Sarbanes-Oxley whistleblower ruling leaves gap for courts, Congress

The recent U.S. Supreme Court ruling extending Sarbanes-Oxley whistleblower protection to private contractors of publicly-traded companies has some attorneys concerned about the lack of any limiting principle.

The decision in Lawson v. FMR LLC was the court’s first stab at interpreting an important if unclearly worded provision that protects employees who report violations of federal securities law at publicly-traded companies.

The court, after struggling with statutory language that fails to clearly define “employee” and sifting through the legislative history, came to the conclusion that the anti-retaliation provision in the act extends to the employees of private contractors of covered companies.

But with little guidance beyond that, some attorneys left to figure out the limits of the ruling on their own wonder if it could lead to a spate of new retaliation suits.

“We will be advising [our clients] to take this issue more seriously,” said Bryan House, a partner in the Milwaukee office of Foley & Lardner LLP, where he represents public and private companies in whistleblower actions and other matters.

But others say it’s early to predict the effect of the decision, which has a limited set of facts that courts can easily use to distinguish it in future cases.

“I don’t really see the floodgates of litigation opening,” said Sean Carnathan, a partner in the Burlington, Mass. office of O’Connor, Carnathan & Mack LLC.

Sued by the babysitter?

The case involves a retaliation lawsuit brought by employees of privately held Boston-based financial services companies that were contractors for the Fidelity family of mutual funds. Like most mutual funds, the Fidelity companies are public but don’t have employees. Instead they are managed by contractors like the ones that employed the plaintiffs.

The plaintiffs claim that they were fired by their respective employers after reporting alleged violations of federal regulations related to shareholder fraud, a violation of 18 U.S.C. §1514A, the provision of the Sarbanes-Oxley Act that prohibits retaliation “against an employee in the terms and conditions of employment” for blowing the whistle on alleged corporate wrongdoing.

The companies sought to dismiss the claims, arguing that SOX whistleblower protections extend only to employees of public companies, not to privately-held contractors of public companies.

The district court sided with the employees, but the 1st U.S. Circuit Court of Appeals reversed and ordered the complaints dismissed, finding that employees of privately-held contractors are not covered by the SOX whistleblower provisions.

In a 6-3 ruling, the Supreme Court reversed.

“Our reading of §1514A’s text aligns with the provision’s purpose,” said Justice Ruth Bader Ginsburg, author of the majority opinion, as she announced the decision from the bench on March 4, 2014. “A reading of §1514A that did not reach the employees of contractors [would] have a notably extreme consequence in the mutual fund industry. … As the industry is structured, the contractor’s employees are likely to be the only firsthand witnesses to the shareholder fraud of concern to Congress. In short, we decline to [endorse] a design that would leave mutual funds unchecked by the retaliation ban.”

Justice Sonia Sotomayor, joined by Justices Anthony Kennedy and Samuel Alito Jr., dissented, saying the majority ruling lacked limiting principles.

Under the majority’s reading, Sotomayor wrote, a retaliation cause of action is available to “any household employee of the millions of people who work for a public company and any employee of the hundreds of thousands of private businesses that contract to perform work for a public company.”

“The Court’s interpretation gives §1514A a stunning reach, [allowing] a babysitter to bring a federal case against his employer — a parent who happens to work at a local Walmart (a public company) — if the parent stops employing the babysitter after he expresses concern that the parent’s teenage son may have participated in an Internet purchase fraud,” Sotomayor wrote.

First impressions

The ruling marks the first time the high court considered the whistleblower provision of the Sarbanes-Oxley Act, which was passed in 2002 in response to the Enron scandal and other cases of massive accounting fraud at publicly-held companies that cost stockholders billions of dollars.

Given that backdrop, the unclear statutory text and an unusual set of facts involving a public company with no employees, the court did the best it could in crafting a ruling that is fair, if not a product of pure statutory construction, Carnathan said.

“It seems like the majority opinion was somewhat divorced from the text of the statute, but the dissent is divorced from the facts,” he said.

House agreed.

“Under the facts, you get it. It makes sense,” he said. “I think that was what drove the opinion. … Both sides would have to admit that their interpretation isn’t perfect.”

The complications will come when lawyers try to apply the holding to other situations.

“I have a client in the same spot,” House said. “[But] my client is not in a mutual fund situation, [so] it’s a very different situation than this fact pattern.”

Employee advocates and watchdog groups hailed the ruling, saying it was a practical interpretation of the law that would make it easier to root out the kind of fraud that devastated the markets and harmed tens of millions of investors in the early 2000s.

The ruling “closed a potentially devastating loophole in corporate whistleblower protection,” said Stephen M. Kohn, executive director of the National Whistleblower Center, which filed an amicus brief in the case urging the court to rule that independent contractors are protected by SOX whistleblower provisions.

A ruling to the contrary, he said, would allow public companies like mutual funds to avoid liability by organizing in a way that would give few if any employees the right to bring a fraud-based retaliation claim, thereby shielding themselves from suits and leaving workers at risk of losing their jobs if they report wrongdoing.

“The Court has put an end to the popular shell game which large companies use try to silence whistleblowers,” Kohn said.

But House said the decision could open the door to lawsuits in situations where contractors have a far less direct relationship to alleged wrongdoing than managers of mutual funds do. Without a limiting principle, it’s unclear just how for the whistleblower protection extends, and only Congress can give the court the clarity it needs.

“The court was essentially saying: ‘Look, you wrote this crazy statute that we are trying our best to work out,’” House said. “‘We are doing the best we can, [but] you can tell us we’re wrong by adding a limiting principle” regarding contractors.

Carnathan said he doesn’t anticipate the nightmare scenario of lawsuits being brought by household workers that Sotomayor warned against.

“It makes me think of the “Wizard of Oz”: nannies and babysitters and housekeepers — oh, my!” Carnathan said. “I don’t see that happening.”

But a ruling to the contrary, he said, would have created a different problem: companies carefully crafting their corporate and contractual structures to insulate themselves from whistleblower retaliation liability.

“Publicly-traded companies are well financed and run by smart people,” Carnathan said. “If you tell them, ‘Park your employees with subcontractors. Now you are free to retaliate,’ that is an invitation they would accept.”

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