• The Sarbanes-Oxley Act -- Does it Really Protect the Whistleblower?
  • July 25, 2007 | Author: Mark G. Alexander
  • Law Firm: Holland & Knight LLP - Jacksonville Office
  • In May 2007, the Department of Labor’s Administrative Review Board (ARB) rendered its final decision in one of the first whistleblower termination cases filed under the employee protection provisions of the Sarbanes-Oxley Act of 2002 (SOX). ARB held in Welch v. Cardinal Bankshares Corporation that none of the complaints made by employee David Welch were protected under SOX. In addition, while Welch’s case was under review, a federal court refused to enforce the Department of Labor’s (DOL) order to reinstate Welch to his position. Welch illustrates that ARB is likely to take a narrow view of the employee protection provisions of SOX and undermines an employee’s potential for reinstatement while his or her termination is under ARB review.

    Sarbanes-Oxley Act of 2002

    Enacted in the wake of recent corporate scandals, SOX created significant new securities reporting requirements to protect investors. SOX further created protections for employees who provide evidence of corporate fraud against shareholders. Section 806(a) of SOX (18 U.S.C. 1514a) prohibits publicly-traded companies from discharging employees because they have lawfully provided information regarding conduct which they reasonably believe constitutes a violation of specifically enumerated federal laws, including laws relating to mail fraud, media fraud, bank fraud, security fraud and fraud against shareholders. SOX thus encourages employees to come forward with information regarding potential corporate illegality.

    To secure protection under SOX, an employee must satisfy two key elements. First, the employee must report conduct that relates to the types of fraud enumerated in the statute. Second, the employee’s belief that the company’s conduct violates federal law must be “reasonable.” What constitutes a “reasonable belief” that the company’s conduct violates federal law became an important issue in the Welch litigation.

    Welch v. Cardinal Bankshares Corporation

    In this case, Cardinal, a publicly-traded bank holding company, terminated Welch, its chief financial officer, after he complained to the chief executive officer and audit committee about several of the company’s financial reporting practices. Welch asserted that Cardinal had violated generally accepted accounting standards (GAAS) and federal securities laws, including the overstatement of income in two quarterly reports.

    Welch filed an administrative complaint with the Occupational Safety and Health Administration (OSHA), arguing that his termination violated Section 806 of SOX. OSHA, responsible for investigating SOX whistleblower complaints, concluded that Welch’s claim had no merit. Dissatisfied with OSHA’s decision, Welch requested a hearing before an administrative law judge (ALJ) of the DOL. The ALJ ruled in Welch’s favor and recommended reinstatement, back pay and other forms of relief. Based on the ALJ’s ruling, Cardinal appealed to ARB.

    On appeal, ARB ruled that the ALJ committed error and denied Welch’s complaint for two reasons. First, ARB found that Welch had reported violations of accounting standards, not federal securities laws. Section 806(a) clearly states that SOX protects only those employees who provide information regarding violations of federal law relating to fraud against shareholders. Second, the ARB held that an experienced financial executive could not have reasonably believed the company violated federal securities laws. As a result, SOX did not protect Welch from termination.

    While Welch’s termination was under ARB review, the U.S. District Court for the Western District of Virginia refused to enforce the preliminary reinstatement order. The court reasoned that the ALJ had not provided clear notice that the preliminary order of reinstatement would be in effect while the ARB conducted its review. As a result, Welch never returned to work at Cardinal.

    Significance of Welch v. Cardinal Bankshares Corporation Welch is significant for two reasons. First, it demonstrates how narrowly ARB construes the scope of protected activity under SOX. Even though the audit committee agreed with Welch that Cardinal had misreported income, ARB still did not find that Welch’s complaints involved violations of federal law relating to fraud against shareholders. And, despite Welch’s experience as a certified public accountant and chief financial officer, ARB still concluded that his belief that Cardinal had violated federal law was not “reasonable” within the meaning of SOX.

    Second, the district court’s denial of reinstatement while the litigation proceeds is a particularly significant limitation. Employees would be substantially more likely to sue if they knew they could get their job back while the suit proceeded – effectively having the employer finance the suit.

    Nonetheless, SOX remains a significant source of risk for public employers. SOX complaints have to be answered very quickly and the remedies are substantial. A complainant who prevails under Section 806 of SOX is entitled to the following make-whole relief:

    • reinstatement with the same seniority status that the employee would have had, but for the discrimination

    • back pay and interest

    • compensation for any special damages sustained as a result of the discrimination, including litigation costs, expert witness fees and reasonable attorneys’ fees

    Employers also need to be aware that another whistleblower provision of SOX does not contain either of the limitations of Section 806 and carries criminal penalties. This provision makes it illegal for any person “knowingly, with the intent to retaliate,” to take “any action harmful to any person, including interference with the lawful employment or livelihood of any person,” because he or she has “provid[ed] to a law enforcement officer any truthful information relating to the commission or possible commission of any Federal offense.” A violation may result in a fine or imprisonment for up to 10 years. Thus, publicly-traded employers must exercise great caution before taking adverse action against an employee who has complained about any securities law violations.