Trending publication

In a recent 2-1 decision, a federal appeals court sitting in Boston held that the term “employee” in the Sarbanes-Oxley Act’s whistleblower provision does not cover employees of private companies that manage public mutual funds. Instead, the term applies only to employees of public companies as defined in the statute, and not to employees of contractors or subcontractors of such public companies. The ruling, announced in Lawson v. FMR, marked the first time this issue was decided by a federal appeals court.

In 2002, Congress enacted Sarbanes-Oxley, aimed at preventing financial fraud, in response to accounting problems that led to the Enron and WorldCom scandals. The Act’s whistleblower provision protects employees of public companies covered by Sarbanes-Oxley from retaliation in any manner for providing information, causing information to be provided, or assisting in an investigation into certain alleged misconduct at the company, including mail fraud, wire fraud, bank fraud, securities or commodities fraud, violations of Securities and Exchange Commission rules and regulations, or violations of federal law relating to fraud against shareholders. The appeals court’s recent decision significantly narrows the category of employees who are protected by this whistleblower provision.

The cases before the First Circuit involved two former Fidelity employees who claimed that their former employer unlawfully retaliated against them. One former employee, plaintiff Jackie Lawson, who worked at Fidelity from 1993 to 2007, alleged that after alerting her supervisors to concerns about accounting methods at a mutual fund managed by Fidelity, including the improper retention of millions of dollars in fees, Fidelity unlawfully retaliated against her by failing to promote her and threatening her with punishment. The other former employee, plaintiff Jonathan Zang, worked at Fidelity from 1998 to 2005, when he was terminated. He alleged that he lost his job in response to raising concerns in a widely-circulated email to his superiors about inaccuracies in a draft revised registration statement for certain Fidelity-managed funds.

In both instances, the former employees were employed by Fidelity, which has a contractual, investment advisory relationship with the mutual funds on which they blew the whistle. The mutual funds, which were not parties in either suit, are considered public companies, but Fidelity, the adviser to the funds, is not a public company.

After exhausting administrative remedies, both former employees sought review of their retaliation claims in federal court. In 2010, a federal district judge in Boston ruled that the Sarbanes-Oxley whistleblower provision applied because the mutual funds were public companies, and the whistleblower provision extended to employees of private agents, contractors, and subcontractors of public companies.

The First Circuit disagreed with the district judge’s interpretation of the meaning of the term “employee” in the Sarbanes-Oxley whistleblower provision. Instead, the court sided with Fidelity, which argued that the former employees worked for a private contractor, rather than a public company that Sarbanes-Oxley was intended to cover.

The precise question before the appeals court was:

“Does the whistleblower protection afforded by . . . the Sarbanes-Oxley Act apply to an employee of a contractor or subcontractor of a public company, when that employee reports activity which he or she reasonably believes may constitute a violation” of the kind covered by the whistleblower provision?

In her majority opinion, Chief Judge Sandra Lynch took a narrower view of the term “employee” than the lower court had, concluding that this was the better reading of the statutory language. The majority explained, “[i]f we are wrong and Congress intended the term ‘employee’ . . . to have a broader meaning than the one we have arrived at, it can amend the statute. We are bound by what Congress has written.” The majority also pointed out that Congress has in fact amended the Sarbanes-Oxley whistleblower provision. In 2010, the Dodd-Frank Act explicitly extended whistleblower coverage to employees of public companies’ subsidiaries, as well as employees of statistical rating organizations. The majority stated that “these later actions by Congress are entitled to some weight as an expression of Congress’s understanding of [the Sarbanes-Oxley whistleblower provision], which is consistent with our interpretation.”

One appeals court judge would have affirmed the lower court’s decision. In her dissenting opinion, Judge Ojetta Thompson criticized the majority for imposing “an unwarranted restriction on the intentionally broad language of the Sarbanes-Oxley Act,” and for ruling in a way that “bar[s] a significant class of potential securities-fraud whistleblowers from any legal protection.”

Both the Department of Labor and the Securities and Exchange Commission filed briefs in support of the former employees, but the appeals court stated, “We have considered the arguments in the amicus briefs of the DOL and the SEC, but we owe no deference to the positions stated there.” The U.S. Chamber of Commerce filed a brief supporting Fidelity’s argument.

The full text of the majority opinion and dissent can be read here.

***

This client advisory was prepared by Ian D. Roffman, a partner in the Securities Enforcement and Litigation practice group.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.