SOX Whistleblower Protection Expanded by a Federal Appeals Court

by Holland & Knight LLP
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A federal appeals court recently made it substantially easier for plaintiffs to assert claims that they were fired for "whistleblowing" activity protected by the Sarbanes-Oxley Act ("SOX"). In Wiest v. Lynch, 2013 WL 1111784 (3d Cir. Mar. 19, 2013), the U.S. Court of Appeals for the Third Circuit ruled that an employee who communicates to corporate managers a "reasonable belief” that an accounting irregularity or "misstatement of accounting records" is about to occur may be protected from retaliation by SOX, even if the protest lacks any clear indication that the error had the markings of shareholder fraud, such as its being an intentional misrepresentation as to facts that would be of material significance to investors. Other courts had previously required more than the mere assertion of inaccurate or irregular accounting to rise to the level of "protected activity" under the SOX whistleblower provision. The Wiest court, however, fully embraced a broad re-interpretation of that statute recently advanced by the administrative agency authorized to enforce the SOX prohibition against whistleblower retaliation. If other courts follow Wiest in this new direction, the scope of SOX whistleblower protection will be dramatically expanded.

Under Section 806(a) of SOX (18 U.S.C. §1514a), publicly traded companies are prohibited from discharging, or in any other way discriminating against, employees who lawfully provide information concerning conduct that they reasonably believe constitutes a violation of certain specified federal anti-fraud statutes (namely, mail fraud, wire or media fraud, bank fraud, securities and commodities fraud), any rule or regulations of the Securities and Exchange Commission, or "any provision of Federal law relating to fraud against shareholders" (emphasis added). Unless one of these six categories enumerated by Section 806 is implicated by the employee's protest, the SOX anti-retaliation protections do not apply. It is this last category — generically, "shareholder fraud" — that appears to have grown in significance in the Wiest decision.

Background

Wiest worked for 30 years in the accounting department of Tyco Electronics before he was fired in April 2010, after having raised concerns about the proper accounting treatment for several large and questionable expenses. Wiest's objections to the accounting for these expenses arose from his belief that they were inconsistent with standard accounting practice. Wiest sued, but the district court dismissed his SOX whistleblower complaint, in part because he failed to allege that his internal corporate communications "definitively and specifically" related to a statute or rule listed in Section 806 that would have been violated by these accounting improprieties.

In reversing the lower court, the Third Circuit wholeheartedly adopted a new standard of "protected activity" adopted by the Department of Labor's Administrative Review Board (ARB), which is the federal agency authorized by SOX to enforce and, in the first instance, interpret its whistleblower protections. While an earlier ARB decision had adopted the "definitely and specifically" standard relied on by the district court in Wiest, that standard was expressly rejected by the ARB in 2011 in its decision in Sylvester v. Parexel Int’l LLC, ARB 07-123, 2011 WL 2165854, at *11 (Dep’t of Labor Mar. 25, 2011). There, the ARB ruled, among other things, that SOX whistleblower protection does not require the claimant to have protested fraud against shareholders, but only to have claimed that there were violations of any of the laws enumerated in Section 806, even if it was "merely one step in a process leading to shareholder fraud" or, in the case of any mail or wire fraud, even if unrelated to the financial reporting of public companies. Id. at *17. Applying that standard, the ARB extended SOX whistleblower protection to internal communications that asserted a falsification of clinical data violating the drug-testing protocols of the Food and Drug Administration.

Adopting the more relaxed Sylvester standard, the Third Circuit held that Wiest's objection to treating certain lavish corporate events as a business expense (rather than as imputed income to the employees who attended) constituted "protected activity" subject to SOX whistleblower protection. The reason was because, in accepting Wiest's recommendation, corporate managers acknowledged that treating the event as an advertising expense “would have resulted in a misstatement of accounting records and a fraudulent tax deduction.” (Those were their words, not Wiest's.) According to the court, this was enough to put four corporate managers on notice that Wiest was objecting to the possible violation of “[a] provision of Federal law relating to fraud against shareholders,” in part because he and others were familiar with the scandal involving Dennis Kozlowski, the former CEO of Tyco’s parent, who had charged many lavish personal expenses to the corporation.

The defendants in this case have filed a petition for en banc review of the Third Circuit's 2-1 decision.

Concerns About the Ruling

The troubling aspect of Wiest is not in its rejection of the "definitely and specifically" standard. Many federal statutes outlawing retaliation against employees who protest unlawful conduct (such as race discrimination or denial of federally mandated family leave) have for years been construed in such a way that the protected employee need not "specifically" state the statute being violated. Rather, as the Third Circuit dissent noted, the problem with the majority's permissive reading of the requirements for establishing protected activity under SOX is that it removes any meaningful requirement that the SOX claimant’s intra-corporate communication "relate in an understandable way" to one of the six enumerated federal anti-fraud laws. Id. at 16. Objecting to the court’s allowing the "fraud against shareholders" category to swallow the limited definition of protected activity under Section 806, the dissent noted: "[i]f it is unnecessary to measure a SOX complainant's reasonable belief against at least some of the elements of securities fraud, like materiality, then virtually any internal questioning of an accounting mistake or a judgment call turns the questioner into a SOX whistleblower." Id. at *21 (emphasis added).

The Wiest decision runs counter to pre-Sylvester decisions issued in other circuits, which have generally ruled that the objections to improper business practices or accounting irregularities do not on their own constitute protected activity under the SOX whistleblower provision. For instance, in Day v. Staples, Inc., 555 F.3d 42 (1st Cir. 2009), the court stated that "to have an objectively reasonable belief there has been shareholder fraud, the complaining employee’s theory of such fraud must at least approximate the basic elements of a claim of securities fraud." Id. at 55. The First Circuit found no proof that an entry-level employee’s complaints about the company’s protocols of processing merchandise returns "would have been viewed by the reasonable investor as having significantly altered the total mix of information made available" to the public concerning the company’s securities. Id. at 57.

Similarly, the Fourth Circuit rejected a whistleblower termination claim made by the company’s former chief financial officer in Welch v. Chao, 536 F.3d 269, 275 (4th Cir. 2008). The court found that the former CFO failed to explain how the issues he had raised — namely, the company’s misreporting of $195,000 as income and allowing non-accountants to make accounting ledger entries — could have reasonably constituted a violation of the anti-fraud laws enumerated in SOX. Id. at 278.

Implications for Public Companies

Public companies should be alert to the increased potential liability that they face under the Wiest standard. To discharge or adversely affect the employment of employees who have made general allegations of corporate misconduct that relate in some way to financial matters may, under the Wiest analysis, subject the corporation — and the individual managers, personally — to claims of retaliation under a statute intended to protect employees who internally "blow the whistle" on potential fraud against shareholders. Until the courts have settled on a universally accepted standard for SOX whistleblowing protection, company managers should be on guard when dealing with any employees who have questioned the accuracy or truthfulness of accounting or other business practices. They must also be careful about the language they themselves use in characterizing the objection that has been raised. 

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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