Since the Corporate and Criminal Fraud Accountability Act of 2002 (Sarbanes-Oxley or SOX) became law, its whistleblower provisions have protected employees who report information that they reasonably believe constitutes fraud upon a public company's shareholders from adverse employment action. Courts, however, have reached different conclusions about whether or not the Act protects only individuals reporting these actions if they are employed directly by a publicly held company, or if the Act also protects individuals reporting these actions employed by privately-held subsidiaries, of a publicly-held entity.
To resolve this dispute, the recently enacted Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 has expanded the language of Sarbanes-Oxley to provide whistleblower protection to employees of public companies' subsidiaries or affiliates whose financial information consolidated into the public company's financial statements.
The question remaining for many public companies is whether or not courts will interpret the Dodd-Frank Act to apply retroactively and cover complaints made before the Act went into effect. A case now pending in the Court of Appeals for the First Circuit, may soon provide some guidance as to this question. The appeal stems from a decision issued by a Massachusetts federal court before the enactment of the Dodd-Frank Act. In that decision, the court considered claims by two employees of privately-held investment advisers who argued they were protected by SOX because their privately owned employer served as the investment advisers for a publicly-traded mutual fund. Mutual funds present a special case because publicly-traded funds typically have no employees of their own and instead contractually arrange for privately-held investment adviser firms to manage the funds' investments. The employers argued that SOX did not protect the individuals because they were not employed directly by a publicly-traded entity.
The court denied the employers' motions to dismiss and rejected the narrow reading of SOX proposed by defendants, reasoning that:
"For the goals of SOX to be met, contractors and subcontractors, when performing tasks essential to insuring that no fraud is committed against shareholders, must not be permitted to retaliate against whistleblowers. . . [otherwise] reporting of fraud involving a mutual fund's shareholders would go unprotected, for the . . . simple reason that no "employee" exists for this . . . type of public company."
Soon after issuing this decision, the court permitted the parties to appeal to the First Circuit and the appeal is still pending. In the meantime, Congress has enacted the Dodd-Frank Act. The Dodd-Frank Act does not directly impact plaintiffs in these cases because they worked for contractors rather than for subsidiaries whose financials were consolidated into the public company's financial statements. However, the First Circuit's interpretation of SOX's original language will likely provide important guidance as to whether the Dodd-Frank Act may be applied retroactively. If the court were to find that SOX's original language protected plaintiffs in this case, it would be holding that SOX has always protected a broader class of employees than those directly employed by a publicly-traded company.
That reading would support the position that the Dodd-Frank Act simply clarified SOX's original language, and therefore, should apply retroactively. Alternatively, an opposite finding by the court, would suggest that SOX's original language should be read narrowly and effect the retroactive application of the Dodd-Frank Act. For this reason, the First Circuit's decision, once issued, could have important implications, not only for investment advisors in the mutual fund industry but more broadly for public companies concerned about the reach and retroactive application of the Dodd-Frank Act.
>> The Bottom Line
In the past, companies have had considerable success defending SOX complaints on the grounds that the complaining employee worked for wholly-owned subsidiaries rather than directly for their publicly-traded parents. However, the Dodd-Frank Act was passed to close that loophole. In the future, employees who have publicly-traded parents in the chain of their ownership should assume that their employees have the protection of SOX if they make whistle-blowing complaints, which means that employers cannot retaliate against an employee for making a complaint.
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