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Employers Beware; General Assertions of Alleged Fraud May be Enough to Trigger SOX Whistleblower Protection
Under Section 806 of the Sarbanes-Oxley Act (SOX), it is illegal for publicly traded companies to retaliate against employees who report suspected fraud. 18 U.S.C. § 1514A. Seemingly straightforward in many respects, this anti-retaliation provision has generated significant litigation since its passage by Congress. Among other things, for example, courts across the country have confronted questions concerning the scope of so-called protected activity; that is, examining the type of “whistleblowing” activity required of the employee to trigger the statute’s protection.
By statute, employees are protected if they engage in lawful acts to provide information regarding “any conduct which the employee reasonably believes constitutes a violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders.” 18 U.S.C. § 1514A(a)(1). Employees must, generally speaking, blow the whistle on corporate fraud or, more to the point, what they reasonably believe to be corporate fraud.
Addressing this issue of protected activity, courts have struggled with defining the specificity required in the employee’s whistleblowing report to trigger protection. Companies often argue, understandably, that the whistleblowing must be specific as to the purported violation and must provide facts sufficient to establish each element of the alleged fraud. Conversely, whistleblowing employees suggest less specificity is required by statute.
The United States Court of Appeals for the Sixth Circuit recently weighed in on precisely this issue. In Rhinehimer v. US Bancorp Investments, Inc., a panel of the 6th Circuit unequivocally rejected the “definitively and specifically” standard proposed by the defendant publicly traded company (and previously adopted by the 2nd, 4th, and 5th Circuits). Instead, the Rhinehimer Court adopted the rule “that the employee’s reasonable belief is a simple factual question requiring no subset of findings that the employee had a justifiable belief as to each of the legally-defined elements of the suspected fraud.” As the court reasoned, “[t]he text and design of § 1514A does not suggest any heightened showing of a factual basis for the suspected fraud. . . . Indeed, at every juncture, the statute sweeps broadly, encompassing a wide swath of acts, limited only by their legality, to provide information or assistance to an investigation ‘regarding any conduct’ reasonably believed by the employee to constitute a violation of relevant law.”
In short, according to Rhinehimer, the employee whistleblower need not present a factual showing justifying the suspicion or reasonable belief in corporate fraud. Instead, “the complainant need only show that he or she ‘reasonably believes’ that the conduct complained of” violates one of the enumerated laws.
Employers, even those outside the jurisdiction of the 6th Circuit given legal trends, should be aware that a wider range of employee complaints may technically fall within the ambit of SOX protection. It remains important to promptly and seriously investigate and respond to those complaints. Doing so, as well as acting proactively, may significantly curtail potential liability exposure and legal expenses.
Rhinehimer v. U.S. Bancorp Investments, Inc., No. 13-6641 (6th Cir.) (May 28, 2015)
In an effort to protect corporate fraud whistleblowers, Section 806 of the Sarbanes-Oxley Act makes it unlawful for companies to retaliate against employees for engaging in certain whistleblowing activity. But before a whistleblowing employee can file suit for retaliation, she must first file a complaint with OSHA.
The requirement that whistleblowers exhaust administrative remedies before turning to the courts for relief is nothing new. Similar requirements exist, for example, in discrimination and harassment complaints under Title VII that must first be presented to the EEOC. And like the conciliation process with the EEOC, OSHA has recently issued revised policies and procedures applying a new alternative dispute resolution (ADR) process for whistleblower complaints. OSHA Policies and Procedures
In a press release issued last week, OSHA explains that “[t]he new process is an early resolution process” that “offers whistleblower parties the opportunity to negotiate a settlement with the assistance of a neutral, confidential OSHA representative who has subject-matter expertise in whistleblower investigations.” OSHA Press Release
Hoping to avoid the costs associated with investigations and litigation, the OSHA program offers an early resolution process for settlement negotiations facilitated by a “neutral, non-decision-making OSHA whistleblower expert” and a mediation process that involves a one-day, in-person mediation with “a professional third-party mediator.” Whether such an ADR process will ultimately be effective in resolving whistleblower disputes remains to be seen.
Importantly, OSHA’s new ADR initiative may have an expansive application across industries. OSHA, after all, is concerned with more than just corporate fraud whistleblowers under Sarbanes-Oxley. The agency enforces the whistleblower provisions of 21 other statutes protecting employees who report violations of various trucking, airline, nuclear power, pipeline, environmental, rail, maritime, health care, workplace safety and health regulations, and consumer product safety laws. Employers would be well advised, consequently, to keep themselves at least generally advised of these laws and OSHA’s requirements in the event they confront employee whistleblower complaints.
Fifth Circuit Confirms that SOX Whistleblowers Must Specifically Exhaust Administrative Remedies Before Litigating Issues
Under Section 806 of the Sarbanes-Oxley Act (18 U.S.C. 1514A(a)), employees are protected from retaliation for engaging in certain protected activity related to blowing the whistle on corporate fraud. “Essentially, the employee has to provide information or assist in an investigation that he reasonably believes relates to one or more of six categories of laws and regulations” relating to fraud or SEC rules violations. But before an aggrieved employee can file a lawsuit, he or she must first file a complaint with the Secretary of Labor.
This statutory requirement for SOX whistleblowers is consistent with similar requirements in other laws, but an open question existed as to how specifically courts would examine whistleblowers’ complaints to determine exhaustion. With the Fifth Circuit’s recent decision in Wallace v. Tesoro Corporation, it appears that courts may, indeed, closely scrutinize the specific allegations contained in whistleblowers’ complaints to evaluate exhaustion of administrative remedies.
In Wallace, the plaintiff employee filed an administrative complaint alleging that he was retaliated against for complaining about his employer’s accounting methodology with respect to counting taxes as revenue. After his administrative complaint was dismissed, he filed a lawsuit alleging the same protected activity (complaining about accounting methodology as to taxes as revenue), as well as new allegations that he also engaged in protected activity when he investigated and reported suspected wire fraud. The district court dismissed the new allegations because they were outside the scope of the administrative complaint.
Reviewing the dismissal on appeal, the Fifth Circuit agreed that dismissal was appropriate. Applying the same exhaustion requirement used in Title VII cases, the Fifth Circuit concluded that a SOX whistleblower lawsuit may only properly include those allegations of protected activity that the administrative complaint could be reasonably expected to encompass. Specifically, “[t]he scope of a judicial complaint is limited to the sweep of the OSHA investigation that can reasonably be expected to ensue from the administrative complaint.”
Clearly, SOX-retaliation lawsuits in the Fifth Circuit are limited in scope by the administrative complaint. For employees, that means it is critically important to include everything in the administrative complaint. And for employers, a standard litigation practice should obviously include comparing the allegations in the lawsuit to those in the administrative complaint, moving to dismiss those that were not subject to administrative review.
Wallace v. Tesoro Corp., Case No. 13-51010 (July 31, 2015)
The Securities and Exchange Commission is serious about protecting corporate fraud whistleblowers. Since Congress passed Dodd-Frank in 2010, the SEC has continually attempted to bring more cases on behalf of and initiated by corporate fraud whistleblowers. Enforcement has been more vigorous over the years.
In February, the Wall Street Journal published an article discussing the SEC’s probe of companies’ treatment of whistleblowers. SEC Probe The SEC was reportedly looking into whether companies were attempting to stifle whistleblowing and muzzle whistleblowers through nondisclosure agreements, confidentiality agreements, employment agreements, severance agreements, and the like. Apparently, SEC officials were concerned about a corporate backlash against whistleblowers.
And now the SEC has announced its first settlement with a company accused of improperly restricting whistleblowers through restrictive employment agreements. KBR Settlement KBR, Inc. has agreed to pay $130,000 to settle claims asserted by the SEC that it required employees to sign a confidentiality agreement that could have kept them from reporting possible violations of securities laws to outside authorities. More specifically, the KBR confidentiality agreements purportedly included language warning employees that they could face discipline, including termination, if they discussed internal investigations with outside parties unless they first obtained approval from KBR’s legal department.
The pre-notification requirement in the KBR agreement, according to the SEC, is unlawful because it may have a chilling effect on employees, discouraging them from reporting securities violations to appropriate authorities. As a part of its settlement, KBR agreed to amend its confidentiality agreements to clarify that employees can report possible violations to the SEC and other federal agencies without prior KBR approval.
Along with its announcement of the KBR settlement, the SEC indicated that it has a number of other pending investigations involving companies silencing whistleblowers and that it will vigorously enforce these matters.
Although confidentiality agreements are oftentimes essential tools for companies to use in sensitive situations and in dealing with employees, those agreements must be carefully crafted so as not to run afoul of existing regulations. This is especially true in light of the SEC’s aggressive enforcement initiative.
In the matter of KBR Inc. (SEC File No. 3-16466)
Employers and employees alike are increasingly facing the prospect of being involved in issues relating to allegations of corporate fraud. Oftentimes the issue first arises when an employee-whistleblower voices a complaint internally to her employer. The employer’s response to an internal complaint – and treatment of the employee making the complaint – is critical to determining how the matter progresses. Under Section 806 of the Sarbanes-Oxley Act, of course, employers cannot retaliate against corporate fraud whistleblowers.
Providing guidance to employers and employees, the Department of Labor recently published a final rule addressing procedures and timing for claims of retaliation against corporate fraud whistleblowers. Under the rule, an employee who believes her employer retaliated against her for blowing the whistle on corporate fraud must file a complaint with OSHA within 180 days. In that complaint, which may be written or oral, the employee must show that her whistleblowing was a contributing factor in the adverse action taken by her employer. OSHA is then charged with investigating the complaint and, if it finds reasonable cause to believe the employer violated SOX, issuing a preliminary order providing appropriate relief to make the employee whole, which may include reinstatement.
During OSHA’s investigation, importantly, the employer will be advised of the allegations made and will have the opportunity to show by clear and convincing evidence that it would have taken the adverse action against the employee regardless of the whistleblowing. If the employer makes that showing, the investigation ends.
The Department of Labor’s final rule on SOX whistleblower retaliation – Procedures for the Handling of Retaliation Complaints Under Section 806 of the Corporate and Criminal Fraud Accountability Act of 2002 – was effective as of March 5, 2015. SOX Final Rule
Addressing a SOX whistleblower retaliation claim, the Fourth Circuit in Jones v. SouthPeak Interactive Corp. of Delaware recently rendered a determination favorable to employee-whistleblowers on two separate fronts.
First, the Court addressed the applicable statute of limitations. The employer argued that because the claim sounded in the nature of fraud, a two-year statute of limitations applied. The Fourth Circuit disagreed. Since the employee-whistleblower asserted a claim of retaliation, not fraud, the Court concluded that the federal “catch-all” four-year statute of limitations governs SOX retaliation claims.
Second, the Court addressed the scope of damages to which employee-whistleblowers are entitled. Consistent with prior determinations by the Fifth and Tenth Circuits, the Fourth Circuit determined that emotional distress damages are available under SOX. The Court relied on statutory language providing that a prevailing employee “shall be entitled to all relief necessary to make the employee whole” to conclude that the scope of relief includes damages not specifically enumerated by the statute.
Both aspects of the Fourth Circuit’s ruling should give employers facing prospective SOX liability pause. The duration during which exposure lies may be significant, and the scope of potential liability may be substantially broader than otherwise predicted.
Jones v. SouthPeak Interactive Corp. of Del., Case Nos. 13-2399 and 14-1765 (4th Cir. Jan. 26, 2015)
The Sarbanes-Oxley Act provides legal protections to individuals who blow the whistle on certain unlawful behavior. In doing so, the statute prescribes six categories of U.S. laws encompassed by the whistleblower provision. Generally, SOX bars a publicly traded company from retaliating against an employee who reports what she believes to be mail fraud, wire fraud, bank fraud, securities fraud, a violation of SEC regulations or a violation of a federal law related to shareholder fraud. See 18 U.S.C. 1514A(a).
The Fifth Circuit last year clarified that to engage in protected activity under the Sarbanes-Oxley Act, the whistleblower had to report conduct she reasonably believes violates one of those six categories – not conduct she believes is otherwise unlawful. In the case before the Fifth Circuit, the employee attempting to invoke SOX protection alleged that he had been fired after reporting a tax scheme he believed violated Columbian tax law. The Court concluded that the employee’s conduct was not, under the terms of the statute, protected activity under SOX. He was not reporting violations of US laws, much less the specific ones enumerated in SOX.
Regardless of the alleged violation at issue, though, employers should respond carefully and sincerely to an employee’s whistleblowing.
Villanueva v. United States Dept. of Labor, 743 F.3d 103 (2014)
In several contexts, an employee who blows the whistle on certain improprieties or unlawful conduct is afforded legal protection from retaliation. Under Sarbanes-Oxley, for example, a public company cannot retaliate against an employee who blows the whistle on corporate fraud. Similarly, Dodd-Frank protects employees who blow the whistle on securities fraud to the SEC from retaliation.
But with many reports being made anonymously, the situation can easily arise in which the company mistakenly believes a specific employee is the whistleblower when, in fact, she is not. If the company, based on that mistaken belief, takes adverse employment action against that employee, is it subject to liability for that “retaliation”?
The answer, at least in part, will necessarily depend on the jurisdiction. Although a strict application of the whistleblower laws in question may not entitle the employee to protection (e.g., an employee who makes no report cannot invoke Dodd-Frank), the employer may still be subject to liability under a common law cause of action. Indeed, an appellate court in California recently arrived at precisely that result.
In Diego v. Pilgrim United Church, an employee anonymously reported potential violations of state law pertaining to child day cares to the California Department of Social Services. Diego’s supervisor subsequently asked her questions and made comments demonstrating her belief that Diego was the whistleblower. She was not. Nonetheless, Diego was thereafter terminated. She filed suit alleging her termination was in retaliation for her supervisor’s belief that she blew the whistle.
The trial court dismissed the lawsuit, ruling that Diego had not demonstrated an important public policy was at issue in her termination because she never actually blew the whistle. The appellate court, however, reversed, reasoning that terminating perceived whistleblowers could discourage others from actually blowing the whistle.
From the employer’s perspective, it remains important to tread carefully when it becomes aware of a report. Terminating – or taking other adverse employment action – the whistleblower or perceived whistleblower is rarely the optimal response. And employees should remain cognizant that they may be able to invoke certain protection under whistleblower laws or, perhaps, by wrongful discharge litigation.
Diego v. Pilgrim United Church of Christ, 2014 WL 6602601 (Nov. 21, 2014)
Whistleblower Involvement Leads to Substantially Greater Penalties and Criminal Sentences, Study Finds
According to a recently-released academic study on the impact of whistleblowers on financial misrepresentation enforcement actions, the involvement of whistleblowers in securities enforcement actions has a significant impact on both the penalties imposed and jail time faced by company executives and employees. In particular, SEC and DOJ enforcement actions relating to financial misrepresentations to shareholders result in financial penalties for companies that are $90-$93 million greater, financial penalties for executives that average $50-$56 million more, and prison sentences for executives and employees that average 22-27 months longer when a whistleblower is involved.
Designed as an incentive to encourage employees to report wrongdoing, rewards for whistleblowers can be substantial. Under Dodd-Frank, for example, rewards may range from 10%-30% of monetary sanctions over $1 million from investigations and/or enforcements resulting from the employee’s report. The increasing trend toward greater financial rewards for whistleblowers and high-level government encouragement of their actions give rise to a corollary question whether whistleblower involvement in enforcement actions makes a meaningful difference.
Exploring that question, the study reviewed all SEC and DOJ enforcement actions associated with financial misrepresentation between 1978 and 2012, focusing on the effect of employee whistleblowers’ involvement on financial penalties assessed, sentences imposed, and duration of the enforcement actions. Over the study period, approximately $70 billion in penalties were assessed, and various industries were represented, including financial services, utilities, health care, and manufacturing. In the end, the study concluded “that whistleblower involvement in an SEC or DOJ investigation is associated with a significant increase in penalties.”
Whistleblowers would, therefore, seem to be a valuable source of information for regulators, both in terms of disclosing misconduct that might otherwise go undiscovered and in facilitating higher penalties. Companies across a wide range of industries and sectors would be wise to revisit their policies to ensure they have mechanisms in place to timely and properly address whistleblower complaints when they are voiced.
Yesterday, the Fifth Circuit issued a decision that should give employers pause. In a whistleblower retaliation suit brought under Section 806 of the Sarbanes-Oxley Act, the Court ruled that the employer’s disclosure of the whistleblower’s identity is sufficient to trigger potential liability under the statute.
After the employee complained to both the SEC and to the company (supervisors, Board’s Audit Committee) about what he believed were questionable accounting practices dealing with revenue recognition, the company internally disclosed his identity in the context of a document retention email to his colleagues. In that email, the company’s general counsel instructed the whistleblower’s supervisor and others to retain certain documents because “the SEC has opened an inquiry into the allegations of Mr. [whistleblower].” From there, the supervisor forwarded the email to 15 members of the whistleblower’s work group, thereby disclosing the SEC investigation and that the whistleblower complained to the SEC about their accounting practices. After this disclosure, the whistleblower’s colleagues apparently treated him differently, refusing to work or associate with him.
Ultimately, the employee resigned and filed a complaint under SOX section 806, alleging the company illegally retaliated against him by disclosing his identity, which lead to his ostracism. Initially, the Department of Labor Administrative Law Judge who held a hearing and evaluated the evidence, dismissed the complaint, finding that the disclosure was not an “adverse action” because none of the alleged harm rose to the level of being “materially adverse.” On appeal, the Administrative Review Board reversed, saying the disclosure rose to the level of “material adversity.”
The company appealed the Administrative Review Board’s determination to the Fifth Circuit. Reviewing the standard for adverse action, the Fifth Circuit observed that the ultimate adverse action question is “whether the factual circumstances are such that [the employer]’s actions well might dissuade an objectively reasonable employee in [the whistleblower]’s shoes from engaging in protected conduct.” Judged in that light, the Court could not say the Administrative Review Board’s decision was reversible error because disclosure could serve as a deterrent to whistleblowing, dissuading a reasonable employee in the future from reporting concerns.
Disclosing a whistleblower’s identity, leading to ostracism, isolation, and differential treatment by co-workers, may constitute an actionable adverse action. “It is inevitable that such a disclosure would result in ostracism. . . . Furthermore, when it is the boss that identifies one of his employees as the whistleblower who has brought an official investigation upon the department, as happened here, the boss could be read as sending a warning, granting his implied imprimatur on differential treatment of the employee, or otherwise expressing a sort of discontent from on high.”
Halliburton, Inc. v. Administrative Review Board, Fifth Circuit Case No. 13-60323 (Nov. 12, 2014).