Thursday, October 13, 2011

Company’s Breach of Employee’s Confidentiality with regard to Complaint Filed with Its Audit committee Was Adverse Action under Sarbanes-Oxley

A DOL administrative law judge erred in concluding that a company’s breach of an accounting director’s confidentiality with regard to his complaint filed with the company’s audit committee was not an adverse action under Sarbanes-Oxley whistleblower protection provisions, ruled the DOL Administrative Review Board in Menendez v. Halliburton, Inc., September 13, 2011, Nos. 09-002 and 09-003. The Board affirmed the ALJ’s determinations that the director engaged in protected activity when he filed complaints with the SEC and the company’s audit committee, and that the company did not constructively discharge him.

Accounting concerns. The employee worked as an accounting director supporting the company’s Finance and Accounting (F&A) organization. After becoming concerned with accounting practices that he believed were not in compliance with accounting standards relating to revenue recognition, the employee contacted his supervisors, including the company’s Chief Accounting Officer (CAO). His supervisors disagreed with his assessments, and eventually the company’s VP of Financial Controls advised him to take his concerns to the audit committee. The following month, the employee contacted the SEC by email and reported that the company, with the knowledge of the external auditor, was engaging in questionable accounting practices with respect to revenue recognition. His SEC complaint was filed confidentially.

Three months later, the employee learned that the SEC had contacted the company. After ascertaining his right to whistleblower confidentiality, he sent an email communication to the audit committee stating that the company was in violation of GAAP with respect to revenue recognition and joint venture accounting practices. His complaint to the audit committee raised essentially the same issues and concerns that he had brought to the SEC’s attention and both complaints implicated the CAO and the outside auditor. Although the director provided his name and contact information in the email to the audit committee, he fully expected that his identity would be kept confidential, just as it had been with the SEC.

Confidentiality breach. Upon receipt of the employee’s email complaint, the company’s assistant general counsel forwarded it to the audit committee and, despite the company’s stated policy assuring confidentiality, the assistant general counsel also forwarded copies of the complaint to the general counsel and CFO. In turn, the CFO forwarded the complaint to the CAO, the vice president for investor relations, and someone with the external auditor.

A few days later, the SEC notified the general counsel that it was opening an investigation and directed the company to suspend its normal document retention policy and retain all documents and information related to variable interest entities and revenue recognition transactions. The same day, in a follow-up to the SEC notice, the general counsel issued a document retention email instructing that specified documentation and information be preserved and retained. The general counsel prefaced this email by identifying the employee in stating that, “the SEC has opened an inquiry into the allegations of [the director],” and this was sent to a number of company management officials, including the CFO and the CAO. The same day, the CAO forwarded that email to 15 members of the F&A group, including the employee.

It was undisputed that the company was unaware of the employee’s complaint to the SEC prior to the general counsel’s email connecting him to the SEC investigation. The employee testified that he did not inform anyone of his complaint to the SEC, and no one testifying on the company’s behalf stated that they knew of the employee’s SEC complaint, prior to the general counsel’s announcement. Further, the employee’s testimony that the SEC assured him, subsequent to the general counsel’s email, that it did not reveal his name in connection with its inquiry to the company was uncontroverted.

Immediately following the distribution by the CAO of the general counsel’s email, the employee left the office and stayed out for the remainder of the week on prescheduled leave. When he returned to the office the following week, he received no phone calls, few emails, and his coworkers generally avoided him. The outside auditors, with whom the employee normally worked closely, also refused to interact with him. A few weeks later, the employee’s legal counsel requested that the company grant him paid administrative leave, “given the current environment and circumstances involving the SEC investigation.” The leave request was approved and the employee was granted up to six months of paid leave on the condition that he “fully cooperate with the SEC and with the company in the investigation into his allegations.

Prior to the expiration of the employee’s leave of absence, both the SEC and the audit committee investigation were concluded. The SEC formally notified the company that no enforcement action was being recommended, and the audit committee’s investigation likewise concluded with no changes in the company’s accounting practices. The company informed the employee in a September 19, 2006, letter that he must return to work by October 2, 2006. He was to return to the same position that he left; the only change was that his position would report to the director of external reporting for the F&A group, whom the CAO had promoted while the employee was on leave.

The company extended the return date to October 18, but on October 17, the employee resigned. In his resignation letter, the employee stated that he thought that the company had demoted him by requiring him to report to the external reporting director. He also stated that he believed that “Halliburton intends to persist in violating securities laws and filing inaccurate and misleading financial information. Professionally and ethically, I can not return to active employment under these conditions.” He had taken a job as a consultant to a law firm, during his leave of absence.

Also during his leave of absence, the employee filed a complaint with the Labor Department alleging that the company violated Section 806 of Sarbanes-Oxley by retaliating against him after he alerted the SEC and the audit committee to concerns about GAAP violations with respect to revenue recognition and joint venture accounting practices. After a three-day hearing in September 2007, a DOL ALJ dismissed the case, finding that, although the employee engaged in protected activity, he failed to prove that the company subjected him to retaliatory adverse action.

Protected activity. The ARB ruled that the ALJ correctly found that the employee engaged in protected activity. It was undisputed that he provided information to the SEC, the audit committee, and his supervisors claiming that the company was not in compliance with accounting standards relating to revenue recognition. Also, there was no dispute that the employee participated in the SEC investigation of his complaint.

Nevertheless, the company asserted that the employee’s actions were not protected because his concerns were not objectively reasonable. The ARB cited the ALJ’s observation that the weight of the testimony established that the accounting issues in question were not simple and required judgment and thoughtful analysis and that company witnesses admitted the issues the employee raised were those on which reasonable minds may differ. Thus, the ALJ found that it was possible for the employee to have reasonably believed he had discovered accounting practices that were contrary to relevant standards and, therefore, in violation of SEC rules and the ARB deferred to the ALJ’s factual findings under the substantial evidence standard.

Rejecting the company’s assertion that the ALJ should have considered the materiality of the issues the employee raised, the ARB pointed out that Sec. 806’s plain language contains no materiality requirement for whistleblower complaints. Even if a materiality threshold existed, there was no question that it was met because the actions of management, the SEC, and the audit committee demonstrated that they took the complaint seriously. Had these complaints been immaterial or unreasonable, reasoned the ARB, they would not have warranted one external and two internal investigations.

And the fact that the SEC ultimately approved the accounting methods did not undermine the reasonableness of the employee’s concerns.
Adverse action. The ARB affirmed the ALJ’s determination that the employee’s allegations of isolation, removal of job duties, demotion, and constructive discharge did not independently constitute adverse actions. However, the ARB found that the ALJ erred in concluding that the company’s breach of the employee’s confidentiality with regard to his complaint filed with the audit committee was not adverse action.

At the outset, the ALJ erred in ruling that Title VII’s definition of adverse action likewise applied to SOX whistleblower claims, the ARB ruled. The plain language of Sec. 806’s adverse action provision controls, the ARB explained. Sec. 806 contains very different language than the comparable Title VII provisions and a correspondingly different construction is required. Under Sec. 806, the language “in the terms and conditions of employment” does not limit the provision’s intended protection to economic or employment-related actions.

Ruling that the confidentiality breach did not constitute an adverse action, the ALJ found that the company did no more than identify the employee as having made allegations against the company “to a group of people who would have known it was him anyway,” and thus, this action had “no practical impact” and, therefore, failed to constitute an adverse action under Sarbanes-Oxley. However, once the employee’s confidentiality was breached, evidence that he may have been identified some other way was not only purely speculative, but also was immaterial to an analysis of adverse action. Under Sec. 806, the employee needed only to demonstrate that such activity would deter a reasonable person from engaging in protected activity.

But the ARB noted that the employee also asserted that this action breached his right to confidentiality, in violation of Section. 301, which requires audit committees to develop procedures to handle anonymous complaints from employees. Construing Sec. 301’s requirement that employers establish confidential channels of communication for their employees to afford consistency with Section 806’s anti-retaliation provisions, the ARB held that Sec. 806 provides whistleblower protection to employees who make use of such channels. Accordingly, the ARB agreed with the employee that the right to confidentiality Sec. 301 affords effectively establishes a “term and condition” of employment within the meaning of Sec. 806’s whistleblower protection provision, and that the exposure of his identity in connection with his complaint to the audit committee constituted a violation of that employment term and condition.

Constructive discharge. The ARB affirmed the ALJ’s finding that the employee was not constructively discharged because it was supported by substantial evidence that he resigned because he did not approve of the company’s accounting practices
Remand instructions. Accordingly, the ARB remanded the case for a determination of whether the employee’s protected activity, including his internal allegations and those to the SEC and the audit committee, contributed to the breach of the confidentiality to which his complaint to the audit committee was entitled and whether, if it did, it could prove by clear and convincing evidence that there existed legitimate business reasons dictating the disclosure of the employee’s identity.

If the ALJ determines that the company cannot sustain this burden, the ALJ will then have occasion to fashion relief appropriate in light of the ruling that the fallout from the exposure of the employee’s identity, personal and professional isolation as well as loss of professional opportunities and advancement, should serve as a measure of damages.

This post was contributed by my colleague Cynthia Hackerott and first appeared in CCH Employment Law Daily.

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