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Apr 4, 2014

By Ed Ellis, Gregory Keating, and Stephen Melnick

In Lawson v. FMR LLC, the U.S. Supreme Court massively expanded the scope of the anti-retaliation provision of the Sarbanes-Oxley Act (SOX), from 4,500 publicly held companies to millions of private companies that are “contractors,” “subcontractors” or “agents” of a publicly held company.

Going forward, privately held employers should be aware that SOX provides a remedy for almost all U.S. employees who suffer adverse employment actions for reporting fraud. Employers should train their management and human resources personnel to identify potential employment issues of this type and remedy them before they become costly litigation.

Background for the Lawson Decision

Congress enacted Sarbanes-Oxley in response to the massive scandals at public companies like Enron in the early 2000s. SOX imposed comprehensive new standards for public companies and their boards, managers and accountants.

SOX also contained an anti-retaliation provision that prohibits a public company or an “officer, employee, contractor, subcontractor, or agent of such company” from “discharging, demoting, suspending, threatening, harassing, or in any other manner discriminating” against “an employee,” because that employee blew the whistle on certain kinds of fraud or a violation of an SEC rule or regulation.

Until Lawson, no court had addressed the meaning of the term “an employee.” In Lawson, the plaintiffs worked for privately-held companies that provided services for publicly-traded mutual funds.

The plaintiffs sued under Sarbanes-Oxley for whistleblower retaliation. On appeal, the First U.S. Circuit Court of Appeals in Boston held that the term “an employee” in SOX referred only to an employee of a publicly held company, not employees of private businesses. A few months later, however, the Department of Labor’s Administrative Review Board (ARB) reached a different finding.

In Spinner v. David Landau & Associates LLC, the Review Board held that an auditor who was fired by a privately held firm could bring a Sarbanes-Oxley claim, because the privately held firm had provided compliance services to a public company. The ARB found that the term “an employee” referred not only to employees of the publicly held company, but also employees of its contractors and subcontractors.

The Supreme Court decision

With this split between a court of appeals and the U.S. Department of Labor, the Supreme Court agreed to hear the plaintiffs’ appeal in Lawson. The Court reached the broadest possible interpretation of statutory coverage: SOX applies to employees of publicly held companies, employees of contractors and subcontractors, and even employees of a public company’s “officers,” “employees” and “agents.”

In reaching this conclusion, the Court started with the anti-retaliation language of Sarbanes-Oxley. The Court read the SOX anti-retaliation provision to say that “no contractor may discharge an employee” for blowing the whistle. Simplified in that way, the Court concluded that the “employee” referenced had to be the employee of the contractor, not the employee of the publicly traded company.

The Court also noted that Congress enacted Sarbanes-Oxley in the wake of the Enron debacle. Enron’s fraud continued for so long in part because these contractors were able to retaliate against and even discharge employees who tried to report corporate misconduct, without any legal consequences. Putting this all together, the Court found that “employee” must include employees of contractors.

While the Lawson case presented a “mainstream application” of Sarbanes-Oxley  –  finance professionals allegedly blowing the whistle on fraud at a mutual fund  –  the Court’s decision sweeps far, far wider.

First, the Court did not adopt any limitation to the word “contractor.” Thus, Sarbanes-Oxley could reach employees of companies that have nothing to do with compliance or fraud, such as cleaning or construction companies.

Second, SOX references “subcontractors” of publicly held companies, so a company’s employees could still file claims under Sarbanes-Oxley if the company contracted with a company that contracted with a public company. In short, there are now few companies in the U.S. that are not subject to SOX’s anti-retaliation section.

Further, Sarbanes-Oxley prohibits “officers,” “employees” and “agents” of publicly held companies from retaliating against their employees. Thus, if a parent who works at a publicly held company hires a housekeeper or gardener, that person could have a federal retaliation claim against that parent under SOX.

These somewhat remarkable outcomes were pointed out by a vigorous dissent in Lawson. The majority opinion acknowledged that “housekeepers or gardeners” would fall within Sarbanes-Oxley’s protections, but dismissed these concerns as “more theoretical than real.”

As for the massive number of privately held companies that could now face SOX litigation, the Court found that those concerns “are [no] more than hypothetical.” The Court concluded, “if we are wrong,” then “Congress can easily fix the problem by amending [SOX].”

Impact of Lawson on privately held businesses

Unfortunately for millions of privately held companies, the costs of defending against a Sarbanes-Oxley claim and the potential damages available are neither “theoretical” nor “hypothetical.”

Sarbanes-Oxley has a particularly lengthy and complicated procedure: a case is first investigated by OSHA, which determines whether there is probable cause to support the allegations. If the claimant loses at this phase, s/he can then seek further review through a hearing before an administrative law judge.

If the claimant loses again, the case can be appealed to OSHA’s Administrative Review Board (ARB) for another review. Further, before a final decision is reached by the ARB, the claimant can remove the case to federal district court for review at trial. The cost of defending against even a meritless claim at these multiple levels can be daunting.

Furthermore, if the claimant prevails, then s/he can recover “all relief necessary to make the employee whole,” which can include back pay, compensatory damages, attorneys’ fees, and possibly even reinstatement.

To minimize the risk, privately held businesses in America should take action to implement new strategies to foster a culture of compliance and guard against the prospect of retaliation.

Fortunately, the past decade has seen a wealth of new products, services and technologies designed to assist businesses in strengthening their compliance programs. Because Sarbanes-Oxley now applies to millions of companies in America, many of those will have to at least consider implementing a more robust and structured compliance program.

These measures include adopting compliance policies and creating systems whereby employees can make good faith reports of concerns regarding financial misconduct, and the company can promptly investigate those complaints and take any necessary corrective action.

Further, human resources departments and front-line managers should be trained on identification of financial misconduct, how to marshal the resources necessary to investigate financial misconduct, and how to protect legitimate whistleblowers from retaliation at the hands of dishonest managers.