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High Court Extends Employee Whistle-blower Protections

By Joanne Deschenaux  3/5/2014
 

In a March 5, 2014, ruling, the U.S. Supreme Court said the whistle-blower protections in the Sarbanes-Oxley Act (SOX) apply to employees of contractors and subcontractors of a publicly traded company as well as to employees of the public firm itself.

The justices, voting 6-3, reversed and remanded a 1st U.S. Circuit Court of Appeals decision that SOX’s whistle-blower safeguards, contained in Section 806 of the act, did not protect two former employees of private companies that advised and managed Fidelity mutual funds.

Writing for the majority, Justice Ruth Bader Ginsburg noted that Congress had enacted SOX after accounting problems brought down energy company Enron Corp. and communications provider WorldCom Inc., calling those events the "mischief to which Congress was responding."

She questioned whether Congress, "prompted by the Enron debacle, would exclude from whistleblower protection countless professionals equipped to bring fraud on investors to a halt."

The majority found that SOX's plain text and legislative history, as well as comparisons to other whistle-blower laws, supported its conclusion. The justices said their interpretation of Section 806 “avoids insulating the entire mutual fund industry” from SOX's whistle-blower protections and is unlikely to open any “floodgates” for whistle-blower litigation.

Justice Sonia Sotomayor, joined by Justices Anthony Kennedy and Samuel Alito, dissented, asserting that SOX's text is “deeply ambiguous” and that its headings and statutory context support a narrow interpretation of Section 806 as applying to only employees of public companies.

Enormous Expansion of Coverage

“With this decision, the Supreme Court has expanded the universe of companies regulated by the SOX whistle-blower provision from roughly 5,000 public companies to potentially 6 million private ones, including even the smallest mom and pop businesses,” according to Lloyd Chinn, Proskauer’s whistle-blowing and retaliation group co-head.

“The Supreme Court declined even to adopt any of the potential middle-ground approaches that were presented to it during briefing and oral argument,” Chinn noted. “This is quite obviously a radical expansion of the statute’s coverage and arguably contrary to the intended scope of the act and its amendments.” 

Karen Harned, executive director of the National Federation of Independent Business Small Business Legal Center, said her organization was disappointed by the court’s ruling. “By forcing private companies to comply with the Sarbanes-Oxley Act, the court is downplaying the reality that this decision gives plaintiffs’ attorneys additional incentives to pursue aggressive litigation against independent companies,” she said, adding that Congress never intended for the law to apply to small businesses.

Retaliation Claimed

Two former employees, Jackie Hosang Lawson and Jonathan Zang, brought separate suits in federal district court against FMR and other related private companies that provide, under contract, investment advisory services to the Fidelity family of mutual funds, alleging unlawful retaliation under Section 806 of SOX. The Fidelity mutual funds were not parties to either suit, and the mutual funds are not owned, controlled by or affiliated with FMR.

Lawson alleged she was harassed and, ultimately, forced to quit because she provided Fidelity managers with information on inappropriate expense reporting, retention of investment company fees, and methodologies for reporting or accounting for mutual fund expenses and operations. Zang contended he was fired for informing Fidelity management that disclosures that were being prepared for the Securities and Exchange Commission did not accurately reflect the details of some fund managers' compensation.

FMR moved to dismiss the claims, arguing that the plaintiffs were not “covered employees” under SOX because the statute does not protect employees of private subsidiaries of public companies. FMR maintained that the listing of “contractor” and “subcontractor” simply identifies those who are barred from retaliating against employees of public companies but does not extend protection to the employees of those contractors and subcontractors. The plaintiffs argued that both the employees of public companies and those who are employed by public companies’ contractors and subcontractors are protected under the SOX whistle-blower provisions. The district court denied FMR’s motion to dismiss, and the company appealed to the 1st Circuit.

On Feb. 3, 2012, the 1st Circuit reversed the district court’s interpretation of Section 1514A(a), holding that SOX’s whistle-blower protection is limited to employees of publicly traded companies and does not extend to those employed by a publicly traded company’s contractors and subcontractors. The Supreme Court granted review on May 20, 2013, and oral argument was held on Nov. 12, 2013.

What’s Next?

“Employers of every size and type will have to prepare themselves for potential Sarbanes-Oxley whistle-blower claims merely because they are a contractor or subcontractor of a publicly traded company,” Chinn cautioned.

Edward Ellis, co-chair of Littler Mendelson’s whistle-blowing and retaliation practice, said that because the high court chose not to “draw a bright line” as to who is a contractor, “there will be a lot of litigation in the next few years” in this area. “How many business transactions with a publicly traded company does it take to make a contractor?’ he asked, noting that the justices didn’t answer this question.

Further, Ellis said, “You are going to see more claims and more pressure on nonpublic companies to set up compliance systems and train their HR people as to how to deal with a fraud claim.”

He recommended that private employers consider establishing systems that mirror the ones that publicly traded companies set up. “This will fall on the HR community.”

Joanne Deschenaux, J.D., is SHRM’s senior legal editor.

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