Tuesday, July 19, 2022

Appeals court finds that FCPA is not an SEC rule for purposes of whistleblower protection

By John Filar Atwood

The First Circuit Court of Appeals reversed a lower court decision which denied a motion for summary judgment regarding a whistleblower retaliation claim by a former Smith & Wesson employee. The employee reported conduct that he believed violated the Foreign Corrupt Practices Act (FCPA) and sought whistleblower protection on the grounds that the FCPA is a rule or regulation of the SEC. The appeals court disagreed, holding that the text of Sarbanes-Oxley Act (SOX) Section 1514A is not a rule or regulation of the Commission (Baker v. Smith & Wesson, Inc., July 13, 2022, Lynch, S.).

SOX Section 1514A is the whistleblower protection provision, which limits protection to whistleblower claims about “a violation of section 1341, 1343, 1344, or 1348, any rule or regulation of the Securities and Exchange Commission, or any provision of Federal law relating to fraud against shareholders.” Earl Donald Baker, a former Smith & Wesson employee, sued the company asserting a claim under Section 1514A for whistleblower retaliation.

Baker conceded that his whistleblowing did not involve a violation of any enumerated statute or any provision of federal law relating to fraud against shareholders, and further conceded that his claim of purported wrongdoing was not based on an SEC rule or regulation. Instead, his argument was that the phrase “any rule or regulation of the Securities and Exchange Commission” also refers to statutes within the enforcement power of the SEC.

Termination of employment. Baker worked for Smith & Wesson starting in 2013 and in July 2014 was placed on administrative leave by the company. His employment was terminated in September 2014. Baker filed a complaint against the company asserting that it had retaliated against him for reporting illegal conduct by company employees.

Smith & Wesson moved for summary judgment on the Section 1514A claim, arguing that Baker could not satisfy his burden of showing that he engaged in protected activity under the statute. Baker contended that he engaged in protected activity because he reported conduct that he reasonably believed violated 15 U.S.C. Section 78m(b)(5), an FCPA provision addressing accounting practices and internal controls.

The district court denied Smith & Wesson’s motion for summary judgment, finding that “[a] reasonable jury, crediting [Baker]’s testimony, could conclude that [Baker] 'reasonably believed' that the behavior he reported violated securities rules concerning accounting practices and internal controls.”

Position reversal. The appeals court noted that on appeal Baker argued for the first time that his whistleblowing involved a “provision of Federal law relating to fraud against shareholders” and attempted to repudiate his previous concession to the district court. The appeals court rejected Baker’s reversal of his concession citing a prior ruling that a party cannot concede an issue in the district court and later, on appeal, attempt to repudiate that concession and resurrect the issue.

The only dispute on appeal was whether Baker satisfied his burden of showing the first requirement, that he engaged in a protected activity or conduct. To satisfy the “protected activity” requirement, an employee must show that he had both a subjective belief and an objectively reasonable belief that the conduct that he reported constituted a violation of one of the provisions listed in Section 1514A(a)(1).

Baker argued that he satisfied his burden of showing the “protected activity” requirement because he reported conduct that he reasonably believed violated Section 78m(b)(2), (5). The court noted that he conceded that Section 78m(b)(2), (5) is not one of the fraud statutes listed in Section 1514A(a)(1) and is not a “provision of Federal law relating to fraud against shareholders.” Baker argued only that the FCPA, including Section 78m(b)(2), (5), is a “rule or regulation of the Securities and Exchange Commission.”

Text is clear. The appeal court disagreed, stating that the plain text of Section 1514A(a)(1) makes clear that the FCPA is not a “rule or regulation of the Securities and Exchange Commission.” The court stated that based on the text of Section 1514A(a)(1), “any rule or regulation of the Securities and Exchange Commission” does not include federal statutes, such as the FCPA.

The court cited the Ninth Circuit’s ruling in Wadler v. Bio-Rad Laboratories, Inc. in which it stated that “Congress uses the phrase 'any rule or regulation of the [SEC]' in the same list in which it uses 'any provision of Federal law relating to fraud against shareholders,' which strongly suggests that there is a difference between the meaning of 'rule or regulation' and 'law.'” The First Circuit added that Baker’s interpretation of the phrase “rule or regulation” violates the usual rule against “ascribing to one word a meaning so broad” that it assumes the same meaning as another statutory term. The court also cited the Supreme Court’s ruling in Cuomo v. Clearing House Ass'n. that “'federal law' obviously means federal statutes” and not case law or agency rules and regulations.

The court also held that the inclusion of the qualifier “of the Securities and Exchange Commission” in the statute makes clear that the phrase “any rule or regulation” does not include federal statutes because the SEC does not have the authority to enact statutes.

The court further determined that the text of the statute does not support Baker’s argument that “of” should be defined here as “relating to.” In the court’s opinion, Baker’s strained reading contravenes the ordinary, contemporary, and common meaning of the word “of” read in the context of the surrounding text. Moreover, the court stated that Congress’s use of the words “relating to” in the very next clause—“any provision of Federal law relating to fraud against shareholders"—demonstrates that Congress did not intend for the word “of” to mean “relating to.”

Statutory scheme. Finally, the court held that the statutory structure reinforces its reading of Section 1514A(a)(1). The first clause in Section 1514A(a)(1)’s list enumerates four federal statutes explicitly named by Congress: Sections 1341, 1343, 1344, and 1348. The court noted that Congress specifically did not cite to Section 78m(b)(2), (5) in this first clause.

In addition, the court opined that if Baker were correct that “any rule or regulation of the Securities and Exchange Commission” includes federal statutes, then any federal law “relating to” shareholder fraud would necessarily be a “rule or regulation” relating to the SEC. Congress certainly did not intend for that result, the court stated.

The court concluded that the statutory language is unambiguous and the statutory scheme is coherent and consistent. Accordingly, it reversed and remanded with instructions to enter summary judgment in favor of Smith & Wesson.

The case is No. 21-2019.