Monday, June 17, 2019

Violations of the SOX whistleblower provision are not shareholder fraud under SOX

By Rodney F. Tonkovic, J.D.

A Fourth Circuit panel has shot down claims that the refusal to sign a conflict of interest form was a protected activity under the SOX whistleblower provision. A Northrop Grumman employee complained that signing the company's conflict of interest form bound her to its arbitration policy, which, she maintained, was pre-suit arbitration in violation of SOX. The panel remanded and instructed the ALJ to enter judgment in favor of Northrop, concluding that an alleged violation of the pre-suit arbitration provision did not constitute information concerning fraud against shareholders and was thus not a protected activity (Northrop Grumman Systems Corp. v. United States Department of Labor, June 13, 2019, Quattlebaum, A.).

Squabble over arbitration policy. The case is rooted in a former Northrop Grumman System Corp.'s longstanding opposition to the company arbitration policy. Crisell Seguin filed a defamation suit against Northrop in 2007, asserting that her supervisor made false statements about her in a performance review. The Virginia state court granted Northrop's motion to compel arbitration pursuant to its arbitration policy, which covers employee claims related to their employment. Seguin appealed, maintaining throughout that she was not bound by the arbitration policy, and, ultimately, her writ of certiorari was denied by the Supreme Court in 2010.

After this litigation, Seguin continued to raise concerns about the arbitration policy, and related corporate policies and procedures. Among other concerns, she said that she had been exempted from the policy by senior Northrop executives and that this exemption rendered the company's SEC filings inaccurate. Seguin also refused to sign Northrop's Conflict of Interest form, which she claimed bound unwitting employees to the arbitration policy. This refusal led to her suspension in early 2011, but she was reinstated after signing the form. Seguin was terminated in May 2011 due to a reduction in force in her department.

Seguin then filed a complaint with OSHA, alleging that her termination violated SOX. In 2015, a Department of Labor administrative law judge found that Northrop's termination of Seguin violated the SOX whistleblower provision. Essentially, the judge concluded that Seguin's refusal to sign the Conflict of Interest form constituted protected activity. This was affirmed by the DOL Administrative Review Board in May 2017, which agreed that Northrop's requiring employees to sign the form "effectively secured an employee’s agreement to the company’s mandatory arbitration policy, which Seguin contended violated the SOX prohibition against pre-dispute arbitration agreements." Northrop then appealed to the Fourth Circuit.

Not protected. On appeal, Northrop argued that the ARB erred in holding that Seguin engaged in protected activity. The DOL argued in turn that Seguin reasonably believed that Northrop's arbitration policy violated §1514A(e) of the SOX whistleblower provision, which prohibits pre-suit arbitration of SOX claims. The DOL contended that §1514A(e) is a provision of "Federal law relating to fraud against shareholders," that is, one of the enumerated categories of protected activities under §1514A(a)(1).

The panel disagreed with the DOL's argument that violations of the SOX whistleblower provision itself constitute fraud against shareholders. That clause of §1514A(a)(1) is not a "broad, catchall provision," the court said, and none of Seguin's complaints involved any of the elements of fraud. Simply put, the court said, the DOL's interpretation was contrary to law—Seguin's complaint did not constitute shareholder fraud and was not afforded whistleblower protection under §1514A. To hold otherwise would ignore the parameters of the statute and improperly expand its scope, the court said.

Even if the court accepted the DOL's position, it concluded that Seguin's beliefs were not objectively reasonable. A reasonable person would not believe that the conflict of interest form incorporated Northrop's arbitration policy, the court said, because the form never even mentions that policy and because Seguin was explicitly told that the form had "nothing to do" with the arbitration policy. And, if the form did incorporate the arbitration policy, it would not be reasonable to believe that the policy violated §1514A(e). By its own terms, the policy, which does not apply to claims "as to which an agreement to arbitration . . . is prohibited by law," would not apply to SOX whistleblower claims.

Finally, the court concluded, no reasonable person in Seguin's position could believe that the alleged violation of §1514A(e) constituted shareholder fraud. None of Seguin's complaints showed an objectively reasonable belief that Northrop intentionally misrepresented or omitted material facts to investors. The court accordingly remanded the case to the ALJ with instructions to dismiss Seguin's administrative complaint and enter judgment in favor of Northrop.

The case is No. 17-1811.