What Employers Need to Know About the Sarbanes-Oxley Act of 2002
("Post-Enron Legislation")

By Douglas Morrill
(with special thanks to Mark Hutcheson and Brent Eller for their contributions to this article)
[Fall 2002]

Two scenarios help illustrate the new and potentially far-reaching protections for corporate whistleblowers under the Sarbanes-Oxley Act.

• ABC, Inc., a public company, is in the business of manufacturing paint. An ABC, Inc. supervisor is aware that employees under his direction are improperly disposing of the company's hazardous waste. An employee who had previously engaged in the improper disposition of hazardous waste reports these activities to the Environmental Protection Agency, which institutes an investigation. Management, having been notified of the illegal dumping, suspends the employees who have dumped waste, including the employee who reported the activity. Does the disciplinary action taken by ABC, Inc. against the employee trigger liability under either the civil or criminal protections for whistleblowers under the Sarbanes-Oxley Act?
• An out-of-state patient on vacation is admitted and receives treatment at XYZ Hospital. Later, while processing a bill to the patient's insurer, a clerk notices charges for procedures that are not normally included in treatment for such a condition. The clerk has noticed such charges before from the same doctor, and believes he may be attempting to over bill patients and/or their insurers. She reports this to a senior hospital manager. Not long thereafter, the employee is laid off. Does this discharge trigger either civil or criminal liability under the Sarbanes-Oxley Act?

Under both examples, it is entirely possible that the employer (and individuals involved in the decision to discipline or discharge the employee) could be subject to civil and/or criminal liability under the Act for retaliating against corporate whistleblowers. ¹

This Advisory Bulletin provides a general overview of the Act's provisions that are of special interest to employers and human resources professionals.² For specific information or to seek guidance about specific issues, please contact either of the authors of this article or another Davis Wright Tremaine (DWT) labor and employment attorney.

What is the Sarbanes-Oxley Act of 2002?

The Sarbanes-Oxley Act ("the Act") is a federal statute passed in the wake of Enron and a number of other recent corporate governance and accounting scandals. Its general aim is to improve corporate governance and responsibility. The Act seeks to accomplish this end in a number of ways, creating new measures that deal with financial reporting, conflicts of interest, corporate ethics and private oversight of accounting firms that perform public company audits.

However, the Act also contains provisions that directly affect the employment relationship, and may create pitfalls for unwitting employers. Employers should familiarize themselves with these provisions, especially those providing civil and criminal protections for corporate whistleblowers.

What are the civil whistleblower provisions of the Act?

The Act makes it illegal for a public company to discriminate against an internal whistleblower in the terms and conditions of employment. It also provides a means for such a whistleblower to enforce these rights, first via filing a complaint with the Department of Labor, and second, by filing a private civil action in federal court.

Specifically, the Act states that an employee of a public company may not be discharged, demoted, suspended, threatened, harassed or in any other way discriminated against in the terms and conditions of employment because of a lawful act done by the employee to:

• Provide information or otherwise assist in an investigation by any federal regulatory or law enforcement agency, any member or committee of Congress, or any company personnel with supervisory and investigative authority regarding any conduct the employee reasonably believes constitutes a violation of federal laws regarding fraud or Securities and Exchange Commission rules and regulations; or
• File, cause to be filed, testify, participate in, or otherwise assist in a proceeding relating to an alleged violation of federal anti-fraud laws or Securities and Exchange Commission rules and regulations.

When did these provisions become effective?

The civil whistleblower provisions of the Sarbanes-Oxley Act became effective on July 30, 2002.

What is the process for triggering remedies?

To invoke the protections of the Act, an aggrieved employee must first file a complaint with the Department of Labor ("DOL") within 90 days of the alleged retaliation. The DOL is then obligated to investigate the complaint. If it determines the employee was subject to unlawful retaliation, the DOL must immediately order the employer to reinstate the employee. If the DOL does not issue a final determination within 180 days, the employee may file a complaint in United Stated District Court (provided the delay is not the result of bad faith on the part of the employee).

Either party is entitled to appeal the DOL's investigative findings. On appeal, the parties are entitled to an on-the-record hearing. A hearing must be held expeditiously and the DOL must issue a final order within 120 days after the conclusion of the hearing. If the DOL rules in the employee's favor, the DOL may grant the employee reinstatement, back pay with interest, litigation costs, expert witness fees, reasonable attorneys fees and any other special damages the employee sustained. If an action is brought in federal district court, the employee is entitled to the same relief available in the DOL hearing. The statute does not provide for punitive damages.

What does an employee have to show to prove retaliation in violation of the Act?

To establish a prima facie case of discrimination, the employee must show that the protected activity was a contributing factor in the unfavorable employment decision. An employer may rebut this inference of discrimination by providing "clear and convincing evidence" that it would have taken the same unfavorable action even in the absence of the protected activity by the employee.

Does the Act preempt other sources of whistleblower protections?

The Act does not bar the employee from pursuing rights guaranteed under other federal or state laws, or a collective bargaining agreement. Some state whistleblower statutes provide for punitive damages.

In fact, in states such as Washington, where courts have long recognized a cause of action for discharge in violation of public policy, the Act may be used to expand employee rights. State courts might look to the Act as a source of public policy to expand protections against retaliation in contexts other than publicly traded companies, including employees of private companies.

What companies are covered by the civil whistleblower provisions?

The civil whistleblower provisions apply to any public company "with a class of securities registered under Section 12 of the Securities and Exchange Act of 1934 . . . , or that is required to file reports under Section 15(d) of the Securities and Exchange Act of 1934." Generally, this means the civil whistleblower provisions apply to companies with publicly-traded stock and/or debt. This would exclude however, entities that have tax-exempt municipal bond financing (because the entity is not the issuer and is thus not subject to registration or reporting under federal securities laws) and certain other tax-exempt corporations that are not subject to registration or reporting under federal securities laws.

Note however, that the civil whistleblower provisions would apply to "any officer, employee, contractor, subcontractor, or agent of a public company." As a result, private companies that are contractors, subcontractors or agents of public companies may also be impacted by these provisions.

Does the Act provide for personal liability of company officials?

Yes. One of the more startling provisions of the Act is that liability extends beyond just the company itself. As mentioned, individual officers, employees, contractors, subcontractors and agents may be found personally liable under the Act.

This means that an individual human resources director could be held personally liable for any acts of employment discrimination done in retaliation for an employee's whistleblowing activities. Moreover, liability could also be extended under the Act to include those doing business with publicly traded companies (whether an individual or a corporation), depending on how broadly the terms "contractors, subcontractors and agents" are ultimately defined.

What triggers liability?

The key to establishing an employer's liability is linking the employee's lawful whistleblowing activity with impermissible adverse employment actions. Although termination would almost definitely be such an adverse employment action, liability is not triggered by termination alone. Any number of adverse employment actions can constitute retaliatory acts, including those specifically mentioned in the statute: demotion, suspension, threats, or harassment. Court decisions from other areas of employment discrimination law are likely to provide guidance on this issue.

Further, like other employment discrimination laws, the rights guaranteed an employee are not self-invoking. An employee must raise the issue of discrimination by first filing a charge with the DOL.

Who is protected by the Act?

Note that the Act provides protections only to "employees." While contractors, subcontractors or agents can nevertheless violate the law, such individuals are not included in the class of whistleblowers entitled to receive protection under this section of the Act.

Does the employer have any recourse if an employee brings a frivolous retaliation claim?

Yes, the DOL's administrative rules provide that if the Secretary of the DOL finds a complaint is frivolous or has been brought in bad faith, the Secretary may award to the prevailing employer a reasonable attorney's fee not exceeding $1,000.00. Unfortunately, this monetary limitation may make this only nominally effective to combat frivolous claims.

What are the Civil remedies?

Under the Act, the remedies for employees who are unlawfully retaliated against for raising concern about shareholder fraud include (1) reinstatement, (2) back pay, and (3) compensation for special damages, including litigations costs, expert witness fees, and reasonable attorney's fees. Although not specified, it is possible that special damages would include damages for emotional distress. Punitive damages are probably not allowable under the Act.

What are the Criminal penalties?

In addition to civil liability, the Act also provides for criminal penalties, including imprisonment, for individuals who retaliate against whistleblowers. Specifically, the Act prohibits any person from knowingly taking "any action harmful" to a person who has provided any truthful information to a law enforcement officer relating to the commission (or possible commission) of a federal offense. The Act defines a harmful action to include any interference with "the lawful employment or livelihood" of a whistleblower. Any person who violates this provision may be subjected to fines (generally, up to $250,000.00 for individuals and $500,000.00 for organizations) and/or imprisonment of up to 10 years.

When did these provisions become effective?

The criminal whistleblower provisions of the Sarbanes-Oxley Act became effective on July 30, 2002.

How do the criminal whistleblower provisions differ from the civil whistleblower provisions?

The criminal whistleblower provisions differ from the civil provisions in three important ways. First, whereas the civil provisions protect the reporting of information the whistleblower "reasonably believes" evidences a violation of specified federal law, the criminal provisions protect only the reporting of "truthful information." Accordingly, there is no criminal liability under the Act for an employer who disciplines an employee for making erroneous reports of wrongdoing, regardless of how reasonable the employee's belief.

Second, the criminal provisions protect only information that is reported "to a law enforcement officer." By contrast, the civil whistleblower protections attach to information reported to a federal agency, member of Congress, or company official with investigative authority.

Finally, the criminal whistleblower provisions protect reports relating to "any Federal offense." Civil protections harbor only reports that relate to federal anti-fraud or securities laws.

Who may be liable?

Criminal liability extends to any person violating the law, including public or private corporations (which are commonly treated as "persons" for the purposes of criminal law). In this regard, there is nothing in the criminal provisions that restricts corporate liability based on whether the corporation is publicly or privately held, whether it files reports with the SEC, or any other provision relating to corporate form or required filings. Similarly, there is nothing in the criminal provisions that restricts liability to those within the employment relationship. One could be liable under the Act for harmful acts inflicted against an informant, even though the informant had no working relationship with the defendant whatsoever.

How might the criminal provisions be used?

The Act's criminal provisions are invoked by federal prosecutors, not employee litigants. In this regard, there is a significant risk that the new provisions might be used as leverage against corporate managers or supervisors in litigation concerning corporate environmental crimes or other white collar criminal litigation. Since the Act now prohibits interference with an informant's employment, the current statutory language might provide prosecutors with a powerful tool to encourage testimony from such managers. An unwitting disciplinary action could be made to look retaliatory by aggressive prosecutors seeking information.

Can you give me an example of how this all works?

Criminal violation:
In the initial example concerning ABC, Inc., and the company's suspension of an employee whistleblower who was also engaged in wrongdoing concerning environmental crimes, criminal liability may attach. Although ABC, Inc. is a public company and thus would be covered under the civil provisions of the Act, such rules only apply to whistleblowing activities regarding alleged violations of federal anti-fraud or securities laws. Since the whistleblowing here relates to possible environmental crimes, civil liability under the Act should not attach.

Criminal liability is implicated (regardless of corporate form) where a disciplinary action is taken because of an informant's whistleblowing activity concerning violations of federal criminal offenses. Since the employee here reported possible criminal violations of federal environmental law, discipline taken because of such reporting may violate the criminal provisions of the Act. However, the employer (and any individuals involved in the disciplinary decision) may avoid liability if it is careful to document that discipline is being given because of the employee's participation in wrongdoing, not because of his whistleblowing. Also, it is unclear that the reporting here would qualify for protection, since the Act only protects reports to law enforcement officers. It is possible that reporting to agency officials does not implicate the Act.

Civil violation:
In the example concerning XYZ Hospital, and the lay off of an employee who had reported billing irregularities to her supervisor, civil liability may attach. Criminal provisions are not invoked because the report at-issue was not made to a law enforcement officer.

In regard to potential civil violations, it is possible that the hospital may not be a public company within the coverage of the Act. However, if the hospital is subject to the Act, there is a potential for liability. The clerk reported activity which could amount to mail fraud under federal law. Reports of mail fraud are covered under the civil provisions of the Act. Additionally, the clerk reported the information to a high-level hospital manager, who presumably has investigative authority over such matters. The case will hinge on whether the hospital is a "public company" and whether the clerk's lay-off can be independently justified, or was the true reason for discharge.

What other provisions in the Act are important to employers?

In addition to the civil and criminal protections afforded whistleblowers, the Act affects the employment relationship in other ways.

Loans to Officers or Directors
The Act makes it unlawful for public companies to extend or arrange for personal loans and other forms of credit to directors and executive officers. Although existing loans may, in some circumstances, be allowed after the effective date of the Act, they likely cannot be renewed or modified thereafter. This provision took immediate effect on July 30, 2002.

ERISA
The Act acknowledges that there may be "blackout periods" in which individual account plan participants are prohibited from making changes to their individual account investment elections. Plan administrators are required to provide participants 30 days' written notice prior to such periods. Further, the Act prohibits directors or officers of public companies from purchasing or selling company stock during blackout periods if the director or officer acquired the stock as part of his employment as a director or officer. These provisions go into effect January 26, 2003.

What can employers do to prevent liability?

In light of the Act's expansive protections provided to whistleblowers, publicly traded companies should review their employment policies and practices with respect to whistleblowers and take all steps necessary to prevent discrimination and protect the company from civil and criminal liability under the Act. For instance, companies should:

• update their personnel policies to prohibit discrimination and retaliation against whistleblowers;
• develop effective procedures for soliciting whistleblower complaints;
• educate and train managers about the Act; and
• investigate promptly and fully all claims of discrimination, and take immediate and appropriate remedial action which is necessary to end the alleged discrimination.

In addition, corporate officers and managers should take special note that the Act's civil whistleblower provisions cover not only publicly traded companies, but also their officers, employees, contractors, subcontractors and agents. That would appear to leave officers and employees subject to liability in their individual capacities. As such, employers should review insurance policies to determine whether officers and employees are covered under existing policy for such whistleblower violations.

Corporations undergoing investigation by federal agencies or prosecutors for violations of federal environmental or other laws should take special efforts to educate their managers and supervisory personnel with respect to the Act's criminal provisions, especially those related to the destruction of documents.

Finally, for specific information or to seek guidance about specific issues, please contact one of Davis Wright Tremaine's (DWT) labor and employment attorneys.

FOR FURTHER INFORMATION, PLEASE CONTACT THE AUTHORS:

Doug Morrill, 206-628-7745, douglasmorrill@dwt.com

Contributing authors:
Mark Hutcheson, 206-628-7678, markhutcheson@dwt.com
Brent Eller, 206-628-7786, brenteller@dwt.com

FOOTNOTES:

1 A detailed analysis of civil and criminal liability under these fact patterns is provided in the full text of the advisory, available by clicking the above link.
2 A broader overview of the Act is available on our Corporate Finance practice group's website at http://www.dwt.com/practc/corp_fin/corp_fin.cfm.

This Employment Law Advisory is a publication of the Employment Law Department of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent developments in employment law. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations. Copyright © 2002, Davis Wright Tremaine LLP.

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