Private companies that contract with publicly held firms can be held liable for violating the Sarbanes-Oxley Act of 2002 if they retaliate against employees that act as whistle-blowers against the public firms, the U.S. Supreme Court said in a ruling that expands many observers' understanding of the law.
Observers note, however, that ambiguity remains as to who within a privately held contractor or subcontractor working for a public company would be subject to Sarbanes-Oxley, and expect further litigation and, perhaps, new regulations on the issue.
“Given Congress' concern about contractor conduct of the kind that contributed to Enron's collapse, we regard with suspicion construction of (Sarbanes-Oxley's whistle-blower provision) to protect whistle-blowers only when they are employed by a public company, and not when they work for the public company's contractor,” Justice Ruth Bader Ginsburg wrote for the 6-3 majority in Jackie Hosang Lawson et al. v. FMR L.L.C. et al. (see related story).
The ruling overturned a February 2012 decision by a panel of the 1st U.S. Circuit Court of Appeals in Boston, which held that employees of private contractors working for public firms were not protected by the Sarbanes-Oxley whistle-blower anti-retaliation provision.
The ruling combined separate suits, brought by former employees of private contractors that advised and managed the Fidelity family of mutual funds operated by Boston-based FMR Corp.
One of the employees raised concerns about accounting issues and the other raised concerns about a draft securities filing.
Both plaintiffs lost their jobs with their privately held firms and charged they had been retaliated against for their whistle-blowing activities. They contend they are covered under Section 806 of Sarbanes-Oxley, which protects whistle-blowers against retaliation.
The ruling “expands coverage of the statute far beyond what most people who practice in this area ever thought it would be, and has significant implications for companies that are not publicly traded but that do business with publicly traded companies,” said Edward T. Ellis, a partner at law firm Littler Mendelson P.C. in Philadelphia, which submitted an amicus brief on behalf of the Alexandria, Va.-based Society for Human Resource Management in support of Fidelity's stance.
“It's obviously an expansive reading” of the law, and “the court made it clear that companies can't structure their way around these protections by using independent contractors or affiliates” or other privately held entities, said Thomas O. Gorman, a partner at Dorsey & Whitney L.L.P. in Washington.
The ruling “was clearly motivated by what the court perceived the statute as having tried to address, which was the previous lack of protection for security and financial fraud whistle-blowers,” said Geoffrey C. Rapp, a law professor at the University of Toledo School of Law in Ohio.
The ruling “is in line with a straight reading of the statute, and affords a whistle-blower protection as Congress intended,” said Rosanne Felicello, principal attorney at Felicello Law P.C. in New York, who represents whistle-blowers.
The court “found this case easy because the plaintiffs were accountants or auditors working for a publicly traded fund, and that sort of strikes at the core of what Sarbanes-Oxley was meant to remedy,” Mr. Ellis said. “But both the opinion and the dissent are full of examples of how a literal reading of the statute” could lead to what many would call an absurd result “unless the Department of Labor chooses to provide the limitations and the courts honor it.”
Observers say they expect the ruling to spark additional litigation over who is covered by the law.
Congress “didn't think through some of the other examples” about who could be covered by the law's whistle-blower provisions, but “creative lawyers” did, said Richard Moberly, a law professor at the University of Nebraska College of Law in Lincoln. Lower courts now are “going to have to deal with the limiting issues.”
With the ruling, nonpublic companies must not assume “that a technicality is going to keep you out of the reach of Sarbanes-Oxley,” said Nicholas De Baun, a partner at Seyfarth Shaw L.L.P. in New York.
Whistle-blower provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act also are broadly written and cover “basically any type of fraud that is prohibited by federal law,” including securities, mail and wire fraud, said Eric D. McArthur, a partner at Sidley Austin L.L.P. in Washington. So it is “safe to say that any time an employee is reporting what could be construed as fraudulent conduct, employers need to take care to assure that no adverse employment action is taken against the employees because of their report.”
Privately held firms “need to make certain their policies cover the reporting of fraud” by their customers and clients, just as publicly held firms have had to do since Sarbanes-Oxley, said Connie N. Bertram, a partner at Proskauer Rose L.L.P. in Washington.
The ruling will require “many companies to create compliance systems and to train their human resources personnel to identify fraud problems, investigate them and protect whistle-blowers or would-be whistle-blowers,” Mr. Ellis said.
However, private companies should examine their risks before spending “a lot of money on compliance activities and initiatives that may or may not be required, depending on their level of activity with the companies they are working with,” said Jimmy Lin, vice president of product management and corporate development at Atlanta-based consulting firm The Network Inc.