Whistleblowing: SOX's Unintended Victims

Under Stonecipher's watch, the internal governance office issued handbooks and other materials to explain the use of the hotline, and encouraged all employees to make referrals if they suspected any wrongdoing. Additionally, all employees, regardless of rank, were required to sign a code of conduct every year. During an interview last year, Stonecipher said that if any senior executives ran afoul of the new rules, he would not hesitate to mete out punishment. “You can rest assured that we will investigate any tip, and if we find out that somebody did something they shouldn't have, we will deal with it swiftly and summarily,” he said. It is probably fair to assume that he did not expect that he would be his policy's highest-profile casualty.

Sarbanes-Oxley

The Sarbanes Oxley Act (SOX) was intended to remedy the ethical breaches epitomized by WorldCom, Enron and other notable examples of corporate excess. Those cases ushered in a new period of corporate accountability and compliance, highlighted by the passage of SOX and its whistleblower protection provisions.

Broad Interpretations

But the issues seem to be quickly going far beyond fraud against shareholders per se. While some courts have construed SOX's whistleblower protections narrowly, others have opened the door to a broader interpretation, permitting a remedy to employees who reasonably believe that their employer's conduct constitutes a “fraud upon shareholders,” without clear definitions or limitations on what that term means. Harvey v. Safeway Inc. (2004 SOX 21 (DOL OAL Feb. 11, 2005)) illustrates the point. There, the complainant, a grocery stock clerk earning $6.60 per hour, alleged that he was not being paid for his time worked, in violation of the Fair Labor Standards Act. He complained internally to Safeway's corporate counsel about the alleged failure, and his hours were subsequently reduced and changed. He filed a complaint, alleging that he was terminated in violation of SOX for having reported possible fraud against shareholders. Safeway moved to dismiss, claiming that the alleged conduct was not protected by the Act.

While the administrative law judge granted Safeway's motion, he nevertheless held that, had the facts involved a more significant violation, the allegations could have given rise to a SOX violation.

Initially, the administrative law judge noted that a protected activity under SOX has three components:

1) the report or action must involve a purported violation of a federal law or SEC rule or regulation relating to fraud against shareholders; 2) the complainant's belief about the purported violation must be objectively reasonable; and 3) the complainant must communicate his concern to his employer or the federal government.

The complainant argued that Safeway's under-compensation of its employees could impermissibly alter the accuracy of its financial disclosures mandated by SOX. The administrative law judge agreed that the argument “has some logical appeal, [but] the connection between individual Fair Labor Standards Act violations and SOX becomes tenuous upon close examination of SOX.” The reason was that the law requires that the facts related to finances that are alleged to be inaccurate must be “material” in order for a SOX violation to occur.

Thus, the complainant's reports of the underpayment of his wages — totaling only $1 an hour over the course of 4 weeks — would, if uncorrected, have a “microscopic, if any, effect on any financial report prepared by Safeway for the benefit of its shareholders.” Nor did the complainant's allegations of systemic Fair Labor Standards Act violations do the trick, because they were not “factually or reasonably viable.” Moreover, the complainant's internal complaints only concerned his own pay.

The administrative law judge therefore ruled that the complainant's allegations of Fair Labor Standards Act violations did not rise to the level of conduct that could constitute a fraud against shareholders because his complaints “did not include an objectively reasonable complaint that Safeway was also engaged in a significant, material and company-wide underpayment of its employees to the extent a fraud was being perpetrated on its shareholders.” Had the complainant's allegations met that test, there is little doubt but that the administrative law judge would have found that, in alleging that he was discharged as a result of blowing the whistle on that conduct, he had stated a violation of SOX.

SOX Limitations

Other administrative law judge decisions have held that to state a SOX whistleblower claim, the allegation of misconduct must have a more direct relation to fraud against shareholders. Thus, for example, in Tuttle v. Johnson Controls (2004 SOX 0076 (Jan. 3, 2005)) the administrative law judge rejected the complainant's allegation that his discharge for having reported to his employer that significant numbers of its batteries were defective stated a claim under SOX. The administrative law judge noted that the complaint “does not address any kind of fraud or any transactions relating to securities.” Nor did the complaint allege that the activities “involved intentional deceit or resulted in a fraud against shareholders or investors.”

A more direct rejection of a SOX whistleblower claim when the allegations do not explicitly tie into a conventional fraud against shareholders can be found in Minkina v. Affiliated Physician's Group (2005 SOX 00019 (Feb. 22, 2005)). There, the complainant alleged that she was discriminated against after filing reports with the Occupational Health and Safety Administration (OSHA) regarding a ventilation problem in her workplace. In granting the employer's motion to dismiss, the administrative law judge flatly stated: “It is undeniable that the Complainant's reports concerned air quality and had nothing to do with fraud or the protection of investors.”

The administrative law judge cited another case rejecting SOX's application to alleged retaliation resulting from the complainant having reported to OSHA and his employer the release of thousands of gallons of sludge water (see Hopkins v. ATK Tactical Systems, No. 2004 SOX 0019 (May 27, 2004)).

“Quite simply,” the Minkina judge held, “while the Complainant may have had a valid claim of poor air quality, Sarbanes-Oxley … was enacted to address the specific problem of fraud in the realm of publicly traded companies and not the resolution of air quality issues, even if there is a possibility that poor air quality might ultimately result in financial loss” (Minkina at 6-7).

Range of Conduct

It thus appears, at this early stage, that there is inconsistency in the way that Department of Labor administrative law judges are viewing the matter. Some seem to hold that if alleged conduct does not itself constitute a fraud against shareholders, then a complaint about the conduct, no matter how severe it may be, is not protected by SOX. But Harvey v. Safeway suggests that the complaint may be protected even if the alleged wrongdoing does not specifically relate to a financial loss or a fraud against shareholders per se, if the alleged wrongdoing is significant enough that its continuation could constitute a fraud against shareholders.

Stonecipher appears to be only one of many unintended victims of Sarbanes Oxley. He was dethroned as a result of his self-created ethics policies, hotline and email abuses. Clients need to understand that the SOX whistleblower remedy is not confined to the company balance sheet, but may extend to any alleged conduct that puts at risk the interests of shareholders.

It seems fitting to recall Samuel Morse's first telegraph message now that his telecommunications progeny Bernie Ebbers, former chief executive of WorldCom, has been convicted on all nine counts claiming that he helped mastermind an $11 billion accounting fraud at his former firm, now known as MCI. Ebbers had been charged with one count of conspiracy, one count of securities fraud, and seven counts of filing false statements with securities regulators. He could serve up to 85 years in prison. Meanwhile, another senior executive of a major corporation has been undone – not by business fraud, but by a personal affair.

Whistleblowing At Boeing

Boeing's chief executive, Harry Stonecipher, was recently forced to step down after an employee whistleblower disclosed his relationship with a female corporate executive. Stonecipher was evidently done in by a “secret tipster” who also revealed evidence of at least one very graphic e-mail written by the chief executive. The irony, of course, is that Boeing had hired Stonecipher in order to restore its scandal-ridden image. Shortly after his hire, Stonecipher hired outside ethics consultants and created a centralized Office of Internal Governance, reporting to him, which was responsible for handling ethical issues, internal audit and compliance with the new rules. He set up a toll-free hotline, called the Boeing Ethics Line.

Under Stonecipher's watch, the internal governance office issued handbooks and other materials to explain the use of the hotline, and encouraged all employees to make referrals if they suspected any wrongdoing. Additionally, all employees, regardless of rank, were required to sign a code of conduct every year. During an interview last year, Stonecipher said that if any senior executives ran afoul of the new rules, he would not hesitate to mete out punishment. “You can rest assured that we will investigate any tip, and if we find out that somebody did something they shouldn't have, we will deal with it swiftly and summarily,” he said. It is probably fair to assume that he did not expect that he would be his policy's highest-profile casualty.

Sarbanes-Oxley

The Sarbanes Oxley Act (SOX) was intended to remedy the ethical breaches epitomized by WorldCom, Enron and other notable examples of corporate excess. Those cases ushered in a new period of corporate accountability and compliance, highlighted by the passage of SOX and its whistleblower protection provisions.

Broad Interpretations

But the issues seem to be quickly going far beyond fraud against shareholders per se. While some courts have construed SOX's whistleblower protections narrowly, others have opened the door to a broader interpretation, permitting a remedy to employees who reasonably believe that their employer's conduct constitutes a “fraud upon shareholders,” without clear definitions or limitations on what that term means. Harvey v. Safeway Inc . (2004 SOX 21 (DOL OAL Feb. 11, 2005)) illustrates the point. There, the complainant, a grocery stock clerk earning $6.60 per hour, alleged that he was not being paid for his time worked, in violation of the Fair Labor Standards Act. He complained internally to Safeway's corporate counsel about the alleged failure, and his hours were subsequently reduced and changed. He filed a complaint, alleging that he was terminated in violation of SOX for having reported possible fraud against shareholders. Safeway moved to dismiss, claiming that the alleged conduct was not protected by the Act.

While the administrative law judge granted Safeway's motion, he nevertheless held that, had the facts involved a more significant violation, the allegations could have given rise to a SOX violation.

Initially, the administrative law judge noted that a protected activity under SOX has three components:

1) the report or action must involve a purported violation of a federal law or SEC rule or regulation relating to fraud against shareholders; 2) the complainant's belief about the purported violation must be objectively reasonable; and 3) the complainant must communicate his concern to his employer or the federal government.

The complainant argued that Safeway's under-compensation of its employees could impermissibly alter the accuracy of its financial disclosures mandated by SOX. The administrative law judge agreed that the argument “has some logical appeal, [but] the connection between individual Fair Labor Standards Act violations and SOX becomes tenuous upon close examination of SOX.” The reason was that the law requires that the facts related to finances that are alleged to be inaccurate must be “material” in order for a SOX violation to occur.

Thus, the complainant's reports of the underpayment of his wages — totaling only $1 an hour over the course of 4 weeks — would, if uncorrected, have a “microscopic, if any, effect on any financial report prepared by Safeway for the benefit of its shareholders.” Nor did the complainant's allegations of systemic Fair Labor Standards Act violations do the trick, because they were not “factually or reasonably viable.” Moreover, the complainant's internal complaints only concerned his own pay.

The administrative law judge therefore ruled that the complainant's allegations of Fair Labor Standards Act violations did not rise to the level of conduct that could constitute a fraud against shareholders because his complaints “did not include an objectively reasonable complaint that Safeway was also engaged in a significant, material and company-wide underpayment of its employees to the extent a fraud was being perpetrated on its shareholders.” Had the complainant's allegations met that test, there is little doubt but that the administrative law judge would have found that, in alleging that he was discharged as a result of blowing the whistle on that conduct, he had stated a violation of SOX.

SOX Limitations

Other administrative law judge decisions have held that to state a SOX whistleblower claim, the allegation of misconduct must have a more direct relation to fraud against shareholders. Thus, for example, in Tuttle v. Johnson Controls (2004 SOX 0076 (Jan. 3, 2005)) the administrative law judge rejected the complainant's allegation that his discharge for having reported to his employer that significant numbers of its batteries were defective stated a claim under SOX. The administrative law judge noted that the complaint “does not address any kind of fraud or any transactions relating to securities.” Nor did the complaint allege that the activities “involved intentional deceit or resulted in a fraud against shareholders or investors.”

A more direct rejection of a SOX whistleblower claim when the allegations do not explicitly tie into a conventional fraud against shareholders can be found in Minkina v. Affiliated Physician's Group (2005 SOX 00019 (Feb. 22, 2005)). There, the complainant alleged that she was discriminated against after filing reports with the Occupational Health and Safety Administration (OSHA) regarding a ventilation problem in her workplace. In granting the employer's motion to dismiss, the administrative law judge flatly stated: “It is undeniable that the Complainant's reports concerned air quality and had nothing to do with fraud or the protection of investors.”

The administrative law judge cited another case rejecting SOX's application to alleged retaliation resulting from the complainant having reported to OSHA and his employer the release of thousands of gallons of sludge water ( see Hopkins v. ATK Tactical Systems , No. 2004 SOX 0019 (May 27, 2004)).

“Quite simply,” the Minkina judge held, “while the Complainant may have had a valid claim of poor air quality, Sarbanes-Oxley … was enacted to address the specific problem of fraud in the realm of publicly traded companies and not the resolution of air quality issues, even if there is a possibility that poor air quality might ultimately result in financial loss” (Minkina at 6-7).

Range of Conduct

It thus appears, at this early stage, that there is inconsistency in the way that Department of Labor administrative law judges are viewing the matter. Some seem to hold that if alleged conduct does not itself constitute a fraud against shareholders, then a complaint about the conduct, no matter how severe it may be, is not protected by SOX. But Harvey v. Safeway suggests that the complaint may be protected even if the alleged wrongdoing does not specifically relate to a financial loss or a fraud against shareholders per se, if the alleged wrongdoing is significant enough that its continuation could constitute a fraud against shareholders.

Stonecipher appears to be only one of many unintended victims of Sarbanes Oxley. He was dethroned as a result of his self-created ethics policies, hotline and email abuses. Clients need to understand that the SOX whistleblower remedy is not confined to the company balance sheet, but may extend to any alleged conduct that puts at risk the interests of shareholders.