The Sarbanes-Oxley Act was passed in 2002 to combat fraudulent accounting practices and other corporate misconduct in the post-Enron era.  The Act (often colloquially called “SOX”) provides whistleblower protection to employees of publicly traded companies who engage in certain kinds of protected activity.  Because whistleblower claimants must exhaust an elaborate administrative process before suing in court, caselaw guidance on the meaning and application of the Act’s whistleblower provision has been emerging very slowly.  Recent federal court decisions have now begun to clarify several key aspects. 

 

Whom Does The Act Cover?  SOX applies to publicly traded companies and the officers, employees, contractors, subcontractors, and agents of publicly traded companies.  A U.S. District Court in Michigan held in Rao v. DaimlerChrysler that SOX does not cover a non-publicly traded subsidiary of a publicly traded parent.  The court explained, however, that the Act may cover a non-publicly traded subsidiary of a publicly traded parent if there are overlapping executives between the two entities and if the parent is itself involved in the subsidiary’s employment decisions. 

In O’Mahoney v. Accentune, a U.S. District Court in New York recently extended whistleblower protection to a foreign plaintiff.  An earlier precedent, Carnero v. Boston Scientific Corp., had declined to extend whistleblower protection to a foreign plaintiff.  The O’Mahoney court emphasized that the foreign plaintiff was employed and compensated by a U.S. subsidiary of a foreign parent, that the alleged misconduct involved U.S. employees and occurred in the U.S., and that the plaintiff named both the U.S. subsidiary and the foreign parent as defendants.  In contrast, in Carnero, the plaintiff was employed and compensated by a foreign subsidiary that had a U.S. parent, the reported misconduct had occurred in Latin America, and the plaintiff only named the foreign subsidiary as a defendant.  Consequently, SOX whistleblower protection may extend to a foreign plaintiff when a U.S. company employs the plaintiff and the alleged misconduct occurs within the U.S.

What Activity Does The Act Protect?  SOX protects employees of publicly traded companies who file, testify, participate in, provide information, or assist in an investigation of employer conduct that the employee reasonably believes constitutes a violation of one of the Act’s “enumerated laws.”  The “enumerated laws” are:  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. 

Some courts have held that the “enumerated laws” apply only to fraud against shareholders.  The New York federal court in O’Mahoney, however, concluded that the “relating to fraud against shareholders” phrase only pertains to the final enumerated category.  As a result, the “fraud” categories may be considered more broadly.

The U.S. Court of Appeals for the Fourth Circuit reasoned in Livingston v. Wyeth Inc. that a violation of federal law is “relating to fraud against shareholders” only if it is sufficiently material that it could impact shareholders.  That court also held that an employee’s belief that his employer’s complained-of conduct violates securities laws must be “reasonable.”  The court concluded that Food and Drug Act (FDA) violations (the alleged misconduct in that case) are not “relating to fraud against shareholders.”  The court opined that it was not clear that the employer had an obligation to inform shareholders of the alleged FDA violations, and it emphasized that FDA violations generally lack the requisite materiality.

In sum, a complaint of a violation of federal law that is too attenuated to involve fraud against shareholders should not support a SOX whistleblower claim.  The Fourth Circuit extended the “reasonable belief” test recently in Welch v. Chao by holding that a bank executive who complained of accounting irregularities could not have reasonably believed the irregularities violated federal securities laws.

In Allen v. Administrative Review Board, the U.S. Court of Appeals for the Fifth Circuit also utilized both subjective and objective standards to scrutinize the reasonableness of the plaintiff employee’s belief that a violation had occurred.  To be subjectively reasonable, the court held, the employee must have actually believed that a violation occurred, even if the employee’s belief was mistaken.  To be objectively reasonable, the employee’s belief must be reasonable in light of the employee’s access to information, experience, and background.  “The objective reasonableness of a belief is evaluated based on the knowledge available to a reasonable person in the same factual circumstances with the same training and experiences as the aggrieved employee.” 

Non-publicly traded employers confronted with a SOX whistleblower complaint should aggressively challenge whether it is a covered entity.  Any employer should carefully assess whether the alleged misconduct constitutes a violation of one of the Act’s enumerated laws and whether the employee, given his or her background, knowledge, and experience, could have reasonably believed that a violation of one of the enumerated laws occurred.  Although the SOX whistleblower provision has its place in legislation designed to protect investors, intended limitations on its reach are being recognized as these cases now begin to reach the courts.

Eric J. Pelton

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