Sarbanes-Oxley Implementation: Why Should Privately Held Companies and Nonprofit Entities Care About SOX?

Apr 18, 2014

Related Practices: Employment and Nonprofit

This post originally appeared on the blog Employer's Practical Advice.

The Sarbanes-Oxley Act (“SOX”) is generally perceived as applying to only publicly traded companies. This perception fails to take into account two little-noted provisions of SOX that have always applied to privately held companies, nonprofit entities, and to the individuals who work for them. Consequences for violating these provisions are significant, and they include:

  • Intentionally destroying, altering or falsifying records or documents with the intention of impeding or influencing a federal agency investigation(1) or a federal bankruptcy proceeding is a crime, punishable by fines and up to 20 years imprisonment. (See 18 U.S.C. § 1519).
     
  • Retaliating against someone who provides a law enforcement officer with truthful information relating to a possible federal offense is a crime, punishable by up to 10 years’ imprisonment. (See 18 U.S.C. § 1513(e)).

While these provisions have received little attention in the past, the current zeitgeist of heightened scrutiny and suspicion aimed at businesses and employers from the public, the media, and government might well bring these provisions to bear.

Indeed, the courts’ and the government’s attention has already turned to the whistleblower provision of SOX (“Section 806″), which, historically has been thought to only protect employees of publicly-traded companies. In 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank”) expanded whistleblower protections under several federal laws, SOX among them.(2) The result is that whistleblower claims, alleging retaliatory conduct in employment (e.g., termination, discipline), are on the rise. A quick search on the internet suggests they are the claim “du jour.” Three important decisions just this year exemplify the increased attention and expanding reach of SOX protections to employees of private entities.

The first is Lawson v. FMR LLC, decided on February 3, 2012 by the U.S. Court of Appeals for the First Circuit.(3) The plaintiffs, Jackie Hosang Lawson and Jonathan M. Zang, brought separate suits alleging unlawful retaliation by their employers, which are private companies that acted as contract advisers for the Fidelity family of mutual funds. The funds were not party to the lawsuit, but they qualified as public companies under SOX. Zang alleged he was terminated in retaliation for raising concerns about inaccuracies in a draft registration statement for certain Fidelity funds, which he reasonably believed violated federal securities laws. Lawson alleged she was constructively discharged after raising concerns about cost accounting methodologies. Because the two plaintiffs worked for private companies, they had to establish that Section 806 does more than protect employees of public companies. Lawson put to the test whether (a) contractors, subcontractors, and agents of a public company are prohibited from retaliating against an employee of a public company, and (b) whether private companies are also prohibited from retaliating against their own employees.

In its analysis, the court focused on the precise language of Section 806; for example, the title of the provision is “Protection for Employees of Publicly Traded Companies Who Provide Evidence of Fraud,” and the heading for the first subsection is “Whistleblower protection for employees of publicly traded companies.” According to the court, those references are clear in limiting the protections to employees of public companies, and “the clause ‘officer, employee, contractor, subcontractor, or agent of such company’ goes to who is prohibited from retaliating or discriminating, not to who is a covered employee.” Ultimately, the court concluded that Section 806 includes contractors and subcontractors as parties that may not retaliate, but the employees covered by Section 806 are only those who work for a public company.

The court also highlighted the difference between Section 806 and Section 1107 (18 U.S.C. § 1513(e), discussed above). This provision is entitled “Retaliation Against Informants” and requires neither a public company nor any employment relationship. The court found the contrast explicit and clear in the protections intended by the two provisions.

The Lawson decision is in direct contrast to a decision from the U.S. Department of Labor’s Administrative Review Board (“ARB”), Spinner v. David Landau & Assocs. LLC, decided on May 31, 2012.(4) Spinner was an internal auditor for David Landau & Associates (“DLA”), a privately held auditing firm, which had contracted with a publicly traded company, S.L. Green Realty Corp. (“Green”) to provide auditing services. Complainant was assigned to perform full-time auditing services for Green and then terminated approximately a month later. Spinner claimed he was discharged in violation of Section 806 for reporting “internal control and reconciliation problems” at Green to DLA. Contrary to the court in Lawson, the ARB determined that Spinner, as an employee of a contractor of a public company, was a covered employee under Section 806. The ARB expressly declined to adopt the First Circuit’s interpretation of Section 806, characterizing it as “implausible.” The ARB reasoned that the caption title was not determinative; SOX does not specifically define “employee” as an employee of a public company, though Congress could have; and other whistleblower statutes that do not define “employee” have been construed to cover employees of contractors.

The decision by the ARB is inconsistent with Lawson, but it is consistent with DOL’s prior decisions on the matter, and with its belief that Section 806 should be broadly interpreted. In fact, one recent decision noted that, “Congress intended to enact robust whistleblower protections for more than employees of publicly traded companies,” including “employees of certain private firms that work with, or contract with [them].”(5)

The third case is Leshinsky v. Telvent Git, S.A. et al, decided by the U.S. District Court of New York on July 9, 2012.(6) Plaintiff Leshinsky is a former employee of a privately owned engineering company, PB Farradyne, which was acquired in 2006 by Telvent GIT, a publicly traded company. The acquisition deal was structured such that a holding company with no employees actually acquired PB Farradyne. The holding company was owned by a wholly-owned subsidiary of Telvent. The following year, Telvent acquired Caseta Technologies Inc., and Leshinsky was assigned to Caseta, but remained formally employed by Farradyne. Leshinsky alleged that he was fired in July 2008 after objecting to a proposal to use fraudulent information in a Caseta bid for a contract, in violation of Section 806. The court’s decision did not address the merits of Leshinsky’s claim, but rather, the application of Section 806 to an employee of a nonpublic subsidiary of a publicly traded company and, in particular, whether the 2010 Dodd-Frank amendments would apply retroactively to his termination in 2008.

The court first determined that the Dodd-Frank amendment, which added the terms “subsidiary” and “affiliate of a public company” to Section 806, should apply retroactively because this amendment merely “clarified” rather than “changed” the statute. In reaching this conclusion, the court relied upon a 2011 decision from the ARB, which regarded the amendment as a mere clarification of the previous statute, intended to make “what was intended all along ever more unmistakably clear.”(7) The court next determined that the interrelationship between Farradyne and Telvent was sufficient to qualify Leshinsky as a covered employee under Section 806—”Telvent sought to establish a uniform global corporate brand that included all of its subsidiaries. Indeed, press releases by subsidiaries included a reference to the parent company and the fact that it is publicly traded[.] [T]he subsidiaries directly contributed to the financial state of the company and the financial information of the subsidiaries was included in the consolidated financial statement of the parent.”

While these decisions come from different lines of authority and there is no definitive ruling by the U.S. Supreme Court on the scope of the whistleblower protections for employees of private entities, the message is clear: Whether employees of private companies are protected against retaliation under SOX is a matter that will continue to get more attention from the courts and the legislators in the months and years to come. As such, private entities should be mindful of employee complaints and concerns regarding financial or accounting misdeeds and improprieties. They should work to build a culture of compliance from the top down, which includes an ample reporting and investigatory mechanism for such complaints, and encourages managers and supervisors to bring these issues to the attention of senior management.

There are also practical and beneficial reasons for meeting the compliance obligations of SOX:

  • It facilitates raising capital and fundraising. Private investors, lenders, and donors are more likely to direct their money toward entities that are managed in accordance with best practices.
     
  • Companies in compliance with SOX are less likely to be sued, and in a stronger position to defend if they are, having already established best practices.
     
  • Companies hoping to go public will have to be in compliance with SOX before they can do so.
     
  • Directors are better able to discharge their fiduciary responsibilities if they act independently and based upon complete and accurate information.
     
  • Nonprofit entities that are tax exempt under the Internal Revenue Code are generally subject to a complex set of compliance and reporting requirements that encourage, and in some cases require, adherence to the principles of SOX. Best practices aligned with the requirements of SOX will help nonprofit entities meet their compliance and reporting requirements.

In sum, the courts and the media already are paying attention to SOX; private entities and nonprofits should, too. Some of its provisions directly impact them, and others enhance their ability to raise capital, fundraise, and maintain a better public image.


(1) The EEOC, IRS or Department of Labor, for example. (return to post)

(2) SOX, Section 806, as amended by Dodd-Frank states: “No company with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l), or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o (d)) including any subsidiary or affiliate whose financial information is included in the consolidated financial statements of such company, or nationally recognized statistical rating organization (as defined in section 3(a) of the Securities Exchange Act of 1934 (15 U.S.C. 78c), or any officer, employee, contractor, subcontractor, or agent of such company or nationally recognized statistical rating organization, may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee.” 18 U.S.C. § 1514A(a) (return to post)

(3) 670 F.3d 61 (1st Cir. 2012). (return to post)

(4) ARB No. 10-111, ALJ No. 2010-SOX-29 (ARB May 31, 2012). (return to post)

(5) See Johnson v. Siemens Building Tech., ARB No. 08-032, ALJ No. 2005 SOX-15 (2011). (return to post)

(6) No. 10-4511, (S.D.N.Y. July 9, 2012). (return to post)

(7) See Johnson v. Siemens Building Tech., ARB No. 08-032, ALJ No. 2005 SOX-15 (2011). (return to post)

Copyright © 2012 by the Bureau of National Affairs, Inc. 
Reproduced with Permission from BNA Bloomberg Corporate Accountability Report, 10 CARE 848, 8/17/2012. www.bna.com