Justice Oliver Wendell Holmes, Jr. maintained that the law could only be understood as a response to the needs of society. According to Justice Holmes, political, social, and economic forces play a major role in shaping the statutes that are ultimately enacted and the decisions that courts ultimately render. This article reviews three interesting employment law developments, each of which reminds us of Justice Holmes' words that the law does not exist in a vacuum but responds to "felt needs of society." Each of these developments also underscores the fact that the workplace is one of the most regulated areas of American life.
The first development extends the strong public policy underlying the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley") to the employees of subsidiaries of publicly traded companies. The second development involves a recent decision by the United States Supreme Court that refused to apply the protection of the federal age discrimination laws to a worker over 40, who alleged favoritism of an even older worker. The third development reflects the continuing tension between the use of stock options and other long-term incentive programs, on the one hand, and the use of forfeiture provisions to restrain (or at least to discourage) the movement of executives between competitive organizations, on the other hand.
Whistleblower Protection Under Sarbanes-Oxley
Section 806 of Sarbanes-Oxley generally prohibits employers from discriminating against employees in situations in which the employee has reported a violation of federal securities law. By its terms, this whistleblower protection only applies to employees of publicly traded companies. However, earlier this year an administrative law judge held that the whistleblower protections of Sarbanes-Oxley extend to employees of non-public subsidiaries of publicly traded companies.
In Morefield v. Exelon Services, Inc., No. 2004-SOX-00002 (ALJ, Jan. 28, 2004), a former Vice President was allegedly harassed and eventually terminated for filing a complaint about manipulated financial reports with the Occupational Safety and Health Administration (the division of the Department of Labor responsible for Sarbanes-Oxley whistleblower provisions). Exelon Services, as the respondent, argued that Morefield was not a protected whistleblower because he was not an employee of a publicly traded company. The company also asserted that Morefield's actions did not constitute "whistleblowing" because the allegedly false financial statements of the subsidiary company had no material effect on any information publicly disclosed by the parent corporation.
The administrative law judge held that the full protections of Sarbanes-Oxley were applicable to Morefield, even though he was the employee of the non-public subsidiary. The judge acknowledged that the whistleblower provision specifically applies only to employees of publicly traded companies and their agents and contractors. Nonetheless, the judge reasoned that the non-public subsidiaries are "an integral part of the publicly traded company" and "more than mere agents." Therefore, the judge concluded that employees of non-public subsidiaries must be treated as inseparable from their parents in order to evaluate the integrity of financial information. The judge also relied on the general purpose and intent of Sarbanes-Oxley, noting that "Congress has long employed the inside whistleblower as a first line of defense against various types of abuses which it deems unacceptable."
The judge then examined the corporate structure before him. The court observed that the respondent, Exelon Services, was one of several subsidiaries of Exelon Enterprises, which itself was one of several subsidiaries of Exelon Corporation, a publicly traded company. If whistleblower protection was not extended to employees of subsidiaries, the judge reasoned, "not a single whistleblower in Exelon Corporation's vast network of non-publicly traded corporate subsidiaries would be entitled to Sarbanes-Oxley whistleblower protection" and the free flow of potentially crucial information regarding financial impropriety would be stifled. In other words, the administrative law judge was responding to the "felt needs of society," much the same way Justice Holmes did over seventy years ago.
The judge also dismissed the company's argument that the financial reports about which Morefield complained were internal to the subsidiary and immaterial to the parent corporation. The judge stressed that the value of the whistleblower provisions is in enlisting the aid of corporate insiders so that an employee may "head off the type of manipulations" that would deceive the public before they are disclosed. The fact that there had not yet been public dissemination of false or material information was thus immaterial to the court because "Sarbanes-Oxley is largely a prophylactic, not a punitive measure."
The Federal Age Discrimination Law Does Not Prohibit "Reverse" Discrimination
This year's second development involves a new ruling under the Age Discrimination in Employment Act of 1967 (the "ADEA"). The ADEA prohibits "discrimination . . . because of [an] individual's age" and protects all employees over the age of 40. Under the ADEA, an employer shall not discriminate against an older worker (who is over 40) in favor of a younger worker. However, the reverse situation is not protected by the ADEA: that is, under federal law, an employer may discriminate against a younger worker in favor of an older worker. A recent Supreme Court decision has established that an employer does not violate the ADEA by providing preferential treatment to older workers over younger ones, even where the younger workers are over the age of 40.
On February 24, 2004, the United States Supreme Court decided General Dynamics Land Systems, Inc. v. Cline, No. 02-1080, 540 U.S. __ (2004). In General Dynamics, the company and its union negotiated a new collective bargaining agreement that offered retiree health benefits only to those employees who were at least fifty years of age at the time of the new agreement. A group of employees who were in their forties sued, claiming that the age requirement constituted illegal age discrimination in violation of the ADEA.
The Supreme Court disagreed and held that the ADEA only prohibits discrimination in favor of younger employees and does not address discrimination that favors older workers. The Court acknowledged that the statute on its face could be read to prohibit discrimination in favor of older employees. The Court, however, reviewed the legislative history of the ADEA and determined that the purpose of the law was only to prohibit discrimination in favor of younger employees. Thus, the Court reversed the Sixth Circuit Court of Appeals, holding that the ADEA does not prohibit reverse age discrimination.
General Dynamics, however, only settles the question of reverse age discrimination or preferential treatment under federal law. New York state and city law, in contrast, may still prohibit employers from favoring older employees over younger ones. Unlike the ADEA, the New York State and City Human Rights Laws regarding age discrimination apply to all employees who are 18 or over. Moreover, at least one New York case has found that reverse age discrimination violates New York state law. In McLean Trucking Co. v. State Human Rights Appeal Bd., 437 N.Y.S. 2d 309 (1st Dep't 1981), aff'd, 55 N.Y.2d 910 (1982). The New York appellate court held that an employer violated the New York State and the New York City Human Rights Law when it applied a minimum age requirement of 24 to reject a 23-year-old applicant. Therefore, although the Supreme Court's decision in General Dynamics precludes reverse age discrimination claims under the ADEA, such claims may still survive under state and local laws.
Forfeiture For Competition And The Employee Choice Doctrine
Our third development profiles the growing trend among companies to find creative ways to enhance the enforceability of restrictive covenants or non-compete agreements in the employment context. One approach taken by many companies amending their stock option and restricted stock plans is to provide that an employee will forfeit his right to exercise options or sell restricted stock if the employee competes in any way with the company upon the termination of his employment.
In 1979, the New York Court of Appeals, in Post v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 93 N.Y.2d 382, held that a forfeiture provision based on a broad non-competition covenant is enforceable, without regard to its reasonableness, where the employee chooses to leave the company and compete with his former employer. A decision from the Second Circuit has clarified this "employee choice" doctrine. In doing so, the Second Circuit established that a forfeiture-for-competition provision in a stock option plan is inappropriate for summary judgment in situations in which a factual dispute existed regarding whether the employee resigned voluntarily or was fired from the company. The recent proceedings on remand to the District Court are also instructive of the complications that are likely to arise when there are conflicting inferences to be drawn regarding whether an employee departed voluntarily from the company or was fired.
Edward Lucente, an IBM executive who was president of IBM's Asia-Pacific Division and who reported directly to the CEO, retired from IBM. A few months before he left IBM, IBM's CEO told Lucente that his business plan for the upcoming year was not acceptable, and that he was "being replaced" in Tokyo. IBM's CEO encouraged Lucente to seek the best opportunity he could find, "either within IBM, or ominously, at another company." In spite of these "signals," IBM's CEO maintained that "it was perfectly all right by me [for Lucente] to stay in the IBM company if that was his choice" but noted that there were only two or three jobs in the entire company with similar responsibility to the position Lucente held in Tokyo. Two months later, Lucente left the company, and, two years later, after an interim position elsewhere, Lucente took a job with an IBM competitor. IBM then cancelled Lucente's stock options and restricted stock pursuant to a forfeiture-for-competition provision, and Lucente sued.
The United States District Court for the Southern District of New York (MacMahon, J) granted Lucente summary judgment, holding that the forfeiture provisions were unreasonable and unenforceable as a matter of law because a reasonable juror could not find that Lucente left IBM voluntarily. In the subsequent decision, the District Court awarded Lucente damages in connection with his stock options and restricted stock in excess of $6 million.
The Second Circuit, however, reversed and remanded in late 2002, holding that there was a disputed question of fact as to whether Lucente quit or was fired. Lucente v. International Business Machines Corp., 310 F.3d 243 (2d Cir. 2002). The Second Circuit clarified employee choice by setting forth three requirements for the doctrine to apply and for this forfeiture provision to be enforced. First, the employer must "demonstrate its continued willingness to employ the party who covenanted not to compete" in order to take advantage of the doctrine. Second, the employer must not have involuntarily discharged the employee without cause because enforcing a non-competition provision under such a circumstance would destroy the mutuality of obligation on which the restrictive covenant was based. And third, the Court, citing prior cases, noted that "the factual determination whether an employee was involuntarily terminated is generally not appropriate for summary judgment.
On the record presented, the Second Circuit held that a reasonable juror could conclude that Lucente left IBM involuntarily, and the Court therefore remanded the case to Judge MacMahon for further proceedings consistent with this ruling. In doing so, the Court reaffirmed the general principle that "where an employee who elects to leave a company makes an informed choice between forfeiting a certain benefit or retaining the benefit by avoiding competitive employment," that employee will forfeit the benefit if he competes with his former employer.
The proceedings on remand lasted for eighteen months of pre-trial discovery and motion practice - a longer time period than the first round of proceedings before the District Court prior to the Second Circuit appeal. Given the Second Circuit's ruling, there was substantial discovery of the alleged "oral understandings" between Lucente and IBM's CEO, and over discovery relating to IBM's treatment of the incentive awards of other "departing executives." Thus, the Second Circuit's ruling appears to have opened the flood gates for extensive discovery relating to the circumstances regarding Lucente's departure from IBM and IBM's conduct in the months preceding his departure. Finally, in November 2003, the case settled for an undisclosed monetary sum - prior to a trial on remand of what the Second Circuit called somewhat ironically the "bedrock question of whether Lucente quit or was fired".
As 2004 progresses, the legislature and the courts will no doubt continue to seek to respond to the "felt needs of society" in balancing the inherent tensions between regulation and free competition, between the promotion of a fair workplace and one that permits some preferential treatment for some older workers, and between the protection of the needs of an employer and the employee choice doctrine.
Michael C. Lasky is a Partner and Daniel A. Feinstein is an Associate in the Litigation Department and Employment Practices Group of New York-based Davis & Gilbert LLP.