Whistleblower Policies: Not Just for Large Organizations Anymore

May 2014 By Jacob Parks, J.D., CFE When a seminar speaker gets to a point in a presentation about the Sarbanes-Oxley Act (SOX), it historically has meant one thing for attendees who do not work directly with public companies: good time for a coffee break. However, those days seem to be coming to an end — at least when whistleblower issues are at hand.

May 2014

By Jacob Parks, J.D., CFE

When a seminar speaker gets to a point in a presentation about the Sarbanes-Oxley Act (SOX), it historically has meant one thing for attendees who do not work directly with public companies: good time for a coffee break. However, those days seem to be coming to an end — at least when whistleblower issues are at hand.

There are several forces pushing on organizations of all shapes and sizes to implement whistleblower programs that are designed to both comply with laws that protect those who come forward about violations, as well as help the organization gather tips to root out fraud. Perhaps the most significant factor in recent events was the U.S. Supreme Court’s decision on March 4, 2014, in Lawson v. FMR LLC , which expanded the scope of SOX whistleblower protections to more than just employees of public companies and their affiliated entities.

SOX was the federal government’s response to the financial reporting fraud crisis in the early 2000s that resulted in the fall of corporate giants Enron and WorldCom, as well as one of the “Big Five” accounting firms, Arthur Andersen (now they call them the “Big Four”). Thousands of people lost their jobs or saw their investments vaporized. Congress investigated what allowed these massive fraud schemes to happen, and one of the conclusions was that the high risk of retaliation that whistleblowers face from employers has a substantial chilling effect on fraud reporting.

To mitigate this risk, 18 U.S.C. § 1514A prohibits agents of public companies from retaliating against an employee who lawfully blows the whistle on federal securities violations, wire fraud, mail fraud, or banking fraud. If any person retaliates in violation of Section 1514A, then the employee may file a suit to recover damages necessary to make the employee whole, including reinstatement of position and compensatory damages.

Employment lawsuits can be both expensive and embarrassing for the employer, so many public companies sought to implement programs to protect whistleblowers, educate employees and avoid actions that could be construed as retaliation.

The Other Side of the Coin

Alternatively, as in the Lawson case, public companies avoided SOX regulations through loopholes. The two plaintiffs in this case were employees for a group of firms (collectively called FMR). While all of the FMR entities were private companies, they provided contract services to various mutual funds that were public companies. As is common in the industry, the public mutual funds had no employees; all advisory and management services were provided through private contractors like FMR. Since the SOX whistleblower protections in question only applied to employees  of public companies and certain affiliates (not contractors’ employees), one of the benefits of the mutual funds having no employees was that neither it nor its contractors could be subject to civil retaliation claims — or so the theory went.

The plaintiffs alleged that they blew the whistle on putative frauds regarding the mutual funds, and that their employer, FMR, retaliated against them. One plaintiff claimed that she raised concerns about cost accounting methodologies that resulted in overstated expenses regarding the operation of the mutual funds. After a series of adverse actions, she was constructively discharged from FMR. The other plaintiff alleged that after he pointed out inaccuracies in a draft SEC registration statement regarding certain mutual funds, he was fired in retaliation. Both plaintiffs brought civil actions against FMR as whistleblowers under the SOX provisions. In both cases, FMR argued that the case should be dismissed because the plaintiffs were employees of privately held companies, and the SOX whistleblower provisions only allow for retaliation claims when the employees work for a public company.

In a 6–3 decision, the Supreme Court held that the SOX whistleblower protections do extend to employees of private contractors of public companies when the employees raise fraud issues about the client. The court recognized that common contractors of public companies — administrators, accountants, auditors, consultants, attorneys and many others — have an important role in reporting fraud in the public companies with whom they contract. Specifically, the investment advisers at FMR were often the only employees who would ever be potentially able to witness fraud involving their mutual fund clients. The fear of retaliation for these employees is quite real, and the court reasoned that similar fears were in part responsible for the lack of reporting that occurred within Enron, as well as the destruction of documents at its external auditor, Arthur Andersen, to conceal the fraud. The decision in Lawson allowed the plaintiffs’ cases against FMR to continue, rather than being dismissed outright.

Casting a Wide Net

As for the broad effects of the case, the number of organizations and individuals covered by the SOX whistleblower laws increased dramatically. In her dissenting opinion, U.S. Supreme Court Justice Sonia Sotomayor expressed concern over how wide the scope of the protections now are, stating:

“If §1514A creates a cause of action for contractor employees, the majority concludes, so too must it create a cause of action for ‘housekeepers’ and ‘gardeners’ against their individual employers if they happen to work for a public company, […] subjecting individual employers to litigation if their employees claim to have been harassed for providing information regarding any of a host of offenses.”

Rather than disputing the breadth of the scope claimed by Justice Sotomayor, the majority opinion characterized such extreme cases as realistically unlikely to occur and outweighed by the need to extend whistleblower protections. Virtually any organization that contracts with a public company can now be a defendant in a SOX whistleblower action. While SOX offenses are often associated with securities violations, some courts have held that SOX whistleblowing activity includes reporting a violation of federal wire fraud, mail fraud and banking fraud statutes, even when the violation was not a traditional securities scheme.

Fraud examiners should speak to management at the private organizations they work with about the risk of potential whistleblower violations. The leaders of these organizations should ask themselves:

Do we have a reporting mechanism for incidents of fraud?

If our employees discovered an incident of fraud at this organization or a contracting public company, would they know the proper reporting procedures?

If our managers or supervisors received a fraud-related tip or complaint, would they know what to do?

Do our employees know what constitutes retaliation and how to avoid it?

Are these facts and procedures documented in a whistleblower policy that is communicated to employees and relevant agents?

Is the culture of our organization such that whistleblowers are not afraid to come forward with potential violations?

If the answer to any of the above questions is “no,” then the organization might be vulnerable to a highly undesirable retaliation lawsuit. To make matters worse, ongoing frauds that can harm both the bottom line and the reputation of the organization are less likely to be detected. In light of the recent ruling in Lawson and the dangers of suppressing the discovery of fraud, implementing a whistleblower program is a wise decision for practically every organization — whether a multinational corporation or a local business with only a few employees.