Sarbanes-Oxley Act Covers Public Companies’ Contractors and Subsidiaries

Originally published as a DLA Piper client update (March 2014)

Co-authored by RACHEL COWEN and JAMIE KONN

In Lawson v. FMR LLC, No. 12-3, __ U.S. __ (Mar. 4, 2014), the United States Supreme Court’s first decision interpreting the whistleblower protection provisions of the Sarbanes-Oxley Act of 2002 (“SOX”), the Court held that the term “employee” applies not only to employees of public companies, but also encompasses employees of private contractors and subcontractors that perform services for public companies. 

Lawson exponentially expands the reach of SOX’s whistleblower protections, and undoubtedly will lead to an increase in litigation. To avoid being caught in that wave (or to at least be protected if it sweeps you up), private employers that provide services to public companies should put systems in place to prevent retaliation against any SOX whistleblower.

Background

SOX was designed with robust whistleblower protections to encourage the reporting of fraud involving public companies. One of those provisions is Section 806 of the Act, codified at 18 U.S.C. § 1514A. Generally speaking, subsection (a) prohibits companies that are registered with or file periodic reports with the Securities Exchange Commission (“SEC”) from discriminating against employees that lawfully provide information to or assist the SEC, Congress, or the employee’s supervisor, in an investigation regarding any SEC violation or other fraud; subsection (b) allows a person who alleges discharge or other discrimination in violation of subsection (a) to file a complaint with the Secretary of Labor and, if the Secretary does not issue a final decision within 180 days, to bring a federal court lawsuit.

Lawson addressed lawsuits brought by two former employees of an advisory firm to a leading mutual fund. The plaintiffs alleged that they had been fired in retaliation for complaining to their supervisors about improper accounting and public disclosures by the fund. The relationship between the advisory firm and the mutual fund raised an issue as to the scope of Section 806. Mutual funds, like the one in Lawson, file SEC reports and are subject to Section 806, but generally do not have any employees. Instead, separate advisory firms manage the mutual funds and, among other things, prepare their SEC filings. The advisory firms generally are not public companies and are not subject to Section 806 on that basis. 

The issue facing the Court was whether the employees of a private company are covered by Section 806 when the private company is a contractor to a public company and the employees allege they were terminated in retaliation for complaining to their supervisors about a fraud by the public company. The intermediate appellate court, the U.S. Court of Appeals for the First Circuit, had held that the employees were not covered.

The Decision 

The Supreme Court ruled in the employees’ favor and reversed the First Circuit decision. The Court reasoned that Section 806’s plain language and context demonstrated that the statute covered the employees of contractors to public companies. Subsection (a) of the statute does not refer only to public companies; it also includes “any officer, employee, contractor, subcontractor, or agent of such company” within its textual scope. As Justice Ginsburg explained, “Absent any textual qualification, we presume the operative language means what it appears to mean: A contractor may not retaliate against its own employee for engaging in protected whistleblowing activity.” This was particularly true because Congress had explicitly limited other portions of SOX to “an employee of a public company,” when it had not used that limiting language in Section 806. It made sense to construe Section 806 to prohibit a contractor from discharging its own employees as distinguished from the public company-client’s employees, which of course the contractor cannot fire (and cannot restore to their prior status if the plaintiff wins the lawsuit, as contemplated in the remedy provisions of the statute). Two concurring justices agreed with this textual analysis, providing a 6-3 majority in support of the plaintiffs.

The Court also addressed the practical aspects of this statutory construction. If Section 806 was not read expansively, the mutual fund industry would effectively be insulated from its reach. As mutual funds have no employees of their own, the only persons who write mutual funds’ SEC disclosures and who are in a position to blow the whistle on any reporting fraud are the employees of the separate private advisory firms, such as the plaintiffs in the case.

The Court also reasoned that the legislative history of Section 806 supported a broad scope for the statute. SOX had been passed in response to Enron and other corporate frauds. Congress was concerned that outside professionals be allowed to report fraud by the public companies with whom they contract, as gatekeepers, free of retaliation, when supposedly a “corporate code of silence” had allowed the company to perpetuate the fraud. Moreover, other parts of SOX regulate accountants, auditors and lawyers to public companies. The two concurring justices did not join this portion of the opinion, as they reasoned it was neither necessary nor appropriate to go beyond the text of the statute.

Implications

Tens, maybe hundreds, of thousands more individuals are now (were always?) protected by Section 806 if they blow the whistle on shareholder fraud. The Court rejected arguments that its decision would open the floodgates for whistleblowing suits outside SOX’s purposes, but the decision certainly increases the number of individuals who are now incentivized to and protected if they do report covered fraud. Whistleblowing will increase and with it the potential for unlawful retaliation – intentional or not – against covered employees.

Section 806 broadly prohibits retaliation – discharge, demotion, suspension, threats, harassment, or discrimination in the terms and conditions of employment – against whistleblowers. As such, private contractors and subcontractors of covered public companies should follow the lead of their public company clients and implement internal controls and procedures that facilitate appropriate responses to complaints of shareholder fraud – ensure complaints are reported and addressed promptly, thoroughly investigate complaints, identify whistleblowers (but not anonymous whistleblowers), use caution when taking adverse employment action against a whistleblower, document performance issues on a real-time basis, etc. – to prevent unlawful retaliation against those (now) protected by SOX.


© David Priebe 2016