ARB Ruling Takes Broad View of Scope of Protected Activity Under SOX

In the latest sign that the Department of Labor (DOL) is taking a harder line against employers defending whistleblower claims under the Sarbanes-Oxley Act (SOX), the DOL’s Administrative Review Board (ARB) recently ruled in Sylvester et al. v. Parexel International LLC, ARB No. 07-123 (May 25, 2011), that (1) SOX complaints filed with the Occupational Safety and Health Administration (OSHA) are not subject to the pleading standards under Twombly and Iqbal; (2) SOX-protected conduct is not limited to complaints relating to fraud against shareholders; (3) the reported misconduct need not “definitely and specifically” relate to one of the laws enumerated under SOX Section 806—a reasonable belief of a violation is sufficient; and (4) a complainant can engage in protected activity under SOX Section 806 even if he or she fails to allege, prove, or approximate the specific elements of fraud, such as materiality, scienter, reliance, economic loss, or loss causation.

ARB Announces Standards Applicable to SOX-Protected Activity

Parexel is a publicly traded company that tests drugs for pharmaceutical companies and other clients. Complainant Sylvester was a Case Report Forms Department Manager who was responsible for the accurate reporting of clinical study data pursuant to the FDA’s Good Clinical Practice standards. Complainant Neuschafer was a Clinical Research Nurse responsible for reporting accurate clinical data. The complainants alleged that one or both of them had reported two instances of the false reporting of clinical data to a manager and a supervisor, but that nothing was done about their complaints. They also alleged that Parexel declined to investigate the alleged conduct because doing so would have adversely affected its profits from the clinical studies, thus adversely impacting the value of its stock. Finally, they alleged that to the best of their knowledge, the false data had never been corrected and was reported as accurate by Parexel in communication through the U.S. mail and by wire communications such as the Internet. The complainants alleged that they were subject to adverse employment decisions after these reports, including but not limited to termination of employment.

The complainants filed SOX whistleblower claims with OSHA. OSHA dismissed both complaints. On appeal, the Administrative Law Judge (ALJ) granted Parexel’s motion to dismiss the SOX complaints on the grounds that the complainants failed to adequately plead activity protected under SOX Section 806.

Hearing the appeal en banc, the ARB ruled that the ALJ had committed reversible error on several grounds. See Sylvester, ARB No. 07-123.

Pleading Standard for SOX Complaints Before OSHA

First, the ARB held that the pleading standards set forth by the U.S. Supreme Court in Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007), and Ashcroft v. Iqbal, 129 S. Ct. 1937 (2009), do not apply to SOX claims initiated with OSHA. SOX complaints are governed by regulations that do not require any “particular form of complaint,” but require that the complaint be in writing and contain “a full statement of the acts and omissions, with pertinent dates, which are believed to constitute the violations.” 29 C.F.R. § 1980.103(b). OSHA then has a duty, if appropriate, to interview the complainant and supplement a complaint that lacks a prima facie claim. 29 C.F.R. § 1980.104(b)(1). If the complaint, as supplemented, alleges a prima facie SOX claim, OSHA initiates an investigation.

The ARB ruled that the pleading standards in Twombly and Iqbal are inappropriate for SOX complaints and the procedures noted above for supplementing those complaints even if they are deficient as originally filed. Further, the ARB stated that “SOX claims are rarely suited for Rule 12 dismissals,” and that ALJs should freely grant parties the opportunity to amend their initial filings to provide more information about their complaint before the complaint is dismissed.

SOX-Protected Conduct: Reasonable Belief Standard

The ARB ruled that a SOX complainant need only express a “reasonable belief” of a violation to establish that he or she engaged in protected activity. The reasonable belief standard requires an examination of the subjective and objective reasonableness of a complainant’s beliefs. The objective standard “is evaluated based on the knowledge available to a reasonable person in the same factual circumstances with the same training and experience as the aggrieved employee.” Sylvester, ARB No. 07-123 at 14 (quoting Harp v. Charter Commc’ns, 558 F.3d 722, 723 (7th Cir. 2009)).

The ARB ruled that the complainant need not actually convey the reasonableness of his or her beliefs to the employer, and that the issue of reasonable belief often involves factual issues that “cannot be decided in the absence of an adjudicatory hearing.” Sylvester, ARB No. 07-123 at 15. The ARB ruled that the ALJ erred by dismissing the complaints without examining the facts relating to the reasonableness of the complainants’ beliefs.

The ARB further ruled that the complainant need not complain about an actual violation of the law. A reasonable, but mistaken, belief that a violation of one of the laws in Section 806 has occurred will suffice.

SOX-Protected Conduct: “Definite and Specific” Standard

The ARB also held that the ALJ erred by applying the “definite and specific” evidentiary standard to the complainants’ reports. In Platone v. FLYi, Inc., ARB No. 04-154 (September 29, 2006), the ARB imposed a requirement, drawn from case law under the Energy Reorganization Act, that a SOX complainant must establish that the activity or conduct for which protection is claimed “definitely and specifically” relates to one or more of the laws enumerated under Section 806. As noted by the ARB in Sylvester, this standard has been followed in a number of other ARB decisions, and several circuit court decisions. The ARB in Sylvester, however, ruled that the standard is whether the complainant provided information that he or she reasonably believed related to a violation of one of the laws listed under Section 806, and that it was “error for the ALJ to dismiss the complaints in this case for failure to meet a heightened evidentiary standard espoused in case law but absent from SOX itself.” Sylvester, ARB No. 07-123 at 18-19.

In light of the prior circuit court decisions referencing the “definite and specific” standard, it is unclear whether circuit courts in the future will defer to the change in position of the ARB with respect to this standard.

In addition, as recognized by the concurring and dissenting opinion of Deputy Chief Administrative Appeals Judge Brown, the majority opinion in Sylvester does not abrogate the requirement, previously recognized by the ARB and the Fourth Circuit, that in reporting misconduct, an employee “must identify the specific conduct that the employee believes to be illegal.” Id. at 41 (Brown, J., concurring and dissenting) (quoting Welch v. Chao, 536 F.3d 269, 276 (4th Cir. 2008)).

SOX-Protected Conduct: Alleging Fraud

The ARB ruled that SOX-protected conduct extends to reporting a reasonable belief of a violation of any of the laws enumerated under Section 806-not only fraud against shareholders. The laws listed in Section 806 are mail fraud (18 U.S.C. § 1341); wire, TV, and radio fraud (§ 1343); bank fraud (§ 1344); securities fraud (§ 1348); any rule or regulation of the Securities and Exchange Commission (SEC); or any violation of federal law relating to fraud against shareholders. The ARB noted that only the last category of unlawful conduct refers to fraud against shareholders, and that “[o]n their face, mail fraud, fraud by wire, radio, or television, and bank fraud are not limited to frauds against shareholders.” Sylvester, ARB No. 07-123 at 20. In fact, the ARB noted that a violation of “any rule or regulation” of the SEC may be “completely devoid of any type of fraud.” Id.

Finally, the ARB ruled that:

[A] complainant can have an objectively reasonable belief of a violation of the laws in Section 806, i.e., engage in protected activity under Section 806, even if the complainant fails to allege, prove, or approximate specific elements of fraud, which would be required under a fraud claim against a defrauder directly. In other words, a complainant can engage in protected activity under Section 806 even if he or she fails to allege or prove materiality, scienter, reliance, economic loss, or loss causation.

Id. at 22. The ARB reasoned that SOX was designed to prevent potential fraud at its earliest stages. The ARB noted, however, that a complainant’s concerns could involve “such a trivial matter that he or she did not engage in protected activity under Section 806.” Id.

Conclusion

Applying these standards to the allegations by the complainants in Sylvester, the ARB ruled that the complainants had satisfied the pleading standard for alleging SOX-protected conduct. According to the ARB, the complainants alleged that they reported fraudulent activities to a manager or supervisor, described how the allegedly fraudulent activities related to the financial status of the company, stated that those activities related to one or more of the laws listed in SOX Section 806 (with a focus on mail and wire fraud), alleged that their employer had knowledge of their protected activity, and alleged that they were subjected to adverse employment actions in retaliation for such protected activity. The ARB, therefore, reversed the ALJ’s dismissal and reinstated the complaints.

Impact of Sylvester on SOX-Covered Companies

In light of this ruling, a broader array of conduct may be considered protected activity under SOX than might have been considered protected before Sylvester. The result of this decision likely will be that more employees will be able to claim that they engaged in SOX-protected conduct, more SOX whistleblower claims will be filed, and fewer claims will be dismissed on a prehearing motion.

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Fair Credit Reporting Act Implicates Employer Liability for All Types of Background Checks, Not Just Credit Reports

The titles Fair Credit Reporting Act and the “Consumer Credit Reporting Reform Act” (which contains relevant amendments) are often misunderstood as being only applicable to credit reports. The truth of the matter is that the FCRA’s coverage is actually very broad. Indeed, reports prepared by consumer reporting agencies containing criminal, educational, employment history, and other types of common records checks are covered by the FCRA and require advance notice, disclosure, and consent.

As illustrated recently, employers have been forced to pay hefty settlements in class action cases where it was alleged that they failed to comply with federal law when conducting criminal background checks on prospective employees. Employers are advised to proceed with caution and follow certain procedures, detailed below, when conducting background checks on both employees and applicants.

RECENT FCRA SETTLEMENTS

In April, Vitran Express, Inc., a freight company, paid $2.6 million to settle Ohio class actions claims that it improperly obtained criminal background checks on job applicants. The named plaintiff in the case, Thomas Hall, alleged that Vitran ordered a criminal background report from a consumer reporting agency as part of his job application even though he had not authorized the company to do so. The report identified a different “Thomas Hall,” but someone with the same first name, middle initial, last name, and date of birth as the named plaintiff, as having 27 felony convictions. Based on that report, Vitran refused to offer Hall employment, but did not tell him why; Hall only learned of the inaccurate report when he was notified by the consumer reporting agency. In the lawsuit, Hall claimed that Vitran did not seek or receive an appropriate disclosure from applicants prior to obtaining the reports and did not provide the applicants with pre-adverse action notices, including a copy of the applicants’ criminal background report and a statement of the applicants’ rights. The class was composed of anyone who had applied with Vitran and for whom Vitran had procured a consumer report without giving written notice or obtaining authorization, regardless of whether or not they were ultimately offered employment.

Though Vitran did not admit any wrongdoing in the settlement, it did concede that a portion of the individuals seeking employment may not have been aware that it was obtaining background checks for employment purposes. Beyond the Vitran case, there has been a rash of FCRA-related class actions filed lately, such as one involving transit operator FirstGroup PLC, which, in March, agreed to pay $5.9 million to settle two class actions brought against its subsidiaries by job applicants.

COMPLYING WITH FEDERAL LAW

To avoid the similar fate of costly FCRA litigation, employers must take certain steps to ensure that they are in compliance with federal law. Before delving into these steps, it is important to understand that the law provides for an expansive definition of a “consumer report,” which is why employers are required to give advance notice, disclosure, and consent on background checks other than just credit reports. A consumer report is a report prepared by a consumer reporting agency that consists of any written, oral, or other communication of any information by a consumer bearing on an applicant’s or employee’s credit worthiness, credit standing, credit capacity, character, general reputation, personal characteristics, or mode of living which is used or expected to be used or collected for employment purposes. This definition should be kept in mind when reviewing the below compliance recommendations.

Employer Certifications to the Consumer Reporting Agency

An employer must first certify, in writing, to the consumer reporting agency retained that it will follow the FCRA rules concerning disclosure, authorization, notice, and adverse action notices, and that it will not use information in violation of any state or federal discrimination laws.

Disclosure and Authorization

Prior to obtaining a consumer report, an employer must:

  • Provide to the employee or applicant a clear and conspicuous disclosure—in a standalone document—that a report may be requested; and
  • Secure written consent from the employee or applicant to obtain the consumer report.

When an employer requests an “investigative consumer report,” which is a type of consumer report where information is gathered through personal interviews of associates of the employee or applicant, additional protocol is to be followed. Specifically, it must be disclosed to the employee or applicant that an investigative consumer report is being requested, and the disclosure has to inform the employee or applicant of their right to request further information about the nature of the investigation. Should information be requested, an employer must respond within five days.

Providing Documents Before the Adverse Action

If the results of a consumer report influence, in whole or in part, the decision not to hire an individual or to take any adverse employment action involving a current employee, the employer must provide the following two documents to the individual before taking any such action:

  • A copy of consumer report relied upon; and
  • The Federal Trade Commission document, “A Summary of Your Rights Under the Fair Credit Reporting Act.”

Notice After the Adverse Action

If, after an employer has provided a copy of the consumer report and the FTC summary of FCRA rights, it intends to make the adverse action decision final, one more step must be taken. The employer must provide an adverse action notice, informing the employee or applicant that a final decision has been made and containing:

  • The consumer reporting agency contact information;
  • A statement that the consumer reporting agency is not the decision maker and cannot inform the individual as to why the adverse action was taken;
  • A statement of the individual’s right to obtain a free copy of the consumer report; and
  • A statement of the individual’s right to dispute with the consumer reporting agency the accuracy of any information in the report.

U.S. Supreme Court: Investors Can Seek Class Action Status Without Proving Loss Causation

In Erica P. John Fund, Inc. v. Halliburton Co., 563 U.S. __ (June 6, 2011), the U.S. Supreme Court resolved a split in the lower courts as to whether securities fraud plaintiffs must prove loss causation to obtain class certification, ruling in a unanimous opinion that such proof is not a prerequisite to obtaining class certification in a securities fraud case. The investors alleged that the company made various misrepresentations designed to inflate its stock price in violation of Section 10b of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. The district court found that the suit could not proceed as a class action because the plaintiff did not show loss causation, which the Fifth Circuit required of securities fraud plaintiffs seeking class certification. The Fifth Circuit affirmed the denial of class certification, see 597 F.3d 330 (5th Cir. 2010), but the Supreme Court reversed.

Although this ruling will affect class certification proceedings in the Fifth Circuit, the narrow scope of the opinion—coupled with the fact that several other circuits had already rejected the requirement of showing loss causation at the class certification stage—makes it unlikely that this decision will have a significant effect outside the Fifth Circuit or the securities fraud context.

Background

The Erica P. John Fund’s (EPJ Fund’s) class action complaint asserted that Halliburton made false statements about “(1) the scope of its potential liability in asbestos litigation, (2) its expected revenue from certain construction contracts, and (3) the benefits of its merger with another company.” Halliburton, 563 U.S. ___, slip op. at 2. It further alleged that Halliburton later issued corrective disclosures that caused the stock price to drop and, consequently, investors to lose money. Id.

The Supreme Court’s Decision

The sole question before the Supreme Court was whether the claims of the EPJ Fund satisfied Federal Rule of Civil Procedure 23(b)(3), which requires a court to find “that the questions of law or fact common to class members predominate over any questions affecting only individual members” in order to certify a class. Halliburton, 563 U.S. ___, slip op. at 3-4 (quoting Fed. R. Civ. P. 23(b)(3)). The Supreme Court noted that the answer to this question “begins, of course, with the elements of the underlying cause of action . . . [and] a securities fraud action often turns on the element of reliance,” i.e., whether the plaintiff relied on the alleged misrepresentation or omission in making the investment decision. Halliburton, 563 U.S. __, slip op. at 4. Before Halliburton, the circuit courts were split as to whether proving loss causation was necessary to obtain class certification in a Rule 10b-5 action.

In Basic Inc. v. Levinson, 485 U.S. 224, 243 (1988), the Supreme Court articulated the “fraud-on-the-market theory” as giving rise to a rebuttable presumption of reliance in certain securities fraud cases. The fraud-on-the-market theory holds that the market price of shares is a function of all publicly available information about the company and its business, which necessarily includes any misrepresentations. Accordingly, when shares are traded on well-developed and efficient securities markets, a misstatement may defraud the entire market by affecting the price of the stock. Under this theory, the Supreme Court held that a stock purchaser is entitled to a presumption of reliance on the market price of the stock whenever he or she “buys or sells stock at a price set by the market,” even if the purchaser did not directly rely on any misstatements. Id. at 244. To invoke this presumption of reliance, plaintiffs must demonstrate that the alleged misrepresentations were publicly known, that the stock traded in an efficient market, and that the purchase or sale took place between the time the misrepresentations were made and the truth was revealed. Id. at 241-48.

In Halliburton, the Supreme Court held that the Fifth Circuit had impermissibly imposed an additional burden by requiring plaintiffs to prove loss causation at the class certification stage as a precondition to Basic‘s rebuttable presumption of reliance. Halliburton, 563 U.S. __, slip op. at 6. In rejecting this requirement, the Supreme Court explained that loss causation “requires a plaintiff to show that a misrepresentation that affected the integrity of the market price also caused a subsequent economic loss.” Id. at 7. Although the Fifth Circuit held that an inability to prove loss causation would necessarily prevent a plaintiff from invoking the rebuttable presumption of reliance, the Supreme Court stated:

Such a rule contravenes Basic‘s fundamental premise—that an investor presumptively relied on a misrepresentation so long as it was reflected in the market price at the time of his transaction. The fact that a subsequent loss may have been caused by factors other than the revelation of a misrepresentation has nothing to do with whether an investor relied on the misrepresentation in the first place, either directly or presumptively through the fraud-on-the-market theory.Id.

The Limited Significance of Halliburton

Halliburton is perhaps most notable for its brevity and the narrowness of its holding. The opinion does not address any other “questions about Basic, its presumption, or how and when it may be rebutted.” Id. at 9. The Court also left the door open for Halliburton to challenge class certification on grounds other than the plaintiffs’ inability to prove loss causation, noting that “[t]o the extent Halliburton has preserved any further arguments against class certification, they may be addressed in the first instance by the Court of Appeals on remand.” Id. Moreover, the Court did not offer any hint that it was prepared to reconsider the presumption of reliance or the fraud-on-the-market theory more generally.

In short, this decision can best be understood as a very specific answer to a very specific question-whether securities fraud plaintiffs must factually prove loss causation before a class may be certified. Halliburton will of course affect class certification proceedings in Fifth Circuit securities actions. However, given that several other circuits (the Second, the Third, and the Seventh) had already rejected the Fifth Circuit’s approach, Halliburton, 563 U.S. ___, slip op. at 3, it is unlikely to have a major effect on litigation in other jurisdictions