was concerned about shareholder fraud could be derived from his job responsibilities. Therefore, the court held that Portes' complaints to Wyeth fell outside the scope of protected activity under SOX. Id., at *5.
The holdings in Portes v. Wyeth Pharmaceuticals, Inc. and Welch v. Cardinal Bankshares Corp., demonstrate that a specific showing that an employee had a reasonable belief that federal fraud statutes and/or SEC rules were being violated by their employer is of paramount importance when asserting a claim under the whistleblower protection provision of SOX.
2. Reasonable Belief Requirement
In order gain protection under the whistleblower provisions of Sarbanes-Oxley, an employee must act upon a "reasonable belief" that a specified federal securities or fraud law was violated.4 ALJs have found that the belief must be objectively reasonable and it must be the actual belief of the complainant. See, e.g., Grant v. Dominion E Ohio Gas, 2004 SOX 63 (ALJ March 10, 2005). The belief must also pertain to federal law violations. In one case involving state insurance law violations, where no evidence of related federal law violations was presented, an employee's refusal to participate and provide allegedly false answers in a random telephone interview conducted by the California Department of Insurance did not constitute protected activity supportive of a SOX claim. Williams v. Sirva, Inc., 2006-SOX-6 (ALJ Feb. 13, 2006). While an employee who acts on a reasonable belief is protected even if that belief later turns out to be wrong, where the complainant's belief is unreasonable from the outset, the complainant's activity will not be protected. Bechtel v. Competitive Technologies, Inc., 2005-SOX-33 (ALJ Oct. 5, 2005) (finding the employee's belief - based on advance knowledge of the outcome of a lawsuit based on a draft press release, an overheard portion of a telephone conversation, and rumor - that his employer was attempting to purchase company stock insufficient basis for a reasonable belief).
For example, in Tuttle v. Johnson Controls Battery Div., 2004-SOX-76 (ALJ Jan. 3, 2005), an ALJ explained:
Protected activity is defined under SOX as reporting an employer's conduct which the employee reasonably believes constitutes a violation of the laws and regulations related to fraud against shareholders. While the employee is not required to show the reported conduct actually caused a violation of the law, he must show that he reasonably believed the employer violated one of the laws or regulations enumerated in the Act. Thus, the employee's belief "must be scrutinized under both subjective and objective standards." Melendez v. Exxon Chemicals Americas, ARB No. 96-051 (July 14, 2000).
The "reasonable belief" standard has generated some anomalous results to date in several cases in which some ALJs have required that the plaintiff show that the reasonable belief was about "fraud" of shareholders and not simply about violations of any rule or regulations of the SEC or any provision of Federal law relating to fraud against shareholders. See the following:
Grant v. Dominion East Ohio Gas, 2004-SOX-63 (ALJ Mar. 10, 2005) (ALJ held that raising concern about mere "day-to-day accounting irregularities" could not support a SOX claim without some reasonable belief the company was committing fraud against its shareholders. The ALJ explained that the complainant's belief "must be scrutinized under both subjective and objective standards, i.e., he must have actually believed the employer was in violation of the relevant laws or regulations and that the belief must be reasonable." Reasonableness is "determined on the basis of the knowledge available to a reasonable person in the circumstances with the employee's training and experience." The ALJ also explained that the mere fact that a company investigates a complaint does not establish that complainant had a reasonable belief of unlawful conduct. Additionally, the ALJ rejected plaintiff's expert testimony on the reasonableness of plaintiff's belief that fraud occurred. The ALJ stated that SOX protects only "employees who report reasonable beliefs based in articulable fact of illegal activity designed to defraud shareholders."
Walton v. Nova Information Systems and Bancorp., 2005-SOX-107 (Mar. 29, 2006), relied on a N.D. GA decision, Collins v. Beazer Homes USA, Inc., 334 F. Supp. 2d 1365 (N.D. Ga. 2004) (disclosures alleging attempts to circumvent the company's systems of internal accounting controls violate Section 13 of the Security Exchange Act and are protected by SOX). In Walton, the plaintiff, a former database administrator for NOVA, the third largest credit card processor in the United States, complained that she was terminated in retaliation for raising concerns about "security lapses" in the company's data bases which could "foreseeably result in large scale criminal fraud against cardholders, merchants and their banks, customers and shareholders." She further contended that the security lapses violated the company's obligation to comply with statutory and regulator requirements mandated by SOX and other federal laws. The Company filed a 12(b)(6) motion to dismiss, arguing that the complaint merely reported violations of internal procedures and did not implicate fraud against a company's shareholders. The Company argued that it is not enough to report a violation of a rule or regulation of the SEC - that the rule or regulation of the SEC that is reported must relate to fraud against the shareholder.
The ALJ rejected this argument, concluding that SOX does in fact protect a whistleblower who has provided information of a violation of a rule or regulation of the SEC. The AlJ also concluded that the filing of SOX complaint is in fact protected activity; and declined to limit the Act's protection for whistleblowers "who do nothing more than perform the job for which they were hired.
In Lerbs v. Buca Di Beppo, Inc., 2004-SOX-8 (ALJ June 15, 2004), an ALJ granted the employer's motion for summary decision because the complainant, a "cash manager" for the restaurant chain, failed to show he engaged in protected activity, largely because he did not show he reasonably believed the employer engaged in illegal activity that misled investors or potential investors. The ALJ found that although the employee may have felt that certain practices "compromised the validity of the annual audit, which shareholders rely on to make investment decisions," he did not have an actual belief at the time of the complaint that the practice was illegal. The complainant also contended that the company inappropriately attempted to inflate the sales of one of its restaurants, which provided reduced-price lunches to employees at corporate headquarters, by increasing the prices of the lunches, thereby inflating its "same store sales" figures released to shareholders. The ALJ found that complainant failed to show it was reasonable to believe this practice was illegal, as "there is simply nothing unlawful or improper about a decision by Buca to adjust upward the amount it paid for employees' meals to bring the cost into line with the cost of meals for non-employee consumers." Id. at 13.
In Harvey v. Safeway, Inc., 2004-SOX-21 (ALJ Feb. 11, 2005), complainant contended that his complaints about discrepancies in his weekly paychecks violating the FLSA constituted protected activity. The ALJ found that the employee's "personal experience over the course of a couple of weeks with Safeway and an anecdotal report of one other employee's wage concerns did not provide an objectively reasonable factual foundation for a . . . complaint about systematic wage underpayment."
In Barnes v. Raymond James & Assoc., 2004-SOX-58 (ALJ Jan. 10, 2005), complainant voiced concerns that her supervisor was conducting improper "switches" of mutual fund accounts in order to generate unnecessary client fees. The ALJ held that complainant's belief that her supervisor engaged in improper switches was not reasonable in light of the absence of any evidence of such transactions, the fact that complainant failed to raise her complaints earlier, a subsequent company investigation concluding no improper switches occurred, and her own sworn statements stating that her supervisor engaged in more "exchanges" than switches.
In Allen v. Stewart Enter. Inc., 2004-SOX-60 (ALJ Feb. 15, 2005), complainant inquired into whether respondent was taking steps to comply with securities regulations. The ALJ found that complainant did not have a reasonable belief that respondent had violated a SEC rule where the relevant documents were internal working documents not intended for submission to the SEC and complainant admitted that she was not aware of any law making the SEC rule applicable to those internal documents. Additionally, the ALJ reasoned that respondent already knew about the problem before complainant reported it and was making it a priority to remedy the problem.
In Nixon v. Stewart & Stevenson Services, Inc. 
, 2005-SOX-1 (ALJ Feb. 16, 2005), an ALJ granted summary decision for respondent because there was no evidence that complainant reasonably believed the conduct he reported could have been mail fraud. The ALJ reasoned that not only was there was no evidence that the letters to which complainant referred, even if false, were part of a scheme or artifice to obtain money or property, but also there was no evidence that complainant actually considered respondent's conduct to constitute mail fraud, because the first mention of mail fraud was made before the ALJ. The ALJ also found that there was no evidence that complainant reasonably believed the conduct he reported could have been a violation of SEC Rule S-K. The ALJ reasoned that there was no evidence of any pending legal proceeding or that governmental authorities were contemplating any legal proceeding that would have needed to have been reported under Rule S-K.
In Bechtel v. Competitive Technologies Inc., 2005-SOX-33 (ALJ Oct. 5, 2005), an ALJ found that reporting alleged insider trading was not protected activity because his conclusions were not "objectively supported" and because he failed to act in a way that would lead one to believe he thought fraud was taking place. The ALJ noted that complainant did not report the alleged conduct to any authority and did not follow the company's procedures for making allegations regarding insider trading. The ALJ concluded that this "failure to bring such a serious allegation to anyone's attention is inconsistent with his expressed concerns for how his disclosure would affect shareholders and the company's compliance with SOX disclosure rules." However, the ALJ did find that complainant's refusal to sign disclosure forms and his expressed concerns about the disclosure committee were protected activities under Section 806.
In contrast, in Platone, 2003-SOX-27, the ALJ ruled that a former airline labor relations manager engaged in protected activity by raising concerns about financial irregularities within the company. Specifically, the complainant complained of discrepancies in the "flight loss" pay system, an arrangement which effectively shifted the cost of paying pilots from the company to the union by requiring the union to reimburse the company for portions of a pilot's pay when the pilot was called away from flight duty to attend to official union business. Complainant reported that some members of the union leadership were improperly taking advantage of the flight loss system for their own monetary gain. After her reports went unheeded, complainant concluded that members of company management, who needed bargaining leverage to obtain concessions from the union in upcoming negotiations, had devised a plan to improperly funnel the airline's money to members of the union through the flight loss compensation arrangement.
Despite an absence of evidence reflecting that the company was ever reimbursed by the union or that this purported arrangement ever resulted in any financial loss to the company, the Platone ALJ determined that the complainant's "suspicions were reasonable, and that she had good grounds to believe that a fraud was being perpetrated" on the company and its stockholders. Curiously, the ALJ did not address the materiality requirement and did not specify which predicate federal fraud or securities provision may have been violated.
Similarly, in Welch v. Cardinal Bankshares Corp., 2003-SOX-15 (ALJ Jan. 28, 2004), an ALJ found that complainant had a reasonable belief that improper entries totaling $195,000 on the company's financial statements were improper, were material and could mislead potential investors.
In Kalkunte v. DVI Financial Servs. Inc., 2004-SOX-56 (ALJ July 18, 2005), complainant, an attorney, alleged that respondent improperly commingled funds and its senior management altered delinquency reports and incorporated those altered reports into disclosure statements made to the public. The ALJ determined that complainant had a reasonable belief that the alleged conduct constituted a covered violation. The ALJ reasoned that the alleged conduct plainly violated SEC rules and regulations and constituted fraud against shareholders and, therefore, an attorney with complainant's experience and background "would easily discern these activities as potential violations of the Sarbanes-Oxley Act." The ALJ also noted that complainant had documentary evidence to support her allegations.
In Jayaraj v. Pro-Pharmaceuticals, Inc., 2003-SOX-32 (ALJ Feb. 11, 2005), complainant alleged that respondent was using an unregistered broker to solicit investors in exchange for a commission. Under the Exchange Act, it is unlawful for any "broker or dealer" to use interstate commerce to "effect any transactions in, or to induce or attempt to induce the purchase or sale of, any security" unless the individual is registered as a broker/dealer. The ALJ found that complainant's belief that respondent's conduct violated the Exchange Act was reasonable. The ALJ reasoned that complainant was aware that the broker was not a licensed broker, knew that one could not sell securities unless one were registered as a broker or broker dealer, knew the broker was trying to bring private investors to the company, knew he would not assist the company without payment for his efforts, overheard company officials discuss paying him a commission, participated in a call in which the broker asked for a commission, and, unbeknownst to complainant, the company had entered into a consulting agreement with the broker.
In Taylor v. Wells Fargo, Texas, 2004-SOX-43 (ALJ Feb. 14, 2005), an ALJ found that complainant reasonably believed that her supervisor's practice of backdating letters of credit could have involved mail, wire and bank fraud. Although respondent argued that there was no specific evidence that it was committing fraud, the ALJ noted that an actual violation of the law is not required. The ALJ reasoned that complainant reasonably believed that backdating the letters of credit constituted falsifying a bank document, which she believed "would constitute an illegal and criminal act," and when complainant raised her concern, respondent "admitted it must be careful to not deceive any government regulators or creditors of the applicant when backdating letters of credit."
See also Gonzalez III, 2004-SOX-39 (complainant's persistence in his concerns, including multiple conversations with company officials, demonstrated his reasonable belief); Henrich v. Ecolab, Inc., 2004-SOX-51 (ALJ Nov. 23, 2004) (complainant reasonably believed that company's shareholders may be subjected to fraud by alleged "cheating" in accounting for inventory, material losses and labor costs) aff'd 2004-SOX-51 (ARB June 29, 2006) (finding that the ALJ properly focused on whether complainant had a reasonable belief that the practice was a violation of a law or regulation listed in the SOX provisions); Halloum v. Intel Corp., 2003-SOX-7 (ALJ Mar. 4, 2004) (complainant reasonably believed that he had been asked to commit an illegal activity even though a subsequent investigation concluded otherwise).
Sometimes, a complainant may have initially engaged in protected conduct by raising concerns about fraud or violations of SEC rules, but intervening circumstances caused continued concern regarding such violations to become unreasonable. For example, in Williams v. U.S. Dep't of Labor, 2005 U.S. App. LEXIS 25011 (4th Cir. Nov. 18, 2005) (per curiam), the Fourth Circuit, addressing a complaint filed with the DOL under various environmental protection statutes, agreed with the DOL that the complainant engaged in protected activity in raising concerns about lead in schools, but after respondent, in response to those concerns, undertook significant activity to ensure that the environment was safe, that any potential problems were corrected, and that a plan was in place to ensure the safety of students and staff, "it was no longer reasonable for her to continue claiming that these schools were unsafe . . ." Accordingly, the court concluded that "her activities lost their character as protected activity."
3. Fraud
To constitute protected activity, the subject matter of a SOX complaint must implicate a purported violation of "section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders." 18 U.S.C. § 1514A(a). SOX's legislative history reflects that fraud is an integral element of a cause of action under the whistleblower provision. See, e.g., Cong. Rec. S7418 (daily ed. July 26, 2002) (statement of Sen. Leahy) (whistleblower provision to protect "those who report fraudulent activity that can damage innocent investors in publicly traded companies"); S. Rep. No. 107-146, 2002 WL 863249 (May 6, 2002) (the relevant section "would provide whistleblower protection to employees of publicly traded companies who report acts of fraud to federal officials with the authority to remedy the wrongdoing or to supervisors or appropriate individuals within their company").
While some ALJs have narrowly interpreted the scope of Sarbanes-Oxley to protect only complaints relating to matters of potential securities fraud, other ALJs have found the statute, as it language would appear to mandate, to cover a broader range of fraudulent activity including mail and wire fraud.5 Some ALJs have upheld claims on this basis. See, e.g., Taylor v. Wells Fargo Texas, 204 SOX 43 (ALJ Feb. 14, 2005) (complaints that a coworker has been backdating letters of credit are protected activity under the Act, since mail fraud, wire fraud, and bank fraud may be implicated.)
The ARB recently addressed this issue in Platone v. FLYi, Inc., ALJ No. 2003-SOX-27, ARB No. 04-154 (ARB Sept. 29, 2006), holding that, "when allegations of mail or wire fraud arise under the employee protection provision of the Sarbanes-Oxley Act, the alleged fraudulent conduct must at least be of a type that would be adverse to investors' interests." See also, Mozingo v. S. Financial Group, Inc., 2007-SOX-4, slip. op. at 11 (ARB Dec. 6, 2006)(claim dismissed where complainant unable to show that the transfer of a customer's account, even if fraudulent, would have adverse impact on shareholders).
a. Violation of Enumerated Fraud Provisions
Section 806 protects against retaliation for reports implicating the enumerated federal fraud statutes (mail, wire, bank or securities fraud), SEC rules, or federal law "relating to fraud against shareholders." For example, in Allen v. Stewart Enterprises, Inc., 2004-SOX-60, 61 & 62 (ALJ Feb. 15, 2005), complainant raised concerns about possible violations of state laws which could result in sanctions and revocation of respondent's state licenses. The ALJ found that this was not protected activity because Section 806 only provides protection for reporting violations of the enumerated fraud provisions.
Similarly, in Rogus v. Bayer Corp., 2004 U.S. Dist. LEXIS 17026 (D. Conn. Aug. 25, 2004), plaintiff asserted causes of action for common law wrongful discharge and violation of the state whistleblower statute. Plaintiff contended that she suffered retaliatory discharge for internally complaining that her supervisor allowed production yields to be over-reported and production workers were overpaid bonuses that would not have been paid had the true number been reported. The court stated in a footnote that plaintiff's complaint would not be protected under SOX "because the conduct she complained of did not 'constitute[] a violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders.'"
Merely raising complaints about violations of internal policy is not protected activity. For example, in Reddy v. Medquist, Inc., 2004-SOX-35 (ARB Sept. 30, 2005), the complainant, a medical transcriptionist, had expressed concerns to management by e-mail regarding management's policy of decreasing line counts in her transcriptions thereby reducing her rate of pay. In one e-mail, complainant referred to this policy as an "Enron-type" accounting practice. The ARB held that complainant failed to show she engaged in protected activity where the evidence demonstrated that the complaints concerned internal company policy as opposed to actual violations of federal law.
In Marshall v. Northrup Gruman Synoptics, 2005-SOX-8 (ALJ June 22, 2005), complainant alleged that he reported to management his supervisor's misclassification of internal expenses, use of company contractors to provide personal home remodeling, and falsification of internal reports. The ALJ found that complainant did not engage in protected activity because his allegations merely implicated violations of internal company policies and ethical standards rather than SOX's enumerated laws or regulations related to fraud against shareholders. Although some of his allegations related to accounting irregularities, there was no evidence of misrepresentation of the company's financial situation or fraudulent conduct. The ALJ concluded that "[t]he fact that the concerns involved accounting and finances in some way does not automatically mean or imply that fraud or any other illegal conduct took place."
In Minkina v. Affiliated Physician's Group, 2005-SOX-19 (ALJ Feb. 22, 2005), an ALJ granted summary decision, concluding that complainant's reports concerning air quality were unrelated to fraud or the protection of investors. The ALJ rejected complainant's contention that poor air quality could result in financial loss to respondent, reasoning that SOX "was enacted to address the specific problem of fraud in the realm of publicly traded companies and not the resolution of air quality issues, even if there is a possibility that poor air quality might ultimately result in financial loss."
In Heaney v. GBS Properties LLC d/b/a Prudential Gardner Realtors, 2004-SOX-72 (ALJ Dec. 2, 2004), complainant, on separate occasions, expressed concerns over a purchaser's use of an unlicensed home inspector and concerns over a condominium project which he thought a developer had built in violation of certain codes. The ALJ found that neither communication constituted protected activity under SOX.
In Barnes, 2004-SOX-58, complainant voiced concerns that her supervisor was conducting improper "switches" of mutual fund accounts in order to generate unnecessary client fees. The ALJ found that complainant did not engage in protected activity, in part because complainant acknowledged that she raised the issue of improper switches only as an example of unethical conduct and not as an example of fraud against shareholders or investors.
In Armstrong v. Wal-Mart Stores, Inc. (OSHA Jan. 27, 2006),6 complainant alleged that he reported that managers were having workers perform personal services while on the clock, that a supervisor was using company resources for personal use, that employees falsified financial reports to increase employee bonuses, and that managers misappropriated money raised for charity. OSHA concluded that complainant's reported evidence of favoritism by managers, violations of company policy, and other issues, was not protected activity under 806.
In contrast, in Morefield v. Exelon Servs. Inc., 2004-SOX-2 (ALJ Jan. 28, 2004), an ALJ broadly construed the catchall "any provision of Federal law relating to fraud against shareholders." The ALJ held that this provision "may provide ample latitude to include rules governing the application of accounting principles and the adequacy of internal accounting controls implemented by the publicly traded company in compliance with such rules and regulations." Id. at 5.
Likewise, in Mann v. United Space Alliance, LLC, 2004-SOX-15 (ALJ Feb. 18, 2005), an ALJ denied summary decision to respondents on the issue of protected activity because complainant's allegation of a perpetuation of a fraud on NASA by improperly favoring certain vendors in violation of federal acquisition regulations, although less than direct, could also perpetrate a fraud on shareholders under certain circumstances. See also Kalkunte v. DVI Financial Servs. Inc., 2004-SOX-56 (ALJ July 18. 2005) (where complainant alleged that respondent improperly commingled funds and its senior management altered delinquency reports and incorporated those altered reports into disclosure statements filed to the public, ALJ found that these activities "plainly violate SEC rules and regulations, and constitute fraud against shareholders").
b. Intent to Deceive or Defraud
Some ALJs have held that, because an essential element of fraud is an intent to defraud or deceive, a Section 806 complaint must allege a degree of intentional deceit or fraud. For example, in Hopkins v. ATK Tactical Systems, 2004-SOX-19 (ALJ May 27, 2004), an ALJ found that a complaint that did not address any kind of fraud and did not allege that the activities involved intentional deceit or resulted in a fraud against shareholders or investors did not fall within the purview of the SOX whistleblower provision. The employee's complaint questioned whether the employer's systems illegally resulted in the release of sludge water into the ground water system due to poor maintenance and overdue inspections. The ALJ found that such an activity failed to state a cause of action because "an element of intentional deceit that would impact shareholders or investors is implicit" under the SOX whistleblower provision.
In Allen, 2004-SOX-60, 61 & 62, an ALJ found that complainants did not engage in protected activity by reporting accounting irregularities because they did not actually believe that the respondent had acted intentionally when an unintentional mistake within the computing system resulted in incorrect interest calculations. The ALJ observed that a complainant must reasonably believe the reported activity was fraudulent, and "a fraudulent activity cannot occur without the presence of intent."
Similarly, in Grant, 2004-SOX-63, complainant voiced concerns that her supervisor was conducting improper "switches" of mutual fund accounts in order to generate unnecessary client fees. The ALJ held that complainant did not engage in protected activity where none of his expressed concerns "contained any reference to fraud or implication that the company had acted intentionally to mislead shareholders or misstate the company's bottom line."
c. Effect on Shareholders or Investors
ALJs have noted that, although the fraud provisions enumerated in Section 806 go beyond those specifically relating to securities fraud, to constitute protected activity, the alleged conduct must impact shareholders or investors. For example, in Tuttle, 2004-SOX-76, complainant alleged he was terminated because he complained that significant numbers of its batteries were defective. The ALJ granted summary d