7th Circuit Reinstates RICO Whistleblower Lawsuit, Applies Broad Relationship Standard

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The United States Court of Appeals for the Seventh Circuit reversed a lower court decision dismissing whistleblower Michael DeGuelle’s lawsuit against his former employer, S.C. Johnson & Son, Inc. (SCJ) and members of management.  The Court recounted the facts alleged by DeGuelle that gave rise to the lawsuit:

[While working in SCJ’s tax department,]DeGuelle discovered that SCJ improperly received over $5 million in foreign tax credits.  In January of 2001, DeGuelle reported his findings to [Daniel Wenzel, SCJ’s Global Tax Counsel,] and asked how these errors should be remedied.  Wenzel responded that they should wait and “[t]his is why I go to church on Sundays.”  Wenzel reported DeGuelle’s findings to Robert Randleman, Vice President and Corporate Tax Counsel, but not to the IRS.  Instead Wenzel directed DeGuelle to alter or destroy records so that the errors would not be detected.  Subsequently, altered reports were submitted to the IRS. . . .

In 2002, Wenzel instructed DeGuelle and a fellow employee to structure a transaction so that SCJ could claim a tax deduction by exploiting tax accounting rules.  Wenzel told DeGuelle and his fellow employee to fabricate a business purpose for the transaction and then destroy associated business records in case “the IRS examines this transaction in the future.” DeGuelle believes SCJ received a benefit in excess of $2 million in the form of reduced tax liability as a result of this structured transaction. Further, Wenzel received a significant discretionary bonus for his role.

In February of 2005, Wenzel directed DeGuelle to fraudulently alter an income statement, which would result in approximately $3.7 million in financial benefits for SCJ.  DeGuelle refused to alter the statement.  He discussed his concerns with Donald Pappenfuss, a supervisor within the tax department, who instructed DeGuelle to alter the form pursuant to Wenzel’s instructions.  Wenzel approved the altered income statement and submitted it to the IRS by mail.

. . .

In March of 2008, Wenzel told DeGuelle to bring any concerns about issues in the tax department to appropriate department personnel instead of taking such concerns to accounting or human resources.  Wenzel was loud and physically aggressive toward DeGuelle during this meeting.  Wenzel also made disparaging comments about DeGuelle in front of other SCJ employees.  That same month, DeGuelle received a negative six-month performance review even though such mid-year reviews were not routine, and despite the fact that DeGuelle received an Officer’s Award in recognition of his superior job performance in January of that year.

. . .

On September 23, 2008, Wenzel and DeGuelle had another verbal altercation and DeGuelle received a negative “needs improvement” performance review from Wenzel.  DeGuelle contacted [Kristen Camilli, Director of human Resources,] and alleged that his review was retaliation for his whistleblowing activities.  Camilli informed DeGuelle on October 10, 2008, that the negative review would be investigated.

. . .

On December 18, 2008, DeGuelle met with [another manager, Gayle Kosterman,] and Camilli.  They informed DeGuelle that the negative review was retaliatory in nature and it would be revoked. . . .  Kosterman directed DeGuelle to drop his complaints of tax fraud, but DeGuelle stated he would file a whistleblower complaint with the Department of Labor.  Later that day, Kosterman and Camilli contacted DeGuelle by telephone and. . . offered to make a partial payment of DeGuelle’s attorney’s fees if DeGuelle agreed to sign a release of claims and confidentiality agreement.

. . .

DeGuelle continued to contact federal agencies about SCJ’s tax fraud.

. . .

On March 19, 2009, DeGuelle provided SCJ counsel with a five-page memorandum detailing his concerns about tax fraud within the company. . . . Kosterman met with DeGuelle and offered him the opportunity to resign with one year of salary and benefits if he signed a confidentiality agreement and released all claims.  Again, DeGuelle refused SCJ’s offer.

DeGuelle was subsequently terminated by SCJ.  DeGuelle’s complaint alleges that Wenzel, Randleman, and Pappenfuss engaged in tax fraud in order to receive significantly higher discretionary bonuses, and that management retaliated against him for disclosing the fraud to the government – a violation of the Racketeer Influence and Corrupt Organizations Act (RICO).

Sec. 1962(c) of RICO makes it unlawful for an employee of an enterprise engaged in interstate commerce “to conduct or participate, directly or indirectly, in the conduct of such enterprise’s racketeering activity . . . .”  Violations of RICO can include mail fraud, tax fraud, the destruction of records, and whistleblower retaliation.

The district court erroneously determined that the alleged tax fraud and alleged retaliation were patently unrelated for purposes of RICO, because the schemes “involved different actors, motives, and victims.”  The Seventh reversed the district court and agreed with DeGuelle’s argument that the Sarbanes-Oxley Act’s addition of Sec. 1513(e) as a RICO predicate act allows his claim to proceed.  Under RICO, violations of Sec. 1513 constitute “racketeering activity.”  Congress enacted the Sarbanes-Oxley Act or SOX to address growing concerns about the reliability and accuracy of disclosures made by publically-traded corporations.

Applying a relatively broad relationship standard, the Seventh Circuit stated:

When an employer retaliates against an employee, there is always an underlying motivation.  In this case, for example, the motivation was to retaliate against DeGuelle for disclosing the tax scheme.

. . .

We believe the district court erred in finding that the retaliatory actions taken against DeGuelle were unrelated to the ongoing tax fraud scheme.

The case is DeGuelle v. Camilli.

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U.S. DOL ARB Ends Landmark Year Holding Summary Decision Improper Unless Employer Proves Sarbanes-Oxley Act Does Not Apply

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On December 16, 2011, the United States Department of Labor’s Administrative Review Board issued important decision for whistleblowers and their advocates to end a year of landmark Sarbanes-Oxley Act of 2002 (SOX) decisions by the ARB, including:

In the ARB’s final SOX decision for 2011, Charles v. Profit Inv. Mgmt., ARB No. 2009-SOX-40 (ARB December 16, 2011), the ARB overturned an Administrative Law Judge’s (ALJ) premature summary decision in favor of the employer.  The ALJ believed erroneously that whistleblower Lisa Charles’s employer (Profit Investment Management) could not be subject to the whistleblower provisions of SOX.

Profit Investment Management employed Charles from 2004 to 2008, terminating her employment after she reported SEC violations to the CEO.  Charles then filed a SOX complaint with the U.S. Department of Labor in August 2008, resulting in the employer’s motion for summary decision.

The ALJ granted the employer’s motion for summary decision and dismissed the case at least in part on the basis that Charles’s former employer was not a covered employer under SOX, because it is a privately owned company.

The SOX whistleblower protection provision (Section 806) states:

(a) WHISTLEBLOWER PROTECTION FOR EMPLOYEES OF PUBLICLY TRADED COMPANIES. No company with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l), or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)), including any subsidiary or affiliate whose financial information is included in the consolidated financial statements of such company, . . . or any officer, employee, contractor, subcontractor, or agent of such company, . . .  may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee  —

(1)  to provide information, cause information to be provided, or otherwise assist in any investigation regarding any conduct which the employee reasonably believes constitutes a violation of section 1341 [mail fraud], 1343 [wire, radio, TV fraud], 1344 [bank fraud], or 1348 [securities fraud], any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders, when the information or assistance is provided to or the investigation is conducted by – [a Federal regulatory or law enforcement agency, a supervisor, or in support of a related proceeding.]

The ARB noted that the burden lies with the moving party to demonstrate the absence of any material fact genuinely in dispute in order to prevail on a motion for summary decision.  In this case, there is a genuine issue of fact regarding whether Profit Investment is a covered employer under SOX.  Profit Investment failed to establish a record showing that it was not a subsidiary, contractor, or agent of a public company.  The ARB states:

The plain language of Section 806(a) identifies several categories of potentially covered entities beyond the registration and reporting requirements of SOX (i.e., “any officer, employee, contractor, subcontractor, or agent of such company”).  The Second and Sixth Circuits have concluded that the use of the term “any” preceding the listing of the several entities identified in Section 806(a) is an indication that Congress intended the clause “officer, employee, contractor, subcontractor, or agent” to be interpreted in an allencompassing manner.

(Internal citations omitted).

The ARB also cited its decision in Johnson, supra, in which it found that “. . . Congress intended to enact robust whistleblower protections for more than employees of publically traded companies.”  Congress also intended to not only protect whistleblowers who work for publically traded companies, but also “employees of private firms that work with, or contract with, publically traded companies.”

The ARB concluded that in this case the ALJ’s summary decision was improper.  Much of the factual record of the case remains in dispute: particularly the nature of the contractual relationship between Profit Investment Management and a publically traded firm to which it is connected.  Consequently, whistleblowers will more easily prevail against motions for summary decision based on employer coverage, unless the employer proves it has no connections to a public company that might give rise to Section 806 liability.

Michigan Federal Court Rules Severance Agreement Cannot Bar Qui Tam Claim

In U.S. ex rel. McNulty v. Reddy Ice Holdings, Inc., the United States District court for the Eastern District of Michigan held that a whistleblower’s severance agreement releasing all claims against the employer does not bar qui tam claims where the government was unaware of the underlying fraudulent activity when the severance agreement was signed.  Whistleblower Martin G. McNulty alleges that his former employer, Arctic Glacier, colluded with competitors since 1997 to raise the price of packaged ice by geographically dividing the market.  According to McNulty, the government spent in excess of $150 million on packaged ice during that time period.

McNulty further alleges that Arctic Glacier terminated him after he learned of and refused to participate in the anticompetitive scheme.  He later filed this qui tam claim under the False Claims Act (FCA), alleging that his employer overcharged the federal government for packaged ice.  Although the court dismissed McNulty’s claims on jurisdictional grounds and a failure to particularly plead his claim, more importantly the court also dismissed Arctic Glacier’s counterclaim alleging breach of the severance agreement – a significant victory for future whistleblowers.   The Court found the release of claims provision in the severance agreement unenforceable against qui tam claims that allege fraud that the government has not yet uncovered.  In support of its finding, the Court states:

. . . [T]hese courts have applied the balancing test set forth by the Supreme Court in Town of Newton v. Rumery, 480 U.S. 386, 392 (1987), which in the context of FCA claims, weighs “the public interest in having information brought forward that the government could not otherwise obtain [against] the public interest in encouraging parties to settle disputes.”  Nowak, 2011 WL 3208007, at *21 (internal quotation marks and citation omitted).  When considering a release of claim in the prefiling period, the court’s “focus must be on the incentive effect in achieving the FCA’s goals of detecting and deterring fraud.”

Ranbaxy Laboratories to Pay $500 Million in Settlement with Food and Drug Administration

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Last week, India’s largest drug manufacturer, Ranbaxy Laboratories Ltd., announced that it had entered into a consent decree with the Food and Drug Administration (FDA) and had set aside a provision of $500 million to cover any liability arising out of a separate investigation by the Department of Justice (DOJ).

The consent decree comes after a 2008 decision by the FDA to ban dozens of Ranbaxy’s generic drugs from entering the US due to alleged violations of FDA manufacturing and quality standards at two of Ranbaxy’s plants in India. Additionally, the FDA alleged that Ranbaxy had falsified data about the shelf life, ingredients, and stability of certain medications including drugs that were to be distributed to foreign countries as part of the President’s Emergency Plan for AIDS Relief program (PEPFAR).

According to the consent decree, Ranbaxy has agreed to strengthen its compliance with industry standards. While the agreement is not an approval for Ranbaxy to resume manufacturing and importing drugs to the U.S., it will allow the company to seek FDA approval to resume importing pharmaceuticals produced at the two allegedly tainted factories. The consent decree is pending approval by the U.S. District Court for the District of Maryland. The $500 million reserve is intended to cover any of Ranbaxy’s potential civil and criminal liability.

Japan-based Daiichi Sankyo Co. acquired a majority stake in Ranbaxy in 2008 and has announced that it expects its net income to decline over 60% in the coming year due to Ranbaxy’s settlement with the DOJ. Some analysts have predicted that the settlement may wipe out Ranbaxy’s expected profits for the next two years. Because of the $500 million provision and the decreased profit forecasts, Daiichi Sankyo Co. has decided to cut executive pay for six months.

SEC Charges GlaxoSmithKline Unit with Defrauding Employees in Low Valuation Stock Buybacks

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Last week, the Securities and Exchange Commission (SEC) charged Stiefel Laboratories Inc. (Stiefel Labs), a subsidiary of GlaxoSmithKline PLC, and the company’s former chairman and chief executive officer Charles Stiefel with defrauding employees and company shareholders by allegedly making stock buybacks at significantly undervalued prices.

The SEC alleges that Stiefel Labs failed to report certain information to employees and shareholders, thereby enabling the company to buy back stock from employees and shareholders at undervalued prices.  According to the SEC’s complaint, which was filed in the U.S. District Court for the Southern District of Florida, “Charles Stiefel knew that five private equity firms had submitted offers to buy preferred stock in November 2006 based on equity valuations of Stiefel Labs that were approximately 50 to 200 percent higher than the valuation later used for stock buybacks.” Despite knowing of the offers, Stiefel Labs continued to purchase stocks that were below estimated equity valuations.  Shareholders and employees who sold undervalued stock to Stiefel Labs lost more than $110 million, according to Eric I. Bustillo, director of the SEC’s Miami Regional Office.

The SEC is seeking permanent injunctive relief for shareholders and employees, financial penalties, disgorgement of ill-received gains with prejudgment interest against both Stiefel Labs and Charles Stiefel. The SEC is also seeking to permanently bar former CEO Charles Stiefel from serving as an officer or director of any publicly traded company