On January 28, 2008, President Bush signed into law the National Defense Authorization Act for Fiscal Year 2008 (H.R. 4986), which includes a provision protecting employees of defense contractors who blow the whistle on contracting fraud. Section 846 amends 10 U.S.C. § 2409 to protect employees who disclose to Congress, an Inspector General, the Government Accountability Office, or a Department of Defense employee responsible for contract oversight or management information that the employee reasonably believes is evidence of gross mismanagement of a Department of Defense contract or grant, a gross waste of Department of Defense funds, a substantial and specific danger to public health or safety, or a violation of law related to a Department of Defense contract (including the competition for or negotiation of a contract) or grant.
A complainant must be filed with the Inspector General (IG) of an agency, and unless the IG determines that the complaint is frivolous, the IG will conduct an investigation. Once the complainant exhausts administrative remedies, the complainant may bring a de novo action in federal court and is entitled to a jury trial. Remedies at the administrative level and in federal court include reinstatement, back pay, compensatory damages, and attorney fees and costs.
On January 22, 2008, the Fifth Circuit issued an opinion providing significant guidance about the parameters of protected conduct under Section 806 of the Sarbanes-Oxley Act. See Allen v. Administrative Review Board, No. 06-60849 (5th Cir. Jan. 22, 2008). Affirming the ARB’s decision that the plaintiff did not engage in protected conduct, the Fifth Circuit established the following standards for assessing whether a SOX whistleblower engaged in protected conduct:
- “Reasonable Belief” Standard Protects a Mistaken Belief That an Employer Violated an SEC Rule. Consistent with the plain meaning of Section 806, which requires a plaintiff to demonstrate only a “reasonable belief” that there was a violation of one of six enumerated categories of protected conduct (not an actual violation), the Allen Court held: “Importantly, an employee’s reasonable but mistaken belief that an employer engaged in conduct that constitutes a violation of one of the six enumerated categories is protected.” This is significant because it counters a popular defense contention that a SOX whistleblower must demonstrate that shareholders have been harmed by the SEC violation or other misconduct about which the whistleblower complained.
- Objective Reasonableness is Not Solely a Question of Law. In Welch v. Cardinal Bankshares Corp., 2003-SOX-15 (ARB May 31, 2007), the ARB erroneously held that objective reasonableness is a question of law. That decision is pernicious because it encourages ALJs who lack knowledge of securities law to determine prior to trial whether a SOX whistleblower engaged in protected conduct. The Allen Court, however, has held that while the objective reasonableness of an employee’s belief can be decided as a matter of law in some cases, “the objective reasonableness of an employee’s belief cannot be decided as a matter of law if there is a genuine issue of material fact . . . . [and if] reasonable minds could disagree on this issue, the objective reasonableness of an employee’s belief should not be decided as a matter of law.”
- SOX Protects a Disclosure About a Reasonably Perceived Violation of “Any Rule or Regulation of the SEC.” Although the plain language of Section 806 protects an employee who provides information to a person with supervisory authority over the employee related to a violation of “any rule or regulation of the SEC,” many employers continue to argue that protected conduct is limited to disclosures about shareholder fraud. The Fifth Circuit has rejected that tortured construction of SOX, holding that a disclosure about a violation of any SEC rule is protected.
- Consult a Securities Law Expert Before Engaging in Protected Conduct. Unfortunately, the Fifth Circuit appears to be requiring SOX complainants to become experts in securities law in order to engage in protected conduct. In particular, the Fifth Circuit held that because the plaintiff was a licensed CPA, “the objective reasonableness of [plaintiff]’s belief must be evaluated from the perspective of an accounting expert” and she therefore should have known that internal consolidated financial statements need not be compliant with SAB-101, which prohibits publicly-traded companies from recognizing sales revenue before they deliver merchandise to the customer. Under this decision, complaining to management about internal accounting repots overstating gross profit is not protected conduct because the relevant SEC rule does not technically apply to internal financial statements. This aspect of the Allen Court’s holding completely misses the point of Section 806. As Judge Levin pointed out in Morefield v. Exelon Servs., Inc., 2004-SOX-2 (ALJ Jan. 28, 2004), Section 806 “is largely a prophylactic, not a punitive measure” designed to encourage employees to head off the type of “manipulations” that have a tendency or capacity to deceive or defraud the public. By blowing the whistle, they may anticipate the deception buried in a draft report or internal document, which if not corrected, could eventually taint the public disclosure. Section 806 is not a private right of action to enforce SEC rules, but instead is a retaliation action designed to ensure that employees can disclose accounting fraud and reasonably perceived violations of SEC rules without fear of reprisal, before shareholders are defrauded. Blowing the whistle on deceptive or inaccurate draft financial statements should be protected because if left uncorrected, the draft statements will be distributed to shareholders. If an employee is retaliated against for blowing the whistle on misleading internal financial statements, then the employee will not take the risk of blowing the whistle on publicly-filed financial statements. Finally, a SOX whistleblower should not need to consult a securities lawyer in order to engage in protected conduct.
Although Section 806 of SOX has been narrowed by some courts, it continues to afford robust protection to whistleblowers and does not require proof of an actual violation of an SEC rule. The lesson of Allen is that SOX whistleblowers need to plead protected conduct in detail and be prepared to establish a strong link between their disclosure and a reasonably perceived violation of an SEC rule, which in some cases will require expert witness testimony.
Today Rep. Wynn introduced the Congressional Disclosures Act (HR 4650), which would protect federal employees and employees of government contractors who disclose information to a Member of Congress or a Congressional Committee concerning a violation of any law, gross mismanagement, a gross waste of funds, an abuse of authority, or a substantial and specific danger to public health or safety. The Congressional Disclosures Act amends the Lloyd Lafollette Act, codified at 5 USC § 7211, which prohibits interfering with or denying “[t]he right of employees, individually or collectively, to petition Congress or a Member of Congress, or to furnish information to either House of Congress, or to a committee or Member thereof.” As described by Government Accountability Project Legal Director Tom Devine, the Lloyd Lafollette Act is a “right without a remedy” in that there is no private right of action to enforce the right conferred by the statute. Under the Congressional Disclosure Act, however, a whistleblower subjected to retaliation could bring an action in federal court for triple lost wages, lost benefits, reinstatement, costs including reasonable expert witness fees, triple attorney fees, triple compensatory damages including emotional distress and lost reputation, and equitable, injunctive, and any other relief.
Today New Jersey Governor Jon Corzine signed into law the New Jersey False Claims Act, which is similar to the federal False Claims Act. New Jersey is the 17th state to adopt a False Claims Act. The New Jersey False Claims Act closes a loophole that the D.C. Circuit read into the federal False Claims Act in United States ex rel. Totten v. Bombardier Corp., 380 F.3d 488 (D.C. Cir. 2004). Under Totten, liability is limited to companies that present false claims directly to the federal government. This loophole has enabled subcontractors to escape liability for submitting a false claim to prime contractor where the claim was not directly presented to the federal government. The New Jersey False Claims Act closes the Totten loophole by prohibiting any company from “knowingly presenti[ng] or caus[ing] to be presented to an employee, officer or agent of the State, or to any contractor, grantee, or other recipient of State funds, a false or fraudulent claim for payment or approval.”
On December 31, 2007, President Bush signed into law the “Openness Promotes Effectiveness in our National Government Act of 2007,” which amends the Freedom of Information Act (FOIA) by providing an online mechanism for FOIA requesters to track their requests; establishes an ombudsman program to resolve FOIA disputes; imposes penalties for failure to comply with the response times set forth in the FOIA; clarifies that FOIA encompasses records maintained by government contractors; and requiring agencies to pay attorney fees from their own budgets. While this legislation addresses many critical issues, it remains to be seen whether it will result in improved response times absent increased appropriations for agency FOIA offices. In whistleblower litigation, FOIA can be a critical means of obtaining documents that corroborate the whistleblower’s concerns. However, when it takes more than a year to get a response to a FOIA request, the case may have already been tried on the merits. Hopefully, this new legislation will enable whistleblowers to promptly obtain documents.