For corporate attorneys, some of the most frequently overlooked and problematic of all claims for their clients are those alleging retaliation for complaints about fraud, misconduct or some form of discrimination.
That's bad news for companies at a time when such "whistleblower" claims are clearly on the rise. One important way to avoid such litigation -- while also protecting the company and its shareholder interest -- is to
develop and adhere to a standard of "best practices."
Awards in whistleblower suits have become much heftier than other types of employment claims in recent years. According to Jury Verdict Research, between 1997 and 2003, the median award in whistleblower suits was $338,386, outpacing all other types of employment claims. Discrimination claims, for example, rose to a median award of $178,500 over the same time period.
There's a major reason for the heightened risk for employers in retaliatory claims: The cases often have a jury appeal because of their simplicity. Employees need only show that they exposed some conduct they believed was unlawful and then soon after suffered an adverse employment action, such as a demotion or discharge. The company involved has a much higher burden of proof -- while facing allegations of misconduct, the company must convince a jury that the timing was merely coincidental and not retaliatory.
The burden of whistleblower claims on companies has only grown heavier with the Sarbanes-Oxley Act of 2002 (SOX). The law gives broad protection to employees of public companies who reveal any type of corporate conduct that violates Securities and Exchange Commission policies.
Congressional focus on SOX has raised public awareness of corporate accountability and the powers afforded an individual employee litigating against their former employer. Employees are now armed with information, and the media has raised the volume. After the Enron and Arthur Andersen scandal, Time magazine named three whistleblowers as its persons of the year, placing them on the same level as presidents and Nobel Peace Prize laureates.
Highly publicized allegations of accounting fraud brought by former employees have recently hit companies in a broad spectrum of industries -- from Coca-Cola and Intel, to DaimlerChrysler, HealthSouth and the Food and Drug Administration.
In 2003 alone, according to the U.S. Department of Labor, 181 whistleblowers invoked SOX in litigation against former employers. To date, more than 300 workers filed complaints accusing companies of retaliating against them for pointing out financial misconduct under SOX -- and that is only one of the 13 federal whistleblower protection laws already on the books. Many of these laws were implemented by the Occupational Safety and Health Administration and have been on the books for decades, originally offering protection to workers who expose safety or health issues in industries such as trucking, nuclear power and airlines.
For all of these reasons, whistleblower claims will likely continue to rise in the foreseeable future. There are several steps, however, that companies large and small can take to ensure a culture of compliance and disclosure. This will not only prevent some claims, but also place companies in the best possible position to defend claims before a jury, should a conflict arise.
• Enact a code of conduct articulating ethical standards for the work force, particularly among high-level employees who have access to privileged financial information. The code must include standards to promote honest and ethical conduct, accurate and timely disclosure of information, compliance with applicable governmental rules and regulations, prompt internal reporting of violations and accountability for adherence to the code. Above all, management must know that retaliation is prohibited against an employee who reveals fraud or other violations that fall under any of the whistleblower protection laws.
• Employees should be directed to report illegal or unethical behavior. The company must provide anonymous reporting procedures, and explicitly prohibit retaliation against employees who report violations. Employees should also know how to report complaints and the process of how they are investigated. Typically, the compliance officer will be responsible for investigating any reports of financial, ethical, legal or other misconduct. For public companies, there are SOX obligations as well, including establishing an audit committee to adopt procedures for handling complaints received by the company regarding accounting or auditing matters.
• Ensure the code's objectives are carried out in practice. The general counsel's office or the chief compliance officer should ensure the code of conduct is regularly distributed to employees. Distribution can be done through the company intranet, and in hard copy along with employees' paychecks. Human Resources should require formal review and acknowledgement of the code as part of the annual performance review process.
• The company's employment lawyer must also remain abreast of changing whistleblower laws in states where the company does business. California has strengthened its whistleblower law, requiring employers to post the statute's provisions inside offices and factories and setting up a hot line to the state attorney general. Illinois implemented a law adding protection for whistleblowers at private companies. New Jersey now requires posting and annual distribution of information about its whistleblower law.
• Maintain sound record-keeping practices for employee discipline. Performance management is frequently critical in the resolution of whistleblower claims. Human resources must train managers on the importance of accurately assessing employee performance. All too often, managers will avoid written assessments of their employees in annual reviews. Then, when they contend they terminated a whistleblower because of performance deficiencies, their paper trail is missing.
• Establish sound communications among business, human resources and legal departments to minimize risk from termination decisions. For example, termination decisions must be reviewed before they are implemented to see whether that employee revealed any fraudulent activity. In a recent case involving Coca-Cola, the whistleblower was terminated as part of a reduction in force shortly after reporting his complaint to management, which was apparently not communicated with the legal team. Negative publicity, as well as costly investigations, ensued.
• Communication is also key when advising whistleblowers of the outcome of investigations. Companies should avoid the temptation of disclosing as little as possible, because doing so may cause the whistleblower to escalate the complaint outside of the organization. Instead, there should be communication with the complainant, and full explanation of the company response and reiteration of their position on zero tolerance for retaliation.
David W. Garland
Special to Law.com
01-07-2005
David Garland is co-chair of the Employment and Labor Department at Sills Cummis Epstein & Gross P.C., with offices in Newark, N.J., and New York. Lynne Anne Anderson, a member of the firm, also contributed to this article.
No Escaping Sarbanes-OxleyNEWS ANALYSIS, Business Week
By David Henry and Amy Borrus, January 6, 2005,
Executives are frustrated with the law's financial and organizational burdens, but corporate reform is here to stay.
Nearly three years ago, Congress set out to clean up the way companies do business after accounting and governance scandals rocked investor confidence and damaged the reputation of companies large and small. Now, as the final stages of reform mandated by the Sarbanes-Oxley Act 2002 go into effect, much of Corporate America is in an uproar.
CEOs and CFOs complain they're burdened with huge implementation costs as armies of nitpicky auditors check every corner of their operations. "Common sense is gone," says Wisconsin Energy (WEC ) controller Stephen Dickson, voicing an increasingly common gripe. "You have to document everything."
WORTH THE TROUBLE. True enough, it hasn't been the easiest year for CFOs and their staffs. And there's no denying that the costs of implementing Sarbanes-Oxley are high -- upwards of $35 million on average for large companies this year alone. Complicating matters, the promised benefits of the reform movement are hard to spot and difficult to quantify: frauds that never happened, or the boost to investor confidence that has helped bring life back to U.S. markets.
Fears have thus taken hold that a backlash is under way. Clearly, executive complaints are reaching Washington: The U.S. Chamber of Commerce has targeted Securities & Exchange Commission Chairman William Donaldson and is compiling a dossier of examples of what it calls regulatory or enforcement overreach. And concern that the Administration's appetite for reform -- or support for Donaldson -- could wane in the second term were stoked in mid-December when Treasury Secretary John Snow called for more "balance" in regulation.
Yet despite the grumbling, there is increasing evidence that reform has been well worth the trouble. Already, intense scrutiny of accounting methods and internal controls has unearthed lingering problems in the way companies operate. And fixing weak financial controls has nipped a lot of accounting problems in the bud. "You know the CEOs and CFOs are doing much more due diligence inside their companies," says Neri Bukspan, chief accountant for Standard & Poor's, the credit-rating service.
FANNIE'S FOLLIES. Perhaps most important, the reforms have helped renew investor confidence in companies' reports -- a payoff that will grow in time. Says Donaldson: "The benefit will come in the long haul, with greater credibility in the marketplace and higher stock price multiples."
What's more, there's little chance that the SEC will be reined in. Following Fannie Mae's (FNM ) $9 billion restatement and continued controversy over megamillion-dollar parachutes it handed ousted top execs, corporate scandal is still too fresh to allow politicians to backtrack.
The White House made it clear on Dec. 16 that the President "appreciates" the job Donaldson is doing to crack down on corporate wrongdoers. Snow has affirmed his support for Sarbanes-Oxley and Donaldson -- although he still thinks regulators and prosecutors need to better coordinate their rulemaking and probes. "The system may have become too prosecutorial," Snow told BusinessWeek on Jan. 4 (see BW Online, 1/6/05, "Sarbanes-Oxley: A Sense of 'Siege'").
BEAN COUNTERS' BLITZ. Nevertheless, the complaints, which have been growing through the fall, will probably intensify in coming weeks due to widespread frustration with a single feature of Sarbanes-Oxley, Section 404. It requires that corporate executives and their auditors document, and certify to investors, that their internal financial controls work properly. It is biting hardest now because the first deadlines for completing the work begin taking effect next month for large-cap companies.
The law requires, for example, proof that someone is cross-checking the numbers that make up earnings, such as the value of inventory and receivables. Seems reasonable enough, but execs grouse that auditors are applying the law in mind-numbing detail. "It requires an army of people to do the paperwork," says William Zollars, chairman and CEO of Yellow Roadway (YELL ), the nation's largest trucking firm. Zollars dispatched some 200 Yellow employees to the task last quarter and paid about $9 million to accountants for their work -- or some 3% of annual profits for 2004.
Costs vary across companies, depending mostly on their complexity, auditors say. A survey of board members conducted by RHR International for Directorship magazine found that big companies with $4 billion or more in revenues are spending an average of $35 million to comply with the act. Another survey by Financial Executives International found $3.1 million in added costs for companies with average revenues of $2.5 billion.
SMALL OUTFITS, BIG HURT. Those numbers are grist for lobbyists in Washington. The U.S. Chamber of Commerce is collecting such evidence to take to Congress. The group's top priority this year is a "push back" for changes in Sarbanes-Oxley, says David T. Hirschmann, senior vice-president of the Chamber. He'll probably have plenty of ammunition. Mario Gabelli, CEO of Gabelli Asset Management (GBL ), says he put off hiring 12 security analysts in order to pay for complying with Section 404. "It has been a major drag on the economy," Gabelli says.
But small public companies may have the best argument, since they have fewer revenues to offset basic compliance costs. "This is a regressive tax against small business," says venture capitalist Gary Morgenthaler of Menlo Park (Calif.)-based Morgenthaler Ventures.
While accountants predicted that the internal controls section of Sarbanes-Oxley would be a burden, few people expected this much grief. After all, Section 404 restates what was already required in other federal laws and regulations. Since the late '70s, the Foreign Corrupt Practices Act has required companies to have internal controls, and auditors have long been expected to test them before signing off on financial statements.
UNPLEASANT DISCOVERIES. Sarbanes-Oxley only adds the requirement that execs and auditors certify the controls work. Lawmakers did that to ensure that top managers were held accountable for problems and to make it easier to prosecute cheaters. "The fact that companies are having difficulty complying, after controls have been in federal law for 25 years, doesn't speak well for the quality of their controls," says one high-ranking regulator.
That may be an understatement. In November, 119 companies publicly reported finding weaknesses or deficiencies in their internal controls, up from 11 in the same month a year before, according to industry newsletter Compliance Week. Many problems involved closing books, reconciling accounts, or dealing with inventory. SunTrust Banks (STI ) said in November that it had fired three officers after discovering errors in how it calculates allowances for losses in loan portfolios.
Visteon (VC ), a car-parts supplier, said it found problems recording and managing accounts receivable from its major customer, Ford Motor (F ). It's now fixing those problems. "We are finding that the focus on internal controls is uncovering problems at the best of companies," says Samuel DiPiazza Jr., CEO of auditor PricewaterhouseCoopers International
"TIGHTENED UP." Many businesses are discovering other benefits. General Electric (GE ), which spent about $30 million on the work last year, "had good controls before this, but it has added more rigor," says CFO Keith Sherin. "It certainly gives [CEO Jeffrey Immelt] and me more confidence when we're signing off on the results."
United Technologies (UTX ) used the work to standardize checks on bookkeeping in its disparate businesses around the world. "We had a fair degree of latitude in how people document things. We've tightened that up," says Jay Haberland, UTC's vice-president for business controls.
The biggest advantage of all, though, may be the greater confidence investors have in financial results. "The auditors are doing better audits and charging for that. More questions are being asked by everyone," says Donald Nicolaisen, the SEC's chief accountant. That's why fine-tuning the regs, rather than any kind of rollback, is what's likely this year.
SMALL PRICE? Regulators are encouraging auditors to focus on critical issues that pose the biggest risks rather than sweating the little stuff that wastes time and resources -- and drives managers nuts. And come the spring, they have promised to review the complaints and determine whether the procedures can be improved.
Some officials say it could take three years for companies, auditors, and regulators to apply the law efficiently. That may seem like a long march for many executives. Yet in the long run, it will be a small price to pay for more smoothly running organizations and renewed investor confidence.
Henry is a senior writer for BusinessWeek in New York. Borrus is a correspondent in BusinessWeek's Washington bureau
with Louis Lavelle and Diane Brady in New York, Michael Arndt and Joseph Weber in Chicago, and bureau reports Related Stories:
Restore the TrustWhistleblowers Still Need Protection: UpdateSarbanes-Oxley Arrives For FedsSEC Must Strengthen Disclosure
