Katz, Marshall & Banks partner Debra S. Katz and associate Maura Dundon published an article in Legal Times entitled “Please Protect the Whistleblowers.” The article, published on March 2, 2009, discussed obstacles to the whistleblower protections granted under the Sarbanes-Oxley Act of 2002. The full-text of the article is available below.
Commentary: Please Protect the Whistleblowers
By Debra Katz and Maura Dundon
As the recent financial scandals show, the need for strong legal protections to encourage whistle-blower disclosure about illegal corporate practices has not decreased since Enron. If anything, it has become much more urgent.
Congress, of course, responded to the Enron and MCI scandals by passing the Sarbanes-Oxley Act of 2002, which includes in Section 806 a whistle-blower provision intended to “encourage and protect” employees at publicly traded companies who report fraud or violations of federal securities laws.
But instead of giving this anti-retaliation provision the teeth that Congress intended, the courts and the U.S. Department of Labor, which has jurisdiction to investigate and adjudicate SOX whistle-blower claims, have provided unduly restrictive interpretations of the law, creating legal obstacles Congress certainly did not envision.
President Barack Obama’s Department of Labor, headed by the just-confirmed Hilda Solis, should pay close attention to this whistle-blower trend and take all available steps to reverse it. Whistle-blowing employees serve as the “eyes and ears” of the investing public, and they must have the full legal protection Congress intended when they report their employers’ fraud or securities-law violations.
Three developments in particular deserve attention: The defense that an employee’s exercise of a job duty or “duty speech” cannot constitute protected whistle-blowing; the requirement that the employee’s communications to her employer “definitively and specifically relate” to the underlying fraud or securities violations; and the imposition of a “reasonable expert” standard holding professional employees to an unjustifiably high standard of expertise in their whistle-blowing.
The “duty speech” doctrine, which can be found nowhere in the statute itself, posits that an employee whose job involves identifying fraud or ensuring compliance with securities or anti-fraud laws—for example, an internal auditor or an in-house lawyer—by definition cannot be a whistle-blower because she is “just doing her job,” not blowing the whistle. At least one Labor Department administrative law judge has applied this doctrine in a SOX case.
The duty speech defense, however, would perversely knock out from the act’s protection those employees who are the most effective whistle-blowers. Employees whose job duties involve identifying fraud or ensuring compliance with securities laws are in the best position to discover serious fraud and noncompliance, to understand it well enough to effectively blow the whistle, and to pose the kind of real threat that might inspire retaliation. These are the exact employees Congress intended to protect, and muzzling those individuals best able to disclose corporate fraud would severely undermine the act.
Moreover, the unintended consequences of the duty speech defense may ultimately prove damaging to corporations themselves. The doctrine, as interpreted in other areas of the law, contains an escape hatch: If employees raise their concerns outside of their normal chain of command or outside of the organization, they have left behind their normal job duties and gained possible legal protection. As a result, the doctrine creates an incentive for employees who want to protect themselves to go straight to Congress, the Securities and Exchange Commission, the audit committee, or the media as soon as they believe they have discovered fraud.
Corporations should not want to encourage this immediate escalation. They should prefer, instead, to allow employees to raise their concerns internally first so that problems can be investigated and resolved at a lower and more private level.
WHAT’S THE MAGIC WORD?
The second troubling SOX interpretation is the onerous “definitively and specifically” requirement imposed on how an employee must have communicated her concerns about securities violations or fraud to her employers.
Obviously, the employee whistle-blower must put her employer on notice that she believes something illegal may have happened to gain protection from retaliation for disclosing fraud or securities law violations. Section 806 itself requires only that an employee “provide information” about fraud or securities law violations to her employer. But the Administrative Review Board of the Bush administration’s Labor Department and several courts, most recently the 4th Circuit in 2008, have imposed the stricter requirement that the employee’s communications must have “definitively and specifically related to one of the areas accorded protection” in SOX.
The 4th Circuit’s 2008 decision in Platone v. U.S. Department of Labor demonstrates that an employee can only meet the “definitively and specifically” requirement by engaging in a highly technical and sophisticated level of communication, which may in practice be out of reach to the average employee.
In Platone, the whistle-blower told a company official that she had discovered that a group of employees active in the union were engaged in a scheme that was “cheating the company out of money,” that the employees’ union was angry at her for investigating the cheating, and that she feared her boss, who had relayed the union’s anger to her, would retaliate against her for continuing her investigation into the cheating.
The ALJ held that given the context, these communications, among others, sufficiently relayed to the employer the employee’s belief that fraud had taken place. The Administrative Review Board reversed, holding that the statements did not relate specifically enough to fraud or securities law violations to constitute whistle-blowing under the act. The 4th Circuit (giving an incomplete recital of the facts) upheld the Administrative Review Board’s determination, but with the proviso that while the communications must “definitely and specifically” relate to the legal violation, the whistle-blower need not actually cite a law or regulation to her employer.
The distinction the 4th Circuit attempts to make between citing an actual provision of law and making a statement that “definitively and specifically relates” to the law is, in practice, unavailing.
Had the Platone whistle-blower simply used the word “fraud” instead of “cheating,” it seems likely that the 4th Circuit and the Administrative Review Board would have held that she adequately expressed her concerns. But to any nonlawyer, including most employers and employees, “fraud” and “cheating out of money” are indistinguishable concepts about illegal wrongdoing.
Thus, despite the 4th Circuit’s statements to the contrary, the “definitely and specifically relates” requirement in practice demanded that the employee add the magic legal word “fraud” to her communications to be protected.
Thankfully, other courts have offered a less formalistic interpretation of what it means to “provide information.” These decisions place the emphasis where it should properly lie: on whether the employer understood the employee to be complaining about fraud or a securities law violation, not on the employee’s bare words abstracted from context. The Labor Department’s existing SOX procedural regulations already suggest this approach, requiring that to establish a prima facia case during the initial investigation, the employee need show only that the employer “knew or suspected, actually or constructively” about the whistle-blowing.
RAISING THE BAR
A third obstacle to whistle-blowers is the “reasonable expert” standard, which raises the bar for professional employees to obtain protection.
Under Section 806, while a whistle-blower need not actually prove a violation of the underlying law, she must have “reasonably believe[d]” the violation occurred when she blew the whistle.
In evaluating whether such a belief was reasonable, the 5th Circuit held in Allen v. Administrative Review Board (2008) that a Certified Professional Accountant should be judged by a heightened “reasonable accountant” standard, rather than a “reasonable person” standard.
The CPA had complained to her employer that the company’s internal financial reports were not in compliance with a particular SEC Staff Accounting Bulletin, SAB-101, which offers guidance on proper accounting practices for SEC reporting. The court found that although the company’s failure to comply with SEC guidance on proper accounting practices may have caused the employee to suspect that the company was not compliant in its SEC filings, she was not protected because she complained only about internal financial reports, not the SEC filings. Under the reasonable accountant standard, the court held, she had to examine the SEC filings themselves to look for SAB-101 noncompliance.
The court’s conclusion ignores the common-sense logic that noncompliant internal financial reports could very likely serve as the basis for noncompliant external SEC financial reports.
An employee should not be deprived of the benefit of such inferences, even if she is an expert.
Combined, the duty speech exception, the definitively and specifically requirement, and the reasonable expert standard will have a devastating effect on corporate whistle-blowers. Only employees with expertise in the subject about which they are blowing the whistle—the kind of expertise that comes only from having job duties in those subject areas—will be able to meet the definitively and specifically requirement. But these sophisticated employees are, of course, the exact employees who would be disqualified from SOX protection under the duty speech exception or who would be subjected to the heightened reasonable expert standard.
Together, these three doctrines would eliminate a broad swath of protected whistle-blowers and leave the investing public vulnerable to the abuses that occur when corporations can engage in wrongdoing with impunity.
Secretary Solis should prioritize correcting this undermining of SOX. Given the current financial climate, the public cannot wait.
Debra S. Katz is a partner at D.C.’s Katz, Marshall & Banks, which represents employee whistleblowers. Maura Dundon is an associate at the firm.