Blowing the Whistle on Fraud - Sarbanes-Oxley´s Provision That Protects Employees Who Report Wrongdoing May Pose Problems

The recently enacted Sarbanes-Oxley Act received widespread attention for its provisions requiring that certain officers and directors of public companies certify their companies' financial statements, prohibiting most corporate loans to officers and directors and the destruction of auditing documents, creating the Public Company Accounting Oversight Board and regulating potential conflicts of interest relating to accounting firms and stock analysts. The act drew attention also for the criminal penalties it imposes. Discussed less often is the provision of the act that protects whistleblower employees.

The language and legislative history of the whistleblower provision of the act raise questions about how it will be interpreted by the courts. It is instructive to compare the act's whistleblower provision to the anti-retaliation provision of Title VII of the Civil Rights Act of 1964 and analyze judicial interpretations of that provision.Sec. 806 of the act prohibits most public companies, their officers, employees and agents from discharging, demoting, suspending, threatening, harassing or otherwise discriminating against employees who provide information to federal regulatory or law enforcement agents, members of Congress or their supervisors or assist in the investigation of conduct that the employee reasonably believes constitutes a violation of criminal fraud statues, any rule or regulation of the Securities and Exchange Commission or any provision of federal law relating to fraud against shareholders. The act also protects employees who file or participate in lawsuits or other proceedings alleging such violations.

The act's legislative history indicates that its whistleblower provision is intended to impose the "normal reasonable person standard used and interpreted in a wide variety of legal contexts" and that "[t]he threshold is intended to include all good faith and reasonable reporting of fraud." 148 Cong. Rec. S7481-01. However, application of the "reasonable person" standard to claims under the whistleblower provision may present difficulties for courts, especially in today's highly charged corporate-fraud environment.

The current state of stock prices and the economy, combined with the recent attention given to high-profile cases of alleged corporate fraud, has highlighted the issue in the public mind; much of the public believes that many corporations engage in some form of fraud. Polls conducted in June show that 82% of Americans had heard of, or read about, recent corporate accounting scandals and bankruptcy filings and that 70% followed these stories either "very closely" or "somewhat closely" (Bloomberg News), that 79% of Americans believe "questionable accounting" is widespread among American corporations, only 27% believe that corporate executives are honest (CBS News) and that 61% of Americans feel that the current cases of wrongdoing among chief executives of major businesses represent a widespread problem in which many business executives are taking advantage of a failing system (CNN/Gallup).

Yet, while the areas of financial accounting and securities regulation are highly specialized ones that nonlawyers (and even some lawyers) may find difficult to understand, the act arguably contemplates protection for mistaken beliefs regarding the lawfulness of the activity being reported. This raises the question: How will the courts apply the "normal reasonable person" standard to complicated questions of accounting and securities law? Will they review employees' beliefs from the perspective of a person with some understanding of these issues, or will they afford protection to employees who, while ignorant of accounting principles and securities laws, believe in good faith that the conduct they have reported may constitute a violation?

Because the act's whistleblower provision applies to employees at all levels -from CEOs down-the level of sophistication and understanding of securities laws may vary greatly among whistleblowers. Employees may report an array of circumstances and activities that might, in their judgment, reasonably appear to be unlawful. These could range from a company's controller or accounting staff member reporting an accounting practice that might be considered "aggressive" under the Generally Accepted Accounting Principles, to a member of the maintenance staff reporting having been asked to quickly remove shredded paper from the accounting department. Even if lawful, such situations may appear to the employee to support a "reasonable," good-faith belief that a violation had occurred.

One can imagine corporate attorneys or reporting officers spending considerable time and corporate resources responding to internal complaints or inquiries from governmental agencies (spurred on by public interest in corporate prosecutions) resulting from reports by employees who feel empowered by the whistleblower provision. This likely is an unintended consequence of the act's whistleblower provision. What is a reasonable belief? When an employee claims to have been terminated or otherwise subjected to an adverse employment action in violation of the act, on what basis can a court rule that the employee's belief was unreasonable?This question likely will arise when a decision is made to terminate, demote or withhold a promotion from an employee who had previously reported what he or she believed to be a violation of the securities laws by the employer. Even if the employment action is unrelated to this activity, it can be anticipated that an employee might claim that it was a result of his or her having reported suspected violations covered by the whistleblower provision. Under the terms of the act, the employee may file a complaint with the U.S. secretary of labor and, if no decision is made on the complaint within 180 days, may sue the employer seeking reinstatement and/or restoration of seniority, back pay with interest and compensation for any special damages, including litigation costs, expert witness fees and reasonable attorney fees. 18 U.S.C. 1514A(c). Such claims may be raised even in the context of a general reduction in force.

This type of situation is not entirely unique to the Sarbanes-Oxley whistleblower provision. Although other federal whistleblower statutes, including Title VII, do not expressly incorporate the "reasonable belief" standard, it has traditionally been imposed by the courts. See, e.g., Clark County School District v. Breeden, 532 U.S. 268, 270 (2001) (recognizing application of "reasonable belief" standard by 9th U.S. Circuit Court of Appeals). When considering claims under federal whistleblower provisions, courts generally hold that in order to survive a motion to dismiss or for summary judgment, an employee/plaintiff must state a prima facie case by pleading or introducing evidence to support a finding that: he or she participated in protected activity known to the defendant; he or she was the subject of an adverse employment action; and there was a causal connection between the protected activity and the adverse employment action. Quinn v. Green Tree Credit Corp., 159 F.3d 759, 769 (2d Cir. 1998).

Often, the most effective and efficient manner for an employer to resolve unmeritorious retaliation claims is to seek dismissal or summary judgment on the basis that its employee or former employee has not satisfied the first element of his or her prima facie case. While the crux of a retaliation claim is causation, determination of this issue frequently requires a trial on the merits. However, employers are often able to avoid trial by showing that the employee did not engage in protected activity because, even if genuine, the employee's belief that the activity reported was a violation of relevant statutes or regulations was unreasonable, and his or her reporting of it therefore was not protected activity.

The question of reasonableness is one that courts are reluctant to take from the jury in many contexts, but they appear to be willing in the retaliation context to rule that no reasonable person could believe that the reported activity was a violation of the applicable laws. The U.S. Supreme Court recently upheld the dismissal of a Title VII retaliation claim on the basis that no reasonable person could have believed that the conduct reported by the employee violated Title VII. Clark County School District v. Breeden, 532 U.S. 268 (2001). In that case, Shirley Breeden, a school district employee, sued under Title VII, alleging that she had been transferred in retaliation for reporting alleged sexual harassment.

During a meeting at which Breeden, her supervisor and another school district employee, both males, were to review the psychological evaluations of job applicants, her supervisor read aloud a notation that one applicant had commented to a co-worker, "I hear making love to you is like making love to the Grand Canyon." After reading the comment, Breeden's supervisor looked at her, and stated "I don't know what that means"; in response, the other employee said "Well, I'll tell you later," and both men chuckled. Breeden complained about the comment to her superiors. The school district later transferred her. She alleged this was in retaliation for her complaint. The district court granted summary judgment for the school district. The 9th Circuit, applying the "reasonable belief" standard, reversed. The Supreme Court neither accepted nor rejected the 9th Circuit's application of the "reasonable belief" standard to Title VII's anti-retaliation provision, but held that no reasonable person could believe that the conduct reported met the legal test for sexual harassment.

Significantly, in analyzing the reasonableness of Breeden's belief, the high court looked not only to the language of Title VII, but also to its decisions interpreting it. The court cited a series of decisions spanning more than a decade that resulted in the court's pronouncement, in Faragher v. Boca Raton, 524 U.S. 775 (1998), that "sexual harassment is actionable under Title VII only if it is so severe and pervasive as to alter the conditions of the victim's employment and create an abusive working environment." It then held that "no reasonable person could have believed" that the actions of Breeden's co-workers would satisfy that standard.

Because most employees have little or no knowledge of securities laws, they may "report first and ask questions later" when they perceive a possible violation. If so, employers will inevitably be confronted with claims under the act's whistleblower provision when they implement personnel decisions, especially in light of the recent wave of corporate downsizing.

If courts apply the standard enunciated by the Supreme Court in Breeden to these claims and require that "reasonable" plaintiffs seeking the protection of the act's whistleblower provision correctly apply both the securities laws and court precedent interpreting them, it is more likely that employers will often be successful in dismissing cases brought by their employees.

However, if courts try to encourage the reporting of potential violations by taking into account the unfamiliarity of the average employee with securities laws and judicial interpretations of them when determining what is reasonable, the whistleblower provision of the act may quickly become a major headache for employers.

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