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First Circuit Narrows Whistleblower Protections Of Sarbanes-Oxley – Discrimination, Disability & Sexual Harassment



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On July 13, 2022, the United States Court of Appeals for the
First Circuit ruled that the whistleblower protections contained in
Section 806 of the Sarbanes-Oxley Act (SOX) do not apply to
employees who report potential violations of the Foreign Corrupt
Practices Act (FCPA). The ruling in Baker v. Smith &
Wesson, Inc.
, 40 F.4th 43 (1st Cir. 2022) is the second recent
decision narrowing the important whistleblower protections of the
Act, coming on the heels of a recent Award in the 9th Circuit.
While these decisions are significant and will likely generate
further litigation as whistleblowers seek to avoid the impact, the
practical effects for future whistleblower cases are likely to be
limited as there may be workarounds. Regardless, we would not
expect any change in the need for companies to maintain robust
compliance programs that incentivize internal reporting by
employees.

SOX Whistleblower Protections

Whistleblower protections are central to the suite of SOX
oversight reforms, encouraging and protecting individual reports of
potentially fraudulent conduct. SOX contains a number of
whistleblower protections. For example, Section 301 of the Act sets
out requirements for internal procedures employers must use to
receive and process whistleblower complaints regarding accounting
or auditing matters. Section 1107 criminalizes any retaliatory
actions where a whistleblower has provided “truthful
information” concerning the commission of a Federal offense to
a law enforcement officer.

The most commonly invoked whistleblower protections in SOX are
those in Section 806, which protects whistleblowers who report
certain kinds of fraudulent activity internally from retaliation by
their employer. Section 806, codified as 18 U.S.C. § 1514A,
grants whistleblowers, under certain conditions, a civil cause of
action to recover compensatory and other damages resulting from
retaliation. Section 806 provides these protections as long as the
reported activity falls within one of three statutory categories:
the report must (1) concern a rule or regulation of the U.S.
Securities & Exchange Commission (SEC); (2) concern a violation
of mail fraud, wire fraud, bank fraud, or securities fraud
statutes, or (3) concern a provision of Federal law relating to
fraud against shareholders. Such protections are intended to work
hand in hand with other provisions of SOX which require
organizations to build out internal procedures for compliance and
incentivize executive leadership to ensure that their firm is
acting within the bounds of the law. Whistleblowers are
particularly important in first detecting and reporting violations
of the FCPA, which frequently stem from the conduct of remote
subsidiary or affiliate entities or are carried out via schemes
that endeavor to avoid corporate reporting or accounting programs.
Section 806 has been understood as an important protection to
incentivize this internal reporting.

First and Ninth Circuits: Reporting FCPA Violations Not
Protected Under SOX

Recently, an appeal of large jury award in a civil action in the
Northern District of California limited the protections in Section
806 that apply to whistleblowers in the FCPA context. In Wadler
v. Bio-Rad Labs., Inc.
, 916 F.3d 1176 (9th Cir. 2019), Wadler,
Bio-Rad’s former general counsel, internally reported potential
violations of the FCPA, and was fired as a result. The jury
returned an $11 million award for Wadler based on instructions that
identified the FCPA was a “rule or regulation of the SEC”
for purposes of the whistleblower protections in Section 806.
Bio-Rad appealed the jury’s decision.

On appeal, the Ninth Circuit ruled that the jury instructions
were incorrect because the relevant text of Section 806
unambiguously limited whistleblower protections to
“administrative rules and regulations” of the SEC, not a
statute like the FCPA. The Ninth Circuit did not address whether
Section 806 protections could apply to the reporting of an FCPA
violation if the report (1) identified a violation of mail, wire,
bank or securities fraud statutes or (2) concerned a provision of
Federal law relating to fraud against shareholders. The Ninth
Circuit also rejected Wadler’s policy argument that the Section
806 whistleblower protections should be applied broadly based on
SOX’s remedial purpose of protecting employees, explaining that
the plain language of Section 806 did not require consideration of
such arguments. The Ninth Circuit ultimately upheld the
verdict—and the $11 million award–in Wadler’s favor
on independent state law grounds. Still, the decision questioned
whether Section 806’s whistleblower protections applied to
reporting of FCPA violations.

In Smith & Wesson, the First Circuit was squarely
faced with precisely the same question as the Wadler
Court—whether reports of potential FCPA violations are
protected as potential violations of a “rule or regulation of
the SEC.” The Court held that they do not. Plaintiff Baker
conceded that the FCPA is not one of the fraud statutes listed in
Section 806—i.e. mail, wire, bank, or securities
fraud—and is not a “provision of Federal law relating to
fraud against shareholders.” He argued only that the FCPA, is
a “rule or regulation of the Securities and Exchange
Commission.” The First Circuit agreed with the Ninth
Circuit’s decision in Wadler and held that the FCPA is
not such a rule or regulation of the SEC, and therefore, the
whistleblower protections of Section 806 do not apply. Like the
Ninth Circuit, the First Circuit concluded that the plain language
of Section 806 precludes any interpretation that would include the
FCPA and therefore, policy and legislative history arguments need
not be considered. As such, a whistleblower’s internal report
of potential FCPA violations does not receive the protections of
Section 806 of the Act.

Despite being the second Court of Appeals to narrow the scope of
Section 806, the First Circuit’s decision may have limited
impact on SOX whistleblower cases in the long run. First, other
reform legislation–including but not limited to
Dodd-Frank–has resulted in additional protections of, and
rewards for, employees who report on illegal conduct that is likely
to capture some whistleblowing that falls outside the
newly-narrowed ambit of SOX protections. Moreover, the two cases
described above shared an unusual feature in that the alleged FCPA
violations were characterized only as violations of a “rule or
regulation of the SEC.” With this avenue apparently
foreclosed, plaintiffs will likely be able to re-cast the FCPA
violations as also violations of mail, wire, bank, or
securities fraud, or will point to internal controls lapses leading
to the violations as a “fraud against
shareholders”—requiring only a minor recharacterization
of the allegations to permit them fall within the scope of the Act.
With no indication that the Department of Justice and the SEC will
be slowing FCPA enforcement in the near term, companies should
tread cautiously in considering any changes to compliance programs
in response to these decisions. As part of any evaluation of a
company’s compliance culture, DOJ and the SEC will continue to
expect companies to encourage reporting and not to retaliate.
Effective internal reporting – which in turn depends on
having viable channels by which reports are made, and on
individuals willing to make such reports – remains a
fundamental component of any compliance program, as it is an
essential prerequisite to a company being in a position to
investigate and remediate potential violations and thereby avoid or
mitigate potential penalties.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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