News & Information

EMPLOYMENT LAW — 7/4/06

Decision clarifies SOX whistleblower liability, protected activity standards

A vice president's report of discrepancies in inventory balances that he believed could affect the accuracy of company financial statements could be protected activity under the whistleblower protection provisions of the Sarbanes-Oxley Act of 2002 (SOX). The subject matter of the report was encompassed by SOX and it was "certainly possible" that he could have believed that the problems amounted to a violation of Securities and Exchange Commission rules and regulations, held the Administrative Review Board of the Department of Labor (ARB). Reversing an administrative law judge's (ALJ) dismissal of the employee's SOX complaint, the ARB remanded the case to the ALJ for further proceedings. In addition to providing guidance on what constitutes protected activity, the decision also discusses the proper analysis for determining the liability of a private subsidiary of a publicly-owned parent company. (Klopfenstein v PCC Flow Techs Holdings, Inc, DOL ARB, Dkt No 04-149, May 31, 2006)

Background. Keith Klopfenstein was Vice President of Strategic Operations for Flow Products, Inc. (Flow), a division of a limited partnership owned by subsidiaries of a subsidiary (Holdings) of Precision Cast Parts Corp (PCC), a publicly-owned company. In November 2002, Klopfenstein became aware of a discrepancy in inventory balances that he believed would cause a material overstatement of Flow's assets if uncorrected and would also materially affect Flow's income for a period when corrected. He instructed a subordinate to investigate the discrepancy who then reported it to the finance department. When the discrepancy continued, Klopfenstein began noting it on inventory reports prepared for weekly managers' meetings.

During the investigation of the inventory imbalances, the investigator became aware of possible violations of the company's revenue recognition policy implicating Klopfenstein. Klopfenstein was terminated in April 2003 after a separate investigation concluded that he was responsible for changing shipping procedures, which allowed revenue to be prematurely recognized. He filed a complaint with OSHA alleging that his termination in retaliation for reporting the inventory imbalances violated SOX. The complaint named Holdings and Allen Parrott, Flow's Vice President of Finance. OSHA concluded that the complaint lacked merit.

ALJ decision. After a hearing, the ALJ first ruled that neither Holdings nor Parrott was covered by SOX whistleblower provisions. Holdings was not an agent of PCC, the ALJ reasoned, because it shared officers with PCC and because PCC, not Holdings, was largely responsible for Klopfenstein's termination. The ALJ also held that Klopfenstein "failed to establish a case for retaliation under the Act." The ALJ made no findings regarding whether Klopfenstein engaged in protected activity or whether any of the individuals involved in his termination had knowledge of any protected activity (Klopfenstein v PCC Flow Techs Holdings, Inc, DOL ALJ, Dkt No 04-SOX-11, July 7, 2004).

SOX coverage. Common law agency principles should be applied to determine whether a non-public subsidiary of a publicly-traded company is covered by SOX whistleblower protection provisions, the ARB held. The ARB faulted the ALJ for concluding that neither Holdings nor Parrott was covered by SOX whistleblower provisions, without making the factual findings required to determine whether Holdings and/or Parrott acted as PCC's agent in terminating Klopfenstein.

As interpreted by the ARB, SOX does not require a complainant "to name a corporate respondent that is itself 'registered under §12 or . . . required to file reports under §15(d),' so long as the complainant names at least one respondent who is covered [under SOX] as an 'officer, employee, contractor, subcontractor, or agent' of such company," the ARB observed. The ARB found nothing in the Act, the regulations or the common meaning of the term "agent" to prevent a subsidiary or an employee of a subsidiary from ever being a parent's agent for purposes of the SOX whistleblower provisions.

The individual responsible for terminating Klopfenstein was both President of Holdings and Executive Vice President of PCC, the ARB noted. Contrary to the ALJ's reasoning, the ARB observed that overlapping officers between PCC and Holdings and the involvement of PCC officers and employees in overseeing and approving Holdings' investigation, "make more probable that Holdings was PCC's agent." Although Parrott did not work for either Holdings or PCC, he was asked by Holdings to investigate the revenue recognition violations and was directed by Holdings' CFO in consultation with the PCC CFO. Therefore, according to the ARB, it was "quite possible" that Parrott was acting as PCC's agent in investigating Klopfenstein, whether or not he was PCC's agent for other purposes.

Protected activity. With respect to determining whether Klopfenstein engaged in protected activity, the ARB observed that the complainant need not be the first to raise an issue for his conduct to be protected. Nor must the complainant believe he is reporting fraud. Nor does the communication have to relate to published information. "A complainant need not express a concern in every possible way or at every possible time in order to receive protection, so long as the complainant's actual communications 'provide information, cause information to be provided, or otherwise assist in an investigation' regarding a covered violation," said the ARB. The ARB directed the ALJ to determine whether Klopfenstein's belief that his concerns related to a violation covered by SOX was reasonable and whether his actions sufficed to "express" his concern and constitute the "provision" of "information."

Causation. The ARB also faulted the ALJ for requiring Klopfenstein to prove more than what SOX requires to prove causation. The correct standard is whether the protected activity was a contributing factor--any factor, which alone or in combination with other factors tends to affect in any way the outcome of the decision--in Klopfenstein's termination. The complainant does not have to prove pretext. In addition, should the ALJ analyze temporal proximity on remand, the ARB directed him to consider the time gap between Klopfenstein's termination and any protected activity in which Klopfenstein may have engaged.

For more information on this and other topics, consult CCH Employment Practices Guide or CCH Labor Relations.

Visit our News Library to read more news stories.