Part I of this article appeared in the July 2005 issue of The Metropolitan Corporate Counsel.
Recent Cases Under Sarbanes-Oxley
The Sarbanes-Oxley whistleblower provision, like many similar federal and state whistleblower statutes, is quite broad and, as more than one commentator has noted, open to abuse.
For one, the employee does not actually have to prove that there was a SOX violation, only that he "reasonably believed" that he was reporting a potential violation. In addition, the boundaries of what constitutes a Sarbanes-Oxley complaint are being constantly expanded, beyond the area of securities to almost any financial impropriety that could even loosely be argued as potentially injuring shareholders.
Case One: The Company's Marketing Director is about to be fired for an attendance problem. She comes forward to report that her boss is "padding" his expense account. She is later fired. The employee then argues that she was reporting conduct which she "reasonably" believed amounted to a "fraud on shareholders."
Would that employee have a SOX complaint? Answer - In September 2004, a federal judge said yes - and found that the marketing director of an Atlanta-based home builder could proceed with a SOX whistleblower claim, based on similar allegations.1
Case Two: Your CFO, who is "on the rocks" because of weak performance and battling with the CEO over other issues, refuses to certify the company's quarterly financial reports. Two weeks later he refuses to meet with the company president - which the company considers to be clear insubordination.2 The CFO is fired.
Was this a SOX violation? Answer - Yes . In January 2004, a judge at the Department of Labor found the bank had violated SOX by firing Welch. After a series of appeals, that same ALJ just ordered the terminated CFO reinstated, rejecting all of the bank's arguments as to the disruption and tension which that reinstatement would cause.3
Case Three: The Vice President for investor relations of a small, start-up company gets into a number of disputes with the CEO over his business strategy. She is asked to attend a meeting with an unregistered broker - she refuses to go to the meeting, claiming that there is a potential securities law violation. She is fired 10 days later.
Does the VP have a valid SOX claim? Answer - Yes . An ALJ at the Labor Department ordered her reinstated, and awarded over $200,000 in damages and attorneys fees.4
Case Four: Your Labor Relations Manager is having an affair with an employee. This is a clear violation of published policies. At around the same time this is discovered, the manager reports some financial irregularities between a union and some officials at the company. She is later fired for failing to disclose the affair.
Was this "protected activity" under Sox? Answer - Yes - The ALJ concluded that the manager "reasonably believed" that executives were perpetrating a "fraud," which could hurt stockholders. Her termination was found to have been based, at least in part, on her disclosure of that fraud.
What Do These Cases Have In Common?
- First, in all four cases, the executives fired were highly-placed within the company, with access to the CEO or others in upper management. This gave the plaintiff unique knowledge of the company's innermost secrets.
* Lesson learned: Every executive - no matter how high in the company or how trusted - should be viewed in times of crises to be a potential SOX complainant.
- Second, it was not clear in these cases what SOX policies or "checks and balances" had been put into place by the companies of issue. In Case Two, it appeared that the bank CFO was fired before a full investigation was conducted into his SOX allegations. The same occurred in Cases One and Three.
* Lesson learned: Every termination (even if directed by the CEO) that contains even a "whiff" that there may be SOX issues must be reviewed and approved by the SOX compliance officer.
- Third, the boundaries of a potential SOX claim are being expanded by creative plaintiffs and their attorneys everyday. SOX has thus become, at least in the area of whistleblowing, a "moving target." For example, how are allegations that an expense account was being "padded" a violation of the Securities Law or a SOX violation? Likewise, how are financial irregularities between a union and corporate executives a SOX violation? Yet, in each case these complaints were found to be covered by SOX.
* Lesson learned: Any complaint (formal or informal) that potentially involves company finances, such as: violations of accounting procedures, a purchasing manager getting kickbacks from vendors, a construction manager getting "free" labor from a contractor - should be handled from the onset as if it is a potential SOX violation.
- Fourth, the SOX compliance office and SOX whistleblowing policy must be given real "teeth." A policy is only as valuable as the people who administer it. The SOX compliance officer must conduct "real" investigations and must be prepared to veto troublesome decisions.
* Lesson learned: The position of SOX compliance officer is not one for the "faint of heart."
What Do You Need To Do To Protect Your Company?
- Adequate complaint procedures for all situations - apart from SOX - The SOX whistleblower is not the only potential plaintiff you as an employer need to be concerned about. Your company (or your client) must have in place written grievance or complaint procedures, covering everything from sexual harassment, to discrimination, to workplace violence, to fraud. Such policies should be posted and handed out to all employees.
- Adequate SOX policies and controls - At this point, almost three years after the SOX statute was enacted, every public company should have developed a series of procedures for compliance with the Act. Most of these procedures will relate to SEC reports and financial reporting - but they must include some policies or protocols for dealing with employees who choose to blow the whistle. Ask to see these procedures.
What should the policy say? Ideally, one executive should be designated the SOX compliance officer. That person should also be the primary recipient of any SOX complaints or grievances. Many commentators believe that any good SOX policy should also give an employee who wishes to report a potential SOX violation multiple avenues to pursue SOX complaints. If you decide to enact such a policy, you should specify by name the alternate managers or executives that the employee may go to if - for some reason - he/she does not wish to report the issue to the SOX compliance officer. You must name the executives who may receive SOX complaints, to ensure these complaints are handled properly. If you are going to have these multiple "portholes" for SOX complaints, it is essential that every executive who may be the recipient of a SOX complaint be educated and understand the importance of following up on such complaints promptly, and reporting them through the appropriate chain of command.
Are these polices being followed? As is the case with the discrimination laws, the wage and hour laws, and virtually all of the other employment statutes - a SOX policy is only worthwhile if it is actually followed. We recommend that clients do at least a SOX audit and review complaints and terminations to see if SOX issues are being raised. Questions to ask:
- Have there been any complaints of financial irregularities?
- If so, how were they handled?
- Was an investigation conducted?
- What were the results?
- Did someone (hopefully the SOX compliance officer) do a critical review of the discharge?
In each of the four cases we discussed, where the SOX whistleblower succeeded, it is not clear whether the company's internal SOX complaint policies worked effectively. In Case Two, consider: who ordered the CFO's firing? Likewise, in Case Four, did anyone critically examine whether the affair provided a legitimate basis to discharge the Labor Relations Manager? Did anyone examine whether there were objective grounds for her termination? Likewise, in Case One, once the Marketing Director made her report, did anyone put a "hold" on the discharge until the complaint was reviewed and investigated?
We do not profess to know enough about the facts of these cases to offer our opinion about any specific situation. However, in each case, some preventative and proactive measures may have well avoided the liability that later resulted.
Conclusion
Where does this leave us? SOX is here to stay, and whistleblower litigation will likely continue to be a headache for years to come. However, by enacting good policies and putting strong competent people in charge of implementing those policies - you can get your client or company on a path that will lead away from liability. The keys to success are:
- Education - so that executives and managers understand the law and the company's obligations;
- Investigation - so that a full review is done of potential SOX complaint before disciplinary action is taken; and
- Critical Analysis - the SOX compliance officer cannot be afraid to ask the "hard questions" and overturn or halt a discharge, if the facts do not objectively support the decision.
No company can prevent a troublesome employee from bringing baseless litigation. However, by following these guidelines you may well succeed in discouraging frivolous suits, and setting up good solid defenses if you are forced to litigate a SOX or other whistleblower claim.
1 Collins v. Beazer Homes USA, Inc., 334 F.Supp.2d 1365 (N.D.Ga., 2004).
2He refused to have the meeting because he was not permitted to bring an attorney.
3 Welch v. Cardinal Bankshares Corp., No. 2003-SOX-15, 2005 WL 990535 (Feb. 15, 2005) (Purcell, A.L.J.).
4 Jayaraj v. Pro-Pharmaceuticals, Inc., (2003-SOX-32) (ALJ, Feb. 11, 2005).
Published August 1, 2005.
