Supreme Court Extends Whistleblower Protection to Employees of Contractors of Public Companies

Diana Uhimov, March 11, 2014.

Early this month, a divided U.S. Supreme Court ruled that the whistleblower provision of the Sarbanes-Oxley Act of 2002 (SOX) protects employees of private contractors conducting work for publicly-traded companies in the same way as it protects the public company’s employees.  The relevant part of the statute at issue states that “no public company … or any … contractor … of such company may [retaliate] against an employee … because of [SOX – protected activity].”  The Court found that a plain reading of the phrase “employee” in the statute described “the contractor’s own employee”.  Justice Ruth Bader Ginsburg’s decision for the majority in Lawson v. FMR LLC overturned the decision of the U.S. Court of Appeals for the First Circuit, which held that this provision applied only to employees of publicly-traded companies and denied protection to employees of privately-held companies.

The plaintiff whistleblowers in Lawson initiated the lawsuit against their former employers, privately-held companies that advised and managed Fidelity mutual funds.  The Fidelity funds, public companies covered by SOX, themselves had no employees of their own, which is common in the industry. After raising concerns about accounting methods and inaccuracies in federal filings, the employees were subjected to adverse actions and discharge.  Under the First Circuit’s decision, the plaintiffs were denied shelter from retaliation by the statute.

Although the particular merits of the plaintiffs’ claims will be decided by the First Circuit on remand, the Supreme Court’s decision is a big win for whistleblowers—it essentially closes a loophole that would deny protection to everyone who works for mutual funds. The Court rejected the narrower interpretation suggested by the defendant employers that Congress included “contractors” in the statute only to avoid permitting public companies to evade liability by hiring a private contractor to retaliate on their behalf.  The defendants even illustrated their position by invoking George Clooney’s character from Up in the Air, an “ax-wielding specialist” brought in for the sole purpose of terminating employees.

The Court’s opinion was largely based on a broad reading of Congress’s intent in enacting SOX to “safeguard investors in public companies and restore trust in the financial markets following the collapse of the Enron Corporation” by preventing retaliation against employees that question fraudulent financial activities, among other measures. Major corporate accounting scandals from 2000-2002 left thousands unemployed, lost billions for investors, and challenged the integrity of the U.S. securities market.  Enron and other companies misstated their income and inflated the equity value on their balance sheets, while hiding huge debts and losses in other companies it had created, abetted by privately-held accounting firm, Arthur Andersen.  Eventually, Enron declared bankruptcy and share prices plummeted to penny stock levels.

A significant factor in the majority’s analysis was the enormous reach of the investment advising industry, which today manages $14.7 trillion on behalf of almost 94 million investors.  Confidence in public markets may well be bolstered by the assurance that employees, including attorneys and auditors, will be shielded from retaliation if they disclose information about financial practices that may harm investors.

Despite providing added security for the 94 million investors, the majority opinion is being criticized for failing to limit the scope of its opinion to resolve potential issues of overbreadth of contractors covered. Justice Sonia Sotomayor, writing for the dissent, opined that the majority’s ruling would lead to “absurd results”, such as allowing a “babysitter to bring a federal case against his employer—a parent who happens to work at the 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.  The significant expansion of coverage of SOX beyond publicly-traded companies could expose millions of small businesses to suits by employees seeking to exploit them.

Although Congress likely did not mean to leave an executive working for a mutual fund manager without a remedy, the decision surprisingly opens the door to low-level employees bringing federal retaliation cases after reporting minor offenses. While this scenario seems “more than hypothetical” to the majority, there is a major concern that employment lawyers will seek out contractor employees with any plausible claim of retaliation that can be connected to a financial matter.

Privately-held companies must now review their compliance systems and processes for investigating whistleblower complaints, as well as update training procedures for human resources departments regarding fraud-related issues.  Whether whistleblower protection will extended to all they way down to personal service contractors employed by executives and officers of publicly-traded companies is an open question.


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