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Sarbanes-Oxley Update: The Whistleblower Provisions

On July 30, 2002 President Bush signed the Sarbanes-Oxley Act of 2002,1 instituting sweeping changes in the accounting and disclosure requirements applicable to public companies.  The legislation contains several provisions that entail important changes in employment law.  Section 806 of the Act creates a civil action for employees of public companies who have been subject to retaliation due to their disclosure of illegal activities perpetrated by their employers.2  Section 501 of the Act mandates protection from retaliation for securities analysts who report negatively on corporations that have an investment banking relationship with the analysts’ employers.3  Finally, Section 307 of the Act requires the promulgation of new rules of professional conduct that require attorneys who “appear” or “practice” before the SEC to make reports of evidence of certain violations of law to the public company’s chief legal counsel, chief executive officer or board of directors.  These provisions, particularly the anti-retaliation sections of the Act, are a marked departure from the prior status of whistleblower protection under New York law.

Background
New York courts currently recognize no statutory or common law protection for private sector employees who suffer any adverse employment action as a result of reporting or disclosing fraudulent practices perpetrated by an employer.  New York does, however, provide very limited statutory protection against retaliation for private sector whistleblowers.  Section 740 of the Labor Law states that an


“employer shall not take any retaliatory personnel action against an employee because such employee … discloses, or threatens to disclose to a supervisor or to a public body an activity, policy or practice of the employer that is in violation of law, rule or regulation which violation creates and presents a substantial and specific danger to the public health or safety….”4

Protection under the statute is explicitly limited to private sector employees who report on an illegal practice that presents a danger to the “public health or safety.”5   This limitation has been interpreted stringently by New York courts.  Indeed, a panel of the Second Department of the Appellate Division has held that a “plaintiff’s allegations of fiscal improprieties do not portend ‘a substantial and specific danger to the public health or safety’ and thus do not fall within the ambit of” Section 740.6


It is also well settled that there is no general common law protection against retaliation for private sector employees who disclose wrongdoing by their employers in New York.  In Murphy v. American Home Products Corp., 58 N.Y.2d 293, 448 N.E.2d 86 (1983), the Court of Appeals addressed whether an employee who alleged that he was discharged “because of his disclosure to top management of alleged accounting improprieties on the part of corporate personnel”7  had adequately stated a claim for “abusive or wrongful discharge.”8  The court held that to recognize such an action would “alter our long-settled rule that where an employment is for an indefinite term it is presumed to be a hiring at-will which may be freely terminated by either party at any time for any reason or even for no reason.”9  Therefore, the court declined to recognize such an action, stating that “such a significant change in our law is best left to the Legislature.”10  Now Congress, recognizing that “[c]orporate employees who report fraud are subject to the patchwork and vagaries of current state laws, although most publicly traded companies do business nationwide,”11  has enacted a federal statute to punish retaliation against whistle-blowers.12

Section 806
Section 806 of the Sarbanes-Oxley Act provides that no “officer, employee, contractor, subcontractor, or agent” of a publicly traded company


“may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee—

(1)  to provide information, cause information to be provided, or otherwise assist in an investigation regarding any conduct which the employee reasonably believes constitutes a violation of [title 18] section 1341, 1343, 1344, or 1348,13 any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders, when the information or assistance is provided to or the investigation is conducted by—


(A)  a Federal regulatory or law enforcement agency:


(B)  any Member of Congress or any committee of Congress; or


(C)  a person with supervisory authority over the employee (or such other person working for the employer who has the authority to investigate, discover, or terminate misconduct); or


(2)  to file, cause to be filed, testify, participate in, or otherwise assist in a proceeding filed or about to be filed (with any knowledge of the employer) relating to an alleged violation of [title 18] section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders.”14

An employee who is the subject of retaliation under the provision is not granted immediate access to federal district court.  In order to utilize this cause of action, an aggrieved employee first must file a complaint with the Department of Labor (“DOL”).  Only if the DOL has not issued a final decision15  within 180 days of the filing of the complaint, and “there is no showing that such delay is due to the bad faith of the claimant,” can an action be brought in federal district court.16  The statute requires an aggrieved employee to file a complaint with the DOL within 90 days from the date upon which the retaliation occurred.17  An employee who prevails in an administrative or judicial action brought under this statute is entitled to “all relief necessary to make the employee whole.”18  Such relief is explicitly defined to include reinstatement, back pay with interest accrued, and compensation for “special damages … including litigation costs, expert witness fees, and reasonable attorney fees.”19


Section 501
Section 501 of the Sarbanes-Oxley Act provides protection for securities analysts against retaliation by their employers for the generation of negative reports on issuers of securities with whom their employers may have a current or potential investment banking relationship.  Recent media reports have focused attention on alleged conflicts of interest arising from the task that research analysts perform for the firms by which they are employed.  Critics assert that analysts purport to render objective opinions about issuers of securities in whose valuation they, and their employers, may have a direct interest.20


Section 501 attempts to address this criticism by requiring the Securities and Exchange Commission to promulgate rules that, inter alia:


“requir[e] that a broker or dealer and persons employed by a broker or dealer who are involved with investment banking activities may not, directly or indirectly, retaliate against or threaten to retaliate against any securities analyst employed by that broker or dealer or its affiliates as a result of an adverse, negative, or otherwise unfavorable research report that may adversely affect the present or prospective investment banking relationship of the broker or dealer with the issuer that is the subject of the research report, except that such rules may not limit the authority of a broker or dealer to discipline a securities analyst for causes other than such research report in accordance with the policies and procedures of the firm….”21


The Securities and Exchange Commission has not yet promulgated any rules to effectuate this statutory mandate.


Section 307
Section 307 of the Sarbanes-Oxley Act requires the Securities and Exchange Commission to promulgate rules setting forth


“standards of professional conduct for attorneys appearing and practicing before the [Securities and Exchange] Commission in any way in the representation of issuers, including a rule—


(1)  requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof, to the chief legal counsel or the chief executive officer of the company (or the equivalent thereof); and


(2)  if the counsel or officer does not appropriately respond to the evidence (adopting, as necessary, appropriate remedial measures or sanctions with respect to the violation), requiring the attorney to report the evidence to the audit committee of the board of directors of the issuer or to another committee of the board of directors comprised solely of directors not employed directly or indirectly by the issuer, or to the board of directors.”22


On November 6, 2002 the Securities and Exchange Commission issued a press release announcing that the Commission had voted to propose rules based on Section 307.   The Commission announced that “the proposed rule would adopt an expansive view of who is an attorney subject to the rule, covering all attorneys … whether employed in-house by an issuer or retained to perform legal work on behalf of an issuer.”   The Commission also stated that the rule will not require an attorney to know that a violation has occurred, but that reporting obligations will be implicated whenever “an attorney ‘reasonably believes’ that a material violation has occurred….”   The proposed rules will also permit and/or require an attorney whose internal complaints have been ignored to effectuate a “‘noisy withdrawal’” by “disaffirm[ing] a submission to the [Securities and Exchange] Commission which the attorney believes has been tainted by a material violation….”   It is important to note however that neither Section 307, nor the recent announcement of the forthcoming rules to be promulgated pursuant to that provision, provide explicit protection against retaliation for attorneys who disclose violations by an issuer.  In-house attorney whistleblowers would presumably be protected as “employees” under Section 806 of the Act, but it is unlikely that that this provision would provide protection to outside counsel.



1.        P.L. 107-204, 116 Stat. 745 (2002).
2.        18 U.S.C. § 1514A.  The Act also criminalizes retaliation, including “interference with the lawful employment or livelihood” of anyone who provides “to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offense….”  
18 U.S.C. § 1513(e).
3.        15 U.S.C. § 78a(15)(D)(a)(1)(C).
4.        N.Y. Lab. Law § 740(2)(a) (Consol. 2002).
5.        Id.
6.        Lamagna v. New York State Assoc. for the Help of Retarded Children, Inc., 551 N.Y.S.2d 556, 557, 158 A.D.2d 588, 589 (2nd Dep’t 1990).
7.        Murphy, 58 N.Y.2d at 297-98, 448 N.E.2d at 87.
8.        Murphy, 58 N.Y.2d at 300, 448 N.E.2d at 89.
9.        Id.
10.        Murphy, 58 N.Y.2d at 301, 448 N.E.2d at 89.  See also Mulder v. Donaldson, Lufkin & Jenrette, 623 N.Y.S.2d, 560, 563, 208 A.D.2d 301, 305 (1st Dep’t 1995) (refusing to extend exception to at-will employment doctrine recognized for attorneys to plaintiff auditor in retaliation suit against defendant securities dealer).

11.        S. Rep. No. 107-146, at 10 (2002).
12.        To encourage employees to come forward, Section 301 of the Sarbanes-Oxley Act requires issuers of securities to form “audit committees” made up of independent directors who would be required, among other duties, to establish procedures for the confidential and anonymous receipt of complaints from employees regarding accounting or auditing matters.  See 15 U.S.C. § 78f(m)(4).  These provisions are, at least in part, a reaction to the perceived role of employees in disclosing, or failing to disclose, improprieties in the recent corporate accounting scandals.  See David Barboza, Teaching Them How to Blow the Whistle, N.Y. Times, July 21, 2002, § 3, at 2.
13.        18 U.S.C. §§ 1341, 1343, 1344 and 1348 are the federal criminal provisions relating to mail fraud, wire fraud, bank fraud and securities fraud, respectively.
14.        18 U.S.C. § 1514A(a)(1)-(2).  The provision only applies to corporations “with a class of securities registered under Section 12 of the Securities and Exchange Act of 1934 (15 U.S.C. 781), or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d))….”  18 U.S.C. § 1514A(a).  

15.        The Act provides that proceedings at the DOL will be governed by the procedures set forth in 49 U.S.C. § 42121(b), which is the federal statute governing the protection of employee whistleblowers in the airline industry.  See 18 U.S.C. § 1514A(b)(2)(A).  These procedures mandate that, within 60 days of the receipt of a complaint, the DOL must determine whether there is reasonable cause to believe a violation has occurred, and, if so, issue a preliminary order granting temporary relief.  See 49 U.S.C. § 42121(b)(2).  Within 30 days of the issuance of this preliminary  finding, either party can request a hearing on the record.  See id.  If a hearing is not requested, the preliminary order will be deemed a final order.  See id.  If a hearing is held, then the DOL must, within 120 days of the conclusion of the hearing, issue a final order providing or denying the relief requested.  See 49 U.S.C. § 42121(b)(3)(A).
16.        18 U.S.C. § 1514A(b)(1).  The Act provides that any action brought in federal district court will be governed by the burdens of proof set forth in the federal statute governing the protection of employee whistleblowers in the airline industry.  See 18 U.S.C. § 1514A(b)(2)(C).  This system of proof requires the claimant to make a “prima facie” showing that wrongful retaliation was a “contributing factor” in the adverse personnel action.  However, relief may not be granted if the employer demonstrates by “clear and convincing” evidence that the employer “would have taken the same unfavorable personnel action in the absence of” the employee’s disclosures.  See 49 U.S.C. § 42121(b)(2)(B).

17.        18 U.S.C. § 1514A(b)(2)(D).
18.        18 U.S.C. § 1514A(c)(1).
19.        18 U.S.C. § 1514A(c)(2).  The statute does not provide for the imposition of punitive damages.  See 18 U.S.C. § 1514A(c).
20.        See Patrick McGeehan, Goldman Wooed A Star Analyst, Documents Show, N.Y. Times, Oct. 12, 2002, at C1; Editorial, Jack Grubman’s Last Deal, N.Y. Times, August 17, 2002, at A10.21.        15 U.S.C. § 78a(15)(D)(a)(1)(C).
22.        P.L. 107-204, § 307, 116 Stat. 745, 784 (2002).  In his speech on the Senate floor in support of this provision of the Act, Senator Enzi discussed the prior state of the rules governing the professional conduct of attorneys with regard to their effect on reporting obligations.  Enzi stated that:
“in this case, the State bars as a whole have failed.  They have provided no specific ethical rule of conduct to remedy this kind of situation.  Even if they do have a general rule that applies, it often goes unenforced….  Similarly, the American Bar Association’s Model Rules of Professional Responsibility do not have mandatory rules for professional conduct for corporate practitioners which require them to take specific action.  The ABA merely has a general rule that an attorney must represent the bestinterests of an organization and suggests a number of ways an attorney could respond, including reporting illegal conduct to a responsible constituent of the organization, such as the board of directors.  But this does not mandate action.”

148 Cong. Rec. S6555 (daily ed. July 10, 2002) (statement of Sen. Enzi).
23.        The proposed rules were published on November 21, 2002.  The text of the rules can be accessed at http://www.sec.gov/rules/proposed/33-8150.htm .  Comments on the proposed rules are due by December 18, 2002.
24.        Press Release, Securities and Exchange Commission, SEC Proposes Rules to Implement Sarbanes-Oxley Act Provisions Concerning Standards of Professional Conduct for Attorneys (Nov. 6, 2002), at http://www.sec.gov/news/press/2002-158.htm.
25.        Id.
26        Id.  The rules will provide that such a disaffirmation does not breach the attorney-client privilege.  See id.

Legalese