Quirky Question #285: Potholes on the Ethical “High Road”

by Dorsey & Whitney LLP
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Question:  We learned that some of our employees may have been engaging in unethical, and perhaps even illegal, behavior.  We don’t tolerate this, so we hired a law firm to conduct an investigation, and based on the results of that investigation, we terminated the employees.  The terminated employees were high-profile employees, and we told some people why they were fired.  Also, when we fired the employees, we briefly referenced the investigation, but didn’t provide them with any substantive information about it.  Do you see any problems with that?

Answer: Unfortunately, yes.  When an employer investigates possible ethical violations by employees (particularly high-ranking, high-profile employees), the risks are numerous and multi-directional.  While ignoring or minimizing the impact of suspected unethical behavior can have extreme negative repercussions for a company, particularly in a highly-regulated business such as insurance or securities, mismanaging an investigation and any subsequent terminations comes with its own unique set of risks.

Even when an employer seeks to take the ethical “high road” by immediately investigating alleged violations and taking action by firing the employees involved based on the investigative findings, certain steps need to be taken to safely and effectively limit the employer’s risk exposure. Allstate Insurance recently learned this lesson the hard way after a jury in an Illinois federal court returned a $27 million verdict against them.

In Daniel Rivera, et al. v. Allstate Insurance Company, Allstate received information suggesting that four of their employees responsible for investing Allstate’s equity portfolio may have been timing their trades in a way that benefited them personally, regardless of how the timing affected the portfolio.  Allstate said the employees were trying to “game” their bonus system through the timing of these transactions.  After hiring an outside law firm to complete an investigation, Allstate terminated the employees based on the investigation results. Allstate discussed the reasons for the termination in an SEC filing and in some communications with other Allstate employees.  After the terminated employees sued, a federal jury returned a $27.1 million verdict for defamation.  In addition to the defamation verdict (which accounted for almost all of the damages), Allstate was found to have violated the Fair Credit Reporting Act by failing to provide the employees a summary of the investigation report.

DEFAMATION VERDICT

Allstate was sued for defamation by four employees whom it had terminated for allegedly violating the company’s ethics code by timing trades in Allstate’s equity portfolios (which their division managed) to inflate their individual bonuses. The contention that the employees acted unethically was stated or suggested in an SEC filing by Allstate.  In addition, Allstate’s Chief Investments Officer told other Allstate employees about the reasoning behind the terminations, accusing the former employees of “gaming” the bonus system.

The jury disagreed and awarded a total of $17.1 million in compensatory damages and $10 million in punitive damages.

The damages awards are particularly notable because the court had handed Allstate a favorable ruling on the nature of defamation damages prior to the case going to the jury. The court found that the employees could not claim general compensatory damages under the doctrine of defamation per se, but rather had to plead and prove actual damages.

THE FCRA CLAIM

            As soon as Allstate learned that their employees were potentially engaging in unethical behavior, they immediately hired an outside law firm to conduct an investigation. The law firm retained another third-party, an economic consulting firm, to review the trading data for the investigation.  Ultimately, the investigation concluded that the employees had violated Allstate’s ethics code.  When the employees were terminated, Allstate followed a script and informed the employees that the termination was for cause, i.e., for violating both the ethics codes and the conflict of interest policy.  Allstate did not provide the terminated employees with any other information regarding the investigation.

Ultimately, the jury found that Allstate’s actions violated the Fair Credit Reporting Act (“FCRA”). See generally 15 U.S.C. § 1681b(b).  How did legislation involving credit reports become important to an investigation of employees managing a large investment portfolio for an insurance company?  Well, under the FCRA, when employers use third parties to investigate reports of employee misconduct, those third parties become “consumer reporting agencies” – even when the investigation has nothing to do with an employee’s credit history.  This is because, based on the statutory definitions of  “consumer reporting agency”  and “consumer report,” any person who is paid to assemble or evaluate information which will be provided in a communication that contains information regarding a consumer’s character, general reputation, or personal characteristics which is used for employment purposes, qualifies as a consumer reporting agency. See 15 U.S.C. § 1681a(d) & (f).  For example, a third-party hired by an employer to conduct an investigation regarding claims that an employee sexually harassed a coworker qualifies as a consumer reporting agency.  When an employer subsequently relies on an investigation report received from a consumer reporting agency in making an adverse employment decision, under the FCRA, the employer must supply the employee with a summary of the report. See 15 U.S.C. § 1681a(y)(2).  This obligation exists whether or not the employee asks for a summary of the report.

In this case, the jury found that Allstate relied on the report compiled by the outside law firm that conducted the investigation in deciding to terminate the employees, and that Allstate failed to provide the employees with a summary of the report. At trial, Allstate argued that it had satisfied the FCRA’s requirements when it verbally informed the employees that they were being terminated due to the results of an investigation into their trading practices.  The jury wasn’t persuaded with Allstate’s argument and awarded damages to the former employees based on Allstate’s violation of the FCRA.

POINTS TO REMEMBER

  • It is always risky to impugn the ethics of employees when you are terminating them. They will almost certainly disagree with your accusations and will be extremely concerned about its impact on their reputations;
  • In many cases, the employer’s conclusion that employees acted unethically will be subject to at least some doubt. The underlying facts (and the ability of the employees to present the best arguments in favor of their position) will often look very different in litigation, where the employees have access to discovery and aggressive, talented lawyers to make their case, than those facts appeared to investigators working solely at the employer’s behest;
  • Strongly consider the option of simply not disclosing the results of internal investigations to others, either in public filings (assuming there is no legal requirement to disclose the information) or within the company. Defamation is often a self-inflicted wound; if you are not legally required to disclose negative information about an ex-employee, don’t do it. If you are legally required to disclose, craft your statements with extreme care;
  • A jury may not agree with the conclusions of your internal investigation;
  • When you decide to have an investigation handled externally, remember that you must give the employee a summary of the report when you decide to take adverse action against the employee. This obligation exists even if the employee does not ask for a report summary;
  • The summary does not need to identify the sources of information received during the investigation – but it does need to include more than a mere list of the topics involved and should relay the main points of the investigation’s methods and its conclusions;
  • While the summary can be verbal to satisfy the FCRA, it should be written in order to avoid a he said/she said scenario in front of a jury; and
  • Always check state laws regarding employee background checks and investigations – many states have their own fair credit reporting laws that might impose additional obligations besides those imposed by the FCRA.

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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