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Despite several years of litigation, one essential question about the whistle-blower provision of the Sarbanes-Oxley Act remains unresolved: Does it cover employees of nonpublic subsidiaries of public companies? Although the vast majority of the administrative law judges who have ruled on the matter have adopted a standard that restricts coverage of nonpublic subsidiaries to limited situations, at least one ALJ has suggested that all employees of subsidiaries may be automatically covered. Because many publicly traded companies operate through subsidiaries, a broad interpretation of this whistle-blower provision would significantly expand the pool of potential plaintiffs, beyond the apparent intent of Congress. The resolution of this question will have a substantial effect on the reach of Sarbanes-Oxley. LAST-MINUTE ADDITION In 2002, after revelations of corporate corruption and subsequent bankruptcies, Congress enacted the Sarbanes-Oxley Act to protect the public from corporate mismanagement. An eleventh-hour addition to the statute, Section 806, added new protections for whistle-blowers at publicly traded companies. Section 806 prohibits publicly traded companies from retaliating against employees who complain or provide information about conduct they reasonably believe violates specified securities and anti-fraud laws. Section 806 created a new enforcement scheme and new substantive rights for covered employees. Those who believe they were retaliated against may file a complaint with the Labor Department within 90 days of the challenged employment action. The resolution of a Section 806 complaint involves a series of administrative and judicial determinations. An official at the Labor Department’s Occupational Safety and Health Administration initially investigates the complaint. Either party may file objections to the investigator’s findings and request a hearing before a Labor Department administrative law judge. The ALJ’s ruling is subject to discretionary review by the Labor Department’s Administrative Review Board. If the department has not issued a final ruling within 180 days of his complaint, the claimant may file suit in federal district court. The typical situation in cases involving private subsidiaries proceeds along these lines: An employee of the subsidiary — let’s call him Joe “Whistle” Blow — complains to a company hotline or a supervisor about alleged fraudulent financial reporting by the subsidiary. The subsidiary reports Joe’s complaint to the parent company or, perhaps, the parent has some involvement in the resulting investigation. Shortly thereafter, the subsidiary terminates Joe for reasons that, it says, are entirely unrelated to the whistle-blowing. Does Joe have the right to assert a SOX claim against the subsidiary or the parent under Section 806? Today the answer to that question would likely require a detailed analysis of the parent’s involvement in Joe’s employment and, potentially, the subsidiary’s operations. WHO IS COVERED? Section 806 applies, by its express text, to companies that (1) are required to file reports under Section 15(d) of the Securities and Exchange Act of 1934 and (2) have a class of securities registered under Section 12 of the 1934 act. Section 806 prohibits a covered company and “any officer, employee, contractor, subcontractor, or agent” of such a company from retaliating against “an employee.” In assessing the application of this provision to nonpublic subsidiaries of public companies, ALJs have focused on two issues: whether the publicly traded parent was named in the administrative complaint and, if the parent was named, whether the complainant can sustain a claim against the parent or its subsidiary for alleged violations of Section 806. Most ALJs have held that Sarbanes-Oxley does not protect employees of a nonpublic subsidiary if it is the only entity named in the administrative complaint. Among the relevant ALJ decisions are Grant v. Dominion East Ohio Gas (2005) and Powers v. Pinnacle Airlines Inc. (2003). As the Grant judge explained, “The plain language of the statute provides no cause of action against a non-public subsidiary standing alone. “ When the publicly traded parent is named in the complaint, ALJs have generally recognized that a complainant cannot pursue a whistle-blower claim under Section 806 unless he shows that he was an “employee” of the parent under a theory of joint employment (employed by both companies at once) or alter ego (the parent is essentially the subsidiary). Adopting the standards articulated by the Supreme Court in United States v. Bestfoods (1998) for parent company liability, ALJs have recognized that liability under Section 806 may be imputed to a parent for a subsidiary’s actions only if the parent and its subsidiary are “so intertwined as to represent one entity.” As an ALJ explained in Hughart v. Raymond James & Associates Inc. (2004), even in situations where there are “indicia” of an interrelationship, the parent will be deemed the “employer” only if “it controlled or influenced the work environment of, or termination decisions about, employee[s] of its subsidiary company” or was involved in the challenged employment action. READING THE CAPTION Recent ALJ decisions have focused on the express text and legislative history of Section 806 in limiting its application to situations where the complainant can be found to be the employee of the publicly traded parent. In both Goodman v. Decisive Analytics Corp. (Jan. 10, 2006) and Ambrose v. U.S. Foodservice (April 14, 2006), the ALJs focused on the statutory caption of Section 806. The caption reads, “Whistleblower Protection for Employees of Publicly Traded Companies.” Based on this, the judges concluded that the term “employee” in the employment discrimination prohibition refers only to an employee of a publicly traded company. Similarly, in Bothwell v. American Income Life (2005), the ALJ, relying on the text and legislative history, recognized that if Congress had wanted to include nonpublic subsidiaries, it could have done so in drafting the statute. Thus, expanding the scope of the statute to include subsidiaries “would widen the scope of the Act beyond the intentions of Congress.” Applying these principles in Hughart, the ALJ found that the parent company will only be held liable where it “controlled or influenced the work environment of, or termination decision about, an employee of its subsidiary company.” The publicly traded parent in Hughart controlled certain aspects of the subsidiary’s operations; provided employee benefits to employees of the subsidiary; required the subsidiary to comply with the parent’s ethics policy; used the same letterhead, logo, and mailing address as the subsidiary; and housed portions of its operations at the subsidiary’s facilities. Nevertheless, the parent and the subsidiary were not a “single, integrated operation” for purposes of Sarbanes-Oxley liability. Significantly, there was no evidence that the parent hired or paid the complainant or was involved in any of the employment decisions that affected him. Similarly, the ALJ in Bothwell granted summary decision, finding that the complainant failed to produce evidence “to show sufficient commonality of management and purpose to justify piercing the corporate veil” between the subsidiary and its publicly traded parent. Although there was some evidence of “integrated operations” — including the pooling of litigation costs, integrated administrative functions, and common management and ownership — it was insufficient to justify piercing the corporate veil because there was no evidence of “centralized control of labor relations.” The ALJ found no indication that the subsidiary was acting as an agent for its parent company “with respect to employment practices” toward the complainant, such as hiring, firing, or paying the complainant. BUT THERE’S ONE DECISION Unfortunately, despite these many rulings, the issue is not settled. One 2004 decision, Morefield v. Exelon Corp., suggests that a subsidiary of a publicly traded company may be held liable under Section 806, regardless of the parent’s lack of involvement in its operations or the employment of the complainant. In Morefield, rather than focus on the text and legislative history of Section 806 itself, the ALJ reviewed the history leading up to Sarbanes-Oxley and its remedial structure. The decision noted that a publicly traded corporation “is, for Sarbanes-Oxley purposes, the sum of its constituent units,” including nonpublic subsidiaries. Based on this review, the ALJ concluded that employees of nonpublic subsidiaries of publicly traded companies are covered by the whistle-blower provision. Although the ALJ did not apply a joint employment standard or a derivative liability standard for imposing liability on the parent, the particular facts of this case likely would have satisfied either standard. The complainant alleged that (1) an employee of the publicly traded parent intimidated and berated him when he refused to deviate from accepted accounting practices, (2) he reported his concerns to the parent, and (3) neither the parent nor the subsidiary investigated his concerns. Subsequent ALJ decisions have declined to adopt Morefield‘s analysis of the scope of Section 806. This decision is viewed by employer counsel as an “outlier” that implicitly applies the narrower standard adopted by the other ALJs who have addressed this issue. However, the Administrative Review Board has not directly addressed this issue and may adopt in connection with pending appeals the Morefield analysis or a standard that is broader than a majority of the ALJs. BE MINDFUL OF THE RISK Until then, public companies and their subsidiaries must be mindful of the potential for claims by employees of the subsidiary. Publicly traded parents and their subsidiaries need to critically examine the various factors the Labor Department’s ALJs consider in assessing whether liability may be imposed on parent companies, under either the joint employment or alter-ego analysis. In addition, subsidiaries should consider developing (perhaps independent of the parent) policies and training to ensure that they respond appropriately to complaints and other whistle-blower activities. Parent companies also need to consider how they would handle allegations at a subsidiary. Although the parent may have a business interest in correcting a problem at a subsidiary, its natural reaction to intervene may buy it legal trouble. If a parent company becomes involved in resolving whistle-blower complaints of its subsidiary’s employees, helps make decisions concerning those employees, or fails to maintain sufficient corporate separateness between the two entities, the parent may inadvertently extend its potential liability. Keeping a certain distance may reduce this risk. Ultimately, the Labor Department and potentially the courts will have to resolve this unanswered question concerning the scope of Section 806. In the meantime, prudent companies — both parents and subsidiaries — should develop procedures to deal with the legal uncertainty.
Connie N. Bertram is a partner in the D.C. office of Winston & Strawn, where she represents employers in employment litigation, including Sarbanes-Oxley whistle-blower actions. In 2004, Bertram was named a Leading Lawyer in labor and employment law by Legal Times and subsequently chosen the top Leading Lawyer among the group by a vote of the D.C. legal community.

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