Thursday, June 01, 2006

The Sarbanes-Oxley Whistleblower Provisions: Unfolding Ramifications

Now that we have the criminal verdicts in the Enron criminal trial, it may be time to check in on one of the key legal reforms to arise from the Enron scandal. Among the key provisions that Congress included in the Sarbanes-Oxley Act was the so-called whistleblower provision, a tribute to the role of whistleblower Sherron Watkins in the Enron scandal. Section 806 of the Sarbanes-Oxley Act was included to encourage employees to blow the whistle on corporate wrongdoing by shielding them from retaliation. The law applies to all publicly traded companies and carries both civil and criminal remedies.

When the Department of Labor Occupational Safety Health Administration released the regulations implementing Section 806, some commentators speculated that the whistleblower laws and regulations "may well have as much effect on business practices, in the twenty-first century, as did civil rights laws in the twentieth." But three years' experience under the laws suggest that the reality -- at least so far -- is falling short of these predctions.

According to a recent Washington Post article, of the approximately 750 whistleblower complaints filed so far, the vast majority have been dismissed. Only five whistleblowers have won, though the number fell to four when one case was reversed on appeal. Three of the other four cases remain on appeal.

But while these statistics might suggest that the potential threat from whistleblower cases was overblown, there are other considerations that suggest that the potential danger from whistleblower cases should continue to be taken very seriously. First, of the roughly 750 cases filed so far, approximately 100 cases have been settled. Second, the rate of filing has increased each year since the law's enactment. Only about 150 cases were filed in the first year, but more than double that number were filed in the most recent year. Since many cases were filed only recently, the number of settlements is a significant statistic.

The most significant suggestion that whistleblower cases remain a serious corporate risk is the development in a recent case, where an employee's claim was permitted to proceed even though there was no accounting fraud involved. In a March 29, 2006 decision, the tribunal filed in favor of a fired employee of Nova Information Systems (a subsidiary of US Bancorp). The employee claimed she had been retaliated against for complaining that the financial institution's security controls were inadequate, increasing the risk of identity theft. Her employer argued, among other things, that no statutory violation occured because the alleged disclosure did not involve an allegation of fraud against shareholders. According to the Post article, the tribunal ruled that it was sufficient to survive a dismissal motion for the complaintant to allege that she provided information of a violation of an SEC rule or regulation, regardless whether the violation related to shareholder fraud. (The tribunal has not yet made a final decision on whether the employee was illegally fired.)

A similar issue is involved in a closely watched case pending before a US District Court in North Carolina. A former employee of Wyeth Pharmaceuticals (who has exhausted administrative procedures) alleges that he was fired in retaliation for raising concerns that vaccine production employees were improperly trained, in violation of FDA regulations. Wyeth argues that the allegations, even if true, are not sufficient to state a whistleblower claim because only disclosure of accounting fraud is protected against retaliation. A lengthy discussion of the Wyeth Pharmaceuticals whistleblower case may be found here.

A broad reading of the whistleblower protection could represent a significant concern to employers. If employees may claim that a job action arose in retaliation for an employee's supposed complaint about a violation of any rule or regulation (that is, not just disclosure of accounting fraud, and not even just disclosure of a violation of an SEC rule, but disclosure of a violation of an FDA rule or any other federal rule or regulation, which would pretty much encompass an entire universe of possibilities), whistleblower complaints could indeed become the threat that early commentators feared. Potential consequences include not only the whistleblower's make-whole civil remedy under the statute (including attorneys' fees), but in serious cases the threat of an investigation by a regulatory agency, adverse publicity, and even criminal sanctions.

The Enron criminal case may have gone to the jury, but the ramifcations from the scandal continue to unfold. The whistleblower statute may yet prove to be one of the more important permanent legacies of the Enron scandal. A good overview of the case law "so far" -- including a discussion of the numerous issues that remain unresolved -- can be found here.

An interesting commentary on Sherron Watkins, questioning the bona fides of her whistleblowing credentials, can be found here.

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