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From Securities Regulation Daily, October 26, 2015

Director liability possible under SOX and Dodd-Frank

By Brandi O. Brown, J.D.

Striking a heavy blow against defendants who attempted to weed out some of a whistleblowing employee's claims by way of a motion to dismiss, a federal district court in California ruled that the employee's individual claim against one of the corporate directors could proceed under Sarbanes-Oxley and that all disputed claims under Dodd-Frank and the California Labor Code could proceed. Although there was "scant case law" addressing whether directors could be held individually liable under SOX for retaliatory conduct in light of the ambiguous language of 18 U.S.C. §1514A(a), the court found that the context and purpose of the law supported a conclusion that it did. Likewise, the court found that Congress intended the ambiguous terms in Dodd-Frank to encompass individual liability (Wadler v. Bio-Rad Laboratories, Inc., October 23, 2015, Spero, J.).

Problems in China. In a lawsuit filed by Bio-Rad's former longtime general counsel, the attorney accused the employer and its individual directors of retaliating against him after he aired concerns in 2013 about corruption in the company's Chinese operations and later repeated those concerns at a meeting between the employer, its outside counsel, and its outside auditor. According to the employee, he had discovered in 2011 a documentation failure with regard to China-related sales that caused him to worry that violations of the Foreign Corrupt Practices Act (FCPA) were occurring. He spent the intervening time trying to track down documents, with little success, until he met with some success in 2012. Then, in early 2013, he learned that standard language regarding FCPA compliance had been removed from documents, without his approval, when those documents were translated into Chinese. After he complained to the Board of Directors' Audit Committee, the committee engaged outside counsel to investigate the violations.

Earlier problems in Thailand, Vietnam, and Russia. However, the employee objected to the counsel selected because it had been involved in an earlier, allegedly botched, investigation into similar issues occurring in other foreign markets that had resulted in a consent decree and over $55 million in fines for the employer. In that matter, the same firm had initially determined that there was no evidence of bribery. The employee, therefore, contended that the law firm had a conflict of interest arising from the earlier failure. Nevertheless, the firm was engaged and when, in the meeting to discuss its findings, the firm again reported that there was no evidence of improper payments, the employee challenged the conclusion and raised specific issues that had not been addressed. Three months later he was fired.

OSHA complaint and lawsuit. In late November 2013, the employee filed an initial complaint with the Department of Labor alleging he had been fired for engaging in protected activity under SOX. He identified the CEO, the founder's son, as having effectuated the termination. He later sought leave to amend the complaint to clarify that he also intended to seek relief from the individual board members. Ultimately he filed suit in federal district court, including a retaliation claim under SOX against both the company and the board members, a retaliation claim under Dodd-Frank against the company and board members/directors, a retaliation claim under the California Labor Code against the company, and claims based on other state law violations against the company. The defendants filed a motion to dismiss, first arguing that the claims against the individual board members under SOX and Dodd-Frank were untenable. They also argued that the claims under Dodd-Frank failed because the employee had not provided information to the SEC. Finally, they asserted that his claim under California Labor Code Section 1102.5(c) failed as a matter of law because he had not refused to participate in covering up an unlawful activity.

Individual liability under SOX. With regard to the question of individual liability of the directors under SOX, the court noted there was "scant case law" addressing the question and, although it found it to be a "close call," concluded that directors could be held individually liable. Along with a prohibition against retaliation by publicly traded companies, the provisions of 18 U.S.C. §1514A(a)(1)(C) provide that no "officer, employee, contractor, subcontractor, or agent of such company" could retaliate against a whistleblowing employee. Focusing on the word "agent," the court considered, and rejected, the authorities cited by the parties, including Black's Law Dictionary and the Restatement (Third) of Agency, as unable to provide a "convincing answer" to whether the term "agent" could encompass directors. Thus stymied, the court turned to legislative intent for assistance.

Although the defendants argued that it was indicative of Congress's intent that it had not listed directors in the section, the court rejected application of that rule in favor of an interpretation that would allow it to effectuate the legislative policy at play in SOX. It was not clear that Congress intended to exclude directors because the term "agents" might encompass them. Moreover, the defendants were unable to point to any actual conflict that would be engendered by construing the term to include directors. There was also no indication that the drafters had pondered inclusion of directors and rejected the idea.

"Most importantly, though," the court concluded that the "context and general purpose" of the Act supported the idea that the term "agent" should encompass directors. The Act came about in response to the Enron scandal and was an attempt to remedy the lack of protection for corporate whistleblower. Congress's "purpose would be significantly undermined" if the court were "to construe the term 'agent' in Sarbanes-Oxley as excluding directors."

CEO stays in, other directors fall out. That said, the employee still faced a hurdle in terms of the timeliness of his claims against the individual defendants. Although the court rejected a "formalistic" approach that would require a whistleblower to meet more stringent pleading requirements in his or her administrative complaint, it concluded that, with the exception of the CEO, the directors did not have fair notice that they would likely be named as defendants in a lawsuit. The CEO, however, was specifically identified in the administrative complaint as having terminated the employee and, as the person who had engaged in the specific conduct, he had fair notice.

Dodd-Frank liability. Almost equally ambiguous was the term "employer" in 15 U.S.C. §78u-6(h)(1)(A) (Dodd-Frank Act). Again, the case law was scant, and it had been applied in both a narrow and broad sense under federal laws. In the absence of a definition, however, the court found it ambiguous and looked again to legislative intent. There was no evidence that the legislature "intended to eliminate individual liability," the court explained, by using the term "employer" rather than listing out "officer, employee, contractor, subcontractor, or agent" as it had in SOX. Quite the contrary, the legislative history of the Dodd-Frank Act indicated that the legislature's purpose was to enact even "more stringent measures" than were found in SOX and increase whistleblower protection. Thus, the court concluded that it provided for "individual liability that is at least as extensive as that of Sarbanes-Oxley" and found that directors could be held individually liable.

Assistance to SEC not required. The defendants also argued that the employee did not qualify for protection under the Dodd-Frank Act because he did not provide information or assistance to the SEC. Although the Ninth Circuit had not addressed this issue, the majority of courts had found persuasive the SEC's own interpretation of Dodd-Frank as also providing protection to internal whistleblowers. The court found the reasoning of those courts persuasive and, applying the Chevron framework, concluded that the provision was ambiguous and the agency's answer was a permissible construction of it. The court disagreed with the Fifth Circuit's conclusion that the provision was unambiguous, and instead found persuasive another court's reasoning that the Dodd-Frank Act was ambiguous because of internal conflicts and because public policy supported a finding of ambiguity. The SEC's interpretation was entitled to deference as a reasonable interpretation because it comported with the broad purpose of the Dodd-Frank Act, as well as its scheme of incentivizing broader reporting. It was also reasonable because it encouraged internal reporting and a narrower reading would weaken its deterrent effect on employers.

The court also rejected the defendants' challenge to the employee’s California Labor Code claim, finding that his allegations supported an inference that he refused to engage in a cover-up of illegal activity.

The case is No. 15-cv-02356-JCS.

Attorneys: Michael John von Loewenfeldt (Kerr & Wagstaffe) for Sanford S. Wadler. Linda M. Inscoe (Latham & Watkins) for Bio-Rad Laboratories, Inc.

Companies: Bio-Rad Laboratories, Inc.

MainStory: TopStory WhistleblowerNews DirectorsOfficers DoddFrankAct SarbanesOxleyAct CaliforniaNews

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