Court Decision Narrows Protections for Whistleblowers

Companies trying to score a recent court decision on employee whistleblower protection will find that it could go down and a win and a loss.

The ruling by U.S. Court of Appeals for the Fifth District Circuit demands that whistleblowers must report their concerns directly to the Securities and Exchange Commission if they want to enjoy anti-retaliation protections included as part of the Dodd-Frank Act. While this offers a new legal defense for companies, it also heightens the risk that employees will bypass internal reporting procedures. More employees taking their concerns directly to regulators means more instances where companies first hear of problems when federal agencies come knocking.  

“The decision may definitely turn up the heat in terms of timing,” says Michael Stockham, a partner at the law firm Thompson & Knight. “It could truncate the internal investigation process, speeding it up, as companies struggle to understand an issue before the SEC arrives.”

The ruling involves Khaled Asadi, an executive of GE Energy with responsibility for GE's Iraq unit. In 2010, Iraqi officials informed him of their concern that GE Energy hired a woman closely associated with a senior Iraqi official to curry favor with that official in negotiating a lucrative joint venture agreement.

Asadi, concerned this alleged conduct violated the Foreign Corrupt Practices Act, reported it to his supervisor and a company ombudsman. Subsequently, he received a “surprisingly negative” performance review and was pressured to step down. He refused and, approximately one year later, was fired.

His subsequent lawsuit against the company claims it violated whistleblower protections enacted under the Dodd-Frank Act, because he was dismissed after reporting a possible securities law violation. The court, however, ruled that Asadi was not entitled to those protections because, despite his actions, he was not technically a “whistleblower” for purposes of the law.

Although the SEC's related rulemaking suggests a broader, expanded definition of “whistleblower,” one that doesn't require such direct reporting to trigger protected status, it did so beyond the scope of what Congress intended when it originally wrote the law, Circuit Court Judge Jennifer Walker Elrod wrote in her opinion, overruling previous court decisions that offered a broader, whistleblower-friendly interpretation.

Congress's description of protected activity in the Dodd-Frank whistleblower-protection provision is “plain and unambiguous,” in that it should only protect whistleblowers from retaliation when they report their concerns to the SEC, Elrod wrote. “Because Asadi failed to do so, his whistleblower-protection claim fails.”

It remains to be seen, however, how much the latest court decision will directly influence employees. “It is too early to tell,” says Chip Jones, shareholder in Littler Mendelson's corporate ethics, compliance, and whistleblower practices. “What will matter is whether the employee has retained counsel. In those situations, then it is certainly a more likely prospect they will go directly to the SEC.”

Review Internal Reporting Mechanisms

The potential hazard for companies because of the decision is that requiring whistleblowers to report directly to the SEC could lead many to ignore internal compliance programs and take complaints to the SEC to ensure that they are protected by the anti-retaliation provisions of the Dodd-Frank Act. This could reduce the amount of time companies have to conduct their own investigations prior to having to deal with a regulator.

That means companies will have to work harder to convince employees to report their concerns internally. “You've got to get your hands around the issue,” says Sarah Bouchard, a partner at the law firm Morgan, Lewis & Bockius. “You need to have a robust complaint process, look for trends, and be on top of complaints so that they don't languish. You also need to have appropriate communications with the whistleblower so they don't get frustrated and decide to take their complaints elsewhere.”

“The Fifth Circuit's decision sends the message that if someone wants the bounty and whistleblower protections available under the Dodd-Frank Act, then they must immediately go to the SEC.”

—Michael Stockham,

Partner,

Thompson & Knight

“The Fifth Circuit's decision sends the message that if someone wants the bounty and whistleblower protections available under the Dodd-Frank Act, then they must immediately go to the SEC,” says Stockham. “When employees report internally before going to the SEC, a company can gather a lot of information from an internal investigation and triage the issue before the government ever calls. Now, companies may lose the ability to investigate before the government comes calling.”

Companies should take the approach that by the time they become aware of a problem the government probably already knows all about it, Stockman says.  An internal investigation must be done expeditiously, with the government apprised of the situation early and adequately. That messaging "may be as simple saying, ‘we know about the problem, we are investigating it, and we'll get back to you when we have more information.'”

Companies having less time to investigate matters could make it more difficult to mount a defense. “Early reporting and rapid reporting can be at odds with thorough reporting. If the reporting is haphazard or piecemeal the agency may look poorly at that,” says Mike Attanasio, a partner at the law firm Cooley and chair of its litigation department. Attanasio stresses the importance of having a “meaningful corporate culture, not just words.”

Annual compliance and fraud training is a must, especially for mid- and senior-level management, he says.

There's no quick fix, however, for the sort or corporate culture that can drive employees to be whistleblowers and bypass internal procedures to go directly to regulators, Jones says. “You need to look at the culture of the business and you can't do that by just setting policy,” he says. “You really have to dig in as a long-term project and ask employees about their concerns. You need to really work at employee engagement and culture; you can't guess at it.”

The court decision could especially affect companies that operate in locations where Foreign Corrupt Practices Act allegations are more common. “If you are a company that has sales representatives around the world, that's where training really needs to be robust and consistent,” Attanasio says. “Companies that do those sorts of things have a much easier time explaining to the SEC that sometimes bad things happen to good companies.”

With its program, the SEC does still encourage whistleblowers to utilize the internal compliance processes. If a whistleblower reports internally, they have an additional 120 days to report to the SEC and still qualify for a bounty and protections. Consideration for an increased award is also given when a whistleblower participates in an internal compliance process. Conversely, a reward is decreased if that employee obstructs or undermines that company review process.

What's Next?

The circuit court ruling is already forming the foundation of other company defenses. Siemens AG, in a Motion to Dismiss filed in U.S. District Court for the Southern District of New York, cited the GE Energy case in a whistleblower battle of its own.

That case involves Meng-Lin Liu, the Taiwan-based compliance officer for a Chinese subsidiary, who alleged that the company fired him in 2010 after he raised concerns that the company was violating terms of a 2008 plea agreement with the Department of Justice, a settlement that resolved FCPA violations. “As the Fifth Circuit recently held, Dodd-Frank protects only those who blow the whistle to the SEC, something Mr. Liu admits he did not do until months after the alleged retaliation,” counsel for the company wrote.

WHAT ABOUT SOX?

Although the Sarbanes-Oxley Act of 2002 protects employees who report internally, Dodd-Frank provides employees with a much greater level of protection. Had the Securities and Exchange Commission's broader interpretation of a “whistleblower” been upheld, it would have undercut those anti-retaliation provisions, says Sarah Bouchard, a partner at the law firm Morgan, Lewis & Bockius.

Among the reasons: Dodd-Frank provides for greater monetary damages—recovery of two times back pay, whereas the SOX anti-retaliation provision provides for only back pay. It also sweetens the pot with a bounty for individuals who offer “high-quality, original information” that leads to sanctions of more than $1 million. Awards can range from 10 percent to 30 percent of the money collected, divided among validated tipsters.

Also, individuals who bring a SOX anti-retaliation claim must first file a complaint with the Secretary of Labor and, only if it has not issued a final decision within 180 days, may proceed to file a claim in a U.S. district court. Dodd-Frank requires no such process or delay.

The defense presented by Siemens AG in a lawsuit involving alleged retaliation against a whistleblower, also invokes SOX protections, specifically their limitations. The Sarbanes-Oxley Act, company counsel points out, does not protect an employee's disclosure of alleged FCPA violations. By statute, it applies only to the extent they report violations of mail, wire, bank, or securities fraud, or violations of any rule or regulation relating to fraud against shareholders.

—Joe Mont

Siemens also cited the extraterritorial nature of their situation as grounds for dismissal. “Mr. Liu is a foreign employee who allegedly raised concerns about foreign transactions and was allegedly retaliated against by a foreign company operating in a foreign country,” its attorneys wrote, adding that the language of the Dodd-Frank Act's anti-retaliation provisions fails to establish foreign reach.

Liu argues that Siemens “voluntarily subjected itself to the full range of U.S. securities laws in return for the benefits of being listed on a U.S. exchange.” The company rejected the claim that a foreign company is subject to U.S. securities laws everywhere it conducts foreign transactions “merely because it has listed some securities [in this case American depositary receipts, not common stock] in the United States.”

While companies refine their whistleblower defenses, the SEC says it will continue to make these complaints a priority. In fiscal year 2012, the program generated more than 3,000 tips, many coming through a dedicated online portal. Although only a handful of awards have been announced thus far, more are promised. New SEC Chair Mary Jo White has also signaled that her staff will more aggressively seek out, and pursue, cases of accounting fraud.

“Those are the types of cases that go hand in glove with a whistleblower program,” Stockham says. “You have people blowing the whistle on issues such as improper revenue recognition that works its way into public filings and a company's records. If the SEC is truly going after accounting cases, whistleblowers are very helpful in initiating and blowing those cases wide open. You may very well see more of that in the future.”