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From Securities Regulation Daily, March 4, 2014

Supreme Court rules SOX whistleblower provision extends to public company’s private contractors, declines to insulate fund industry from provision

By Jim Hamilton, J.D., LL.M.

The U.S. Supreme Court ruled that Sarbanes-Oxley Act Sec. 806, codified at 18 U.S.C §1514A, extends whistleblower protection to employees of privately held contractors and subcontractors who perform work for public companies. Writing for the Court, Justice Ginsburg said that nothing in the statutory language confines the class of employees protected to those of a designated employer. “Absent any textual qualification, we presume the operative language means what it appears to mean: A contractor may not retaliate against its own employee for engaging in protected whistleblowing activity” (Lawson, et al v. FMR LLC, et al, March 4, 2014, Ginsburg, R.).

This was a plurality opinion in which Justice Ginsburg was joined by Chief Justice Roberts and Justices Breyer and Kagan. Justice Scalia filed a concurring opinion, joined by Justice Thomas, in which he agreed with the Court’s conclusion that Sec. 806 protects employees of private contractors from retaliation when they report covered forms of fraud that, as the Court carefully demonstrates, logically flows from the statutory text and broader context. But, Justice Scalia did not endorse what he said were the Court’s excursions “into the swamps of legislative history.” Justice Sotomayor filed a dissenting opinion, joined by Justices Kennedy and Alito.

Mutual fund industry. The Court’s reading of Sec. 806 avoids insulating the entire mutual fund industry from the whistleblower provision. Virtually all mutual funds are structured so that they have no employees of their own, noted the Court, rather they are managed by independent investment advisers. A narrow construction of Sec. 806 would have left the statute with no application to mutual funds. The Court’s reading of the statute protects the employees of investment advisers, who are often the only first-hand witnesses to shareholder fraud involving mutual funds.

The petitioners are former employees of private companies that contract to advise or manage mutual funds. The mutual funds, however, are public companies without employees. “Hence,” reasoned the court, “if the whistle is to be blown on fraud detrimental to mutual fund investors, the whistleblowing employee must be on another company’s payroll, most likely, the payroll of the fund’s investment adviser or manager.”

The Court rejected the argument that excluding the mutual fund industry from the Sarbanes-Oxley whistleblower provision is “tenable” because funds and their investment advisers are separately regulated under the Investment Company Act and the Investment Advisers Act. “But this separate regulation does not remove the problem,” said the Court, “for nowhere else in these legislative measures are investment management employees afforded whistleblower protection.”

Section 806 alone shields them from retaliation for bringing fraud to light, emphasized the Court. Indeed, continued the Court, affording whistleblower protection to mutual fund investment advisers is crucial to Sarbanes-Oxley’s endeavor to protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws. These disclosures are written, not by anyone at the mutual funds themselves, but by employees of the investment advisers.

More broadly, the Court viewed the application of the whistleblower provision to contractor employees as confirmed when the view is enlarged from the term “an employee” to the provision as a whole. The prohibited retaliatory measures enumerated in Sec. 806, discharge, demotion, suspension, threats, harassment, or discrimination in the terms and conditions of employment, are commonly actions an employer takes against its own employees. Contractors are not ordinarily positioned to take adverse actions against employees of the public company with whom they contract. A narrow interpretation of Sec. 806 would, therefore, shrink to insignificance the provision’s ban on retaliation by contractors.

PCAOB and SEC. The Court also discounted the dissent’s suggestion that the Public Company Accounting Oversight Board (PCAOB) and the SEC’s authority to sanction unprofessional conduct by accountants and lawyers, respectively, could provide a disincentive to retaliate against other accountants and lawyers. The Court reasoned that the possibility of such sanctions would be “cold comfort” to the accountants and lawyers who lose their jobs in retaliation for their efforts to comply with the Act’s requirements if, as the dissent would have it, Sec. 806 does not enable them to seek reinstatement or backpay.

The case is No. 12-3.

Attorneys: Eric Schnapper, University of Washington, for Jackie Hosang Lawson. Mark A. Perry (Gibson Dunn & Crutcher LLP) for FMR LLC.

Companies: FMR LLC

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