March 10, 2009
SARBANES-OXLEY ACT
PRIMA FACIE CASE PRIMA FACIE CASE UNDER SOX IS NOT IDENTICAL TO TITLE VII AND MCDONNELL DOUGLAS
In Day v. Staples, Inc. , No. 08-1689 (1st Cir. Feb. 9, 2009) (case below 2006-SOX-34), the First Circuit noted that:
Th[e] prima facie case under SOX is not identical to that under Title VII and McDonnell Douglas , which requires the plaintiff to show (1) he is a member of a protected class; (2) he was qualified for the job; (3) the employer took an adverse employment action; and (4) the position remained open or was filled by a person with similar qualifications. See St. Mary's Honor Ctr. v. Hicks , 509 U.S. 502, 506 (1993). Indeed, the SOX burden may be more difficult to meet because an inference does not arise automatically if the four criteria are met, but only when the circumstances are sufficient to raise an inference and because the employee must show that he engaged in the protected activity.
Slip op. at 22 n.6.
CHEVRON DEFERENCE SOX REGULATIONS ARE ENTITLED TO CHEVRON DEFERENCE
Noting that Congress had explicitly delegated to the Secretary of Labor authority to enforce § 1514A by formal adjudication, the First Circuit held that the DOL regulations implementing the SOX whistleblower provision are entitled to Chevron deference. Day v. Staples, Inc. , No. 08-1689, slip op. at 23 and n.7 (1st Cir. Feb. 9, 2009) (case below 2006-SOX-34).
PROTECTED ACTIVITY PROTECTED ACTIVITY; REASONABLE BELIEF STANDARD
Reasonable belief element
In Day v. Staples, Inc. , No. 08-1689 (1st Cir. Feb. 9, 2009) (case below 2006-SOX-34), the First Circuit addressed the "reasonable belief" element of protected activity under the SOX whistleblower provision. The court indicated that the DOL regulations and caselaw had established a common understanding, with which it agreed, that the term that the term "reasonable belief" has both a subjective and objective component.
Subjective component; relevance of plaintiff's particular background
The court stated that, "[a]s to the subjective component, the law is not meant to protect those whose complaints are not undertaken in subjective good faith." In this regard, the court agreed with the district court that a "plaintiff's particular educational background and sophistication [is] relevant to the subjective component. Subjective reasonableness requires that the employee 'actually believed the conduct complained of constituted a violation of pertinent law.' Welch , 536 F.3d at 277 n.4." In the instant case, there was no evidence that the Complainant did not make his complaints in subjective good faith. The court, therefore, focused on the objective component.
Objective component
a. Three categories of conduct; fraud as a common denominator
In regard to the objective component, the court began its analysis by noting that the SOX only protects the employee's provision of information about three broad categories of conduct: (1) a violation of specified federal criminal fraud statutes, 2) a violation of any rule or regulation of the SEC; and/or (3) a violation of any provision of federal law relating to fraud against shareholders. The court stated that the first and third categories involve "fraud," and that many of the second category claims will also involve fraud.
b. Employee's communication must relate specifically to one of these categories, but does not need to cite precise code violation nor show an actual violation
The court stated that "[t]he employee must show that his communications to the employer specifically related to one of the laws listed in § 1514A." The employee is not required to provide the employer with the citation to the precise code provision in question. The employee is not required to show that there was an actual violation of the provision involved." Slip op. at 25-26 (footnote and citations omitted).
c. Meaning of fraud in context of SOX; employee's communication must at least approximate claim of securities fraud
The court stated that "[t]he reasonableness of [a plaintiff's] belief for purposes of § 1514A must be measured against the basic elements of the laws specified in the statute. 'Fraud' itself has defined legal meanings and is not, in the context of SOX, a colloquial term. …The hallmarks of fraud are misrepresentation or deceit.' … Wire or mail fraud is 'broader than the common law definition [of fraud]' but also emphasizes the deceit requirement." Slip op. at 27 (citations omitted).
The court continued: "To have an objectively reasonable belief there has been shareholder fraud, the complaining employee's theory of such fraud must at least approximate the basic elements of a claim of securities fraud. 'Securities fraud' itself has additional relevant elements. The elements of a cause of action for securities fraud 'resembl[e] . . . common-law tort actions for deceit and misrepresentation.' … Those elements typically include a material misrepresentation or omission, scienter, loss, and a causal connection between the misrepresentation or omission and the loss. … Securities fraud under section 10(b) and Rule 10b-5 requires: " (1) a material misrepresentation or omission; (2) scienter; (3) connection with the purchase or sale of a security; (4) reliance; (5) economic loss; and (6) loss causation." The employee need not reference a specific statute, or prove actual harm, but he must have an objectively reasonable belief that the company intentionally misrepresented or omitted certain facts to investors, which were material and which risked loss." Slip op. at 27-28 (citations omitted).
d. Application of principles to facts of case sub judice
The court then applied these principles to the case before it. The Plaintiff had alleged that he reasonably believed that the Defendant had violated § 1514A through its manipulation of accounting data. The court, however, found that the complaint failed to meet the basic components of fraud or of securities fraud.
-- mere disagreement about corporate efficiency is not actionable
The court stated that "[a] disagreement with management about internal tracking systems which are not reported to shareholders is not actionable." In regard to complaints amounting to allegations that the company's practices did not maximize shareholder profits, the court found that the Plaintiff did not hold an objectively reasonable belief that shareholders have been or are likely to be defrauded. "A company may legitimately decide for a number of reasons that maximizing short-term profits through certain practices is not its goal, particularly if the practices lead to consumer unhappiness. Further, a company's management may legitimately decide that certain practices are more efficient than others. A complaint about corporate efficiency is also not within the intended protection of SOX." Slip op. at 28.
-- mere allegation of needless loss of revenue is not actionable
The Plaintiff had stated a belief that the Defendant's returns procedure constituted fraud on shareholders because it permitted overbilling. The court found this belief not to be objectively reasonable, noting that what the Plaintiff described as data manipulation was unrelated to the financial condition of the company and had not been reported to shareholders. Although the Plaintiff alleged that the procedure resulted in a needless loss of revenue to the detriment of shareholders, the court held that "[a] claim of 'needless loss of revenue' is not a claim of fraud." The mere possibility of overbilling by a delivery company was a far cry from fraud.
-- mere allegation of billing discrepancy is not actionable
Similarly, the Plaintiff had alleged that the Defendant knowingly refused to provide customers with monetary credits to which they were entitled. The court found that this allegation was "not even plausibly a situation of shareholder fraud." Slip op. at 29. The court wrote: "'[A] billing discrepancy, without more, does not equal fraud.' Platone v. U.S. Dep't of Labor, 548 F.3d 322, 327 (4th Cir. 2008). [The Plaintiff] may have made a complaint related to consumer protection, but he does not have an objectively reasonable belief there was shareholder fraud under § 1514A." Slip op. at 29-30.
-- mere allegation of violation of general accounting provisions is not actionable
The court took note that the Plaintiff had attempted to connect his allegations to violations of general accounting principles, and then to connect violations of accounting principles to shareholder fraud. But the court found that this theory was inadequate, the Plaintiff having failed to allege that the numbers he alleged were inaccurate (1) were reported to shareholders, (2) were inconsistent with generally accepted accounting principles ("GAAP"), or (3) constituted fraud.
The court stated that "[a] generalized allegation of inaccuracy in accounting is insufficient to establish a reasonable belief in a violation of GAAP, much less a reasonable belief in shareholder fraud" and that "' merely stating in conclusory fashion that a company's books are out of compliance with GAAP would not in itself demonstrate liability under section 10(b) or Rule 10b-5.'" Slip op. at 30-31 (citations omitted).
The court continued: "Even when a company's accounting method is in violation of GAAP, 'some techniques . . . might prove to be entirely legitimate, depending on the specific facts.' Claims that there has been accounting fraud thus require evidence beyond a belief in a mere accounting irregularity…." Slip op.at 31 (citations omitted).
e. Materiality of alleged inaccuracies to shareholders
The court also found that the Plaintiff's belief was objectively unreasonable because he had not shown that any inaccuracy was material to shareholders. The court wrote that the "materiality requirement means the complainant must believe there is a 'likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the total mix of information made available.' … Thus complaints about purely internal practices that are not financial in nature and are not reported to shareholders do not meet the materiality requirement for an objectively reasonable belief in shareholder fraud." Slip op. at 32 (citations omitted).
f. Company's explanations
Finally, the court stated that a "company's explanations given to the employee for the challenged practices are also relevant to the objective reasonableness of an employee's belief in shareholder fraud." Slip op. at 32. In the instant case, while the Plaintiff's complaints arguably may have initially reflected a reasonable concern, it ceased to be reasonable once the Defendant reiterated rationales for the procedure questioned by the Plaintiffs and assured the Plaintiff that no fraud was being committed.
WAIVER OF ARGUMENT OF VIOLATION OF SEC REGULATIONS WHERE BRIEF FAILS TO SPECIFY WHICH REGULATIONS WERE VIOLATED
Where the Plaintiff's brief made unspecified reference to SEC regulations in regard to the Plaintiff's claim of violations of accounting principles relevant to shareholder fraud, the court found that the argument had been waived. Day v. Staples, Inc. , No. 08-1689 (1st Cir. Feb. 9, 2009) (case below 2006-SOX-34).
PUBLIC POLICY EXCEPTION TO
EMPLOYMENT-AT-WILL DOCTRINE
UNDER STATE LAW
STATE LAW CLAIM FOR CONSTRUCTIVE DISCHARGE IN VIOLATION OF PUBLIC POLICY; SOX WHISTLEBLOWER PROCEDURE NOT SHOWN TO BE INADEQUATE TO PROMOTE PUBLIC POLICY
SOX PROCEEDINGS ARE NOT SECRET
In Nunnally v. XO Communications , No. 07-1323 (W.D.Wa. Jan. 15, 2009), the Plaintiff sued her former employer claiming constructive discharge in violation of public policy under Washington state law. The Defendant argued that, because the Plaintiff could have pursued the claim under SOX, she could not meet the "jeopardy" element of the state public policy law. The court noted that the Plaintiff had filed a SOX complaint alleging many of the same acts that formed the basis of the state complaint, that OSHA had investigated and denied the complaint, and that an appeal had not been taken of this determination. The court found that the Plaintiff failed to take full advantage of the SOX protections, and was not entitled to a second bite at the apple. The court was not persuaded by the Plaintiff's argument that the state law claim sought damages not available under SOX; this did not explain why the available administrative procedure was inadequate for promoting the policy of supporting whistleblowing on the subject of financial improprieties or dishonesty by publicly traded companies. Neither was the court persuaded by the Plaintiff's other arguments as to why the SOX procedure was inadequate to promote the public policy, and specifically rejected the Plaintiff's claim that SOX proceedings are secret: "Proceedings initiated pursuant to the whistle-blower provisions of Sarbanes-Oxley are not secret. … Ms. Nunnally has not cited to any statute or regulation that indicates that proceedings before the administrative law judge or the Ninth Circuit would be kept secret." Slip op. at 21.
STATE LAW CLAIM FOR WRONGFUL DISCHARGE IN VIOLATION OF PUBLIC POLICY; SOX WAS CREATED AS COMPREHENSIVE LEGISLATION TO FILL IN GAPS IN STATE LAWS AND DOES NOT CREATE A NEW COMMON LAW CAUSE OF ACTION UNDER STATE LAW
In Day v. Staples, Inc. , No. 08-1689 (1st Cir. Feb. 9, 2009) (case below 2006-SOX-34), the Plaintiff argued that the Defendant's alleged violation of the SOX whistleblower provision provided him with a basis for a wrongful discharge claim under the public policy exception to the Massachusetts's employment-at-will doctrine. The First Circuit, however, rejected this argument, stating: "In passing SOX, Congress aimed to create comprehensive legislation to fill the gaps in a patchwork of state laws governing corporate fraud and protections for whistleblowers. It would be entirely inappropriate for plaintiff to be able to use a federal statute designed to address the inadequacies of state law to create a new common law cause of action under Massachusetts law." Slip op. at 37.