Whistleblower Victory Provides Lessons For In-House Counsel

Former Solicitor of Labor Eugene Scalia said the ruling is also significant because it “shows how the Sarbanes-Oxley whistleblower provision can implicate companies at the highest level, including board of directors, CEOs and CFOs.”

Corporate directors and officers “are not accustomed to seeing employment cases in which their own interaction with the plaintiff is a central issue. But Sarbanes-Oxley whistleblower cases can present that scenario,” Scalia noted.

Bank Officer

The CFO in the case, David Welch, was terminated shortly after refusing to attend a meeting with high-level company officials responding to his complaints. He claimed that he refused to attend because those officials barred his personal attorney from accompanying him to the meeting.

The company, Cardinal Bankshares Corp., a small southwestern Virginia bank, claimed it fired Welch for insubordination. But Department of Labor Administrative Law Judge Stephen L. Purcell disagreed, concluding the bank’s defense was a pretext and Welch was fired for exercising his whistleblower rights under Sarbanes-Oxley.

(The ruling in Welch v. Cardinal Bankshares Corp. DOL ALJ, No. 2003-SOX-15 (1/28/04), can be found in the important documents section of New England In-House’s website, www.newenglandbizlawupdate.com.)

Welch sued Cardinal Bankshares following his termination in October 2002, alleging he was fired shortly after criticizing the company’s financial practices. Welch alleged the bank’s CEO had engaged in insider trading, that the bank had overstated its income in publicly released documents, and had restricted Welch from meeting with the company’s external auditors.

Following his initial complaints, Welch apparently came under fire from bank officials, particularly the CEO, after he refused to sign two certification forms required under Sarbanes-Oxley.

“What is interesting is that this certification process was not something that had to be done in the past before Sarbanes-Oxley,” noted attorney James W. Ryan, a former prosecutor and a business lawyer at Partridge Snow & Hahn in Providence, R.I.

The company’s audit committee assigned the bank’s outside counsel and its outside auditor to investigate Welch’s complaints. Welch refused to meet with them without his personal attorney, partly because he believed the company was preparing to terminate him.

Protected Activity

Section 806 of Sarbanes-Oxley (18 U.S.C. §1514A) prohibits publicly traded companies from retaliating or discriminating against employees who allege violations of federal security law to their employers or the federal government.

Purcell, the ALJ, said a Sarbanes-Oxley whistleblower must show by a preponderance of evidence that:

An employer can defend against the claim with clear and convincing evidence that it would have taken the same adverse action against the employee in the absence of the protected activity, Purcell noted.

Purcell found that several of Welch’s complaints were protected by Sarbanes-Oxley and that they were a contributing factor in the bank’s decision to terminate Welch.

Purcell emphasized the close proximity in time between Welch’s complaints and his termination: “Within a relatively brief period of time – approximately six or seven weeks – Welch had engaged in a number of activities, all of them which are close in proximity, and inferentially related, to Cardinal’s decision to suspend and then terminate him,” the ALJ wrote.

The proximity in time between the protected activity and the adverse employment action is an important factor, as it is in Title VII retaliation cases, according to David I. Spector of Steel Hector & Davis in Miami.

“Any way you cut it,” Spector said, “if you discharge an employee a short time after bringing information to the forefront, there is going to be a presumption that they violated the whistleblower provision.”

Purcell also found that the bank’s CEO, as well its outside counsel and its auditor, “manipulated” the investigation and the bank’s audit committee.

The judge rejected Cardinal Bankshares’ assertion that it fired Welch for refusing to attend the meeting with its outside counsel and auditor, saying the bank “intend[ed] to create a situation whereby Welch would not attend the meeting so [it] could use that act as a justification for terminating his employment.”

Laura Effel, the Roanoke, Va.-based attorney representing Cardinal, said Purcell’s “principal error was his failure to understand that Cardinal did exactly what the Sarbanes-Oxley Act mandates. The independent directors of Cardinal, constituting the audit committee, took charge of an investigation of alleged wrongdoing by management and directed Welch to cooperate in that investigation. Welch refused. The audit committee investigated anyway and found Welch’s allegations were groundless. Welch was fired for refusing to cooperate.”

Cardinal Bankshares has appealed the decision, which is currently before the Department of Labor’s Administrative Review Board. A ruling by the board can be appealed directly to a federal appeals court, in this case the 4th U.S. Circuit Court of Appeals.

D. Bruce Shine of Kingsport, Tenn., counsel for Welch, said he expects the decision to withstand the bank’s appeal.

“[Purcell’s] findings of fact are exceedingly detailed,” Shine said. “On appeal, one needs to keep in mind that a judge who hears witnesses and makes credibility findings as Purcell did in this case, those findings should be upheld unless they are clearly erroneous. His findings of fact with regard to credibility are well documented.”

Low Threshold?

Companies and their counsel must be aware of the relatively low threshold for a Sarbanes-Oxley plaintiff in establishing a prima facie case, some experts cautioned.

While many employment discrimination statutes require a plaintiff to show that his or her protected activity was a substantial factor in the adverse employment action, Purcell interpreted Sarbanes-Oxley to require that the protected activity be only a “contributing factor.”

The ALJ relied on case law involving whistleblower provisions in other federal statutes, such as the Energy Reorganization Act and the Aviation Investment and Reform Act for the 21st Century.

“Much of employment discrimination case law requires a plaintiff to show that the protected activity was a motivating or substantial factor in the employer’s decision to discipline the employee,” explained Bret A. Cohen, an employment law expert at Pepe & Hazard in Boston. “Analogizing to retaliation claims in the context of employment discrimination cases, the ‘contributing factor’ prong applied by the ALJ in this decision was a rather low threshold.”

Spector agreed.

“The judge applied a low standard when he said the protected activity had to be only a contributing factor in the adverse employment decision,” Spector said. “That is significantly lower than a substantial factor or an actual connection. It is certainly a standard that employers and in-house counsel should be aware of and know.”

But James B. Thalen, a labor and employment attorney at Miller Canfield in Michigan, said the contributing factor standard is neither surprising nor necessarily in error.

“The judge decided that there is nothing in the law that says the protected activity has to be the only factor,” Thalen said. “The judge read the law fairly. Any greater limit does not give employees the protection that the law seems to provide them.”

Thalen added that the “clear and convincing evidence” burden for employers in defending against a prima facie case is imposing, particularly when as in the underlying case the bank “had already started the termination process before the meeting [between Welch and company officials]. That kind of evidence is always going to be fatal to an employer.”

Scalia, co-chair of the labor and employment group in the Washington, D.C. office of Gibson & Dunn, sees another danger for employers from this decision: “When an employee’s daily responsibility is to review and comment on corporate financial information, it becomes easy for the employee after the fact to claim that the accounting complaint was the real reason for an adverse employment he experienced.”

Right To Counsel

The issue of whether a whistleblower has right to counsel also attracted the attention of experts.

“To me, this issue of counsel present is the main issue to study from the [Cardinal Bankshares] case,” said Spector.

“For management lawyers, this is a concern because you want your clients to be able to conduct internal investigations as the client determines is appropriate,” Spector offered. “If an employee is allowed to bring counsel with them during the exchange of information, it will certainly affect both the manner in which the information is exchanged between the employer and the employee, as well as the nature of the information if the employer knows the employee’s attorney will be in the room.”

The bank argued to no avail that the presence of Welch’s personal attorney jeopardized its attorney-client privilege.

Shine, counsel for Welch, however downplayed the issue.

“I’ve seen comments to the effect that this decision says that you cannot discipline or meet with someone unless they have their own attorney present,” Shine said. “I don’t think that’s what this case says at all. What the facts of this case say is that it didn’t make any difference whether [my client] ever met with [the bank’s outside attorney and auditor] with or without an attorney because the decision had already been made to get rid of him. The meeting was nothing but a subterfuge for a potential charge of insubordination.”

Independent Investigations

Many experts point to the absolute need for employers to conduct truly independent investigations once the employee raises what appears to be a Sarbanes-Oxley issue.

“The bank made a couple of mistakes,” Shine said. “First, they made a mistake when the audit committee designated someone other that itself to conduct the investigation. The audit committee should have participated in the investigation rather than delegate it to [its outside counsel and auditor].”

Next, Shine continued, “the bank made a mistake in the people they selected for the investigation. One of those selected was the outside external auditor with whom Welch had already raised points of disagreement over the bank’s accounting practice. The committee also appointed its regular attorney who ultimately ended up representing them in this case. [The outside attorney] was unable to testify as a witness and try the case at the same time.”

Scalia observed that “Sarbanes-Oxley requires that audit committees have the ability to retain outside counsel and advisors to examine allegations of financial improprieties where necessary. This can help assure the independence of the examination of internal complaints. Such an independent examination sometimes is necessary to make sure that the investigation does not simply excuse or explain away mistakes by the company’s regular auditors in the past. In any event, there must be an objective review of serious allegations that is fully calculated to discover the truth and get to the bottom of the allegations.”

Cohen said that using outside counsel to examine a whistleblower complaint under Sarbanes-Oxley is probably necessary to preserve attorney-client privilege. Otherwise, “there will be questions about what hat the in-house counsel was wearing – was he acting as another corporate executive or was he acting as the attorney for the corporation?”

He added: “If an in-house counsel conducts his or her own investigation for the company, they may have to prove that the investigation was thorough for a possible defense to the lawsuit. The in-house counsel may then have to testify. You can’t be the attorney who conducts the internal investigation of Sarbanes-Oxley allegations and then somehow also defend the adequacy of that investigation.”

Other Lessons Learned

Thalen said another lesson for in-house counsel is to “make sure that if you have a disciplinary situation, there is no contradictory evidence in the form of documents or statements or past practices that would cast a doubt on what the reason for the discharge was.”

Spector said the ruling suggests the need for performance reviews even of employees in key positions to prove that they weren’t performing adequately.

Spector also noted that the administrative law judge emphasized that the bank’s auditor reclassified the $195,000 overstatement of income as Welch had suggested.

“Usually a prompt remedial measure is protected and should not harm the defendant. In this case it seemed to favor the plaintiff,” Spector observed.

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