Whistleblower Rights Expand with Supreme Court Ruling

The Case

The SOX whistleblower protections already are a powerful weapon for employees of public companies who asserted that they were punished for reporting corporate malfeasance. In early March, a Los Angeles federal jury awarded $6 million to a former controller of Playboy Enterprises, who alleged that she was unlawfully fired for refusing to set aside $1 million in management bonuses that were not properly approved by the board of directors. Now, under Lawso', such lawsuits can be brought by employees of private companies with a contractual relationship with a public company.

Section 806 of SOX created a new provision, 18 U.S.C Section 1514A(a), which states in relevant part that “[n]o public company … or any officer, employee, contractor or subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other matter discriminate against an employee” because the employee provided information or assisted in the investigation regarding conduct that the employee reasonably believed constituted violations of the federal statutes prohibiting wire fraud, mail fraud, bank fraud, securities or commodities fraud, or any rule or regulation of the Securities and Exchange Commission (SEC). Sections 1514A(b) and (c) allow a person who is the victim of such retaliation to file an action with the Department of Labor (DOL) seeking reinstatement with back pay and compensation for any special damages that resulted.

Background

The plaintiffs, Lawson and Zang, filed Section 1514A actions against their former employers, which were privately held companies that provided advisory and management services to the Fidelity family of mutual funds. As is customary, the funds, although publicly traded, had no employees. Instead, the funds contracted with investment advisers, including FMR LLC, to handle day-to-day operations, including management decisions, preparing shareholder reports and making SEC filings. The plaintiffs asserted that they were punished by their employers after they complained about alleged accounting errors that overstated expenses in connection with operating the funds (Lawson) and misstatements in a draft registration statement that certain funds would file with the SEC (Zang).

The U.S. Court of Appeals for the First Circuit held that the lawsuits should be dismissed on the ground that Section 1414A protected only “an employee” of a public company, not employees of private contractors or subcontractors. By contrast, several months later, the Department of Labor's Administrative Review Board held in an unrelated case that Section 1514A provides whistleblower protection to employees of contractors and subcontractors that provide services to public companies. The Supreme Court agreed to resolve the split in opinion.

The Court's Ruling

As a threshold matter, Justice Ginsburg's majority opinion held that the “ordinary meaning” of an “employee” in Section 1514A (a) referred to the contractor's employee. The Court rejected FMR's argument that Congress included contractors in Section 1514A simply to prevent companies from avoiding liability by employing contractors, like the “ax-wielding specialist” portrayed by George Clooney in the movie “Up in the Air,” to implement the retaliatory discharge of the employee. The majority held that Section 1514A would not insulate from liability a company using the ax-wielder to fire employees at the company's direction, and that an ax-wielding George Clooney was not the “real-world problem” that Congress had in mind when it included contractors in the statute.

Rather, there would be a “huge hole” in Section 1514A's reach without including a contractor's employees. Mutual fund advisers and managers, who actually control and operate the publicly traded funds and are responsible for drafting SEC filings, would go scot-free, which could not be what Congress intended. And rather than inadvertently capturing law and accounting firms, Congress, in the wake of the Enron debacle, presumably sought to provide whistleblowing protections to the professionals who could halt a fraud upon investors.

The Dissent

Justice Sotomayor's dissent, joined by Justices Kennedy and Alito, warned that the majority's opinion would conceivably permit Section 1514A lawsuits by the millions of private company employees and independent contractors. Further, as construed by the majority, Section 1514A would extend to employment relationships between individual employees of a public company and their nannies, housekeepers and caretakers (and presumably to their gardeners, plumbers, electricians and anyone else with whom the employee has a contractual relationship). A Section 1514A suit could be brought by a nanny who was fired after complaining that the employer's teen-aged son had committed Internet fraud. Similarly, under the majority's analysis, a babysitter could bring a Section 1514A action against an employer working as a checkout clerk for PetSmart, a public company, but not Petco, a private company. Congress could not have intended such absurd results.

In response, the majority opinion dismissed possible suits by nannies or babysitters as far-fetched, and stated that there could be “limiting principles” that would preclude any over-breadth problems. A “contractor” does not necessarily cover every “fleeting business relationship,” but could apply only to a party whose contractual performance occurs over a significant period. Justice Ginsburg noted the Solicitor General suggested Section 1514A might protect contractor employees only to the extent that they fulfilled the contractor's role for the public company. But the Court held there was no need to draw such lines since the plaintiffs' suits concerned a “mainstream” application of Section 1514A given allegations that they had been punished for blowing the whistle on efforts to mislead the funds' shareholders and the SEC.

But au contraire, wrote Justice Scalia in a concurring opinion joined by Justice Thomas. Although such a limiting principle may be appealing from a policy standpoint, there was no statutory basis for concluding that Section 1514A protects a contractor's employees only to the extent that the employee performed the contractor's role for the public company.
“[S]o long as an employee works for one of the actors enumerated in Section 1514A(a) and reports a covered form of fraud …, the employee is protected from retaliation.” Thus, a majority of Justices ' three in the dissent and two in the concurring opinion ' rejected the Solicitor General's proposed limiting principle as inconsistent with Justice Ginsburg's statutory analysis. In other words, the scope of Section 1514A, like George Clooney, is left “Up in the Air.” Justice Scalia also heaped scorn on trying to ascertain a Congressional intent apart from the text as useless intellectual hydroplaning because on most issues, “the majority of Senators and Representatives had no view on how the issues should be resolved ' indeed, were unaware of the issues entirely.”

The Dodd-Frank Act

While a close textual analysis supported the plaintiffs'claims in Lawson , it may benefit defendants in another whistleblower-related issue percolating up through the courts: whether the whistleblower protection provisions of the Dodd-Frank Act, which provide more expansive relief to claimants than SOX, apply only to those whistleblowers who reported possible violations to the SEC rather than those who reported only internally. In Asadi v. G.E. Energy (USA), L.L.C., 720 F.3d 620 (5th Cir. 2013), the Fifth Circuit held, in contrast to lower court decisions, that Dodd-Frank's definition of “whistleblower” limited its whistleblower protections only to employees who reported to the SEC.

By contrast, California last October expanded its employee whistleblower protections to include employees who reported possible violations internally to a supervisor or another employee with authority to investigate the complaint. These protections apply to employees “regardless of whether disclosing the information is part of the employee's duties,” which could apply to in-house counsel or compliance officers. The expanded protection also bars retaliation because the employer believes that an employee has or will report possible violations, even if the employee has not actually done so.

Your Private Company Clients

In the wake of Lawson, attorneys for private companies should advise their clients that they could be subjected to SOX whistleblower lawsuits. The first analysis is whether the private company has a business relationship with a public company that might make it a “contractor” or “subcontractor” for SOX purposes. Although Lawson fails to provide clear guidelines, an analysis should include whether there is a written contract with the public company; whether the business relationship has covered a significant period of time; and whether there has been recurring business. There would have to be a further analysis to determine whether the client is a subcontractor of a contractor of a public company. If so, then attorneys should advise the private company clients that they could be sued under SOX and ' depending on how Lawson is applied by the lower courts ' the suit could concern purely internal matters that are unrelated to the public company.

What Lawson Means for Law Firms

First, it is now certain that law (and accounting) firms may be sued under Section 1514A by employees claiming they were retaliated against after raising concerns about a public company client. But firms may also be subject to a Section 1514A action by an employee claiming retaliation for expressing concern about purely internal matters, such as padding a bill (mail fraud) or a false loan application (bank fraud). Indeed, the employee of a firm with public company client A might be able to bring the Section 1514A action after being punished for raising concerns about conduct in private company client B. Only future judicial pronouncements will determine the boundaries of Section 1514A.

Accordingly, law firms need to follow the identical advice that they give to their clients:

• Have a written anti-retaliation policy. Law firms, like their clients, need to have a written anti-retaliation policy that is provided to new employees and is circulated to all employees annually. Employees need assurance that they will not be victimized for raising ethical and legal concerns, and that the firm will take their complaints seriously. Management should discuss with an employee what inquiry was undertaken in response to any complaint. A hotline should be established so that employees may raise such concerns in confidence.
• No retaliation. Supervisors should be told that there must be no adverse action taken against any employee who makes complaints that are covered by SOX. Such actions include measures that could be considered as a constructive discharge, including reducing the employee's responsibilities; isolating the employee physically; and criticizing the employee in front of co-workers.
• Documentation. The reasons for any dismissal or disciplinary action against an employee should be documented in order to show that it was not retaliation for a complaint.

And a word to the wise ' be nice to your nannies and babysitters.

Jared L. Kopel is the owner of The Law Offices of Jared L. Kopel, which is affiliated with Bergeson, LLP. Mr. Kopel specializes in securities and commercial litigation, and defending clients before the SEC. He can be reached at [email protected]. This article also appeared in The Recorder , an ALM sister publication of this newsletter.

Sometimes, the U.S. Supreme Court surprises us with a decision that cuts across ideological lines and propels the Court out of the intellectual grotto in which it appeared to be dwelling. Such is Lawson v. FMR LLC, No. 12-3 (March 4, 2014), which could have significant consequences for law and accounting firms, as well as all businesses working with public companies.

In Lawson, the Court held by a six-to-three split that the anti-retaliation protections afforded whistleblowers under the Sarbanes-Oxley Act of 2002 (SOX) enacted in the aftermath of the Enron and WorldCom financial scandals apply to employees of contractors and subcontractors of publicly traded companies. Although SOX was enacted to provide greater regulatory oversight of public companies, the Lawson decision means that private companies could be subjected to whistleblower lawsuits. Law firms with public company clients could also face SOX lawsuits that could concern matters unrelated to the public companies.

For a court whose conservative majority determinedly has tried to protect business interests from the burden of excessive litigation and has shown little sympathy for employee rights, the Lawson decision was unexpected. Even actor George Clooney made a surprise appearance in the majority opinion.

The Case

The SOX whistleblower protections already are a powerful weapon for employees of public companies who asserted that they were punished for reporting corporate malfeasance. In early March, a Los Angeles federal jury awarded $6 million to a former controller of Playboy Enterprises, who alleged that she was unlawfully fired for refusing to set aside $1 million in management bonuses that were not properly approved by the board of directors. Now, under Lawso', such lawsuits can be brought by employees of private companies with a contractual relationship with a public company.

Section 806 of SOX created a new provision, 18 U.S.C Section 1514A(a), which states in relevant part that “[n]o public company … or any officer, employee, contractor or subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other matter discriminate against an employee” because the employee provided information or assisted in the investigation regarding conduct that the employee reasonably believed constituted violations of the federal statutes prohibiting wire fraud, mail fraud, bank fraud, securities or commodities fraud, or any rule or regulation of the Securities and Exchange Commission (SEC). Sections 1514A(b) and (c) allow a person who is the victim of such retaliation to file an action with the Department of Labor (DOL) seeking reinstatement with back pay and compensation for any special damages that resulted.

Background

The plaintiffs, Lawson and Zang, filed Section 1514A actions against their former employers, which were privately held companies that provided advisory and management services to the Fidelity family of mutual funds. As is customary, the funds, although publicly traded, had no employees. Instead, the funds contracted with investment advisers, including FMR LLC, to handle day-to-day operations, including management decisions, preparing shareholder reports and making SEC filings. The plaintiffs asserted that they were punished by their employers after they complained about alleged accounting errors that overstated expenses in connection with operating the funds (Lawson) and misstatements in a draft registration statement that certain funds would file with the SEC (Zang).

The U.S. Court of Appeals for the First Circuit held that the lawsuits should be dismissed on the ground that Section 1414A protected only “an employee” of a public company, not employees of private contractors or subcontractors. By contrast, several months later, the Department of Labor's Administrative Review Board held in an unrelated case that Section 1514A provides whistleblower protection to employees of contractors and subcontractors that provide services to public companies. The Supreme Court agreed to resolve the split in opinion.

The Court's Ruling

As a threshold matter, Justice Ginsburg's majority opinion held that the “ordinary meaning” of an “employee” in Section 1514A (a) referred to the contractor's employee. The Court rejected FMR's argument that Congress included contractors in Section 1514A simply to prevent companies from avoiding liability by employing contractors, like the “ax-wielding specialist” portrayed by George Clooney in the movie “Up in the Air,” to implement the retaliatory discharge of the employee. The majority held that Section 1514A would not insulate from liability a company using the ax-wielder to fire employees at the company's direction, and that an ax-wielding George Clooney was not the “real-world problem” that Congress had in mind when it included contractors in the statute.

Rather, there would be a “huge hole” in Section 1514A's reach without including a contractor's employees. Mutual fund advisers and managers, who actually control and operate the publicly traded funds and are responsible for drafting SEC filings, would go scot-free, which could not be what Congress intended. And rather than inadvertently capturing law and accounting firms, Congress, in the wake of the Enron debacle, presumably sought to provide whistleblowing protections to the professionals who could halt a fraud upon investors.

The Dissent

Justice Sotomayor's dissent, joined by Justices Kennedy and Alito, warned that the majority's opinion would conceivably permit Section 1514A lawsuits by the millions of private company employees and independent contractors. Further, as construed by the majority, Section 1514A would extend to employment relationships between individual employees of a public company and their nannies, housekeepers and caretakers (and presumably to their gardeners, plumbers, electricians and anyone else with whom the employee has a contractual relationship). A Section 1514A suit could be brought by a nanny who was fired after complaining that the employer's teen-aged son had committed Internet fraud. Similarly, under the majority's analysis, a babysitter could bring a Section 1514A action against an employer working as a checkout clerk for PetSmart, a public company, but not Petco, a private company. Congress could not have intended such absurd results.

In response, the majority opinion dismissed possible suits by nannies or babysitters as far-fetched, and stated that there could be “limiting principles” that would preclude any over-breadth problems. A “contractor” does not necessarily cover every “fleeting business relationship,” but could apply only to a party whose contractual performance occurs over a significant period. Justice Ginsburg noted the Solicitor General suggested Section 1514A might protect contractor employees only to the extent that they fulfilled the contractor's role for the public company. But the Court held there was no need to draw such lines since the plaintiffs' suits concerned a “mainstream” application of Section 1514A given allegations that they had been punished for blowing the whistle on efforts to mislead the funds' shareholders and the SEC.

But au contraire, wrote Justice Scalia in a concurring opinion joined by Justice Thomas. Although such a limiting principle may be appealing from a policy standpoint, there was no statutory basis for concluding that Section 1514A protects a contractor's employees only to the extent that the employee performed the contractor's role for the public company.
“[S]o long as an employee works for one of the actors enumerated in Section 1514A(a) and reports a covered form of fraud …, the employee is protected from retaliation.” Thus, a majority of Justices ' three in the dissent and two in the concurring opinion ' rejected the Solicitor General's proposed limiting principle as inconsistent with Justice Ginsburg's statutory analysis. In other words, the scope of Section 1514A, like George Clooney, is left “Up in the Air.” Justice Scalia also heaped scorn on trying to ascertain a Congressional intent apart from the text as useless intellectual hydroplaning because on most issues, “the majority of Senators and Representatives had no view on how the issues should be resolved ' indeed, were unaware of the issues entirely.”

The Dodd-Frank Act

While a close textual analysis supported the plaintiffs'claims in Lawson , it may benefit defendants in another whistleblower-related issue percolating up through the courts: whether the whistleblower protection provisions of the Dodd-Frank Act, which provide more expansive relief to claimants than SOX, apply only to those whistleblowers who reported possible violations to the SEC rather than those who reported only internally. In Asadi v. G.E. Energy (USA), L.L.C., 720 F.3d 620 (5th Cir. 2013), the Fifth Circuit held, in contrast to lower court decisions, that Dodd-Frank's definition of “whistleblower” limited its whistleblower protections only to employees who reported to the SEC.

By contrast, California last October expanded its employee whistleblower protections to include employees who reported possible violations internally to a supervisor or another employee with authority to investigate the complaint. These protections apply to employees “regardless of whether disclosing the information is part of the employee's duties,” which could apply to in-house counsel or compliance officers. The expanded protection also bars retaliation because the employer believes that an employee has or will report possible violations, even if the employee has not actually done so.

Your Private Company Clients

In the wake of Lawson, attorneys for private companies should advise their clients that they could be subjected to SOX whistleblower lawsuits. The first analysis is whether the private company has a business relationship with a public company that might make it a “contractor” or “subcontractor” for SOX purposes. Although Lawson fails to provide clear guidelines, an analysis should include whether there is a written contract with the public company; whether the business relationship has covered a significant period of time; and whether there has been recurring business. There would have to be a further analysis to determine whether the client is a subcontractor of a contractor of a public company. If so, then attorneys should advise the private company clients that they could be sued under SOX and ' depending on how Lawson is applied by the lower courts ' the suit could concern purely internal matters that are unrelated to the public company.

What Lawson Means for Law Firms

First, it is now certain that law (and accounting) firms may be sued under Section 1514A by employees claiming they were retaliated against after raising concerns about a public company client. But firms may also be subject to a Section 1514A action by an employee claiming retaliation for expressing concern about purely internal matters, such as padding a bill (mail fraud) or a false loan application (bank fraud). Indeed, the employee of a firm with public company client A might be able to bring the Section 1514A action after being punished for raising concerns about conduct in private company client B. Only future judicial pronouncements will determine the boundaries of Section 1514A.

Accordingly, law firms need to follow the identical advice that they give to their clients:

• Have a written anti-retaliation policy. Law firms, like their clients, need to have a written anti-retaliation policy that is provided to new employees and is circulated to all employees annually. Employees need assurance that they will not be victimized for raising ethical and legal concerns, and that the firm will take their complaints seriously. Management should discuss with an employee what inquiry was undertaken in response to any complaint. A hotline should be established so that employees may raise such concerns in confidence.
• No retaliation. Supervisors should be told that there must be no adverse action taken against any employee who makes complaints that are covered by SOX. Such actions include measures that could be considered as a constructive discharge, including reducing the employee's responsibilities; isolating the employee physically; and criticizing the employee in front of co-workers.
• Documentation. The reasons for any dismissal or disciplinary action against an employee should be documented in order to show that it was not retaliation for a complaint.

And a word to the wise ' be nice to your nannies and babysitters.

Jared L. Kopel is the owner of The Law Offices of Jared L. Kopel, which is affiliated with Bergeson, LLP. Mr. Kopel specializes in securities and commercial litigation, and defending clients before the SEC. He can be reached at [email protected]. This article also appeared in The Recorder , an ALM sister publication of this newsletter.