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U.S. Supreme Court Expands Sarbanes-Oxley Whistleblower Provisions to Private Employers




by:
Jackson Lewis P.C. - White Plains Office

 
March 17, 2014

Previously published on March 11, 2014

Privately owned companies, in addition to publicly traded companies, may be subject to whistleblower liability under the Sarbanes-Oxley Act of 2002 (SOX), the U.S. Supreme Court has ruled in a 6-3 decision. Lawson v. FMR LLC, No. 12-3 (Mar. 4, 2014). The Court held private company employees, in certain circumstances, are entitled to the anti-retaliation protections afforded by SOX. However, the decision left unclear the extent of these circumstances, thus generating ongoing debate about the reach of SOX.

Until now, privately owned companies were not considered subject to SOX whistleblower retaliation claims. Following Lawson, privately owned companies, and contractors and subcontractors of publicly traded companies with employees performing services for publicly traded companies in particular, are potential targets for such claims. Moreover, the extension of SOX liability is not entirely defined by Lawson; thus, the full reach of the statute is still undetermined. First and foremost, it is unclear whether a privately held company is exposed regardless of the nature and extent of the particular services it provides to the publicly traded company.

Seeing a substantial new population of potential SOX whistleblowers (employees of privately owned companies) provoked the dissenters on the Court to warn that the majority’s decision “threatens to subject private companies to a costly new front of employment litigation.”

While debate over the implication of this decision will continue, privately owned companies should assess whether they have exposure to possible SOX whistleblower retaliation claims because of the particular work performed and related circumstances of their employees.

SOX Background

Congress enacted SOX in 2002 against a dramatic backdrop of corporate malfeasance, its ensuing harm to the investment community, and the concomitant rise in status of the whistleblower. Indeed, the era was marked by a series of well-publicized corporate debacles that resulted in the demise of publicly traded companies, such as WorldCom and Enron, which left aggrieved shareholders with significant investment losses. At the same time, the employee-whistleblower was being lionized (Time magazine identified three corporate whistleblowers as the 2002 Persons of the Year). In response to outcry from the investment community and others, Congress passed SOX. The statute imposed comprehensive standards for publicly traded companies. SOX’s anti-retaliation protections for employee-whistleblowers were considered a key weapon in the fight against corporate fraud.

Who is Covered?

In Lawson, the Court considered who is a covered employee; that is, does SOX shield only employees employed by the public company itself, or does it shield as well employees of privately held contractors and subcontractors who perform work for the public company? The Court chose the latter interpretation.

The plaintiffs in Lawson claimed their employer retaliated against them for reporting alleged fraud in a publicly traded mutual fund company’s financial reports — the type of reporting that fits within the SOX whistleblower statute. The complexity here is that the plaintiffs were not employees of the publicly traded company. They were employees of privately owned companies that provided advisory and management services as “contractors” to the publicly traded mutual fund company.

The Supreme Court ruled that even though these plaintiffs were not employees of the publicly traded company, the SOX whistleblower statute applies because they claimed they suffered retaliation for reporting alleged fraud involving financial reporting of the publicly traded company.

The Court focused on the firms’ unique circumstances, particularly that the publicly traded mutual fund company did not have its own employees. The firms relied on a non-employee/all-contractor workforce model, where workers are supplied by privately owned companies, to fulfill the normal management, investment advisor, and accounting functions. Therefore, the Court was concerned that the practical effect of limiting the whistleblower statute to employees of the publicly traded company would be to insulate the entire mutual fund industry, given the commonality of this non-employee/all-contractor workforce model. The Court’s reasoning also considered that SOX has express provisions as to the responsibility of outside accounting firms and law firms to detect and combat fraud by the publicly traded companies served by these professional service firms.

Unfortunately, the Court did not explicitly limit its ruling to the unique mutual fund/non-employee company model, nor did it explicitly limit its ruling to allegations of fraud relating to the services that a privately owned company provides to the publicly traded company. This led to sharp division among the Justices as to how broadly the SOX whistleblower statute should be applied to privately owned companies, regrettably creating uncertainty in Lawson’s wake. The U.S. Solicitor General suggested the Court hold that the SOX whistleblower statute applies to employees of privately owned companies only in the context of performing services related to the shareholder interests of a publicly traded company, but the Court did not adopt that limiting principle. This lack of clarity prompted the dissenting Justices to nearly mock the majority's decision by identifying hypothetical examples involving small privately owned companies that happen to provide services to publicly traded companies and unwittingly find themselves subject to SOX claims.

The Court’s majority opinion (joined by four justices, with two more concurring in part), dismissed the concerns of the dissent and declined to further define the reach of the SOX whistleblower law. The majority argued that examples the dissent gave had not occurred widely in the past (that is, before the Court’s decision expanding the reach of SOX), and that if problems arose in the future it would be up to Congress to limit the reach of the whistleblower statute. The two concurring justices went further, saying there is no “limiting principle” and a whistleblower does not need to show that his or her complaint of fraud related in any way to a publicly traded company or to his employer’s services to a publicly traded company.

***

What is clear post-Lawson is that employees of privately owned companies, in some instances, may avail themselves of the SOX whistleblower provisions. Accordingly, privately owned companies are well advised to assess this risk based on their dealings with publicly traded companies and to prepare accordingly. Such risk assessment likely entails the following key steps.

Assess business relationships with publicly traded companies.

Employers, like those in Lawson, that provide financial, administrative, management or accounting services directly to publicly traded companies should assume that the SOX whistleblower provisions apply to their employees, just as they do to employees of publicly traded companies. Other privately owned companies, especially those with continuing contracts with publicly traded companies, should anticipate SOX exposure — regardless of whether the goods or services exchanged have any connection with financial reporting, administration or management of the publicly traded company. Even privately owned companies with only incidental transactions with publicly traded companies are better off anticipating that employees involved with those transactions may be able to assert a SOX whistleblower retaliation claim.

Update and revise compliance policies, procedures, training and related corporate governance structures.

Exposure to SOX whistleblower claims is best mitigated through a pro-active corporate governance structure supported by a comprehensive compliance program that detects and addresses issues of fraud and corporate misconduct, which includes development of a Code of Conduct that meets industry standards, employee training on that Code, the employment of appropriate personnel to enforce that Code, internal audit and reporting mechanisms, procedures for thoroughly and effectively investigating complaints, corrective action, and procedures for preventing retaliation against those employees who make internal or external complaints of fraud.

Establish anti-retaliation review to mitigate whistleblower retaliation claims.

To the extent a privately owned company believes it may be subject to SOX in light of Lawson, the company should consider developing an anti-retaliation internal review process. This review process will ensure that any adverse action contemplated for employees performing services for publicly traded companies is reviewed in advance. This review will be aimed at confirming whether the adverse action is disassociated, by clear and convincing evidence, from any prior complaints raised by such employees.



 

The views expressed in this document are solely the views of the author and not Martindale-Hubbell. This document is intended for informational purposes only and is not legal advice or a substitute for consultation with a licensed legal professional in a particular case or circumstance.
 

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