EMERGING ISSUES UNDER THE SARBANES-OXLEY WHISTLEBLOWER PROVISION

Transcription

1 EMERGING ISSUES UNDER THE SARBANES-OXLEY WHISTLEBLOWER PROVISION EUGENE SCALIA Gibson, Dunn & Crutcher LLP American Bar Association, Annual Meeting Section of Labor and Employment Law August 9, 2004 Atlanta, Georgia 2004, Eugene Scalia. All Rights Reserved. i

2 Emerging Issues Under the Sarbanes-Oxley Whistleblower Provision TABLE OF CONTENTS Page TABLE OF AUTHORITIES ii I. Overview of the Sarbanes-Oxley Whistleblower Provision....1 II. Issues of Importance to Companies in the Initial Handling of Sarbanes-Oxley Whistleblower Complaints...4 III. Emerging Issues in the Litigation of Sarbanes-Oxley Whistleblower Complaints....8 A. Retroactivity...9 B. Covered Entities...9 C. Protected Activity Relationship to corporate financial reporting Subjective belief in illegality of conduct at issue Materiality Mail and wire fraud Degree to which one s regular job duties may be protected activity...16 D. Preliminary Reinstatement...19 E. Appeal to the Administrative Review Board...20 F. Federal Cause of Action...21 G. Arbitration...23 H. Settlement Issues...24 i

3 TABLE OF AUTHORITIES Page Cases Boss v. Salomon Smith Barney Inc., 263 F. Supp. 2d 684 (S.D.N.Y. 2003)...22 Coker v. Wal-Mart Stores, Inc., 2004-SOX-33 (ALJ June 4, 2004)...24 Corrada v. McDonald s Corp., 2004-SOX-7 (ALJ Jan. 23, 2004)...21 D Agostino v. Workflow Management, Decision in Case No (Aug. 4, 2003)...17, 19 Flake v. New World Pasta Co., 2003-SOX-18 (ALJ July 7, 2003), aff d, (ARB Feb. 25, 2004)...9, 10 Getman v. Southwest Securities, 2003-SOX-8 (ALJ Feb. 2, 2004)...14 Gilmore v. Parametric Technology, 2003-SOX-1 (ALJ Feb. 6, 2003)...8 Harvey v. Home Depot, Inc., 2004-SOX-20 (ALJ May 28, 2004)...11, 14, 15 Hopkins v. ATK Tactical Systems, 2004-SOX-19 (ALJ May 27, 2004)...11, 15 Huffman v. Office of Personnel Mgmt., 263 F.3d 1341 (Fed. Cir. 2001)...16, 17 Hutchins v. Wilentz, Goldman & Spitzer, 253 F.3d 176 (3d Cir. 2001)...18 Lerbs v. Buca Di Beppo, Inc., 2004-SOX-8 (ALJ June 15, 2004)...9, 13 Lowe v. Coca-Cola Co., 2004-SOX-6 (ALJ May 21, 2004)...21 Mahoney v. Keyspan Corp., 2004-SOX-24 (ALJ Feb. 11, 2004)...21 McIntyre v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 2003-SOX-23 (ALJ Jan. 16, 2004)...9 McKennon v. Nashville Banner Publishing Co., 513 U.S. 352 (1995)...19 Michaelson v. Officemax, Inc., 2004-SOX-17 (ALJ June 21, 2004)...25 Montana v. United States, 440 U.S. 147 (1979)...22 Morefield v. Exelon Services, Inc., 2004-SOX-2 (ALJ Jan. 28, 2004)...10, 14 Murray v. TXU Corp., 279 F.Supp.2d 799 (N.D. Texas 2003)...21 ii

4 Platone v. Atlantic Coast Airlines, 2003-SOX (ALJ May 13, 2004)...20 Platone v. Atlantic Coast Airlines, 2003-SOX-27 (ALJ Apr. 30, 2004)...10, 12, 15, 20 Powers v. Pinnacle Airlines, Inc., 2003-AIR-12 (ALJ Mar. 5, 2003)...9 Reddy v. Medquist, Inc., 2004-SOX-35 (ALJ June 10, 2004)...18 Saito v. McKesson HBOC, Inc., No. Civ. A , 2002 Del. Ch. LEXIS 125 (Del. Ch. Nov. 13, 2002)...6 Secretary of Labor on behalf of York v. BR&D Enters., Inc., 23 FMSHRC 697, 2001 WL (June 26, 2001)...19 Stone v. Duke Energy Corp., 2003-SOX-12 (ALJ June 19, 2003)...21 TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438 (1976)...13 United States v. Bergonzi, 214 F.R.D. 563 (N.D. Ca. 2003)...6 United States v. Utah Construction and Mining Co., 384 U.S. 394 (1966)...22 University of Tennessee v. Elliott, 478 U.S. 788 (1986)...22 Welch v. Cardinal Bankshares Corp., 2003-SOX-15 (ALJ Jan. 28, 2004)... passim Welch v. Cardinal Bankshares Corp., 2003-SOX-15 (ARB May 13, 2004)...20 Statutes 15 U.S.C. 78l U.S.C. 78o U.S.C U.S.C U.S.C U.S.C , U.S.C. 1514A...1, 2, 3, 4, 7, 9, 13, U.S.C U.S.C , 7 Regulations iii

5 29 C.F.R C.F.R , C.F.R C.F.R Other Authorities Memorandum by Deputy Attorney General Larry D. Thompson, Principles of Federal Prosecution of Business Organizations (Jan. 20, 2003)...6 Memorandum, Consideration of Employment Arbitration Agreements (Aug. 9, 2002)...23 OSHA and FAA Sign Accord Detailing Safety Complaint Process for Airline Workers, 61 Daily Labor Report (Mar. 29, 2003)...7 Procedures for the Handling of Discrimination Complaints Under Section 806 of the Corporate and Criminal Fraud Accountability Act of 2002, Title VIII of the Sarbanes-Oxley Act of 2002, 68 Fed. Reg. 31, 860 (May 28, 2003)...2, 4 Staff Accounting Bulletin No. 99, 64 Fed. Reg. 45,150 (1999)...14 iv

6 Emerging Issues Under the Sarbanes-Oxley Whistleblower Provision Eugene Scalia The whistleblower provision of the Sarbanes-Oxley Act is an important new employment law that also has significant implications for companies compliance with the securities laws. This paper discusses the Sarbanes-Oxley whistleblower provision in three parts: Part I provides a brief overview of the requirements and administration of the new law. Part II discusses some challenges that companies face during the initial investigation of Sarbanes-Oxley whistleblower complaints. Part III surveys some of the important emerging issues in the litigation of these complaints. I. Overview of the Sarbanes-Oxley Whistleblower Provision. The Sarbanes-Oxley Act of 2002 (or SOX ) makes it illegal to fire or otherwise discriminate against an employee for providing information or assisting an investigation regarding what the employee reasonably believes to be a violation of a rule of Securities and Exchange Commission, the federal criminal laws regarding mail, wire, and bank fraud, or any provision of federal law relating to fraud against shareholders. Protection attaches under the Act when the employee provides information or assistance to a federal regulatory or law enforcement agency, to Congress, or to someone in the company with supervisory authority over the Eugene Scalia is a partner in the Washington, D.C. office of Gibson, Dunn & Crutcher LLP. He is Co-Chair of the firm s Labor and Employment Practice Group and a member of the firm s Appellate and Constitutional Law Practice Group. Mr. Scalia previously served as Solicitor of the U.S. Department of Labor, principal legal officer of the Department, where his responsibilities included overseeing the development of procedures to implement the Sarbanes-Oxley whistleblower provision. I am grateful for the research assistance of Samuel L. Bray of the University of Chicago Law School. 1

7 employee or with authority to investigate, discover, or terminate misconduct. 18 U.S.C. 1514A(a)(1) (2004). The Act also makes it illegal to retaliate against an employee for commencing or participating in a proceeding related to alleged federal securities violations testifying in a securities case, for example. 18 U.S.C. 1514A(a)(2) (2004). And, the Act amends the federal obstruction of justice statute to make it a crime to interfere[ ] with the lawful employment or livelihood of any person in retaliation for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any Federal offense , codified at 18 U.S.C. 1513(e) (2004). Note that while this provision is limited to truthful reports to law enforcement officers, by its terms it is not limited to alleged securities violations; on its face the provision appears to cover reports of any federal offense to a law enforcement officer. The Act s remedial provision states that a prevailing employee shall be entitled to all relief necessary to make the employee whole, including reinstatement, back pay, and compensation for any special damages sustained as a result of the discrimination, including litigation costs, expert witness fees, and reasonable attorney fees. 18 U.S.C. 1514A(c) (2004). In addition, in May 2003, the Occupational Safety and Health Administration ( OSHA ) which is responsible for investigating Sarbanes-Oxley whistleblower complaints issued an interim final rule implementing the Act which provides that OSHA may order preliminarily reinstatement of an employee, prior to any court hearing, when it finds reasonable cause that a violation occurred. Procedures for the Handling of Discrimination Complaints Under Section 806 of the Corporate and Criminal Fraud Accountability Act of 2002, Title VIII of the Sarbanes- Oxley Act of 2002, 68 Fed. Reg. 31, 860, 31,862 (May 28, 2003); 29 C.F.R (a)(2). 1 1 The interim rule took effect immediately. The Labor Department invited public comment on the rule, and changes in the final rule are possible. The comment period ended July 28, 2003, but a final rule had not issued when this paper went to print in late June

8 Complaints under the Act are to be filed within 90 days of the action complained of. 18 U.S.C. 1514A(b)(2)(D) (2004). OSHA has 60 days to investigate the complaint and issue a letter indicating whether it has found reasonable cause to believe a violation occurred. See 49 U.S.C (b) (2004) (provisions of the AIR 21 whistleblower protection law incorporated by reference into Sarbanes-Oxley at 18 U.S.C. 1514A(b)(2)(A) (2004)). The agency often takes longer than this under the other whistleblower statutes it administers, and the same has proved to be the case under Sarbanes-Oxley. Thus, OSHA s Whistleblower Investigations Manual states that [w]hile every effort will be made to notify affected parties of the Secretary s determination within 60 days, in Sarbanes-Oxley matters there may be instances where it is not possible to meet this deadline. Id. at Under the interim final rule implementing the whistleblower provision, OSHA gives employers at least two opportunities to present their position to the agency as it conducts its investigation. First, after receiving notification of the complaint, the employer is given 20 days to file a written statement and any affidavits or documents substantiating its position. A meeting with the OSHA investigator may also be requested. 29 C.F.R (c). Second, toward the conclusion of OSHA s investigation, if the agency has tentatively determined that there is reasonable cause to believe a violation occurred and that preliminary reinstatement is warranted, the agency will again contact the named person to give notice of the substance of the relevant evidence supporting the complainant s allegations as developed during the course of the investigation. This evidence includes any witness statements, which will be redacted to protect the identity of confidential informants where statements were given in confidence; if the statements cannot be redacted without revealing the identity of confidential informants, summaries of their contents will be provided. The named person will be given the opportunity to submit a written response, to meet with the investigators to present statements from witnesses in support of its position, and to present legal and factual arguments. The named person will be directed to present this evidence within ten business days of the Assistant Secretary s notification pursuant to this paragraph, or as soon afterwards as the Assistant Secretary and the named person can agree, if the interests of justice so require. 29 C.F.R (e). 3

9 Cases under Sarbanes-Oxley are tried before Department of Labor administrative law judges ( ALJ s ). (These judges are distinct from those who hear cases under the Occupational Safety and Health Act.) Appeal lies to the Department s Administrative Review Board, or ARB, which issues decisions in the Secretary s name; review by the ARB is discretionary under SOX, and the interim final rule states that review is to be under the substantial evidence standard. Appeal of decisions of the ARB and, if the ARB denies review, of decisions of ALJ s lies to the federal courts of appeals. In its interim final rule implementing the whistleblower provision, OSHA has stated that ordinarily it will not participate in Sarbanes-Oxley proceedings ; instead, after conducting its investigation and issuing its determination as to whether the complaint is meritorious, it will leave the litigation to the private parties, as it does under a number of other whistleblower laws. See 68 Fed. Reg. at 31,862. The agency can be expected to participate occasionally, however, either as a party or an amicus curiae. If the Labor Department has not issued a final decision within 180 days of the filing of the complaint, the complainant may file his case in federal district court. Proceedings will be de novo. 18 U.S.C. 1514A(b)(1) (2004). One hundred and eighty days is not nearly enough time for an OSHA investigation and decision letter; discovery; trial before an administrative law judge; post-trial briefing; issuance of the ALJ decision; and, possibly, briefing and review before the ARB. As a practical matter, then, complainants will often have the opportunity to go to federal court, although for a variety of reasons they may choose to remain before the Labor Department. For further discussion, see pages below. II. Issues of Importance to Companies in the Initial Handling of Sarbanes-Oxley Whistleblower Complaints. A Sarbanes-Oxley whistleblower complaint does not merely initiate an employment case. It also indicates a potential securities investigation and litigation and, apart from any litigation and enforcement activity, may trigger a reappraisal of the corporation s financial reports a reappraisal that may require a public restatement of the company s finances. Consequently, when a SOX complaint is filed, there can be at least four distinct legal tasks for employers: (i) defending the whistleblower case before the Department of Labor; (ii) 4

10 defending the alleged securities violation before the SEC and in private litigation; (iii) investigating the alleged securities violation for the corporation or its audit committee to determine if a restatement or supplemental SEC disclosure is necessary; and (iv) investigating the act of alleged whistleblower retaliation for the corporation or audit committee, to ensure the integrity of internal complaint procedures and non-retaliation policies. These tasks require coordination, but they may also require separation. Counsel knowledgeable in securities law should assist in the company s presentation to the Department of Labor, not only to effectively address one element of the claimant s case reasonable belief that a securities violation occurred but also to assure that the positions taken before the Department are consistent with what the company would represent to the SEC and to courts in any litigation. The company s Labor Department filings must be assumed to be available to the SEC, and an unnecessary concession by the company on a securities-related issue before the Labor Department could, in the SEC investigation, be construed as an admission on a point central to that agency s inquiry. Conversely, too aggressive a position on securities-related issues before the Labor Department could cause the SEC to question the company s good-faith intent to identify and correct financial and accounting irregularities. More generally, as a SOX whistleblower complaint is addressed, three aspects of the securities regulatory environment must be kept in mind: First, the company s obligation to publicly correct material misstatements of its finances. This fact alone means that when SOX allegations are received, the company s response cannot be purely defensive, aimed exclusively at beating back the claimant s contentions. Instead, the company must soberly and objectively assess the securities-related allegations and comply with the securities laws going forward. Second and related, the audit committee of the company s board of directors may decide to conduct its own investigation of the complainant s allegations. Section 301 of Sarbanes-Oxley requires audit committees to establish procedures for the receipt, retention, and treatment of complaints the company receives regarding accounting, internal accounting controls, or auditing matters ; the committee should have the authority and the financial support to engage independent counsel and other advisors, as it determines necessary to carry out its duties. A corporation must therefore be mindful of the consistency between the positions it wishes to take 5

11 and possible determinations of the audit committee. Third, the SEC and the Justice Department place a premium on good-faith cooperation by corporations under scrutiny. For this reason, too, positions taken before the Labor Department on securities issues must be formulated with an eye to how they will be viewed by regulators at the SEC or even the Justice Department. Perhaps the most notable feature of the cooperation expected by the SEC and Justice Department is their increasing interest in waiver of the attorney-client privilege. The Justice Department considers waiver of the privilege when deciding how cooperative a corporation has been and whether to bring criminal charges against it. See Memorandum by Deputy Attorney General Larry D. Thompson, Principles of Federal Prosecution of Business Organizations at 7 (Jan. 20, 2003) ( One factor the prosecutor may weigh in assessing the adequacy of a corporation s cooperation is the completeness of its disclosure including, if necessary, a waiver of the attorney-client and work product protections, both with respect to its internal investigation and with respect to communications between specific officers, directors and employees and counsel. ). A company intending to cooperate with the SEC likewise may face great pressure to produce work-product and privileged documents. Corporations now occasionally waive the privilege in both forums, producing internal memoranda and sometimes even lawyers notes. Often, privileged material is given to the government with a written agreement that the privilege is not being waived as to third parties but the courts have not uniformly accepted this selective waiver of privilege. Compare United States v. Bergonzi, 214 F.R.D. 563 (N.D. Ca. 2003) (holding that the attorney-client privilege and work-product protection were waived as to third parties when privileged communications were provided to the government) with Saito v. McKesson HBOC, Inc., No. Civ. A , 2002 Del. Ch. LEXIS 125 (Del. Ch. Nov. 13, 2002) (attorney-client privilege waived by disclosure to government, but work-product protection not waived because materials produced pursuant to confidentiality agreement). For a corporation, a Sarbanes-Oxley complaint may involve multiple forums, tasks, and clients (the company and audit committee) all reasons that separate counsel will sometimes be advisable for the different aspects of a SOX investigation. Plainly, counsel will need expertise in both securities and labor and employment law. Beyond that, representation before the SEC by counsel who are not regular company counsel and have no prior involvement in the underlying 6

12 facts may give the agency added confidence in the independence and objectivity of the corporation s internal investigation. And, if separate counsel is retained for at least some of the distinct tasks described above, the company may be in a better position to provide the government certain categories of privileged materials from the internal investigation while preserving the strongest possible argument that other documents remain fully privileged and confidential. There is much to the Sarbanes-Oxley whistleblower provision that is familiar to labor and employment lawyers, particularly those experienced with practice before the Department of Labor. For example, the Act incorporates by reference procedures under the AIR 21 whistleblower protection law, and it includes such familiar concepts as the claimant s prima facie case and the respondent s opportunity to show by clear and convincing evidence that it would have acted as it did even in the absence of any protected activity. See 18 U.S.C. 1514A(b)(2)(C) (2004) (incorporating by reference the legal burdens of proof at 49 U.S.C (b)(2)(B) (2004)). There are, however, some features of the law that may require a different approach than in other employment cases. A Sarbanes-Oxley whistleblower must prove he reasonably believed there was a violation of the underlying substantive law. Corporations should take care when approaching this case within the case, for reasons suggested above the whistleblower complaint may often be followed by an SEC investigation or private litigation, and in presenting its corporate financial practices to the Labor Department the company will want to take positions that it would be comfortable reiterating later in a securities investigation or in litigation. Experience defending SOX whistleblower cases to date suggests that OSHA is providing at least some SOX whistleblower complaints to the SEC; notably, OSHA has a memorandum of understanding with the Federal Aviation Administration ( FAA ) providing that in airline safety whistleblower cases, it will promptly provide FAA with a copy of the complaint, findings and 7

13 preliminary orders, investigation reports, and other key documents. 2 Whistleblowers and their attorneys can also be expected to alert the SEC in some cases, either out of genuine desire to further expose alleged financial irregularities, or in a (likely misguided) effort to increase settlement pressure on the company. See the discussion at pages below. A securities lawyer is therefore often a valuable adjunct to a SOX whistleblower team. That said, SOX whistleblower cases will not ordinarily be resolved by demonstrating whether there was an actual securities violation. The complainant need only show reasonable belief that a violation occurred, not a violation in fact. See Welch v. Cardinal Bankshares Corp., 2003-SOX-15 (ALJ Jan. 28, 2004), at 47 (noting that [w]hether Respondent actually violated, or intended to violate, any federal fraud statute or SEC rule or regulation is not, and never has been, at issue in this case ). Moreover, OSHA and Labor Department ALJ s often will have considerably less expertise to draw upon in finance and accounting than the company which will have accountants and other finance experts and than the complainant, who in many instances will have been a highly-placed employee with a financial background. In the face of this comparative lack of expertise, the Department may be inclined to resolve cases on grounds of employment-law principles with which it is more familiar. Accordingly, expertise in corporate financial practices and obligations ordinarily is necessary but not sufficient when defending SOX whistleblower cases. III. Emerging Issues in the Litigation of Sarbanes-Oxley Whistleblower Complaints. At the time this paper went to print in late June 2004, approximately 265 SOX whistleblower complaints had been filed with OSHA. Although only a handful of ALJ decisions had issued after trial on the merits, those decisions together decisions on pre-trial motions suggest a number of issues that will be of continuing importance as the caselaw under the Act 2 See OSHA and FAA Sign Accord Detailing Safety Complaint Process for Airline Workers, 61 Daily Labor Report A-8 (Mar. 29, 2003). 8

14 develops. The remainder of this paper discusses some of the leading issues and trends in the cases to date under the SOX whistleblower provision. 3 A. Retroactivity. An issue of receding importance under SOX that rose repeatedly in the early cases is whether the provision applies retroactively. In the first decision involving the whistleblower provision, Gilmore v. Parametric Technology, 2003-SOX-1 (ALJ Feb. 6, 2003), the ALJ concluded that the provision did not cover adverse employment action that preceded the Act s July 30, 2002 effective date. The same conclusion was reached in a number of subsequent decisions. See, e.g., McIntyre v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 2003-SOX-23 (ALJ Jan. 16, 2004). On the other hand, coverage has been found where the protected activity occurred before the effective date, but the alleged retaliation occurred afterward. See, e.g., Lerbs v. Buca Di Beppo, Inc., 2004-SOX-8 (ALJ June 15, 2004) at B. Covered Entities. The whistleblower provision applies to companies (i) with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l), and to those (ii) that are required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)) U.S.C. 1514A(a) (2004). Several decisions have explored the breadth of this coverage. In two cases, administrative law judges dismissed complaints against corporations on the ground that neither of these preconditions to coverage was met. In Powers v. Pinnacle Airlines, Inc., 2003-AIR-12 (ALJ Mar. 5, 2003), the named respondent was a wholly-owned subsidiary of a company that was in turn a wholly-owned subsidiary of yet another non-publicly traded company that was, in turn, a wholly-owned subsidiary of Northwest Airlines Corporation, which 3 Labor Department SOX decisions are available at the website of the Department s Office of Administrative Law Judges, 9

15 is publicly-traded. The ALJ ruled that because the named respondent was not a publicly traded company, it does not fall under the proscriptions of the Sarbanes-Oxley Act.... Id. at 4. As to the ultimate parent Northwest, which is publicly-traded the ALJ took note of the general principle of corporate law that a parent corporation is not liable for the acts of its subsidiaries. Id. The complainant in the case had not alleged facts that would justify piercing the corporate veil and ignoring the separate corporate entities and consequently, the judge ruled, the parent could not be liable. Id. The ALJ also noted that the complainant s attempt to proceed against Northwest was untimely because it had been added as a respondent after OSHA had completed its investigation, without leave of court, and more than 90 days after the alleged violation. Id. In Flake v. New World Pasta Co., 2003-SOX-18 (ALJ July 7, 2003), aff d, (ARB Feb. 25, 2004), the ALJ declined to extend the Act to a corporation that had filed reports under Section 15(d) of the Securities Exchange Act of 1934, but was not required to do so. The reporting requirement of Section 15(d) is automatically suspended when, at the start of the fiscal year, fewer than 300 persons hold the company s securities. This was the case for the respondent, New World Pasta Co., which nonetheless made some Section 15(d) filings pursuant to an agreement with its lenders. Id. at 4. On appeal before the Administrative Review Board, the complainant contended that the whistleblower provision should be read to include any publicly traded company, regardless of size or value, because Congress had all publicly traded companies in mind when drafting the whistleblower provision. Flake v. New World Pasta Co., (ARB Feb. 25, 2004), at 4. This argument, the Board responded, assumes the untenable proposition that Congress did not know what it was doing when it limited coverage under the statute. Id. Reviewing the case de novo, the Board agreed with the ALJ that New World was not a covered entity and dismissed the case. In two other cases, the corporate separateness of subsidiary and parent received less deference. In Morefield v. Exelon Services, Inc., 2004-SOX-2 (ALJ Jan. 28, 2004), the complainant had been the Vice President of Finance for Exelon Services, a small subsidiary of Exelon Corporation, a publicly-traded firm with more than $15 billion in sales in The ALJ concluded that Congress intended the term employees of publicly traded companies in Section 806 to include the employees of the subsidiaries of publicly traded companies. Id. at 2. The 10

16 ALJ distinguished the case from Flake, which did not address subsidiaries, and from Powers, in which the parent corporation had not been named in the original complaint. Addressing Powers specifically, the ALJ rejected its dicta that employees of a subsidiary of a publicly traded corporation must pierce a corporate veil within their own chain of command before they are entitled to the whistleblower protections of Sarbanes-Oxley.... Id. at 4. The ALJ went on to state that the SOX whistleblower provision protects 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. Id. In Platone v. Atlantic Coast Airlines, 2003-SOX-27 (ALJ Apr. 30, 2004), a former labor relations manager for Atlantic Coast Airlines filed a complaint against the parent corporation, Atlantic Coast Airlines Holdings, Inc. The judge found that there was a great deal of commonality in the senior officers of the two entities, that the logos and titles of the parent and subsidiary purportedly were used interchangeably, and that the employee s initial offer of employment came on the parent company s letterhead, all leading to the conclusion that the corporations made no attempt to keep the corporate identities separate.... Id. at On this basis, the ALJ found that the subsidiary was a mere instrumentality and alter ego of the parent for purposes of the complainant s case, and that a complaint properly could be brought against the publicly-traded parent. C. Protected Activity. Another issue likely to receive sustained attention from decisionmakers in SOX whistleblowers cases is what constitutes protected activity for purposes of the Act. Under this statute enacted to address fraud on shareholders, with what degree of particularity must the complainant have articulated a concern that, for example, the securities laws were being violated? The question is an important one, in part because of the potentially serious consequences for a company when a federal official issues an opinion concluding that one reasonably could believe that corporate officers attempted to defraud shareholders. 11

17 1. Relationship to corporate financial reporting. One question naturally implicated by the SOX whistleblower provision is how closely alleged fraud must be tied to the company s share price and financial disclosures. At least two complaints have been dismissed by ALJ s because the connection was insufficient. In Hopkins v. ATK Tactical Systems, 2004-SOX-19 (ALJ May 27, 2004), the complainant alleged that he was terminated because he reported his employer s release of sludge water into the ground water system due to poor maintenance and overdue inspections. The ALJ dismissed the complaint because it was untimely and because the claim which did not allege fraud and did not involve transactions relating to securities fell outside the purview of the employee protection provisions of the Act. Id. at 5. [A]n element of intentional deceit that would impact shareholders or investors is implicit in the Act, the judge stated. Id. The ALJ found the claim meritless and border[ing] on the frivolous when considered under the Sarbanes-Oxley Act. In Harvey v. Home Depot, Inc., 2004-SOX-20 (ALJ May 28, 2004), the complainant had alleged race discrimination by his employer. As in Hopkins, the ALJ dismissed the complaint on the grounds that it was untimely and there was no protected activity. The judge considered the implicit argument that a company which permits discriminatory practices despite its public policy of equal opportunity is acting contrary to the best interests of its share holders, but rejected this approach because SOX protected activity must involve an alleged violation of a federal law directly related to fraud against share holders. Id. at 12. The judge also considered the reasonable argument that since SOX mandates the accuracy of corporate disclosures, a reported incident of racial discrimination within a publicly traded company that represents itself to be non-discriminatory may amount to a violation of a SOX disclosure requirement and thus involve a federal law related to fraud against shareholders. Id. While finding some logical appeal to this approach, the judge observed that the requirement of Section 302 of SOX for accurate reporting of material facts relating to finances[] demonstrates Congress intention to protect shareholders by requiring accurate reporting of a corporation s financial condition. Id. at 13 (emphasis in original). Whether there had been compliance with nondiscrimination principles has a very marginal connection with those two components. Id. Perhaps, the failure to disclose a class action lawsuit based on systemic racial discrimination with the 12

18 potential to sufficiently affect the financial condition of a corporation might become the subject of a SOX protected activity if an individual complained about the failure to disclose that situation. Id. But individual rather than systemic discrimination did not reach that materiality threshold. Moreover, the complaint in this case centered on the alleged existence of racial and employment discrimination rather than the company s failure to report such discrimination to the public. Id. In sum, the judge indicated a requirement that protected activity concern accurate reporting of a company s financial condition, that the matter be sufficiently significant to be material to shareholders (see below), and that the complainant s activity address the corporation s obligations under the securities laws, rather than the purported underlying misconduct. Id. By contrast, in Platone, 2003-SOX-27, the claimant alleged that she had complained that certain company employees were receiving reimbursements from the company to which they were not entitled; company managers looked the other way, she alleged, because the employees at issue were union leaders from whom the company sought concessions in collective bargaining. Accepting these allegations as true, the judge concluded that the complainant had engaged in protected activity because she had good grounds to believe that a fraud was being perpetrated on the airline as well as AICA s shareholders. Id. at Subjective belief in illegality of conduct at issue. Another potentially important issue is whether, at the time of the purportedly protected activity, the complainant subjectively believed that the securities laws or another statute identified by the whistleblower provision was being violated. The requirement is implicit in the statute, which extends protection only when the employee reasonably believes that there is a violation of the relevant federal laws or regulations. 18 U.S.C. 1514A(a)(1) (emphasis added). In Lerbs, 2004-SOX-8, the complainant claimed to have engaged in three instances of protected activity inquiring about the reclassification of cash balances, complaining about the company s hiring of accountants from its auditor, and arguing that payments to a company restaurant for catered lunches had been increased in order to inflate the restaurant s revenues. 13

19 The ALJ found none of these matters to involve protected activity. First, the questions about reclassifying cash balances were only general inquiries. [I]n order for the whistleblower to be protected by the Act, the judge explained, the reported information must have a certain degree of specificity ; a whistleblower must state particular concerns which, at the very least, reasonably identify a respondent s conduct that the complainant believes to be illegal. Id. at 12 (emphasis in original). Second, hiring accountants from the auditor was something the complainant thought would compromise[] the validity of the annual audit, but he did not believe at the time that this practice was illegal. Id. at 13. Accordingly, the complainant failed the requirement that his belief be scrutinized under both subjective and objective standards. Id. at 11 (citation omitted). Third, the complainant could not reasonably have believed that increasing the amount paid to the company s restaurant for catered lunches was illegal; these allegations were speculative and unsubstantiated. Id. at Materiality. Whether a securities violation has occurred often depends on whether a matter is material to the company s finances, described by the Supreme Court as a depending on whether there is a substantial likelihood that a reasonable shareholder would consider [the matter] important to his decision to invest. TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976). Quantitatively, the accepted rule of thumb is that omissions or misstatements affecting financial disclosures by less than five percent are presumed immaterial. See Staff Accounting Bulletin No. 99, 64 Fed. Reg. 45,150, 45,151 (1999). Given the importance of materiality under the securities laws, to what extent under the SOX whistleblower provision must a matter be material in order for an employee to reasonably believe that the securities laws are being violated? As noted at pages above, Harvey, 2004-SOX-20, suggested that SOX protected activity must implicate a company s financial reporting and that the matter must be of sufficient significance to be material. The complainant had alleged race discrimination; the judge found this not to be protected activity because, in part, [i]ndividual, rather than systemic, discrimination does not reach that materiality threshold in terms of a corporation s financial 14

20 condition. Id. at 13. On the other hand, SOX might be implicated by failure to disclose a class action lawsuit based on systematic racial discrimination with the potential to sufficiently affect the financial condition of the corporation.... Id. In Getman v. Southwest Securities, 2003-SOX-8 (ALJ Feb. 2, 2004), the complainant was a securities analyst for an investment bank who alleged that she was terminated for failing to upgrade her rating of a particular company s stock. The ALJ discussed materiality and other elements of a 10(b)(5) claim under the securities laws, finding that the disputed information in the case was material because reasonable investors... rely on Respondent s rating in making investment decisions. Id. at 14. By contrast, in Morefield, 2004-SOX-2, the ALJ denied a motion to dismiss where the alleged fraud concerned.0001% of the parent company s revenues. It would not be appropriate in the abstract to dismiss [the complaint] as a matter of law because the matter was relatively insignificant in dollar value, the judge explained. Id. at 5. The SOX whistleblower provision places no minimum dollar value on the protected activity it covers. Whether or not materiality is a required element of a criminal fraud conviction as Respondents contend, we need to be mindful that Sarbanes-Oxley is largely a prophylactic, not a punitive measure. The mere existence of alleged manipulation, if contrary to a regulatory standard, might not be criminal in nature, but it very well might reveal flaws in the internal controls that could implicate whistleblower coverage for seemingly paltry sums. Id. In Welch v. Cardinal Bankshares Corp., 2003-SOX-15 (ALJ Jan. 28, 2004), at 38, the ALJ stated without elaboration that it was reasonable for the complainant to believe that certain disputed journal entries were material, evidently because the respondent subsequently restated its financial statements. The complainant s activities with respect to the company s auditing practices and internal financial controls were held to be protected without discussion of materiality. 4. Mail and wire fraud. Sarbanes-Oxley was enacted to address corporate fraud on shareholders, and discussion of the SOX whistleblower provision has tended to center on its protection for complaints about a 15

21 violation of any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud on shareholders. However, the statute s whistleblower provision refers to reported violations not only of the federal securities laws, but also of federal statutes that prohibit mail, wire, and bank fraud. 18 U.S.C. 1341, 1343, As noted above, a separate section of the Act also makes it a crime to interfere[ ] with the lawful employment or livelihood of any person in retaliation for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any Federal offense , codified at 18 U.S.C. 1513(e) (2004).) There has been little discussion in the caselaw to date of the degree to which complaints implicating mail, wire, or bank fraud are protected activity even when wholly divorced from potential shareholder fraud or other securities-related violations. In Hopkins, 2004-SOX-19, the judge observed that an element of intentional deceit that would impact shareholders or investors is implicit in the Act s whistleblower provision. Id. at 5. A similar view is expressed in Harvey, 2004-SOX-20, at In Platone, 2003-SOX-27, the complainant alleged that the company had allowed certain employees to receive reimbursements to which they were not entitled because the employees were union leaders from whom the company sought concessions in bargaining. Noting that [t]he statutes referred to in the Sarbanes-Oxley Act encompass mail, wire, bank, and securities fraud, the judge found that the employees alleged improper activity in the case by its very nature, would involve the use of the mail and wires, and could constitute fraud on the [corporate] shareholders. Id. at 24. No further discussion of the mail and wire fraud statutes appears in the opinion. 5. Degree to which one s regular job duties may be protected activity. In a large corporation, many personnel routinely express views on matters that concern the company s financial condition and that, accordingly, touch on the company s disclosures to the SEC and shareholders. Accountants, for example, are paid to identify, assess, and resolve issues that ultimately may be reflected in corporate financial statements are they engaged in protected activity every time they opine on the appropriate accounting treatment? Suppose that a 16

22 company wishes to account for an expense in a certain manner to receive more favorable tax treatment. For reasons that are fairly obscure, the company s approach is correct, but one of its accountants insists on a different approach and argues that the company s preferred method violates accepted accounting standards. The employee is wrong, but it s a close question; his belief is not unreasonable. Has he engaged in protected activity? Suppose further that the same employee repeatedly insists on accounting approaches that would be more costly for the company; again, the employee is wrong in believing that the approaches he advocates are required, but his view is never wholly unreasonable. May the employee be terminated for performance reasons? Although these questions have not been addressed to date in decisions of administrative law judges applying SOX, there is reason to expect they may become important as the caselaw under the Act develops. A case that may prove important on the issue is Huffman v. Office of Personnel Mgmt., 263 F.3d 1341 (Fed. Cir. 2001). Huffman was an assistant inspector general at the Office of Personnel Management who reported gross mismanagement and abuse of authority within the agency. He subsequently was removed from his position and filed a complaint under the federal employee Whistleblower Protection Act. The Office of Special Counsel (which investigates and prosecutes whistleblower cases on behalf of federal employees), the Merit Systems Protection Board, and the Court of Appeals for the Federal Circuit all found that Huffman had not engaged in protected activity. Reiterating a rule it has applied in other cases, the Federal Circuit stated that an employee who makes disclosures as part of his normal duties cannot claim the protection of the WPA. Huffman, 263 F.3d at The federal whistleblower law was intended to protect employees who go above and beyond the call of duty and report infractions of law that are hidden, the court explained. Id. at The court also based its decision on the ground that extending protection to assigned normal duties would be inconsistent with the WPA s recognition of the importance of fostering the performance of normal work obligations and subjecting employees to normal, non-retaliatory discipline. Id. at If one s normal duties were protected activity under the Act, the court explained, any discipline for work 17

23 performance would be presumptively illegal.... We find it highly unlikely that Congress intended this result. Id. at An early OSHA decision dismissing a SOX whistleblower complaint suggests a similar concern to distinguish performance of regular job duties from protected conduct under the Act. The complainant alleged that he was removed as an officer and director of the corporation because, in a board meeting, he disagreed with and challenged certain projections made by the firm s financial consultants. Dismissing the complaint, OSHA observed: Complainant s concerns appear to be a legitimate disagreement with [the corporation s financial consultants] which [the consultants] took into consideration during that Board meeting and made adjustments to the recommendations and projections to accommodate Complainant s concerns. Raising such concerns appears to be an appropriate function of a member of a Board of Directors, and in the end Complainant s concerns may have proved justifiable. However, expressing such concerns about potential errors is not a statement of knowledge of fraud or intentional wrongdoing. From the best evidence available, at no time did Complainant assert that [the consultant s] recommendations or cost savings were fraudulent. D Agostino v. Workflow Management, Decision in Case No (Aug. 4, 2003), at 2. On the other hand, ALJ s in a number of other SOX cases have not hesitated to find the complainant to be engaged in protected activity when performing regular job duties. In Welch, 2003-SOX-15, the complainant was respondent s CFO. When he expressed concerns with the company s financial statements and internal controls, the judge observed, the complainant was clearly acting in furtherance of his fiduciary duty to disclose possible wrongdoing. Id. at 47. [P]ermit me to perform the job functions as outlined in my job description, the complainant had insisted to the company. Id. at 9. The judge held this to be protected activity under SOX. Another source that may guide the Labor Department as it develops the law in this area is the caselaw interpreting the provision of the False Claims Act ( FCA ) that prohibits retaliating against an employee for reporting or investigating fraud that violates that Act. 31 U.S.C. 18

24 3730(h) (2004). 4 Courts interpreting the FCA whistleblower provision have required a heightened showing of protected activity for employees whose job involves investigating or reporting fraud. Under these cases, employees with such investigative responsibilities must put [the] employer on notice that the False Claims Act is implicated by, for example, characterizing the employer s conduct as illegal or fraudulent or recommending that legal counsel become involved. Hutchins v. Wilentz, Goldman & Spitzer, 253 F.3d 176, (3d Cir. 2001) (collecting cases) (citations omitted). In sum, the relationship between protected activity and regular job duties is a recurring issue under whistleblower statutes and should be expected to receive increased attention as caselaw develops under the Sarbanes-Oxley Act. D. Preliminary Reinstatement. As noted above, if OSHA finds reasonable cause to believe a SOX whistleblower violation occurred, the agency will issue a preliminary order providing all relief necessary to make the employee whole, including, [w]here appropriate, reinstatement with the same seniority status that the employee would have had but for the discrimination. 29 C.F.R Filing objections and a request for an ALJ hearing stays most of OSHA s preliminary order, but not the order of immediate reinstatement. 29 C.F.R (c). This provision is likely to cause employers considerable difficulty in certain circumstances. SOX complainants often have come from highly-placed positions in the corporation with access to sensitive, confidential financial information. Thus, in the Welch case, the complainant had been the company s CFO; in D Agostino, the complainant had been a corporate officer and director. Companies will often find it difficult to restore to such positions individuals with whom they are in acrimonious litigation. 4 See generally Reddy v. Medquist, Inc., 2004-SOX-35 (ALJ June 10, 2004) at 3, noting that [A]s the whistleblower provisions of Sarbanes-Oxley are similar to whistleblower provisions found in many federal statutes, it is appropriate to refer to case authority interpreting these whistleblower statutes. 19

25 The preamble to the interim final rule implementing the whistleblower provision suggests some grounds for contesting preliminary reinstatement when OSHA has made a finding adverse to the company. It states: [A]s under AIR21 the whistleblower law for airline workers a preliminary order of reinstatement would not be an appropriate remedy where, for example, the named party establishes that the complainant is, or has become, a security risk based upon information obtained after the complainant s discharge in violation of Sarbanes-Oxley, citing McKennon v. Nashville Banner Publishing Co., 513 U.S. 352, (1995). 68 Fed. Reg. at 31,862 (emphasis added). In the context of Sarbanes-Oxley, it seems sensible to read this passage to refer not merely to a physical security risk which is of real concern in airline safety, but has little bearing in the typical Sarbanes-Oxley case but also to the security of the company s financial integrity and confidential financial data. The preamble to the interim rule also states that in appropriate circumstances, in lieu of preliminary reinstatement, OSHA may order that the complainant receive the same pay and benefits that he received prior to his termination, but not actually return to work. Such economic reinstatement frequently is employed in cases arising under section 105(c) of the Federal Mine Safety and Health Act of See, e.g., Secretary of Labor on behalf of York v. BR&D Enters., Inc., 23 FMSHRC 697, 2001 WL **1 (June 26, 2001). 68 Fed. Reg. at 31,862. It is likely that complainants and employers will prefer this approach in certain circumstances. E. Appeal to the Administrative Review Board. An ALJ decision under the SOX whistleblower provision becomes a final order of the Department unless a petition for review is filed within 10 business days. 29 C.F.R In cases where the ALJ issues a decision finding liability and retains jurisdiction to determine damages, the question has arisen whether the petition must be filed immediately after the liability determination, or whether instead appeal should await the conclusion of proceedings before the ALJ. Thus, in Welch, 2003-SOX-15, the ALJ issued a Recommended Decision and Order (RD&O) finding that the employer violated the anti-retaliation provisions of the Act and ordering reinstatement, but retained jurisdiction of the case for purposes of a final determination 20