Courts Grapple with SOX Whistleblower Protections

In Carnero v. Boston Scientific Corp., 2004 U.S. Dist. LEXIS 17205 (D. Mass. Aug. 27, 2004), and Cocone v. Capital One Financial Corp., 2005-SOX-6 (Dept. Labor OALJ Dec. 3, 2004), a federal district court and an administrative law judge, respectively, held that SOX has no extraterritorial effect and thus does not protect employees of U.S. public companies' foreign subsidiaries working exclusively outside the U.S.

In Carnero, the plaintiff was an Argentinean national citizen who worked for the Argentinean and Brazilian subsidiaries of a U.S. public company. In Cocone, the plaintiff was an Italian national employed by a U.S. public company's foreign subsidiaries in Italy and the UK. In both cases, judges dismissed their SOX complaints on grounds that, absent express evidence of a contrary intent by Congress, SOX was not intended to have extraterritorial effect. The judges in both cases noted that application of ' 806 overseas might conflict with foreign laws, which the Carnero judge found to be likely because the plaintiff in that case was seeking reinstatement in an Argentine court under Argentine law.

Neither decision appears to be based on the fact that the plaintiffs were residents and citizens of foreign countries, or that the plaintiffs worked for non-U.S.-based subsidiaries of U.S. public companies. Thus, on their face, the decisions arguably apply to both U.S. and foreign citizens working overseas, regardless of whether they are employed directly by a U.S. public parent company. However, because other federal employment-related statutes that prohibit discrimination and retaliation apply to U.S. citizens working abroad for U.S. companies and U.S.-controlled companies in some situations, such as Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act and the Americans With Disabilities Act (ADEA), and because it is unlikely that future courts would limit other provisions of SOX to U.S.-based activities of publicly traded multinational corporations, multinational corporate employers must await further development of the law before they can know for sure whether SOX provides protection to all foreign-based whistleblowers.

Nonpublic Subsidiaries of Public Companies

With respect to whether SOX protects whistleblower protection to employees of nonpublic subsidiaries of public companies, administrative law judges have issued conflicting decisions. In Powers v. Pinnacle Airlines, Inc., 2003-AIR-00012 (Dept. Labor OALJ March 5, 2003), the plaintiff was employed by a nonpublic subsidiary of a public company. She alleged that her employer harassed her in retaliation for voicing concerns about the accuracy of Pinnacle's on-time flight records and the fraudulent impact they had on stockholders. She initially named only the nonpublic employer in her complaint, and the judge dismissed her complaint on grounds that SOX protects only employees of publicly traded companies. She then moved to add the publicly traded parent as a respondent, which the judge denied on grounds that SOX does not protect employees of nonpublic subsidiaries. The judge noted that her application ignored the general corporate law principle that a parent corporation is not liable for acts of its subsidiaries; thus, barring a showing that the corporate veil should be pierced, which she did not demonstrate, the employer's status as a subsidiary of a public company was irrelevant.

In Morefield v. Excelon Services, Inc. and Excelon Corp., 2004-SOX-00002 (Dept. Labor OALJ Jan. 28, 2004), another administrative law judge came to the opposite conclusion. The plaintiff alleged that his employer, a nonpublic company, and its publicly traded parent, terminated him in retaliation for reporting internal accounting control deficiencies and efforts by top management intentionally to manipulate monthly financial results, forecasts and accounting records to make his employer's performance appear better than actual results.

Citing the Powers decision, the respondents moved to dismiss the complaint because the employer was a nonpublic company. The judge denied the motion. The judge noted that Congress, in enacting SOX, intended to re-fashion the regulatory and private sector environments that had failed to detect or affirmatively allowed deception in the reporting of corporate value and performance and to reform the ethical standards and accounting and reporting systems flaws which allowed fraud to flourish — and turned, among other remedies, to a valuable deterrent resource it had used in the past to help insure compliance with its mandates, ie, employees in an organization who were willing to blow the whistle.

Thus, the judge noted, it did not serve SOX's purposes or policies to take “too pinched a view” of the scope of its remedial whistleblower provisions when it comes to protecting those in an organization who can address the concerns that Congress sought to correct. The judge further noted that, for purposes of SOX, subsidiaries are often an integral part of the publicly traded company, inseparable from it for purposes of evaluating the integrity of financial information, and must be treated as such. The judge concluded that a publicly traded corporation is, for SOX purposes, the sum of its constituent units, and Congress insisted upon accuracy and integrity in financial reporting at all levels of the corporate structure, including the non-publicly traded subsidiaries. In this context, SOX imposed reforms upon publicly traded companies, and through them, to their entire corporate organization. Unlike the judge in Powers, the judge in Morefield did not require the plaintiff to make a showing that the subsidiary's corporate veil should be pierced.

Other Case Law

In three other cases, administrative law judges held that nonpublic subsidiaries can be held liable under SOX conditional upon the plaintiffs' showing of a close connection between the subsidiaries and their publicly traded parents. However, the judges did not apply identical tests. Nor were the judges consistent regarding whether the subsidiary or the parent could be held liable where such a close connection were found to exist.

Conclusion

The Carnero and Cocone decisions thus far appear to shield U.S. publicly traded companies from SOX's whistleblower provisions in respect of employees located outside the U.S. The full scope of those decisions, however, has yet to be fully articulated. Similarly, the conflicting decisions in the cases concerning the applicability of SOX's whistleblower provisions to nonpublic subsidiaries of U.S. publicly traded companies leaves them in the dark to some extent.

In light of the uncertainty concerning the scope of SOX in these two contexts, it is imperative that public companies adopt “best practices” designed to ensure that their employees and their nonpublic subsidiaries' employees are educated and trained about SOX's whistleblower provisions in order to prevent violations that might result in the imposition of civil and criminal penalties under the Act. In addition, public companies should audit their current subsidiary formation and the manner in which employment relationships within their nonpublic subsidiaries are structured in order to try to minimize the risk that judges will expand coverage under the act to those private subsidiaries. These audits should be conducted in conjunction with counsel in order to preserve the attorney-client privilege in connection with the audit process.

Section 806 of the Corporate Accounting and Auditing, Re-ponsibility and Transparency Act of 2002, commonly known as the Sarbanes-Oxley Act (SOX), prohibits publicly traded companies from discharging, demoting, suspending, threatening, harassing, retaliating against or in any other manner discriminating against their employees in the terms and conditions of employment for providing information or otherwise assisting in the investigation of conduct that they reasonably believe constitutes wire fraud, bank fraud, securities fraud or violation of any rule or regulation of the Securities and Exchange Commission (SEC), or any provision of federal law relating to fraud against shareholders. It also prohibits filing, testifying in, participating in or otherwise assisting in a proceeding filed relating to a violation of such fraud laws. Section 806 has proven to be very popular with employees; since SOX's enactment in 2002, over 300 SOX whistleblower claims have been filed.

Courts and administrative law judges have begun grappling with issues concerning the scope of SOX's whistleblower provisions in two types of situations that any U.S.-based multinational corporation might encounter: 1) where the whistleblower is located and the whistleblowing occurred outside the U.S., and 2) where the whistleblower's employer is a nonpublic subsidiary of a publicly traded company.

Whistleblowers Outside the U.S.

In Carnero v. Boston Scientific Corp., 2004 U.S. Dist. LEXIS 17205 (D. Mass. Aug. 27, 2004), and Cocone v. Capital One Financial Corp., 2005-SOX-6 (Dept. Labor OALJ Dec. 3, 2004), a federal district court and an administrative law judge, respectively, held that SOX has no extraterritorial effect and thus does not protect employees of U.S. public companies' foreign subsidiaries working exclusively outside the U.S.

In Carnero, the plaintiff was an Argentinean national citizen who worked for the Argentinean and Brazilian subsidiaries of a U.S. public company. In Cocone, the plaintiff was an Italian national employed by a U.S. public company's foreign subsidiaries in Italy and the UK. In both cases, judges dismissed their SOX complaints on grounds that, absent express evidence of a contrary intent by Congress, SOX was not intended to have extraterritorial effect. The judges in both cases noted that application of ' 806 overseas might conflict with foreign laws, which the Carnero judge found to be likely because the plaintiff in that case was seeking reinstatement in an Argentine court under Argentine law.

Neither decision appears to be based on the fact that the plaintiffs were residents and citizens of foreign countries, or that the plaintiffs worked for non-U.S.-based subsidiaries of U.S. public companies. Thus, on their face, the decisions arguably apply to both U.S. and foreign citizens working overseas, regardless of whether they are employed directly by a U.S. public parent company. However, because other federal employment-related statutes that prohibit discrimination and retaliation apply to U.S. citizens working abroad for U.S. companies and U.S.-controlled companies in some situations, such as Title VII of the Civil Rights Act of 1964, the Age Discrimination in Employment Act and the Americans With Disabilities Act (ADEA), and because it is unlikely that future courts would limit other provisions of SOX to U.S.-based activities of publicly traded multinational corporations, multinational corporate employers must await further development of the law before they can know for sure whether SOX provides protection to all foreign-based whistleblowers.

Nonpublic Subsidiaries of Public Companies

With respect to whether SOX protects whistleblower protection to employees of nonpublic subsidiaries of public companies, administrative law judges have issued conflicting decisions. In Powers v. Pinnacle Airlines, Inc., 2003-AIR-00012 (Dept. Labor OALJ March 5, 2003), the plaintiff was employed by a nonpublic subsidiary of a public company. She alleged that her employer harassed her in retaliation for voicing concerns about the accuracy of Pinnacle's on-time flight records and the fraudulent impact they had on stockholders. She initially named only the nonpublic employer in her complaint, and the judge dismissed her complaint on grounds that SOX protects only employees of publicly traded companies. She then moved to add the publicly traded parent as a respondent, which the judge denied on grounds that SOX does not protect employees of nonpublic subsidiaries. The judge noted that her application ignored the general corporate law principle that a parent corporation is not liable for acts of its subsidiaries; thus, barring a showing that the corporate veil should be pierced, which she did not demonstrate, the employer's status as a subsidiary of a public company was irrelevant.

In Morefield v. Excelon Services, Inc. and Excelon Corp., 2004-SOX-00002 (Dept. Labor OALJ Jan. 28, 2004), another administrative law judge came to the opposite conclusion. The plaintiff alleged that his employer, a nonpublic company, and its publicly traded parent, terminated him in retaliation for reporting internal accounting control deficiencies and efforts by top management intentionally to manipulate monthly financial results, forecasts and accounting records to make his employer's performance appear better than actual results.

Citing the Powers decision, the respondents moved to dismiss the complaint because the employer was a nonpublic company. The judge denied the motion. The judge noted that Congress, in enacting SOX, intended to re-fashion the regulatory and private sector environments that had failed to detect or affirmatively allowed deception in the reporting of corporate value and performance and to reform the ethical standards and accounting and reporting systems flaws which allowed fraud to flourish — and turned, among other remedies, to a valuable deterrent resource it had used in the past to help insure compliance with its mandates, ie, employees in an organization who were willing to blow the whistle.

Thus, the judge noted, it did not serve SOX's purposes or policies to take “too pinched a view” of the scope of its remedial whistleblower provisions when it comes to protecting those in an organization who can address the concerns that Congress sought to correct. The judge further noted that, for purposes of SOX, subsidiaries are often an integral part of the publicly traded company, inseparable from it for purposes of evaluating the integrity of financial information, and must be treated as such. The judge concluded that a publicly traded corporation is, for SOX purposes, the sum of its constituent units, and Congress insisted upon accuracy and integrity in financial reporting at all levels of the corporate structure, including the non-publicly traded subsidiaries. In this context, SOX imposed reforms upon publicly traded companies, and through them, to their entire corporate organization. Unlike the judge in Powers, the judge in Morefield did not require the plaintiff to make a showing that the subsidiary's corporate veil should be pierced.

Other Case Law

In three other cases, administrative law judges held that nonpublic subsidiaries can be held liable under SOX conditional upon the plaintiffs' showing of a close connection between the subsidiaries and their publicly traded parents. However, the judges did not apply identical tests. Nor were the judges consistent regarding whether the subsidiary or the parent could be held liable where such a close connection were found to exist.

Conclusion

The Carnero and Cocone decisions thus far appear to shield U.S. publicly traded companies from SOX's whistleblower provisions in respect of employees located outside the U.S. The full scope of those decisions, however, has yet to be fully articulated. Similarly, the conflicting decisions in the cases concerning the applicability of SOX's whistleblower provisions to nonpublic subsidiaries of U.S. publicly traded companies leaves them in the dark to some extent.

In light of the uncertainty concerning the scope of SOX in these two contexts, it is imperative that public companies adopt “best practices” designed to ensure that their employees and their nonpublic subsidiaries' employees are educated and trained about SOX's whistleblower provisions in order to prevent violations that might result in the imposition of civil and criminal penalties under the Act. In addition, public companies should audit their current subsidiary formation and the manner in which employment relationships within their nonpublic subsidiaries are structured in order to try to minimize the risk that judges will expand coverage under the act to those private subsidiaries. These audits should be conducted in conjunction with counsel in order to preserve the attorney-client privilege in connection with the audit process.