A Massachusetts district court has addressed two thorny issues confronting employers defending against whistleblower claims brought under Sarbanes-Oxley: Who's protected under the statute and whether whistleblowers are entitled to a so-called second bite at the apple.

A March 31 combined ruling by U.S. District Judge Douglas Woodlock addressed motions to dismiss in two separate cases alleging unlawful retaliation against employees of non-public companies in the mutual fund industry who complained of improper business activities by their employers. Judge Woodlock denied motions to dismiss by the defendants, Fidelity Investments and Fidelity Management, which argued that as employees of privately held companies, the plaintiffs aren't covered by the SOX whistleblower provision.

In both cases, Woodlock held that the plaintiffs, Jackie Hosang Lawson and Jonathan Zang, as employees of investment advisers to mutual funds, are covered by SOX Section 806.

"For the goals of SOX to be met, contractors and sub-contractors, when performing tasks essential to insuring that no fraud is committed against shareholders, must not be permitted to retaliate against whistleblowers," the decision states. "These concerns are especially strong for mutual funds, which have no employees and implement the funds' management through contractual arrangements with investment advisers."

If Section 806 only protected public company employees, Woodlock noted that any reporting of fraud involving a mutual fund's shareholders would go unprotected "for the very simple reason that no ‘employee' exists for this particular type of public company."

Eric Martin, an attorney with McGuireWoods, says the holding is likely to encourage an increase in SOX filings by employees who are not obviously within the statute.

"Employees of private employers may be encouraged to bring claims for perceived retaliation after they complain about something that could impact the balance sheet of their employer's customers," he says.

Notably, however, Martin points out that the Court said its interpretation only made sense if it modified the enumerated types of protected activity (e.g., bank fraud, wire fraud, etc.) by the phrase "relating to shareholder fraud."

Courts have previously split on whether that language modifies all of the enumerated activities, or only the final activity, "any other violation of federal law."

The court also held that, while Zang had tried his case before an Administrative Law Judge and received an adverse ruling, he met the statute's requirements for seeking de novo review, allowing him to remove his case to federal court.

According to the decision, Zang obtained the ALJ's decision on March 27, 2008, appealed the decision to the Administrative Review Board on April 9, and notified the DoL on April 16 that he planned to file suit in federal court, which he did on May 6.

Because the matter was on appeal to the ARB and 30 days hadn't yet passed, the ALJ's decision wasn't a "final decision" when Zang filed his complaint in federal district court.

Woodlock's decision cited the Fourth Circuit's 2009 ruling in Stone v. Instrumentation Laboratory Co., the only other opinion to address that issue. The Fourth Circuit in that case ruled similarly that the plaintiff in that case had the right to sue his employer in district court because the Labor Department hadn't issued a final decision within 180 days of his filing an administrative complaint.

Martin describes the ruling as "extremely troubling," since although the plain language of the statute appears to allow it, "it seems contrary to the intent of a quick and less-costly resolution of SOX whistleblower claims."

It essentially gives plaintiffs—but not defendants—two bites at the apple, since whistleblowers who don't like the decision they receive from the ALJ can remove their complaint to federal court and obtain a trial de novo, he says. Under the statute, employers don't have the right to remove cases to the District Court.

"I'd expect to see more employees who lose in front of an ALJ remove their complaint to federal court and try again," with the effect of forcing employers to defend the claims twice, Martin tells Compliance Week.

Compliance Week will provide readers with full details on the decision in an upcoming edition.