Law Considerations Raised by Post-Enron,
“With the sole exception of the war on terrorism, no issue dominates current thought more than the corporate and accountancy ethical scandals which have rocked our country.” McGarrity v. Berlin Metals, Inc., Court of Appeals of Indiana, Case No. 45D05-9812-CT-2564 (Aug. 6, 2002) (reversing summary judgment on former CFO’s claim for wrongful termination in violation of public policy based on allegation that company fired him for refusing to falsify financial and tax records).
The Enron-driven Sarbanes-Oxley Act of 2002 (the “Act”) made sweeping reforms to corporate governance law. Understandably, most publicly held corporations are still attempting to understand the complex new financial reporting, disclosure obligations, and securities and accounting reforms. But there’s more: The Act also contains many employment-related provisions that have potentially far-reaching consequences. This update summarizes the most significant employment law changes.
PROTECTIONS FOR EMPLOYEES
The Act creates federal protection for “whistleblowers.” It provides whistleblower protection to employees of public companies when they act lawfully to disclose information about fraudulent activities within their company.
The Act specifically protects employees when they take lawful acts to disclose information or otherwise assist criminal investigators, federal regulators, Congress, supervisors (or other proper people within a corporation), or parties in a judicial proceeding in detecting and stopping fraud. All that the Act requires is that the employee reasonably believe that a violation of federal securities law, the rules of the SEC, or “any provision of Federal law relating to fraud against shareholders” has occurred or is occurring. The Act protects employees who complain to any person at the company with the authority to “investigate, discover or terminate misconduct,” which likely includes all corporate counsel and human resources professionals. The whistleblowing protections of the Act apply not only to publicly traded companies, but also to their officers, employees, contractors, subcontractors and agents. This statutory language would appear to allow individual liability of officers and employees. If the employer takes illegal action in retaliation for lawful and protected conduct, the Act allows the employee to file a complaint with the Department of Labor (“DOL”).
The “whistleblower” employee must file a complaint with the DOL within 90 days of the alleged retaliation. The whistleblower’s initial burden of proof is to show that the protected activity (i.e., complaint relating to fraud against the shareholders) was “a contributing factor” in the adverse employment decision. By contrast, the employer must prove “by clear and convincing evidence” that it would have taken the same adverse employment action even in the absence of the whistleblower’s protected activity. If the DOL decides to hold a hearing, it must do so expeditiously and must issue a final order within 120 days of the hearing. The employee can bring the matter to federal district court only if the DOL does not resolve the matter within 180 days (and there is no showing that such delay is due to the bad faith of the claimant) as a normal case in law or equity, with no amount in controversy requirement. The Act provides for reinstatement of the whistleblower, back pay with interest, and compensatory damages to make the whistleblower whole, including reasonable attorneys’ fees and costs, as remedies if the whistleblower prevails. The Act does not provide for either punitive damages or a jury trial. Judicial review is only available through an appeal to the Court of Appeals, but such appeal does not automatically stay the DOL’s order. See Senate Report No. 107-146.
Importantly, the Act does not preempt or supplant existing state law or collective bargaining agreement protections for whistleblowers, including tort actions for wrongful termination in violation of public policy (for which emotional distress and punitive damages against the employer are available).
Senator Patrick Leahy offered this amendment to the Act, from the Corporate and Criminal Fraud Accountability Act of 2002 (S. 2010).
In Section 1107, the Act provides that whoever knowingly, with the intent to retaliate, takes any action harmful to any person, including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any federal offense, will be subject to up to 10 years in prison. See Act §§ 806 & 1107 at ¶¶ 1056 & 1073. This new provision arguably subjects any individual involved in an adverse employment action related to any of the broad range of federal crimes to potential criminal liability.
C. Reporting Procedures for Employees
The Act requires public companies, through their audit committees, to provide procedures for the confidential, anonymous submission of employees’ concerns about accounting or auditing matters. Employers might be able to utilize existing “hotlines” for this purpose, but the final decision rests with the audit committee, in which the Act vests significant responsibility and independence.
NEW AND INCREASED INDIVIDUAL PENALTIES
Obstruction of Justice/Document “Shredding”
The Act strengthens an existing federal offense that federal prosecutors often use to prosecute document shredding and other forms of obstruction of justice. Section 1510 of Title 18 of the United States Code currently prohibits individuals from persuading others to engage in “obstructive conduct.” However, it does not prohibit an act of destruction committed by a defendant acting alone. While other existing obstruction of justice statutes cover acts of destruction committed by an individual acting alone, courts have interpreted such statutes as applying only where there is a pending proceeding, and a subpoena issued for the destroyed evidence.
This amendment closes this loophole by broadening the scope of Section 1512. The Act permits the government to prosecute an individual who acts alone in destroying evidence, even where the destruction of evidence occurs prior to the issuance of a grand jury subpoena. A person who acts with the intent to obstruct an investigation should be criminally liable even if he or she acts alone in destroying or altering documents. This amendment will ensure that individuals acting alone would be liable for such criminal acts. See Remarks of Senator Orrin Hatch, Cong. Rec. July 10, 2002, p. 6550. See Act § 1102 at ¶ 1068. Such conduct is punishable by fine and/or 20 years imprisonment.
The Act also prohibits not only the destruction or alteration of documents, but also the falsification of documents or making any false entry. This prohibition applies to any document relevant to the “investigation of any matter within the jurisdiction of any department or agency of the United States or any bankruptcy case, or in relation or contemplation of any such matter or case.” Again, the punishment is a fine and/or 20 years imprisonment.
Given this broad statutory language, the obstruction of justice provisions of the Act arguably apply to wage-hour audits/investigations, EEOC administrative charges, and workplace investigations of fraud and financial whistleblowing.
Mail and Wire Fraud
The Act increases the maximum prison term for mail and wire fraud offenses, from 5 years to 20 years. Because prosecutors frequently use the mail and wire statutes to charge acts of corporate misconduct, Congress believed it was important to ensure that the penalties that apply to such offenses are sufficiently severe to deter and punish corporate wrongdoers. See Remarks of Senator Orrin Hatch, Cong. Rec., July 10, 2002, p. S6550. See Act § 903 at ¶ 1061.
Exchange Act Penalties
The Act amends Exchange Act Section 32(a) to increase the criminal penalties for those who file false statements with the SEC to a maximum penalty of $5 million and 20 years in prison. This is up from $1 million and ten years in prison. If a corporation files a false statement, those fines can increase up to a maximum of $25 million. Under prior law, the maximum corporate fine was $2,500,000. See Act Section 1106 at ¶ 1072.
Attorney Professional Responsibility
Under an amendment offered by Senator John Edwards, the Act requires that attorneys notify company directors of management misconduct that top officers refuse to rectify. It would require the SEC to issue rules of professional conduct for lawyers. A lawyer who learned of a legal violation by a corporation would have to report that violation to corporate senior officers. If managers failed to correct a legal problem, lawyers then would have to inform the company board of directors.
More specifically, the SEC must adopt rules establishing minimum standards of professional conduct for attorneys appearing and practicing before the Commission in any way in the representation of public companies. This includes a rule 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 one of its agents to the chief legal counsel or the chief executive officer of the company. 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), the attorney must report the evidence to the board’s audit committee or to another board committee comprised solely of directors not employed directly or indirectly by the company, or to the board of directors. The SEC must adopt the minimum attorney professional conduct rules within 180 days of enactment, i.e., by January 30, 2003.
As explained by Senator Edwards, the SEC must establish rules to protect investors from unprofessional conduct by lawyers, including conduct that violates the legal standards of the profession. The SEC must make one rule in particular, with two parts. First, a lawyer with evidence of a material violation of the law must report that evidence either to the chief legal counsel or the chief executive officer of the company. Second, if the person to whom that lawyer reports the suspected violation does not respond appropriately by remedying the violation, or by taking other appropriate action to investigate and remedy the suspected violation, that lawyer has an obligation to report the alleged violation to the audit committee or to the board.
In addition, the duty to report applies only to evidence of a material violation of the law. There is no duty to report “small” or immaterial violations. Materiality depends on what a reasonable investor would want to know. Also, when the evidence is reported within the company, the Act does not specify how a CEO or a General Counsel should act to rectify the violation. That is because the appropriate response to cure the problem will vary dramatically, depending on the circumstances. If the CEO can conduct a short investigation, for example, and determine that no violation has occurred or is occurring, then the obligation stops there. But if there is a serious violation of the law, the CEO has to act promptly to remedy the violation. If he or she does not, the lawyer must go to the board. Finally, Senator Edwards assured that nothing in the Act gives any person a right to file a private lawsuit against any person or entity. Only the SEC can enforce the amendment. See Remarks of Senator John Edwards, Cong. Rec., July 10, 2002, p. 6552. See Act § 307 at ¶ 1027.
The Act directs the U.S. Sentencing Commission to review the sentencing guidelines that apply to acts of corporate misconduct and to enhance the prison time that would apply to criminal frauds committed by corporate officers and directors. Congress enacted this enhancement because corporate leaders who hold high offices and breach their duties of trust should face stiff penalties. See Remarks of Senator Orrin Hatch, Cong. Rec., July 10, 2002, p. 6550. See Act § 1104 at ¶ 1070.
EMPLOYMENT BENEFITS REGULATION
Loans to Officers and Directors
Section 402 prohibits loans by a public company to any of its directors or executive officers. Originally, the Sarbanes bill would have mandated the disclosure of loans made by the company to its executive officers and directors. The Senate, however, adopted an amendment offered by Senator Charles Schumer that makes it unlawful for any public company to make loans to its executive officers and directors. Congress designed the loan prohibition to sharply limit the types of hidden compensation that can be offered to executives without being fully disclosed to shareholders. See Remarks of Senator Diane Feinstein, Cong. Rec., July 15, 2002, p. S6762.
The Act ensures that the prohibition on loans to corporate executives will not apply retroactively to loans currently outstanding. Also, neither credit and charge cards issued by businesses to their employees nor margin loans for personal securities brokerage accounts held by employees of a brokerage firm will be subject to the loan prohibition. The latter was needed because the NYSE requires employees of securities firms to maintain margin loan accounts only with their own firm.
The Act's exception for "home improvement" loans is very narrow; it only applies to loans "made or provided in the ordinary course of the consumer credit business of such issuer." Securities Exchange Act, Sec. 13(k)(2)(A). In other words, it only applies where the "issuer" is in the business of providing such loans, e.g., banks, and then only if made "on market terms, or terms that are no more favorable than those offered by the issuer to the general public for such extensions of credit." Id. at subsection (C). The Act does not appear to prohibit a public corporation from acquiring a home as an asset, and then allowing executives or directors to use it, so long as the executive or director has no equity interest in the home. However, the corporation would then have to disclose such home use by its executives or directors to its shareholders.
Finally, loans by financial institutions to their employees that are already subject to regulation by the Federal Reserve are exempted. See Act § 402 at ¶ 1030.
ERISA Penalties and Notice Obligations
Under the Employment Retirement Income Security Act of 1974 (“ERISA”), a violation for squandering a plan participant’s pension, even in the billions of dollars, is a misdemeanor with a maximum penalty of one year. The Act increases the penalty for criminal violation of ERISA to 1 to 10 years, based on the value of what is stolen from an ERISA plan. If the loss in ERISA is a $20,000 pension versus several billion dollars’ worth, the Sentencing Commission can make that judgment, as it does now, to have the penalty be from one but up to 10 years. The Act also increases monetary penalties. See Remarks of Senator Joseph Biden, Cong. Rec., July 10, 2002, p. S6546. See Act § 904 at ¶ 1062.
The Act also requires 30 days advance notice of “blackout” periods that would affect at least one-half of a public company’s plan participants for more than three consecutive business days, which was designed to remedy the situation in which Enron pension plan participants were not allowed to sell company stock in their plans even as the value of their assets dropped dramatically.
Congress passed the Sarbanes-Oxley Act of 2002 hurriedly, and some of the statutory language reflects this fact. In light of the current political climate, employers should understand the new whistleblower protections, increased criminal and other penalties, and employment benefits changes, and act accordingly. The SEC, the courts and regulators will have to sort out some of the broad and/or ambiguous language in the Act, including the provisions affecting the employment relationship discussed in this Article.