September 8, 2008
by Jason Zuckerman & R. Scott Oswald
When the 4th U.S. Circuit Court of Appeals
recently affirmed the Department of Labor (DOL)'s dismissal
of a closely watched Sarbanes-Oxley whistleblower claim, it
appeared at first blush to be the last nail in the coffin of
a whistleblower provision that has been significantly
narrowed and undermined in its mere six years of existence.
A careful reading of the opinion in Welch v. Chao, however,
reveals that it is a substantial victory for employees in
that it resolves many ambiguities in favor of employees and
rejects many of the defense arguments that are commonly
asserted in Sarbanes-Oxley whistleblower cases.
David Welch's Sarbanes-Oxley claim was the first to go to trial, and, in January 2004, a DOL administrative law judge (ALJ) found that Cardinal Bankshares Corp. violated § 806 of the act and ordered Cardinal to reinstate Welch and pay him damages. Employers paid close attention because the case demonstrated the potency of the whistleblower provision. In May 2007, the DOL Administrative Review Board (ARB) reversed, holding that Welch failed to show that he had an objectively reasonable belief that Cardinal was violating securities laws. Nearly six years after Cardinal terminated Welch for opposing its overstatement of earnings and other reasonably perceived violations of U.S. Securities and Exchange Commission rules, the 4th Circuit affirmed, concluding that Welch failed to specifically demonstrate that Cardinal was violating SEC rules.
Although the 4th Circuit's decision is discouraging for whistleblowers in that Welch has not been reinstated to the job from which he was unlawfully terminated, the decision is largely a victory for employees because it rejects many of the contorted interpretations of the statute that the defense bar has used to undermine the protection that § 806 affords to corporate whistleblowers.
Although the plain meaning of § 806 does not limit protected conduct to disclosures about material violations of SEC rules, some ALJs erroneously applied a materiality requirement to § 806, thereby dismissing claims that met the standard for protected conduct under the statute. As was pointed out in Morefield v. Exelon Servs. Inc., a materiality requirement is inconsistent with the prophylactic purpose of § 806, i.e., enabling employees to blow the whistle without fear of reprisal. Employers often assert the materiality argument because it significantly narrows the range of protected disclosures under the act. In holding that there is no materiality requirement, the Welch confirmed that the range of protected disclosures is very broad.
The Welch court also held that protected conduct under the act is not limited to disclosures of actual violations of SEC rules. Instead, § 806 expressly protects an employee who "reasonably believes" that the information he or she discloses constitutes a possible violation of "any rule or regulation of the [SEC], or any provision of Federal law relating to fraud against shareholders." Indeed, the court noted that Sarbanes-Oxley protects a disclosure "based on a reasonable, but mistaken, belief that conduct constitutes a securities violation," citing a 5th Circuit case.
Cardinal asserted that § 806 imposes a heightened pleading standard, and the 4th Circuit categorically rejected this attempt to rewrite the statute. The Welch court specifically held that a whistleblower need not "identify specific statutory provisions or regulations when complaining of conduct to an employer."
The 4th Circuit has clarified that "objective reasonableness is a mixed question of law and fact." As the objective reasonableness of a Sarbanes-Oxley plaintiff's disclosures is almost always an issue of disputed fact, most Sarbanes-Oxley claims should survive summary judgment.
The ARB held that Welch could not have had an objectively reasonable belief that Cardinal's reporting of $195,000 in recovered loans as income violated relevant law because the misclassification of items in a financial statement can never "present . . . potential investors with a misleading picture of [a company's] financial condition," so long as the misclassification does not affect the "bottom line." But the 4th Circuit rejected the ARB's erroneous speculation and held that communications about misclassifications in financial statements may form the basis for a protected disclosure under Sarbanes-Oxley.
Although the dismissal of Welch's claim more than four years after he prevailed at trial suggests that Sarbanes-Oxley whistleblowers face an uphill battle, the court's construction of the act will make it much more difficult for employers to prevail.
Jason Zuckerman and R. Scott Oswald are principals at the Employment Law Group law firm in Washington, where they litigate whistleblower retaliation and other employment-related claims on behalf of employees. They filed an amicus brief in the Welch case on behalf of the Government Accountability Project, the National Whistleblower Center and Taxpayers Against Fraud.
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