Sarbanes-Oxley Strikes . . . . The First Whistle Has Been Blown

Saturday, May 1, 2004 - 01:00

When the Sarbanes-Oxley Act (the "Act" or "Sarbanes-Oxley") was enacted in 2002, it was inevitable the day would arrive when an employee would attempt to use the Act's whistleblower provisions against his publicly-traded employer. Although New Jersey's Conscientious Employee Protection Act ("CEPA") contains similar provisions prohibiting retaliation against employees who engage in good faith reports of alleged violations of law or public policy, and applies to all employers, whether publicly-traded or privately-held, Sarbanes-Oxley has received significant attention because of its national scope and the breadth of its many other requirements. Nonetheless, a recent decision construing the Act has implications for all employers because it may be used as guidance in all types of whistleblower actions.

Earlier this year, in Welch v. Cardinal Bankshares Corp., 2003-SOX-15 (ALJ Jan. 28, 2004), an administrative law judge in Washington, D.C. issued a decision applying the whistleblower provisions of Sarbanes-Oxley, and requiring a company to reinstate its chief financial officer and to pay his back wages, attorneys' fees, costs, and expenses. Cardinal Bankshares has indicated that it intends to appeal the administrative law judge's opinion.

The Cardinal Bankshares decision demonstrates the often competing interests that public companies now face in satisfying their financial reporting obligations accurately while simultaneously managing their workforce and responding to internal allegations of wrongdoing. Most significantly, the decision highlights the necessity for a company to consult with employment counsel before taking any adverse action against an employee who may have engaged in "protected activity" under the Act.

To succeed in a Sarbanes-Oxley whistleblower case, a complainant must establish by a preponderance of the evidence that: (1) the employee engaged in "protected activity" as defined by the Act; (2) the employer was aware of the protected activity; (3) the employee suffered an adverse employment action (such as discharge, suspension, demotion, reduction in pay, etc.); and (4) circumstances exist that are sufficient to raise an inference that the protected activity was likely a "contributing factor" in the unfavorable action. Assuming a complainant meets this burden, his employer may avoid liability only if it produces sufficient evidence to demonstrate clearly and convincingly a legitimate motive for the adverse employment action (in other words, that the employer would have taken the adverse employment action regardless of the complainant's protected activity). In Cardinal Bankshares, the respondent-company's articulated legitimate motive for terminating complainant's employment Ñ that his alleged insubordination threatened the confidentiality of certain proprietary information Ñ was not enough to avoid liability.

In Cardinal Bankshares, the complainant, Mr. David Welch, served as his company's chief financial officer. In that capacity, and over the span of approximately six weeks, Welch repeatedly communicated to the CEO and other senior personnel his concerns regarding the company's financial statements and procedures, including suspected insider trading, inflated earnings reports, restricted access to external auditors, and inadequate internal controls. As a result of his concerns, Welch refused to certify company financial reports. When the company asked Welch to meet with an audit committee without his own personal attorney present (purportedly because the company had its own concerns about disclosure of confidential information), Welch refused, and the company terminated his employment.

Welch filed his whistleblower complaint with the Occupational Safety and Health Administration ("OSHA"), as the administrative procedure of the Act's regulations require. The OSHA investigated Welch's complaint and declined to rule in his favor. Welch then appealed the denial to the United States Department of Labor, Office of Administrative Law Judges ("ALJ"). At the hearing, the company's chief executive officer testified that the company terminated Welch's employment solely based upon Welch's insubordination in refusing to meet with the audit committee without his own personal attorney present, not for any of his "whistle blowing" activities. The company further argued that Welch's activities did not constitute "protected activity" in any event, because Welch could not reasonably have believed that his allegations of wrongdoing by the company were true.

The ALJ concluded that for the alleged retaliatory conduct to be actionable under the Act, Welch need not show that the company actually violated the law, but only that Welch "reasonably believed" that the company had violated the law and that his employment was terminated because he had engaged in activity supported by that belief. The ALJ held that Welch's repeated written complaints were based on his reasonable belief that the company was violating the Act, and thus constituted "protected activity" under the Act. The ALJ specifically recognized, "[w]hether [the company] 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."

In applying the four-part test for establishing a Sarbanes-Oxley "whistleblower" cause of action (as set forth above), the ALJ found present the second element (that the company was aware of the protected activity) and the third element (that the complainant experienced an adverse employment action). By its own admission, the company had been aware of Welch's repeated complaints, and there was no dispute that his employment had been terminated. That left the ALJ to determine the fourth and final element of the test Ñ whether there were circumstances sufficient to raise an inference that Welch's protected activity was likely a "contributing factor" in his termination. Relying almost entirely on the proximity in time between Welch's first complaint and his termination (approximately 2 months), the ALJ concluded, by a preponderance of the evidence, that Welch's conduct was indeed a contributing factor in his termination.

With Welch satisfying all four elements of his whistleblower cause of action, the ALJ next turned to the issue of whether the company had demonstrated, by clear and convincing evidence, that it would have terminated Welch's employment irrespective of him having engaged in protected activity (his complaints). It was the company's last hope to avoid liability and the inevitable resulting scrutiny.

The company argued that it would have terminated Welch's employment regardless of his complaints about the company's alleged wrongdoing. The company maintained, and its CEO testified, that the company had terminated Welch's employment solely because he had refused to meet with the audit committee without his own personal attorney present. The ALJ found the company's articulated motive to be fabricated. The court concluded that the company's requirement that Welch attend the meeting without his attorney present was "arbitrary," and that it was "clearly imposed for the purpose of using Welch's anticipated refusal to comply as a pretext for firing him." The court also found meritless the company's stated concerns that confidential information might be disclosed improperly if Welch's personal attorney were permitted to attend the meeting with the audit committee. Accordingly, the ALJ ordered that: (1) Welch be reinstated as CFO, (2) his personnel file be purged of all references to his engaging in protected activity and the discipline emanating therefrom, (3) the company be required to pay to Welch back pay (with interest), and (4) he be paid his attorneys' fees, costs, and expenses.

Although the company has stated that it intends to appeal, the court's decision in this case is a compelling one, and it should be heeded by all employers, both publicly-owned, because Sarbanes-Oxley applies to such companies, and privately-owned, because the Cardinal Bankshares opinion may be used as a guide in other whistleblower cases. The "reasonable belief" and "contributing factor" standards that the court used in Cardinal Bankshares impose a low threshold for employees to state a claim under the Act. These standards will likely pave the way for additional employee-friendly precedent when it comes to not only Sarbanes-Oxley whistleblower cases, but also other state statutory whistleblower cases. For instance, New Jersey's CEPA also does not require an employee to demonstrate an actual violation of law or public policy Ñ just that the employee "reasonably believed" that a violation had occurred.

The first whistle under Sarbanes-Oxley has been blownÉ make sure your company isn't next to hear it. Consult with your counsel before taking adverse action against any employee who has complained about alleged violations of law or public policy Ñ whether or not those complaints are valid.

David M. Wissert is a member of the firm at Roseland-based Lowenstein Sandler PC, Julie Levinson Werner is counsel to the firm and Vincent A. Antoniello is an associate. All three are members of the firm's Litigation Department and Employment Law Practice Group and can be reached at (973) 597-2500.

Please email the authors at dwissert@lowenstein.com, jwerner@lowenstein.com or vantoniello@lowenstein.com with questions about this article.