Whistleblower concerns just got a little more worrisome for compliance officers, especially if they are the ones blowing the whistle.
That's because a recent appeals court decision effectively gives companies the right to terminate compliance officers for reporting the very violations they were hired to detect.
In a 5-2 decision on May 8, the New York State Court of Appeals ruled in Sullivan v. Harnisch that compliance officers are not exempt from the state's employment-at-will doctrine, which allows employers the right to terminate an employee at any time for any reason absent an employment contract that prohibits it.
“In this day and age of Wall Street scandal and abuses, it's a crying shame that we don't have a law in the state of New York that protects compliance officers,” says Daniel Felber, an attorney with the Law Offices of Daniel Felber, who represented the plaintiff in the case.
The case stems from a lawsuit filed in 2008 against William Harnisch, president and chief executive officer of hedge fund Peconic Partners, by Joseph Sullivan, the firm's chief compliance officer. Sullivan claimed he was fired in retaliation just days after confronting Harnisch about potential “front running”—the illegal practice by stock brokers of executing orders for a stock, pushing up the price, just before placing orders from clients.
According to the complaint, Sullivan's termination violated the company's policy of prohibiting such retaliation. Based on the legal and ethical duties of the firm and his duties as a compliance officer, Sullivan asked the court to recognize an exception to the employment-at-will doctrine when a compliance officer is fired for objecting to misconduct.
Finding Sullivan's claim to be legally sufficient, the New York Supreme Court denied the defendants' motion to dismiss. But the appellate court reversed and dismissed the claim, holding that Sullivan did not have either an express or implied right to continued employment—a decision that the New York Court of Appeals affirmed.
“You have a clear-cut case of a CCO doing his job and getting terminated as a direct result,” says Guy Talarico, chief executive officer of hedge fund consultancy Alaric Compliance Services. He says the decision makes an already risky set of work conditions for compliance officers even more risky.
In a scathing dissent, Chief Judge Jonathan Lippman and Judge Carmen Beauchamp Ciparick expressed similar concerns. “The majority's conclusion that an investment adviser like defendant Peconic has every right to fire its compliance officer, simply for doing his job, flies in the face of what we have learned from the Madoff debacle, runs counter to the letter and spirit of this Court's precedent, and facilitates the perpetration of frauds on the public,” Lippman wrote.
The message that the decision sends to compliance officers is that, if they wish to keep their job, “they should keep their heads down and ignore good-faith suspicions or evidence they may have that their employers have engaged in illegal and unethical behavior,” Lippman added.
The only time that New York's highest court has ever granted an exception to the employment-at-will doctrine was in the case of Wieder v. Skala in which an associate at a law firm alleged he was fired for insisting that his firm report the unethical conduct of another associate at the firm. In its decision, the court reasoned that Wieder's duties and responsibilities as an associate of the firm, and as a lawyer bound by the ethical standards of the legal profession, were “so closely linked as to be incapable of separation.”
Compared with the latest case, the court reasoned that Sullivan was not associated with other compliance officers who are all subject to self-regulation as members of a common profession. Furthermore, the court noted that regulatory compliance was not the only purpose of Sullivan's employment, since he also held the roles of executive vice president, treasurer, secretary, and chief operating officer, and he was a 15 percent partner in the business.
“In this day and age of Wall Street scandal and abuses, it's a crying shame that we don't have a law in the state of New York that protects compliance officers.”
—Daniel Felber,
Lawyer,
Law Offices of Daniel Felber
Felber questions that reasoning. He says any employer can establish such a legal argument “just by making your compliance officer the chief bottle washer.”
The court noted that Sullivan could have been eligible for the whistleblower protections under Dodd-Frank, had he only reported the misconduct to the Securities and Exchange Commission prior to reporting the wrongdoing to his employer. Under the SEC's whistleblower program, those who report alleged securities laws violations may be rewarded up to 30 percent of the proceeds of successful settlements of at least $1 million.
Dodd-Frank also affords whistleblowers the right to report misconduct anonymously, meaning “compliance officers have the ability to protect investors using these anonymity provisions without putting themselves at great risk,” says Jordan Thomas, a partner and chair of Labaton Sucharow's whistleblower representation practice.
That is not to say that compliance officers should report to federal regulators in all circumstances, stresses Thomas. “What's so critical for compliance professionals is to do a good-faith, deep dive in their organizations to be sure that the culture is one where people are comfortable reporting potential problems and that their organizations appropriately respond to these reports,” he says.
If the perception among employees is that they won't receive employment protections when they report problems internally and further will be retaliated against, “people will report externally first,” adds Thomas. “Continually re-assess your reporting systems to ensure that people are encouraged to report possible securities violations and will not be retaliated against for doing so,” he says.
SULLIVAN OPINION
Below is the Judges' opinion in Sullivan v. Harnisch.
Plaintiff, Joseph Sullivan, was, according to his
complaint, a 15% partner in two affiliated firms, defendants
Peconic Partners and Peconic Asset Managers (collectively
called Peconic, and colloquially referred to as a hedge fund).
He was also, the complaint alleges, Peconic's “executive vice president, treasurer,
secretary, chief operating officer and chief compliance officer.” Defendant William Harnisch was the
majority owner, chief executive officer, and president.
Sullivan was fired after a dispute with Harnisch. The
dispute was in part about money: the complaint alleges that the
dismissal occurred within hours after a lawyer for Sullivan
contacted Peconic's counsel to voice objections to a proposed
agreement that would have eliminated Sullivan's ownership
interest. The complaint also alleges, however, that there was
another motive for the dismissal that is more relevant to this
appeal: objections raised by Sullivan, in his capacity as chief
compliance officer, to certain sales of stock by Harnisch for his
personal account and the accounts of members of his family.
According to the complaint, these stock sales amounted
to “front-running”—selling in anticipation of transactions by
the firm's clients—and enabled Harnisch to take advantage of
an opportunity from which the clients were excluded. The complaint
alleges that Sullivan “confronted” Harnisch about these
improper trades, “voiced objection to them, and insisted that
they be reversed or otherwise properly addressed.” Harnisch
refused, and yelled at Sullivan for raising the subject.
Sullivan was fired days later.
Sullivan asserted nine causes of action against
Harnisch and Peconic, of which only one is now before us. That
claim says that Sullivan was fired because he “spoke out” about
“manipulative and deceptive trading practices,” and that his
dismissal violated “a company policy to prohibit retaliation” for
such conduct. The complaint, however, does not identify any
statement of this “company policy”; it infers the existence of
the policy from Peconic's obligations under the securities laws
and the firm's own Code of Ethics to avoid improper transactions,
and from Sullivan's duty as chief compliance officer to see that
those obligations were performed. The gist of Sullivan's claim
is that the legal and ethical duties of a securities firm and its
compliance officer justify recognizing a cause of action for
damages when the compliance officer is fired for objecting to
misconduct.
On defendants' motion for summary judgment, Supreme
Court held this claim to be legally sufficient, but the Appellate
Division reversed and dismissed the claim (Sullivan v Harnisch,
81 AD3d 117 [1st Dept 2010]). The Appellate Division granted
leave to appeal, and we now affirm.
Source: Sullivan v. Harnisch.
In other circumstances, employment protections may also be afforded under the Sarbanes-Oxley Act, which does not require a whistleblower to report externally to obtain employment protections. That provision of SOX, however, applies only to public companies, and Peconic was a private firm. Another option may be to report the matter directly to the board.
Another lesson for compliance officers, say lawyers, is to make sure that protections for reporting wrongdoing are written into employment contracts. “For a compliance officer now to get a job, they're going to be looking for a more protective employment agreement,” says Timothy Selby, a partner with law firm Alston + Bird. Such an agreement should include a provision that prohibits termination for reporting to senior management any wrongdoing.
Congressional Intervention
The Sullivan case also highlights inconsistencies between state law and federal guidelines, says Talarico. While state law allows at-will compliance officers to be terminated without cause, “the SEC is looking at the CCO as its eyes and ears into these organizations to ensure that the firms are complying with the rules,” he says.
A job with that degree of pressure and responsibility requires adequate protections. “Somebody has to make up their mind here,” adds Talarico. “Who do they want watching the shop, and how are they going to protect them?”
In Sullivan, the court deferred to Congress to create protections for compliance professionals who raise internal complaints of misconduct akin to the whistleblower protections of Dodd-Frank. “Nothing in the federal law persuades us that we should change our own law to create a remedy where Congress did not,” the court concluded.
In its dissent, however, Lippman and Ciparick argued that compliance officers should not have to look to federal or state statutes for recourse but that “the common law should protect compliance officers from retaliatory termination from the inception of their investigations into alleged misconduct, even before they make any reports to the government.”
Selby says that institutional investors also have a role to play by insisting on protections for compliance officers to report wrongdoing. Investors should demand assurance that “a compliance officer is operating in an environment in which it's expected and is encouraged to report matters of concern as they relate to compliance,” he says.
Efforts are already underway to get the law changed in New York to provide better employment protections for compliance officers in the state. Felber is working with state legislators to consider new laws. The ball is now in the court of compliance officers, he says, to demand better legislative protections in cases of retaliation.
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