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The federal Sarbanes-Oxley Act (known colloquially as SOX) prohibits publicly traded companies from terminating or otherwise retaliating against employees who report certain fraudulent conduct. But employees that seek to “blow the whistle” under SOX must follow an elaborate administrative framework established by the U.S. Department of Labor (DOL) before suing in court. These administrative hurdles have slowed the development of federal caselaw. Several recent federal appellate decisions, however, provide some useful guidance.

The U.S. Court of Appeals for the Fourth Circuit recently ruled in Stone v. Instrumentation Laboratory Co. that an employee could pursue a SOX whistleblower claim in federal court, even though an administrative law judge (ALJ) had already adjudicated the claim in the employer’s favor, because a final decision had not been reached on the administrative complaint within 180 days. The trial court had dismissed the employee’s lawsuit on the ground that the ALJ’s decision was final and precluded the employee from taking a “second bite at the apple” through a lawsuit. The appeals court reversed, though, holding that the employee was entitled to an independent review by the federal court under SOX because the administrative decision was untimely. This was the first federal appellate decision to directly address this key procedural issue, and it will likely increase the number of SOX whistleblower cases filed in federal courts. The decision may also encourage the Secretary of Labor to process administrative complaints more quickly.

In Van Asdale v. International Game Technology, the U.S. Court of Appeals for the Ninth Circuit clarified the type of complaint that triggers whistleblower protection under SOX. The Van Asdales were a married couple who worked as intellectual property lawyers for IGT, a Nevada company that made slot machines. After IGT merged with Anchor Gaming, the Van Asdales discovered that Anchor’s management had failed to disclose to IGT that one of Anchor’s valuable slot machine patents might be invalid. The Van Asdales raised the issue at a meeting with their new boss — a former Anchor lawyer who had joined IGT as a result of the merger — and the Van Asdales were both terminated shortly after that.

The trial court dismissed the Van Asdales’ SOX claim on the theory that they were only questioning the underlying validity of the patent — i.e., whether there was a potential fraud on the Patent Office — not whether there was fraud on IGT’s shareholders. The appellate court reversed and explained that, to constitute protected activity under SOX, an employee’s communication must “definitely and specifically” relate to one of the enumerated fraud categories in SOX: mail fraud, wire fraud, bank fraud, securities fraud, a violation of an SEC rule or regulation, or a violation of any provision of federal law relating to fraud against shareholders. The appellate court found that the Van Asdales had met the securities fraud standard by telling their boss that Anchor’s nondisclosure of documents in the IGT merger “appeared suspicious” to them. This ruling demonstrates that employees are not required to utter magic words to trigger SOX and even fleeting references to possible securities fraud can suffice.

Nevertheless, claims of fraud that have no logical nexus to an employer’s shareholders or its securities will not support a SOX claim. In Smith v. Psychiatric Solutions, Inc., the U.S. Court of Appeals for the Eleventh Circuit upheld a trial court’s dismissal of a SOX claim brought by a therapist at a privately run treatment center for juvenile delinquents. The therapist alleged that she had been terminated after reporting physical and sexual abuse of youths, Medicaid fraud, and improper alteration of medication forms. Her theory was that investors purchased stock in the company that ran the treatment center without knowledge of the company’s potential civil and criminal liability for the misconduct she complained about. The appeals court found this connection to shareholder fraud too tenuous.

William B. Forrest III