Unlocking The Mysteries of SOX Whistleblower Claims

Published in The Houston Lawyer magazine Jan/Feb 2007

The Sarbanes-Oxley Act ("the Act" or "SOX"),¹ effective July 30, 2002, seeks to protect investors and to improve corporate responsibility in the wake of recent major corporate accounting scandals. The Act also seeks to protect employees who "blow the whistle" on their corporate employers.

The "whistleblower" protection provision applies to companies with securities registered under section 12 of the Securities Exchange Act of 1934 ("’34 Act"), or that are required to file reports under section 15(d) of the ‘34 Act. ² The Act forbids companies from discriminating against employees who engage in protected whistleblowing activity. ³ Prohibited retaliatory acts include discharge, demotion, suspension, threats, and harassment. ⁴ To be protected, an employee must: 1) provide information to a federal regulatory or law enforcement agency, Congress, or a supervisor; or, 2) file, testify, participate in, or assist in proceedings regarding conduct he reasonably believes is or is related to shareholder fraud. ⁵

The criminal prohibition against employee retaliation provides:

Whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any Federal offense, shall be fined . . . or imprisoned not more than 10 years, or both. ⁶

This section of the Act does not distinguish between public and private entities, but rather applies to all employers.

SOX applies to all public companies that maintain a listing in the United States or have registered securities with the Securities and Exchange Commission ("SEC"). ⁷ The Act does not cover a company that has filed a SEC registration statement that has not yet become effective. ⁸ Less clear is the Act’s applicability to United States residents working abroad or foreign residents working abroad for a covered employer. Most courts and administrative law judges ("ALJs") have held that SOX whistleblower protections do not extend to employees working outside of the United States. In a recent case, Carnero v. Boston Scientific Corp., the U.S. Court of Appeals for the First Circuit held that the anti-retaliation provisions do not protect foreign citizens working abroad for foreign subsidiaries of companies covered by SOX. ⁹ The Carnero court reiterated the well-established presumption against extraterritorial application of congressional legislation absent clear indication from Congress.

However, at least one ALJ has applied SOX protections to an American citizen working abroad. ¹⁰ The ALJ held that the employer engaged in much of the protected activity in the United States (while in the United States informing corporate officers of the fraud alleged to have occurred in Italy), and one allegedly retaliatory decision was made in the United States, thus finding a substantial nexus to the United States.

Another thorn in employer’s side has been whether SOX applies to employees of non-public subsidiaries or companies related to public companies. Generally, ALJs have held that an employee of a nonpublic subsidiary is protected by the Act, but whether the employer is covered by the Act is a separate question. ¹¹ Many of the cases read the Act narrowly and limit coverage to public companies and their immediate employees. ¹² Others, however, apply the Act more broadly, holding parent companies responsible for their subsidiaries’ acts under certain circumstances. ¹³ Often in these cases, the subsidiary and the parent company maintained shared management and control, unity of operations, and a high degree of interconnectivity. ¹⁴ Other cases impose SOX liability if a subsidiary acted as a company representative or an agent acting on behalf of the publicly-traded company. ¹⁵ No United States District Court has addressed the issue directly nor has the Department of Labor’s Administrative Review Board ("ARB"), the final administrative stop for a SOX retaliation claim. ¹⁶ Because the law in this area is developing and rapidly evolving, private subsidiaries of public companies cannot be certain how a judge may construe this issue.

In a recent decision, the ARB held that non-public subsidiaries of a public company can be subjected to SOX, even if the parent is not a named respondent, as long as an employee names at least one respondent who is an "officer, employee, contractor, subcontractor, or agent" of a public company. ¹⁷ Notably, the ARB did not hold that non-public subsidiaries of public companies always can be liable under SOX, but looked for an agency relationship between the employer and the publicly-traded parent, even if neither the employer nor its direct parent was publicly traded. ¹⁸ In so holding, the ARB found that typical agency principles are proper in determining whether a non-public subsidiary of a publicly traded company can be liable. ¹⁹

Another issue awaiting clarification is the exposure of privately owned contractors of publicly traded companies. While the Act lists contractors and subcontractors among those who cannot discriminate, it does not specifically address whether the contractor itself must be publicly traded to incur liability. The ALJ in Goodman v. Decisive Analytics Corp., concluded that the contractor itself must be public, noting that "the terms ‘contractor’ and ‘subcontractor’ in the provision reference two of various entities of a publicly traded company that may not adversely affect the terms and conditions of an employee of a publicly traded company." ²⁰ The Act did not protect employees of private contractors and subcontractors because any private company engaged in a contractual relationship with a public entity would suddenly be subsumed under the Act. "At present, the caption and language of the SOX employee protection provision does not extend its jurisdictional reach that far." ²¹

SOX covers the actions of "officers, employees, contractors, subcontractors or agents" of public companies, ²² thus indicating that liability extends to individuals as well as employers. One ALJ held that executives who terminated the complainant’s employment may be properly named as parties. In Gallagher v. Granada Entertainment USA, the ALJ noted, "The Sarbanes- Oxley statute and regulations are broader than previous whistleblower protections," and do not limit the parties to a complainant and his employer. ²³ Because SOX defines "named person" to include individuals as well as employers, ²⁴ a decision-maker may be held individually liable. ²⁵

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