Recent Decisions Regarding The Whistleblower Provision Of The Sarbanes-Oxley Act

Friday, September 1, 2006 - 01:00

The whistleblower provision of the Sarbanes-Oxley Act of 2002 (the 'Act' or 'SOX') protects employees of public companies who report conduct they reasonably believe constitutes a violation of federal law relating to financial, securities or shareholder fraud. Recently, a number of important decisions have been handed down interpreting this provision. These decisions concern various issues, including the Act's reinstatement provision, the 90-day statute of limitations, whether a complaint of class-wide race discrimination constitutes 'protected activity,' and the question of whether an arbitrator or court may determine arbitrability of a SOX claim pursuant to a Form U-4.

Preliminary Reinstatement Orders

The Act's regulations provide not only that an ALJ may order reinstatement of the complainant to his or her former position, but also that any such order may not be stayed pending an appeal to the Administrative Review Board. 20 C.F.R.1980.109(c).

A split Second Circuit Court of Appeals recently held that a federal court should not have enforced the preliminary reinstatement of a SOX whistleblower based on a Department of Labor ('DOL') investigation and order. In Bechtel v. Competitive Techs., Inc. , No. 05-2404 (2d Cir. May 1, 2006), an employee filed a complaint against his employer under the Act alleging he was terminated for, among other things, reporting his concerns to the employer's disclosure committee that potential litigation should be disclosed and informing the CEO that he believed the CEO had engaged in insider trading.

Following an investigation, the DOL issued a determination in February 2005 finding reasonable cause to believe that the employee's termination violated the Act and ordering the employer preliminarily to reinstate him. An ALJ denied the employer's motion for a stay of the preliminary order reinstating the employee. Thereafter, a federal court found that the employee was entitled to an injunction to enforce the preliminary order reinstating him, despite the employer's filing of objections. The court explained that the employer's objections to the ALJ's preliminary order requiring reinstatement did not stay the order; rather, the Act required that the court enforce the order as if it were final. Bechtel v. Competitive Techs. Inc. , No. 3:05CV629 (AVC) (D. Conn. Mar. 13, 2005).

On appeal, the Second Circuit majority held that a preliminary injunction should not have been granted to the employee by the federal court, although the two-judge majority could not agree as to precisely how the trial court had erred in granting the injunction. Judge Jacobs opined that there was nothing in the language of the Act that gave federal courts power to enforce a preliminary reinstatement order, while Judge Ueval wrote that the DOL violated the employer's due process rights by failing to provide details of its findings during the investigation.

In an unrelated matter, the DOL's Administrative Review Board confirmed the reinstatement of the CFO of Cardinal Bankshares. Welch v. Cardinal Bankshares Corp. , DOL 2003-SOX-15 (Mar. 13, 2006). The ruling followed a federal court's refusal to enforce Welsh's reinstatement after a finding that his termination was violative of the Act. The federal judge found that earlier administrative decisions in the case created confusion over who had authority to order reinstatement. The DOL'S latest decision confirmed that 'an AU's decision requiring reinstatement is effective when the employer receives the decision and will not be stayed unless the Board grants a motion to stay the reinstatement.'

Race Bias Complaint To EEOC Not Protected Activity Under The Act

An employee relations specialist at Hewlett Packard who threatened to take to the Equal Employment Opportunity Commission ('EEOC') or the DOL allegations of race discrimination that could result in a class action lawsuit failed to show that such threats were protected activity under the Act. Smith v. Hewlett Packard , DOL 2005-S OX00088 (Jan. 19, 2006). The complainant believed, based on interviews of employees at the company and a company report suggesting that performance evaluations disparately impacted African Americans, that he had uncovered systemic race discrimination. The complainant reported his conclusion that the company had engaged in discrimination but refused to provide the names of the individuals involved in his interviews. The relationship between complainant and the company deteriorated and, after complainant threatened to take his allegations to the EEOC and the DOL and mentioned a possible class action lawsuit, Hewlett Packard terminated his employment. The ALJ found that the complainant was unable to connect his allegations to securities fraud and dismissed the claim. However, the ALJ left open the possibility that a race discrimination claim could be the basis of a SOX claim because of the effect of such a case on investors: 'Had such a suit actually been filed, and if HP had prevented that information from reaching its shareholders, and if [Smith] had learned of this omission and if he had reported it, then he would have engaged in protected activity under the Act.'

Court Permits Former Executive To Pursue SOX Claim And Breach OfContract Claim Alleging Retaliation For Having Reported Wrongdoing

The United States District Court for the Southern District of New York refused to dismiss a former employee's claim that his employer violated the Act when it fired him days after he prepared an email stating that his employer had retained WorldCom bonds for its Los Angeles pension fund clients while selling WorldCom bonds held by its New York pension fund clients. Fraser v. Fiduciary Trust Co. Int'l , No. 04 Civ. 6958 (PAC) (S.D.N.Y. Feb. 15, 2006). The court held that while the e-mail did not expressly state that the company was engaging in illegal conduct, given the context of the email and the circumstances giving rise to the communication, it was nevertheless sufficient to satisfy the pleading requirement for a SOX whistleblower claim. Specifically, the e-mail questioned the company's failure to communicate to the Los Angeles office its prudent decision to have clients of the New York office sell the bonds (thus allowing the Los Angeles clients to suffer losses related to their holding of WorldCom bonds).

The court also applied a rarely-invoked exception to New York's employment at will doctrine to allow the employee to proceed with his breach of contract claim. The court found that the employer's written policy, contained in its employment manual, assuring employees that they would not be retaliated against for reporting in good faith illegal conduct by other employees, 'create[s] a limitation on the at-will nature of [Plaintiff's] employment.' Because the employee alleged that he was aware of this policy and detrimentally relied on it in accepting employment, his breach of contract claim survived a dismissal motion.

No SOX Violation Where Employer Would Have Fired Employee Despite Protected Activity

In Halloum v. Intel Corp. , DOL 04-SOX-068 (Jan. 31, 2006), an Intel employee who reported alleged financial improprieties to the Securities and Exchange Commission and was given unrealistic work goals in retaliation failed to prove his SOX whistleblower allegations because Intel would have fired him anyway. While accepting that complainant engaged in protected activity under the Act, and that Intel took unfavorable personnel action in retaliation, Intel also put forth 'clear and convincing' evidence showing that it would have terminated the complainant even in the absence of protected activity because complainant did not integrate himself into the workforce and he failed to meet expectations by missing meetings, failing to understand Intel's business, and missing work. Because the DOL determined that Intel would have taken the same personnel action in the absence of the protected activity, Intel avoided liability under SOX.

Arbitrability Of SOX Claim Is ADecision For Arbitrators

The Second Circuit Court of Appeals decided that arbitrators not a court must decide whether a whistleblower claim under the Act is subject to arbitration or is an 'employment discrimination' claim exempt from mandatory arbitration under rules for workers in the securities industry. Alliance Bernstein Inv. Research c Mngt. Inc. v. Schaffran , No. 05-4437-CV (2d Cir. Apr. 12, 2006). In Alliance , the complainant signed a Form U-4 when he began working for Alliance Capital Management. While that form contains a mandatory arbitration clause with respect to any controversies between the complainant and his employer, NASD Rule 1020 1(b) contains an exception to the general rule for statutory employment discrimination claims. The only question before the court was whether a court or an arbitration panel should decide the threshold question of arbitrability. The general presumption under the Federal Arbitration Act and state contract law is that the arbitrability question should be decided by the courts unless the parties have clearly and unmistakably provided otherwise. Here, the court decided that the NASD Code of Arbitration - incorporated into the Form U-4 by reference - provides that disputes over the interpretation of its provisions must be arbitrated and this language unmistakably evinces an intent to submit questions of this type to arbitration.

Employee's Ignorance Of SOX Timing Requirements Cannot Save An Untimely SOX Claim

An ALJ recently held that an employee who was fired for insubordination cannot salvage an untimely SOX claim under the theory that the law was so new that he did not know about the Act's 90-day statute of limitations. Moldauer V. Canandaigua Wine Co. , DCL 2004-SOX-022 (Dec. 30, 2005). The ALJ refused to revive the claim, holding that the complainant's attorney's lack of familiarity with the law did not justify waiving the timing requirements: 'Moldauer's argument is not persuasive because ignorance of the law generally will not support a finding of entitlement to equitable modification.'

Lessons For Employers

It is imperative that employers covered by SOX familiarize themselves with the Act and have complaint and investigation procedures in place to handle SOX allegations by employees. While some courts seem to be reluctant to confirm preliminary orders of reinstatement by the DOL, the DOL routinely grants this remedy. The Fraser and Smith cases instruct employers that SOX complainants need not explicitly state their belief that securities or shareholder fraud has occurred. Courts and the DOL may well take a broad view of what constitutes 'protected activity' under the Act. The Halloum case reinforces the importance of creating and maintaining adequate documentation of performance deficiencies and the reasons for adverse employment actions in order to minimize the likelihood of liability under the Act.

Employers should also be aware that, while it is good practice to have whistleblower policies in their handbooks, SOX claimants may seek to pursue breach of contract claims in addition to SOX claims.

Employers who require their employees to sign arbitration agreements should ensure that their agreements mandate that all disputes, including the threshold question of arbitrability of SOX claims, be decided by arbitrators.

Finally, the statute's 90-day statute of limitations will be strictly enforced and ignorance of this short deadline, even in light of the Act's recent enactment, will not excuse a late filing.

Kevin B. Leblang is a Partner and heads the Employment Law Department at Kramer Levin Naftalis & Frankel LLP. Izabel P. McDonald is a Special Counsel at the firm. Her practice concentrates on employment litigation and counseling.

Please email the authors at kleblang@kramerlevin.com or imcdonald@kramerlevin.com with questions about this article.