interest in law enforcement.5 On another level, voluntary whistleblower ...... consistent with the existing compliance role that attorneys are often asked by clients ...
THE PROMISE OF COMPELLED WHISTLEBLOWING: WHAT THE CORPORATE GOVERNANCE PROVISIONS OF SARBANES OXLEY MEAN FOR EMPLOYMENT LAW Elizabeth Tippettg
TABLE OF CONTENTS INTRODUCTION........................................................................................................... 2 I. LITERATURE REVIEW............................................................................................ 3 A. Retaliation-Based Remedies................................................................................. 3 B. Reward-Based Approaches................................................................................... 7 C. Employer Incentives for Investigating Wrongdoing.............................................. 8 D. Punitive Approaches to Whistleblowing............................................................... 9 II. THE LIMITATIONS OF VOLUNTARY WHISTLEBLOWING ............................ 13 A. Failing to Reduce the Social Penalties of Whistleblowing .................................. 13 B. Failing to Adequately Enforce the Law .............................................................. 17 C. Permitting Employers to Ignore Whistleblower Allegations ............................... 20 III. SARBANES OXLEY AS COMPELLED WHISTLEBLOWING LEGISLATION ................................................................................................. 23 A. Forms of Compelled Whistleblowing ................................................................. 24 i. Duty to Engage in Internal Whistleblowing........................................................25 ii. Secondary Liability for Organizational Disclosures ..........................................26 iii. Duty to Investigate Wrongdoing ......................................................................27 B. Compelled Whistleblower Provisions in SOX .................................................... 27 i. Attorney Duty to Report and Investigate ............................................................28 ii. Executive Certification .....................................................................................31 iii. Expanded Audit Committee Duties...................................................................33 IV. THE BENEFITS OF COMPELLED WHISTLEBLOWING .................................. 36 A. Allocating the Risks of Whistleblowing to Those Best Able to Bear Them ........ 36 B. Reducing the Social Penalties of Whistleblowing ............................................... 39 C. Improving the Efficacy of Voluntary Whistleblowing ........................................ 41 D. Producing More Timely and Consistent Disclosures .......................................... 41 CONCLUSION............................................................................................................. 42
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Associate, Wilson Sonsini Goodrich and Rosati, Palo Alto, CA; B.A. 2002 Harvard College; J.D. 2006 Harvard Law School. I thank Christine Jolls, Michael Harper, Susan Carle, Guhan Subramanian, Roger Fisher and Alpana Gupta for their helpful thoughts and suggestions. Thanks also to the Harvard Negotiation Project for its support.
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INTRODUCTION Employment law has traditionally protected whistleblowers through antiretaliation remedies, which provide whistleblowers with a cause of action against their employer if they suffer retaliation for their protected disclosure.1 Through statutes such as the False Claims Act, 2 legislatures have also sought to encourage whistleblowing by offering financial rewards for disclosing wrongdoing. Courts are moving towards offering similar incentives to employers, rewarding them for developing internal mechanisms that prevent and remedy wrongdoing.3 Both anti-retaliation remedies and reward-based approaches to whistleblowing rely upon voluntary acts of disclosure. Neither requires either individual employees or organizations to act in the face of wrongdoing. As a result, voluntary whistleblower legislation suffers from a number of shortcomings both in advancing employee rights and the law enforcement function that whistleblowers serve. On one level, it is unlikely to protect whistleblowers from being marginalized in the workplace.4 This severe social penalty can lead employees to stay silent in the face of wrongdoing, sacrificing the public interest in law enforcement.5 On another level, voluntary whistleblower legislation is problematic because it does not force employers to conduct thorough investigations into the substance of whistleblower disclosures.6 A punitive approach to whistleblowing, which places individual liability on employees for failing to act in the face of wrongdoing, could help to address these limitations. However, employment law scholars have been almost universally opposed to mandatory whistleblowing, comparing it to Nazi Germany, Stalinist Russia, and McCarthyism.7 As a result, there has been little in the way of in-depth discussion on the subject. 8 Punitive approaches to whistleblowing are no longer a matter of mere conjecture, however, with the passage of the Sarbanes-Oxley Act of 2002 (“SOX”).9 SOX imposes whistleblower-like obligations on a number of highly placed corporate actors who work for public companies.10 For instance, attorneys must report evidence of securities fraud to the chief legal officer representing the company, who must initiate an investigation.11 1
See Section I(a) infra. See e.g. the False Claims Act 31 U.S.C. § 3729 (2000). See discussion infra section I(b). 3 See e.g. Faragher v. City of Boca Raton 524 U.S. 775 (1998). See discussion infra section I(c). 4 See Section II(a) infra. 5 See Section II(b) infra. 6 See Section II(c) infra. 7 See Stefan Rutzel, Snitching for the Common Good: In Search of a Response to the Legal Problems Posed by Environmental Whistleblowing, 14 TEMP. ENVTL. L. & TECH. J. L. 1, 43; James Fisher et al, Privatizing Regulation: Whistleblowing and Bounty Hunting in the Financial Services Industries, 19 DICK. J. INT’L L. 117, 130 (2000); Reinier H. Kraakman, Gatekeepers: The Anatomy of a Third-Party Enforcement Strategy, 2 J. OF L. ECON. & ORG. 53, 59 (1986). 8 See discussion infra section II(d). 9 Sarbanes-Oxley Act of 2002, H.R. 3763-2. See discussion infra sections III. 10 See discussion infra section III(B). 11 Sarbanes-Oxley § 307, discussion infra section III(B)(i). 2
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Executives must certify that the company’s financial statements comply with securities law.12 Members of the audit committee of the board of directors are also forced to take a more active role in receiving whistleblower complaints and investigating them.13 This article discusses the extent to which the disclosure-related liabilities imposed by SOX represent a form of compelled whistleblowing for attorneys, executives and audit committee members. I argue that compelled whistleblowing offers a number of previously unrecognized benefits. SOX presents a useful illustration of how compelled whistleblowing can be imposed on high ranking employees who are best able to bear the social penalties of whistleblowing. 14 Indeed, compelled whistleblowing may serve to reduce the stigma of whistleblowing over time 15 and increase organizational responsiveness to voluntary whistleblowers.16 Section I of this article provides an overview of the various forms of whistleblower legislation and scholarship evaluating them. Section II discusses some of the drawbacks of voluntary whistleblower legislation. Section III describes the compelled whistleblower provisions in SOX and how they fit within a corporate and securities law context. Finally, Section IV discusses the potential benefits of compelled whistleblowing. I. LITERATURE REVIEW Employment law scholarship has focused largely on three models of protecting whistleblowers17 and promoting the public interest their disclosures serve: anti-retaliation protections, whistleblower rewards, and employer incentives for investigating wrongdoing. Very little employment law scholarship has addressed punitive approaches to whistleblowing, although they have received some attention in the legal ethics literature.18 A. Retaliation-Based Remedies The primary means by which state and federal law has sought to protect whistleblowers is by providing them with a cause of action against their employer if they suffer retaliation for blowing the whistle.19 12
Sarbanes-Oxley §§ 302, 906, discussion infra section III(B)(ii). Sarbanes-Oxley §§ 301, 207, 407, discussion infra section III(B)(iii). 14 See discussion infra section IV. 15 See discussion infra section IV. 16 See discussion infra section IV. 17 Callahan and Dworkin describe two of the three whistleblower models I discuss – the “anti-retaliation” model and the “incentive” model. They do not distinguish between individual whistleblower rewards and organizational incentives to investigate. Elletta S. Callahan & Terry M. Dworkin, The State of State Whistleblower Protection, 38 AM. BUS. L. J. 99, 100 (2000). 18 See discussion infra Section I(D). 19 Where states recognize a wrongful discharge in violation of public policy claim, whistleblowers can bring a claim against their employer. See e.g. Palmateer v. International Harvester Co., 421 N.E.2d 876, 878 (Ill. 1981); Rocky Mountain Hosp. & Med. Serv. V. Mariani, 916 P.2d 519, 527 (Colo. 1996); Shea v. Emmanuel College, 682 N.E.2d 1348, 1350 (Mass. 1997). State whistleblower statutes also provide 13
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Protection for whistleblowers is neither universal nor uniform.20 Slightly more than half of states allow whistleblowers to bring a claim against their employer for common law wrongful discharge in violation of public policy.21 All states have enacted whistleblower protection statutes,22 although they vary considerably in terms of the type of employees and disclosures they protect. 23 Federal statutes provide protection for employees working in certain industries24 or for reporting violations of certain statutes.25 At both the state and federal level, the availability of whistleblower protections also depends on the recipient of the disclosure26 and the accuracy of the disclosure.27 whistleblowers with a cause of action against their employer. See e.g. Mich. Comp. Laws § 15.363 (2005); Cal. Lab. Code § 1105 (Deering 2006); N.Y. Labor Law § 740(4)(c) (Consol. 2006). Federal whistleblower statutes typically provide employees with an administrative remedy, with a right to appeal the administrative ruling in federal court. See e.g. Aviation Investment and Reform Act 49 U.S.C. § 42121(b) (2000); Clean Air Act 42 U.S.C. § 7622(b)-(c) (2000); Energy Reorganization Act 42 U.S.C. § 5851(b)-(c) (2000). Cf. Occupational Health and Safety Act § 11(c) 29 U.S.C. § 660 (2000)(providing an administrative remedy, and directing the Secretary of Labor to bring a claim in district court if the initial investigation determines that the employer retaliated against the whistleblower). 20 All federal employees are afforded whistleblower protection through the Civil Service Reform Act, as amended by the Whistleblower Protection Act of 1989. 5 U.S.C. § 2302 (2000), 5 U.S.C. § 1201 (2000). See also 5 U.S.C. § 1221 (2000)(providing federal whistleblowers with a federal remedy through the Merit Systems Protection Board). Other whistleblowers may or may not be protected, depending on the subject matter of their disclosure, the industry in which they are employed, and applicable state law. See discussion infra notes 23-27. 21 See Callahan and Dworkin, The State of State Whistleblower Protection, supra note 17, Appendix A (2000). 22 See Callahan and Dworkin. supra note 17 at 100. 23 Fifteen states provide whistleblower protection for all state employees, and sixteen other states provide protection for certain types of state employees. See Callahan and Dworkin. supra note 17 at Table II. A majority provide protection for certain employees in the health care industry. A majority of states also provide whistleblower protection for disclosures relating to workplace safety violations, and violations of civil rights. A minority provide protection for disclosures relating to child welfare, environmental violations, and violations of the minimum wage laws. See Callahan and Dworkin. at Table III. 24 See e.g. Aviation Investment and Reform Act 49 U.S.C. § 42121 (2000) (protecting airline employees for reporting violations of Federal Aviation Administration regulations); Energy Reorganization Act 42 U.S.C. § 5851 (2000) (protecting employees in the nuclear industry for reporting a violation of the Energy Reorganization Act or the Atomic Energy Act); Pipeline Safety Improvement Act 49 U.S.C. § 60129 (2000) (protecting employees of owners or operators of pipeline facilities for reporting a violation of any Federal law or regulation relating to pipeline safety). 25 Clean Air Act 42 U.S.C. § 7622 (2000) (protecting employees for reporting a violation of the Act); Federal Water Pollution Control Act 33 U.S.C. § 1367 (2000) (protecting employees for bringing or participating in an investigation into a violation of the Act); Occupational Safety and Act § 11(c) 29 U.S.C. § 660 (2000) (protecting employees for bringing or participating in an investigation into a violation of the Act)(hereinafter “OSHA”); False Claims Act § 31 U.S.C. § 3730(h) (2000) (protecting employees for bringing or participating in a claim under the Act alleging government fraud); Sarbanes Oxley Act of 2002 § 806, codified at 18 U.S.C.S § 1514A (Law Co-op. 2006) (protecting employees of public companies for reporting fraud and violations of securities law). 26 Some states only protect disclosures to the relevant government agency, while others only require disclosure to a public body. Elletta S. Callahan & Terry M. Dworkin, Who Blows the Whistle to the Media and Why: Organizational Characteristics of Media Whistleblowers, 31 AM. BUS. L. J. 151, note 38 (1994). Only one third of states protect whistleblowing to the media. Id at 157. The more recent federal whistleblower protections, such as the Aviation Investment and Reform Act § 42121(a)(1), the Energy Reorganization Act § 5851(a), and the Sarbanes Oxley Act § 1514A(a)(1), protect both internal whistleblowing (internal disclosures made within the employer’s organization) and disclosures made to the
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Even as there is considerable variation in the coverage of state and federal whistleblower claims, they almost all contain a retaliation element.28 State and federal whistleblower statutes typically prohibit employers from “discharg[ing] or otherwise discriminating” against a whistleblower for her disclosures. 29 Because this statutory language is vague, state and federal whistleblower jurisprudence tends to rely heavily on Title VII retaliation jurisprudence in defining “discriminate.” 30 The recent Supreme Court decision in Burlington Northern v. White defines retaliation broadly to include any action that might “dissuade a reasonable worker from making or supporting a charge of discrimination.” 31 In the whistleblower context, the White standard would prohibit employer actions that might dissuade a reasonable employee from blowing the whistle.32 federal government. Older statutes, such as the Clean Air Act § 7622 (a) and the Water Pollution Control Act §1367 only protect employees from retaliation if they bring a claim or cause a claim to be brought for violations of the Act. Callahan et al note that courts, especially at the federal level, are warming to internal disclosures as a legitimate form of whistleblowing. Elletta Callahan et al, Integrating Trends in Whistleblowing and Corporate Governance: Promoting Organizational Effectiveness, Societal Responsibility, and Employee Empowerment, 40 AM. BUS. L. J. 177, 190 (2002). 27 Most courts do not require that whistleblowers establish that their disclosure related to an actual violation of law in order to prevail. See Callahan and Dworkin supra note 21 at 120. A majority of courts only require that the disclosure was based on a objectively reasonable belief or good faith belief that wrongdoing had occurred. Id at 120-122. 28 See Elletta S. Callahan & Terry M. Dworkin, Do Good and Get Rich: Financial Incentives for Whistleblowing and the False Claims Act 37 VILL. L. REV. 273 (1992). 29 For example, the federal Aviation Investment and Reform Act § 42121, Energy Reorganization Act § 5851, and Clean Air Act § 7622, provide “No employer may discharge any employee or otherwise discriminate against any employee with respect to his compensation, terms, conditions, or privileges” for engaging in whistleblower activity protected by the act. The main California whistleblower statute only states that “an employer may not retaliate” against whistleblowers protected by the act. Cal. Lab. Code. § 1102.5. The Minnesota whistleblower statute imposes a fine on employers for “discharging or otherwise discriminating against any employee.” Minn. Stat. § 177.32 (2005). The New York whistleblower statute defines retaliation as “discharge, suspension or demotion of an employee, or other adverse employment action taken against an employee in the terms and conditions of employment.” N.Y. Labor Law § 740(e) (Consol. 2006). But see The Civil Service Reform Act refers to specific “personal practices” implicated by whistleblower statute, including appointments, promotions, disciplinary or corrective action, transfer, reinstatement, performance evaluation, decision concerning pay, and “any other significant change in duties, responsibilities, or working conditions. 5 U.S.C. § 2302(a). 30 Title VII case law uses the term “adverse employment action” to define what it means to “discriminate” against an employee for asserting their rights under Title VII. 42 U.S.C. § 2000e-3. See e.g. See White v. Burlington Northern, 364 F.3d 789, 795-799 (6th Cir. 2004), cert granted Dec. 5, 2005 (describing the origin of the “adverse employment action” element of retaliation claims). State courts and federal agencies have applied the “adverse employment action” standard in defining retaliation under state and federal statutes. In the California state claim, Yanowitz v. L’Oreal USA, the court noted that although “adverse employment action” was not in the statute, it represents “a familiar shorthand expression referring to the kind, nature, or degree of adverse action against an employee that will support a cause of action.” 116 P.3d 1123, 1135 (Cal 2005). In the federal context, the Department of Labor interpreted the SOX anti-retaliation provisions to “requir[e] that a complainant must show an "adverse action" as part of his case in chief.” Citing other administrative decisions brought under federal whistleblower statutes, the decision noted that most whistleblower decisions look to the Title VII retaliation jurisprudence, although a few have defined “adverse action” more liberally. See Hendrix v. American Airlines, U.S. Department of Labor Office of Administrative Law Judges, 2004-SOX-23 at 30 (December 9, 2004). 31 Burlington Northern v. White, 126 S. Ct. 2405, 2409 (2006). 32 Burlington Northern v. White has not yet been applied to the whistleblower context.
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Whistleblowers must also establish retaliation under common law claims. Wrongful discharge in violation of public policy claims traditionally require the plaintiff to show that he was terminated or constructively discharged for his whistleblowing.33 However, as statutory protections for whistleblowers have become more common,34 some state courts have expressed a willingness to apply broader statutory definitions of retaliation to wrongful discharge claims.35 Much of the scholarship on whistleblowing analyzes the patchwork of federal and state whistleblower protections. Recent research observes a growth in whistleblower protections at both the federal and state level, 36 accompanying an erosion of the traditional employment at-will doctrine.37 At the same time, researchers note that the specificity of federal and state statutes leaves many whistleblowers unprotected. 38 They also express concern at employers’ attempts to curb their liability to whistleblowers through confidentiality 39 and arbitration agreements. 40 In response, scholars tend to advocate stronger, more uniform anti-retaliation protection for whistleblowers. 41 SOX has received attention in the employment law literature for its antiretaliation provisions, which extend protection to employees of public companies who blow the whistle on corporate fraud.42 While scholars view the anti-retaliation provisions 33
See e.g. Petermann v. International Brotherhood of Teamsters, 344 P.2d 25, 28 (Cal. Ct. App. 1959) (presuming discharge as part of the claim); Turner v. Anheuser-Busch Inc. 876 P.2d 1022, 1029 (CA 1994)(requiring employee to demonstrate constructive discharge). Cf. Clark v. Columbia/HCA Information Services Inc., 25 P.3d 215, 220 (NV 2001)(recognizing wrongful discharge claim involving revocation of hospital privileges). 34 See Callahan and Dworkin, The State of State Whistleblower Protection, supra note 17 at Appendix A. 35 See Kulch v. Structural Fibers Inc, 677 N.E.2d 308, 321 (noting that a wrongful discharge claim can be based on “discharged or disciplined,” although the claim itself involved a discharge); Miller v. MedCentral Health System Inc, 2006 Ohio 63, p47 (OH 2006) (noting that whistleblowers could bring a statutory or common law claim for discharge or discipline). 36 See generally Callahan & Dworkin, The State of State Whistleblower Protection, supra note 17 (summarizing state whistleblower statutes and common law protections). 37 Amy M. Carlson, States are Eroding At-Will Employment Doctrines:Will Pennsylvania Join the Crowd?, 42 DUQ. L. REV. 511 (2004) (describing judicial erosion of the at-will doctrine in Pennsylvania, California, New Jersey and Michigan). 38 See Trystan Phifer O’Leary, Silencing the Whistleblower:The Gap Between Federal and State Retaliatory Discharge, 85 IOWA L. REV. 663 (2000). See also Callahan & Dworkin, The State of State Whistleblower Protection, supra note 17. 39 Terry M. Dworkin & Elletta S. Callahan, Buying Silence, 36 AM. BUS. L. J. 151, 179-191 (1998) (examining the growing prevalence of confidentiality agreements and their implications for whistleblowers). 40 Miriam A. Cherry, Whistling in the Dark? Corporate Fraud, Whistleblowers, and the Implications of the Sarbanes-Oxley Act for Employment Law, 79 WASH. L. REV. 1029, 1076-1080. 41 See generally, Elletta S. Callahan & Terry M. Dworkin, Who Blows the Whistle to the Media and Why, supra note 26 (examining the characteristics of media whistleblowers through an empirical study and advocating broader protections for media whistleblowers). See David C. Yamada, Voices from the Cubicle: Protecting and Encouraging Private Employee Speech in the Post-Industrial Workplace, 19 BERKELEY J. EMP. & LAB. L. 1, 39-44 (1998) (noting the complications of using whistleblower protections to protect employee speech); Thomas M. Devine & Donald G. Alpin, Whistleblower Protection: The Gap Between the Law and Reality, 31 HOW L. J. 223, 233-239 (1988) (criticizing the implementation of whistleblower protections for federal employees and describing problematic employer retaliation tactics). 42 Sarbanes-Oxley § 806.
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in SOX as a positive development in employment law,43 they note a number of respects in which the protections fall short.44 By contrast, the corporate governance provisions of SOX have been largely overlooked by employment law scholars, 45 although they have received extensive discussion in corporate law and legal ethics circles. 46 As I will argue, the corporate governance provisions are a significant development in employment law for the liability they impose on executives, attorneys and directors representing public companies. These liabilities amount to a form of compelled whistleblowing and could potentially serve as a useful supplement to traditional anti-retaliation protections for whistleblowers.47 B. Reward-Based Approaches Often characterized as an “incentive-based”48 or the “bounty-hunter”49 model, an alternate means of promoting whistleblowing consists of providing financial rewards to individual whistleblowers for their disclosures. Statutory rewards for whistleblowers are comparatively unusual.50 The False Claims Act51 is perhaps the most well-known statute offering whistleblower rewards, but the Federal Institutions Reform Recovery and Enforcement Act of 1989 (“FIRREA”) and the Insider Trading Sanctions Act, 52 as well as a few state statutes,53 also provide financial incentives for whistleblowers. 43
See Cherry supra note 40 at 1084; Leonard Baynes, Just Pucker and Blow?: An Analysis of Corporate Whistleblowers, the Duty of Care, the Duty of Loyalty, and the Sarbanes-Oxley Act, 76 ST. JOHN’S L. REV. 875, 896 (2002); Robert G. Vaughn, America’s First Comprehensive Statute Protecting Corporate Whistleblowers, 57 ADMIN L. REV. 1,4 (2005) (noting that the breadth and extraterritorial application of SOX may make it “the most important whistleblower provision in the world”). 44 See Cherry supra note 40 at 1085 (arguing that SOX does not force employers to take whistleblower disclosures seriously and is vulnerable to employer arbitration agreements); Leonard Baynes, supra note 43 at 896 (arguing that protection should extend beyond disclosures relating to corporate fraud and that the statute’s definition of retaliation is too narrow). But see John B. Chiara & Michael D. Orenstein, Whistler’s Nocturne in Black and Gold – the Falling Rocket: Why the Sarbanes-Oxley Whistleblower Provision Falls Short of the Mark, 23 HOFSTRA LAB. & EMP. L. J. 235, 262-268 (2005)(arguing that SOX is broader than most whistleblower protections and may make employers vulnerable). 45 The only in-depth discussion of the corporate governance provisions of SOX among employment law scholars comes from Miriam Cherry, who argues that SOX does not force audit committees to make a thorough investigation of whistleblower complaints. See supra note 40 at 1071-1076, and discussion infra section III(B)(iii). 46 See discussion infra section III(B). 47 See discussion infra sections III-IV. 48 See Callahan and Dworkin, The State of State Whistleblower Protection, supra note 17 at 101. 49 See generally Fisher supra note 7. 50 See Fisher supra note 7 at 138. 51 31 U.S.C. § 3730(b)(1) (1988). 52 See Marsha J. Ferziger & Daniel G. Currell, Snitching for Dollars: The Economics and Public Policy of Federal Civil Bounty Programs, 1999 U. ILL. L. REV. 1141, 1146-1147 (1999); Callahan & Dworkin, Do Good and Get Rich, supra note 28 at 278-280 (describing state whistleblower rewards, the Federal Institutions Reform Recovery and Enforcement Act of 1989 (“FIRREA”), and the Insider Trading Sanctions Act); Fisher et al supra note 7 at 135 (noting the reward provisions in the Internal Revenue Service rewards program, FIRREA, and the Insider Trading and Securities Fraud Enforcement Act). 53 Callahan & Dworkin, The State of State Whistleblower Protection, supra note 17 (noting that only a handful of states offer whistleblower rewards, even as incentives have been proven more effective).
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A number of scholarly articles have discussed the success of the False Claims Act both in recovering government funds and in rewarding whistleblowers.54 The False Claims Act allows whistleblowers who disclose frauds perpetrated against the federal government to share in the amount ultimately recovered.55 Scholars note that the Act has “recover[ed] more than three billion dollars between 1986, when the law was revised, and 1999.”56 Where the scale of the fraud is large, whistleblowers have been awarded millions of dollars.57 Callahan et al. argues that the threat of extraordinary False Claims recoveries has led employers to adopt effective internal whistleblower channels.58 Even as scholars tout the effectiveness of whistleblower rewards in promoting whistleblowing and argue that rewards should be offered more broadly, 59 they acknowledge the attendant costs of such rewards. The public may find the rewards unsavory,60 leading to a backlash against whistleblowers by coworkers suspicious of their motives.61 Critics of reward-based systems also argue that rewards will motivate frivolous claims. 62 As I will discuss in Section II, whistleblower rewards also share many of the limitations of anti-retaliation statutes. C. Employer Incentives for Investigating Wrongdoing A growing area of scholarship addresses a third method to promote whistleblowing: providing organizational incentives for employers to protect and support whistleblowers. This area of scholarship emerged in reaction to the federal Corporate Sentencing Guidelines, which provide for reduced penalties for organizations that attempt to detect and address wrongdoing,63 and the Supreme Court ruling in Faragher v. City of Boca Raton, 64 which provides employers with an affirmative defense in harassment cases where they take reasonable measures to prevent and address harassment.65 Under Faragher, the defense is available where the employer can demonstrate that it “exercised 54
See generally, Callahan and Dworkin, Do Good and Get Rich, supra note 28. See also Callahan and Dworkin, The State of State Whistleblower Protection, supra note 17 at 101; Fisher et al supra note 7 at n55. See generally, James B. Helmer Jr., How Great is Thy Bounty: Relator’s Share Calculations Pursuant to the False Claims Act, 68 U. CIN. L. REV. 737 (2000). 55 31 U.S.C. § 3730(b)(1) (1988). 56 Terry M. Dworkin, Corporate Governance, Stakeholder Accountability, and Sustainable Peace: Whistleblowing, MNCs, and Peace, 35 VAND. J. TRANSNAT’L L. 457, 465 (2002). 57 Callahan & Dworkin, Do Good and Get Rich, supra note 28 at 282. 58 Callahan et al supra note 63 at 190. See also note 54 (noting the size of whistleblower claims). 59 See Fisher et al, supra note 7 at 140-142 (using whistleblower incentives to regulate financial markets). 60 See Fisher et al supra note 7 at 143. 61 Callahan & Dworkin, Do Good and Get Rich, supra note 28 at 333. 62 Callahan & Dworkin, Do Good and Get Rich, supra note 28 at 325. 63 56 Fed. Reg. 22,787, 22,787-97 (1991). See Kimberly Krawiec, Corporate Decisionmaking: Organizational Misconduct: Beyond the Principle Agent Model, 32 FLA. ST. U. L. REV. 571, n29 (2005); Dworkin supra note 56 at 464; Elletta Callahan et al supra note 26 at 190. 64 524 U.S. 775 (1998). See also Burlington Indus., Inc. v. Ellerth, 524 U.S. 742 (1998). See Cynthia Estlund, Rebuilding the Law of the Workplace in an Era of Self-Regulation, 105 COLUMBIA L. REV. 319, 336-338 (2005); Susan Sturm, Second Generation Employment Discrimination: A Structural Approach, 101 COLUM. L. REV. 458, 463 (2001); Callahan et al. supra note 26 at 190. 65 Faragher 524 U.S. 805. See discussion infra at section III(d).
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reasonable care to avoid harassment and to eliminate it when it might occur, and that the complaining employee had failed to act with like reasonable care to take advantage of the employer's safeguards.”66 The legal status of the Corporate Sentencing Guidelines remains unclear as a result of the Supreme Court’s Ruling in United States v. Booker.67 To the extent they remain in effect, employers could be subject to reduced liability under the Guidelines for developing better procedures for handling whistleblowers.68 For its part, the Faragher defense is making inroads in the whistleblower context.69 Although much of the scholarship in this area is not whistleblower-focused, its analysis of internal compliance and reporting systems is directly applicable to the whistleblower context.70 Scholars in favor of providing organizational incentives argue that internal whistleblowing tends to be less harmful to the organization and the whistleblower; 71 that organizations are better positioned to serve a problem-solving role; 72 and that improving internal reporting mechanisms is in employers’ best interests.73 Those opposed to organizational incentives for investigating wrongdoing argue that internal systems are ineffective;74 that organizational incentives allow employers to under-invest in preventing and remedying wrongdoing;75 and that courts are not wellpositioned to evaluate internal compliance structures.76 As I will discuss in Sections IV and V, compelled whistleblowing similarly seeks to encourage organizations to investigate wrongdoing but does not suffer from these same pitfalls. D. Punitive Approaches to Whistleblowing Statutes that force employees to blow the whistle to government agencies or law enforcement officials are exceedingly rare. State and federal law requires doctors, teachers, and social workers to report suspected child abuse to state child protective 66
524 U.S. 805. See United States v. Booker 125 S. Ct. 738 (2005)(invalidating the federal sentencing guidelines). 68 See Callahan et al supra note 63 at 190. (noting that the Corporate Sentencing guidelines create incentives for employers to develop better internal whistleblower procedures). 69 See DiCentes v. Michaud, 719 A.2d 509, 513 (Me. 1998) (citing Faragher in analysis of state whistleblower claim); Hughart v. Raymond James, 2004-SOX-9 at 134-145 (applying Faragher affirmative defense to SOX whistleblower claim). See also Callahan et al supra note 28 at 192 (noting that internal reporting mechanisms developed for employees complaining about harassment offers incidental benefits to whistleblowers, who can make use of the same improved reporting mechanisms). 70 The Faragher defense has been applied in a few whistleblower claims. See note 69 infra. 71 See Dworkin supra note 56 at 463. 72 See Sturm supra note 64 at 462-463. 73 See Dworkin supra note 56 at 484-485. 74 See Estlund supra note 64 at 337-338; Krawiec supra note 63 at 596 (citing an empirical study of EEO internal compliance structures). 75 See Krawiec supra note 63 at 577; Michael C. Harper, Employer Liability for Harassment Under Title VII: A Functional Rationale for Faragher and Ellerth, 36 SAN DIEGO L. REV. 41, 59 (1999). 76 See Krawiec supra note 63 at 572, 580-581; Estlund supra note 64 at 337 (noting that the success of organizational incentives under Faragher depends on strong judicial oversight). 67
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services.77 Similarly, New Jersey and Florida require attorneys to reveal a client’s intent to commit a future crime.78 The common law crime of misprision of felony punishes citizens for failing to provide law enforcement with information about felonies but is rarely enforced. 79 Scholars have been strongly opposed to making whistleblowing mandatory. Punitive approaches to whistleblowing are viewed as an affront to civil liberties and have been compared to Nazi Germany, Stalinist Russia, and McCarthyism.80 Because mandatory whistleblowing is so rare and so uniformly opposed, it has not received much scholarly attention. Legal ethics scholars recently debated the issue, however, when the Securities and Exchange Commission (“SEC”) released proposed SOX regulations that would have required attorneys to withdraw from representation and alert the SEC of their withdrawal for “professional reasons” if a public company failed to respond properly to evidence of corporate fraud. 81 The so-called “noisy withdrawal” proposal was greeted with vehement opposition from the bar and from scholars alike.82 Critics argued that the rule would erode lawyer-client confidentiality, leading corporate clients to withhold important information from their attorneys. 83 In response, the SEC shelved the proposal and issued the SOX regulations without the “noisy withdrawal” rule.84 Even absent the noisy withdrawal rule, SOX contains a number of provisions that take a punitive approach to whistleblowing, imposing liability on various corporate actors who fail to act upon evidence of corporate fraud. Attorneys are required to blow the 77
DOUGLAS E. ABRAMS & SARAH H. RAMSEY, CHILDREN AND THE LAW 291 (2d ed. 2003); Kraakman supra note 7 (noting an Arizona child abuse reporting statute); Callahan & Dworkin supra note 54 at 332. 78 See Richard W. Painter, Rules Lawyers Play By 76 N.Y.U. L. REV. 665, n103 (2001). 79 Callahan & Dworkin, Do Good and Get Rich, supra note 28 at 331. Rutzel supra note 7 at 43. 80 See discussion supra note 7. 81 Marc I. Steinberg, Lawyer Liability After Sarbanes-Oxley -- Has the Landscape Changed?, 3 WYO. L. REV. 371, 372. 82 See William Simon, Wrongs of Ignorance and Ambiguity: Lawyer Responsibility for Collective Misconduct, 22 YALE J. ON REG. 1, 32 (2005) (describing the bar’s opposition to the “noisy withdrawal” requirement); Timothy P. Chinaris, More than the Camel’s Nose: The Sarbanes-Oxley Act as Bad News for Lawyers, Their Clients, and the Public, 31 OHIO N.U.L. REV. 359, 372-375 (2005)(opposing the noisy withdrawal rule); Hillary A. Sale, Banks: The Forgotten Partners in Fraud, 73 U. CIN. L. REV. 139, 141 (2004)(referring to SOX as imposing “mandatory whistleblowing” on lawyers, requiring them to “report on the lawyer’s clients”); Lisa H. Nicholson, Sarbox 307’s Impact on Subordinate In-house Counsel: Between a Rock and a Hard Place, 2004 MICH. ST. L. REV. 559, 569 (describing opposition to the “noisy withdrawal” requirement); Stephen M. Bainbridge and Christina J. Johnson Managerialism, Legal Ethics, and Sarbanes-Oxley Section 307, 2004 MICH. ST. L. REV. 299, 313 (2004) (noting opposition to the “noisy withdrawal” requirement). 83 See e.g. Laren C. Cohen, In-house Counsel and the Attorney Client Privilege: How Sarbanes-Oxley Misses the Point, 9 STAN. J. L. BUS. & FIN. 297, 313; Timothy P. Chinaris, supra note 82 at 378-379; Sale supra note 82 at 141. 84 Chinaris supra note 82 at 375 (2003)(noting that the SEC declined to adopt the “noisy withdrawal” rule); Susan S. Fortney, Chicken Little Lives: The Anticipated and Actual Effect of Sarbanes-Oxley on Corporate Lawyers’ Conduct, 33 CAP. U. L. REV. 61, 68 (2004) (noting that “practitioner outcry and organized bar opposition has chilled the SEC's enthusiastic rush to adopt rule provisions requiring lawyers to make an immediate ‘noisy withdrawal’”).
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whistle internally to the chief legal officer if they discover evidence of fraud.85 The chief legal officer, in turn, must launch an investigation into the evidence to determine whether a violation of securities law has occurred.86 Failure to comply with these rules makes attorneys liable for securities fraud.87 SOX also imposes whistleblower liability on executives, who must certify that their company’s public filings “fairly presen[t], in all material respects, the financial condition and results of operations” of the company. 88 In order to avoid liability, executives must choose between demanding revisions of flawed public filings and signaling a flaw to the market by refusing to certify the filing.89 SOX makes inaction in the face of corporate fraud a very risky option for executives. Finally, SOX imposes additional duties on the audit committee of the board of directors, by requiring it to develop procedures to receive whistleblower disclosures from employees. SOX also directs attorneys to report evidence of fraud to the audit committee if they determine that the chief legal officer failed to conduct an adequate investigation.90 Increased information flow to the audit committee subjects directors to increased liability because the receipt of such information triggers their duty of care under state corporate law to investigate and remedy the fraud.91 Though less punitive than SOX’s attorney and executive provisions, the additional burdens placed on the audit committee force them to take a more active role in investigating and remedying corporate wrongdoing. The liability that SOX imposes on attorneys, executives, and directors falls short of what is commonly understood as “mandatory whistleblowing” because SOX does not specifically require these corporate actors to disclose corporate fraud to a government or law enforcement agency. 92 Still, it represents an alternative means of encouraging employees to disclose and investigate wrongdoing internally. Rather than rewarding whistleblowers and organizations for disclosing and investigating wrongdoing, SOX seeks to hold individuals liable for failing to do so.
85
Sarbanes-Oxley § 307; 17 C.F.R. § 203(b). See discussion infra Section III(B)(i). 17 C.F.R. § 203(b)(2). 87 Simon Lorne, An Issue Annotated Version of the Sox Rules for Lawyer Conduct, PRACTICING LAW INSTITUTE, 65-66 (January 2006). 88 Sarbanes-Oxley §§ 302, 906. 89 See discussion infra Section III(B)(ii). 90 Sarbanes-Oxley § 307; 17 C.F.R. § 203(b). 91 See discussion infra Section III(B)(iii). 92 References to “mandatory whistleblowing” typically assume that the employee would be required to disclose the wrongdoing outside of the organization. See e.g. Kraakman supra note 7 at 58-59, Sale supra note 82 at 141. Of course, disclosing wrongdoing within an organization is a protected form of whistleblowing under many federal and state statutes. See Rutzel supra note 7 at 14-15 (noting that external whistleblowing to public authorities is always protected and that a majority of courts protect internal whistleblowing). In theory, the term “mandatory whistleblowing” could include mandatory internal whistleblowing but I use the term to refer only to mandatory external disclosures. 86
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Even as corporate law scholars criticize SOX as a departure from previous law, 93 the legislation is similar to the gatekeeping function that lawyers and other corporate agents have traditionally served. 94 Reinier Kraakman defines gatekeepers as “third parties who can disrupt conduct by withholding support.”95 For example, accountants play a gatekeeping role in SEC filings, as they may refuse to issue an unqualified audit letter regarding a company’s annual report if its financial statements are problematic.96 Similarly, attorneys serve a gatekeeping role in certain SEC filings that require legal opinions.97 Gatekeeping is enforced through the market, which treats the absence of an endorsement as a “red flag.”98 It is also enforced by imposing liability on gatekeepers who endorse disclosures that are financially or legally defective.99 Kraakman notes that the difference between gatekeeper liability and a whistleblowing duty is “a subtle but important question of degree.”100 While a mandatory whistleblower rule would require a third party to report wrongdoing, 101 gatekeeper regimes leave room for errant organizations to avoid detection. Gatekeeper regimes often permit corporations to shop for more permissive gatekeepers if their original gatekeepers refuse to endorse a transaction.102 The “red flags” raised by gatekeeping also tend to be ambiguous, representing “only partial disclosure to the prospective buyer, and, more to the point, no disclosure at all to other prospective buyers.”103 As I will discuss in Section III, I use the term “compelled whistleblowing” to refer to a variety of disclosure-related liabilities that fall short of mandatory whistleblowing.104 Unlike mandatory whistleblowing, compelled whistleblowing does not necessarily require individual employees to inform government agencies of 93
Roberta Romano, The Sarbanes-Oxley Act and the Making of Quack Corporate Governance, 114 YALE L. J. 1521, 1523 (2005) (arguing that SOX “is not just a considerable change in law, but a departure in the mode of regulation,” because SOX encroaches on corporate governance regulation that had previously been left to the states); Larry C. Backer, Surveillance and Control: Privatizing and Nationalizing Corporate Monitoring after Sarbanes-Oxley, 2004 MICH. ST. L. REV, 327, 341 (2004) (arguing that SOX creates privatized surveillance); John Paul Lucci, Enron: The Bankruptcy Heard Around the World and the International Ricochet of Sarbanes Oxley, 67 ALB. L. REV. 211, 217 (2003) (noting that “foreign commentators criticized Sarbanes-Oxley as a hastily drafted, quick-fix to corporate governance problems”). 94 Sale supra note 82 at 408 (noting that SOX “is an attempt to address the gatekeeping concerns” raised by Enron). William Simon argues that SOX is the “ culmination of an important trend toward norms that narrow the range for excuses based on ignorance and ambiguity by encouraging or requiring inquiry and articulation.” Supra note 82 at 2. 95 Kraakman supra note 7 at n2. 96 See Kraakman supra note 7 at 54. 97 See Kraakman supra note 7 at 54. 98 See Kraakman supra note 7 at 58. 99 Kraakman supra note 7 at 54. 100 Kraakman supra note 7 at 58. 101 Kraakman’s definition of whistleblowing does not include what would now commonly be termed “internal whistleblowing” – reporting wrongdoing to an official within the organization. Supra note 7 at 5859. 102 Kraakman supra note 7 at 58. 103 Kraakman supra note 7 at 58. 104 In a footnote, Kraakman notes that “a fuller account of whistleblowing and gatekeeping in market certification contexts might detail in a spectrum of intermediate strategies based on how widely – and how explicitly – the gatekeeper/whistleblower is required to disclose incipient wrongdoing.” supra note 7 at n10.
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wrongdoing committed by others. Instead, compelled whistleblowing legislation imposes liability on employees for failing to internally report, investigate, or correct the misfeasance of others. Imposed on corporate insiders, compelled whistleblowing may prove to be more coercive than gatekeeper liability because it restricts the corporation’s ability to evade their legal obligations by shopping for gatekeepers. 105 Scholars have not examined the corporate governance provisions of SOX as compelled whistleblower legislation, nor have they discussed how they compare to other means of regulating whistleblowers. I now turn to some of the limitations of traditional whistleblower legislation, and how compelled whistleblowing could serve as a useful supplement in addressing those limitations. II. THE LIMITATIONS OF VOLUNTARY WHISTLEBLOWING Non-punitive means of regulating whistleblowers – anti-retaliation remedies, whistleblower rewards, and organizational incentives – rely on volunteers to expose and investigate organizational wrongdoing. As such, they suffer from a number of limitations. First, they generally fail to reduce the stigma of whistleblowing. As a result, they tend to produce too few disclosures Finally, they often permit organizations to conduct insufficient investigations into whistleblower allegations or to ignore them entirely. A. Failing to Reduce the Social Penalties of Whistleblowing In theory, anti-retaliation protections for whistleblowers would deter employers from retaliating against whistleblowers. Damages from whistleblower actions would encourage employers to alter their policies and procedures for dealing with whistleblowers in order to lower their litigation risks. The deterrent effect would presumably be especially strong in the False Claims context, 106 where large whistleblower recoveries could impose a significant financial burden on the company. Despite the statutory protections available, however, the empirical evidence demonstrates continuing retaliation against whistleblowers. Whistleblowers suffer heavy psychological and professional costs for their disclosures. A survey of 84 whistleblowers found that “82% experienced harassment after blowing the whistle, 60% were fired, 17% lost their homes, and 10% admitted to attempted suicide.”107 Another study found that whistleblowers and their families suffer decreased physical and emotional health.108 Even when whistleblowers are ultimately vindicated, like the pair of NASA engineers who disclosed the technical failures that led to the Challenger disaster, they are often subject to continuing social marginalization by co-workers.109 105
See discussion infra Section III(A)(ii). See supra note 58. 107 David Culp, Whistleblowers: Corporate Anarchists or Heroes? Towards a Judicial Perspective, 13 HOFSTRA LAB. & EMP. L.J. 109, 113 (1995) (citing Andrew W. Singer, Patriot or Bounty Hunter, ACROSS THE BOARD, Nov. 1992, at 16, 21). 108 Devine & Alpin, supra note 41 at 236 (citing Hearings on H.R. 25 before the Subcomm. on Civil Service of the House K2-63 Committee on Post Office and Civil Service (1987) (statement of Dr. Donald Soeken)). 109 See Culp supra note 107, at 113. 106
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Admittedly, the studies examining whistleblower retaliation date back to the 1980’s and 1990’s, and may fail to capture any subsequent cultural shift in attitudes towards whistleblowers. Evidence demonstrating a drastic reduction in whistleblower retaliation is, however, lacking. While those outside the organization applaud a whistleblower’s actions, those within the organization can remain ambivalent. Even as Sherron Watkins, the famed Enron whistleblower, was declared one of Time Magazine’s “Persons of the Year,”110 she complained that she was made to feel like an outcast at the company.111 Her marginalization reflects the reality that whistleblowing conflicts with other values that corporate America holds dear. External whistleblowing can conflict with an employee’s duty of loyalty to his employer.112 Internal whistleblowing can be perceived as a form of insubordination, particularly where the whistleblower disregards customary reporting structures in disclosing the wrongdoing.113 At best, workplaces are divided on the propriety of whistleblowing, where some co-workers side with whistleblowers, and others seek to discredit them.114 Scholars view continuing retaliation against whistleblowers as a sign that whistleblower remedies are not strong enough. Miriam Cherry suggests broadening whistleblower protection to include all private employees who disclose violations of federal law.115 Elletta Callahan and Terry Dworkin advocate extending protections to whistleblowers that make disclosures to the media. 116 Others propose extending the incentive-based model, either by making rewards available to whistleblowers or by offering whistleblowers multiple damages, punitive damages or attorney’s fees.117 They seem to assume that if only damages were sufficiently steep, 118 employers would be deterred from retaliating against whistleblowers. Strengthening whistleblower remedies, however, would not necessarily prevent retaliation against whistleblowers. First, even if an employer changes its official policies and procedures in dealing with whistleblowers, it suffers from an agency problem. The 110
Richard Lacayo & Amanda Ripley, “Persons of the Year,” TIME, Dec. 30, 2002, at 30. Time Magazine, “Person of the Week: ‘Enron Whistleblower’ Sherron Watkins, Frank Pellegrini,” January 18, 2002. Available at: http://www.time.com/time/pow/article/0,8599,194927,00.html. 112 See Baynes supra note 43 at 885; Rutzel supra note 7 at 25 (noting that employment contracts have an implied duty of loyalty, obedience and confidentiality); Culp supra note 107 at 115 (noting that a “deep sense a deep sense of institutional loyalty…lies within the heart of most employees…even in the face of damaging evidence of wrongdoing, and at the expense of their more altruistic co-workers”). 113 See Rutzel supra note 7 at 33 (noting that “when whistleblowing circumvents the existing structure of internal responsibility and supervision, it implicitly criticizes the effectiveness of existing systems of internal control, weakens the chain of command and constitutes unpredictable behavior.”) 114 Fisher et al. supra note 7 at 134. 115 Cherry supra note 40 at 1085. 116 See Callahan & Dworkin, Who Blows the Whistle to the Media and Why, supra note 26 at 179. See also Culp supra note 107 at 135 (arguing that whistleblowers should be protected “regardless of the party to whom the party reports corporate wrongdoing”). 117 See generally James Fisher et al supra note 7. See also Callahan & Dworkin, The State of State Whistleblower Protection, supra note 17 at 110 (noting that whistleblower protections offering financial incentives are more effective than anti-retaliation protections). 118 See Fisher et al supra note 7, at 143. See also Stefan Rutzel supra note 7 at 51 (advocating compensatory damages, punitive damages and litigation cases in whistleblower claims). 111
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whistleblower’s supervisors and colleagues tasked with implementing a no-retaliation policy may have self-interested or social reasons for engaging in informal retaliation. Those who appear implicated in the wrongdoing, even by failing to blow the whistle themselves, have a personal incentive to marginalize the whistleblower. Especially if they perceive themselves as honest and ethical, they may struggle with cognitive dissonance, trying to reconcile their self-image with their failure to report or correct the wrongdoing.119 This dissonance is often resolved against the whistleblower, where the supervisor or coworker concludes that the whistleblower has questionable motives, is exaggerating the gravity of the situation, or lacks social skills. Even where organizational incentives reward companies who take “reasonable measures,” 120 an agency problem remains: employees tasked with investigating whistleblower allegations may also find themselves discrediting the whistleblower. Employees may marginalize the whistleblower out of self-preservation, fearing that they will suffer social sanctions for siding with the whistleblower121 or for asking too many questions. 122 Employees may also be influenced by the psychological phenomenon of “social proof”: if they see other employees treating a whistleblower badly, they assume that the whistleblower somehow deserves it.123 In addition, if the investigating employee exposes large-scale wrongdoing that threatens the viability of his department or the entire company, others may view her as a threat to their job security.124 Moreover, even where anti-retaliation protections are strong, co-workers can find ways to covertly marginalize whistleblowers that are not legally actionable. The recent Supreme Court decision, Burlington Northern v. White, takes a broad view of what constitutes retaliation under Title VII, defining it as any action that might “dissuade a 119
See Robert Prentice, Enron: A Brief Behavioral Autopsy, 40 AM. BUS. L. J. 417, 424 (using cognitive dissonance theory to understand employee and auditor failure to expose Enron); Donald C. Langevoot, Where were the Lawyers? A Behavioral Inquiry into Lawyer’s Responsibility for Clients’ Fraud, 46 VAND. L. REV. 75, 102-105 (1993)(arguing that cognitive dissonance theory to describe why lawyers tend not notice or reveal client fraud). See generally, LEON FESTINGER, A THEORY OF COGNITIVE DISSONANCE (1957). 120 Faragher v. City of Boca Raton, 524 U.S. 805. 121 Even where the employee privately believes the whistleblower, conformity pressure may lead coworkers to publicly denounce the whistleblower. See Cass R. Sunstein, Deliberative Trouble? Why Groups go to Extremes, 110 YALE L. J. 71, 79 (citing a study by Solomon Asch where subjects purposefully gave the wrong answer to an easy problem because those preceding them in the task also gave the wrong answer). 122 Rutzel notes:“empirical research suggests a tendency of the organization to resist the change sought by the whistleblower rather than to correct its behavior.” Supra note 7 at 41. 123 See Prentice supra note 119 (using the theory of social proof, that “we all tend to take our cues for proper behavior from those around us,” to explain employee failure to act in the Enron case). For example, a recent study found evidence of social proof in investment bank and brokerage houses’ decision of whether to adopt or abandon coverage of a focal firm. Hayagreeva Rao & Henrich Greve, and Gerald F. Davis, Fool’s Gold: Social Proof in the Initiation and Abandonment of Coverage by Wall Street Analysts, 46 ADMIN. SCIENCE Q. 502, 521 (2001). See generally ROBERT CIALDINI, INFLUENCE: SCIENCE AND PRACTICE (1993). 124 See Callahan and Dworkin, The State of State Whistleblower Protection, supra note 17 at 164 (noting that whistleblowers are at high risk of retaliation when the organization is “highly dependent” on the wrongdoing at issue, and the whistleblowing becomes a “threa[t] to their vital interests.”)
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reasonable worker from making or supporting a charge of discrimination.”125 However, even this generous standard excludes “petty slights or minor annoyances that often take place at work.”126 The court notes that while exclusion from a “weekly training lunch that contributes to an employee’s professional advancement” 127 might be actionable, a supervisor’s refusal to invite an employee to lunch would normally be considered trivial. Practically speaking, even though social exclusion may in fact deter whistleblowers, “snubbing by supervisors and co-workers” 128 is apparently permissible. 129 Thus, someone like Sherron Watkins, who was “made to feel like an outcast”130 but suffered no tangible reprisals for her whistleblowing,131 would not have a cognizable retaliation claim under the Supreme Court’s new standard.132 Whistleblowers who choose to bring a claim against their employer find that litigation tends to worsen rather than improve their workplace environment and prospects. Under a mixed-motive framework, which some states have applied to whistleblowers,133 an employer can avoid certain damages or avoid liability entirely by demonstrating by a 125
Burlington Northern v. White, 126 S. Ct. 2405, 2409 (2006). Id. at 2414. 127 Id at 2416. 128 Id, quoting 1 B. Lindemann & P. Grossman, Employment Discrimination Law 669 (3d ed. 1996). 129 Graham v. Omaha Housing Authority, 2006 U.S. Dist. LEXIS 52520 (D.C. Neb. 2006)(quoting White v. Burlington’s citation of Lindeman & Grossman’s treatise in explaining that “snubbing” is not actionable). 130 See Time Magazine, supra note 108. 131 Five months after her whistleblowing activity, Watkins remained employed with Enron, and her lawyer reported that “there were no retaliations by those colleagues still around these days.” See Time Magazine supra note 111. This is consistent with the advice of Enron’s outside employment counsel, written in response to a now infamous e-mail from Enron inquiring whether Watkins could be fired. Even though Enron’s counsel noted that whistleblower protections in Texas were weak, he advised the company not to retaliate against her and provided detailed instructions on how to avoid formally retaliating against her. He advised that they could honor her request to transfer positions, but should ensure that it has comparable responsibilities and compensation. Watkin’s new boss should also be informed of the situation but be advised that “it is important that she not be treated adversely or differently because she made the report.” See Carl Jordan, Email on “Confidential Employee Matter” August 24, 2001, included in 148 CONG. REC. S1785-1792 (2002). 132 Of course, whistleblowing is not covered by Title VII and the Supreme Court’s standard in Burlington would only apply to the extent SOX or other anti-retaliation provisions follow Title VII jurisprudence. See discussion supra note Error! Bookmark not defined.. 133 Many federal and state claims follow the “mixed motive” standard established in Title VII jurisprudence, requiring plaintiffs to show that the protected activity was a “motivating factor” in the retaliation. See Price Waterhouse v. Hopkins, 490 U.S. 228, 244 (1988). See e.g. Aviation Investment and Reform Act § 42121(b)(2)(B)(1) (“contributing factor” causation standard), Sarbanes Oxley Act § 1514A(b)(2)(c) (“contributing factor” causation standard) , Kinzel v. Discovery Drilling, 93 P.3d 427, 436 (Alaska 2004)(finding that worker terminated after filing worker’s compensation claim entitled to “mixed motive” jury instructions). But see O’Rourke v. Dep’t of Corr., 778 A.2d 1194, 1204 (PA 2000) (requiring plaintiffs to establish “but for” causation); Continental Coffee Prods. Co. v. Cazarez, 937 S.W.2d 444, 450 (TX 1996) (“but for” causation). Some states have allowed plaintiffs to use the McDonnell Douglas framework to establish causation. See e.g. Fleming v. Corr. Health Care Solutions, 751 A.2d 1035, 10411042 (NJ 2000) (noting that plaintiff can establish causation by showing that the employer’s non-retaliatory reason is pretextual). In some states, proximity in time between the protected activity and the adverse employment action can give rise to a causal inference. See e.g. Dicentes v. Michaud, 719 A.2d, 509, 515 (ME 1998). But see West v. General Motors 665 N.W.2d 468, 473 (MI 2003)(temporal proximity not sufficient to show causation). 126
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preponderance of the evidence that it would have taken the same adverse employment action if the whistleblowing had not occurred. This gives employers an incentive to argue that the whistleblower was a terrible employee and deserved to be fired or demoted.134 Even if a whistleblower is awarded reinstatement, she will return to working relationships that have been irreparably tarnished. 135 Alternately, make whole damages will not adequately compensate an employee who works in a tight-knit industry, where she may have difficulty finding another job once branded as a ‘troublemaker.’ 136 Increasing the damages available to whistleblowers would only seem to worsen the extent to which those who bring whistleblower claims are viewed as a threat to the organization. Moreover, whistleblower-friendly legal norms may not translate into office norms over time because voluntary whistleblowing suffers from a selection effect. To the extent whistleblowing imposes social penalties, it will be least costly for those who have few social resources to begin with. An employee who is already marginalized by her coworkers may be more likely to blow the whistle because she has little to lose. Similarly, a poor performer may be motivated to blow the whistle in order to retain the threat of an anti-retaliation suit.137 Even when these already marginalized whistleblowers make valuable disclosures, their lack of credibility limits the effectiveness of such disclosures. Whistleblower rewards only serve to exacerbate the problem, by suggesting that whistleblowers are motivated by greed.138 To the extent that disgruntled employees are overrepresented among whistleblowers, they tend to raise suspicion about even those genuinely motivated by the public interest. As a result, the persistent social penalties of whistleblowing are unlikely to be resolved through voluntary whistleblower provisions alone. B. Failing to Adequately Enforce the Law 134
See Kinzel v. Discovery Drilling Inc., 93 P.3d at 435 (employer avoids liability through showing it would have taken the same employment action). Cf. Desert Palace, Inc. v. Costa, 539 U.S. 90 (2003) (holding that damages are limited in Title VII claims where the employer proves it would have taken the same employment action absent the discrimination). This gives the employer an incentive to argue that the whistleblower was a poor performer. See also, Fisher et al. supra note 7 at 134 (observing that “coworkers feel the tensions and may be drawn into attempts by the whistleblower to gather evidence against the employer, or by the employer to cover up evidence or to discredit the whistleblower.”) 135 Fisher et al. argue: “Because whistleblowers' access to information generally flows from their close relationship with the wrongdoers, as employees, co-workers, insiders of various types, and even family members, whistleblowers risk retaliation from the wrongdoer - dismissal, demotion, ostracism, blacklisting.” supra note 7 at 128. 136 See Pamela H. Bucy, Information as a Commodity in the Regulatory World, 39 HOUS. L. REV. 905, 953 (2002) (reporting empirical study finding that whistleblowers had difficulty obtaining new employment); Culp supra note 107 at 113 (describing a female coal miner who believes she was blackballed by the industry after complaining about sexual harassment). 137 Note however, that these employees would have limited remedies, depending on whether the jurisdiction applies the PriceWaterhouse “mixed motive” standard of proof, where the employer can prove by a preponderance of the evidence that it would have taken the same adverse employment action absent the whistleblowing. See discussion supra note 133. Even where the employer can avoid liability entirely under the PriceWaterhouse framework, the employee would be better off blowing the whistle, because the nuisance value of a whistleblower claim is more valuable than none at all. 138 See Callahan & Dworkin, Do Good and Get Rich, supra note 28 at 333.
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A central justification for whistleblower remedies has been to protect the law enforcement role that whistleblowers serve in bringing wrongdoing to light. In “Silencing the Whistleblower: The Gap Between Federal and State Retaliatory Discharge Laws,” Trystan Phifer O’Leary observes that whistleblower protections were tacked onto a number of federal statutes as a law enforcement mechanism. 139 He notes, “[t]he primary goal of many federal statutes, therefore, is not protection of the whistleblower. Rather, provisions protective of whistleblowers were included primarily as tools by which to advance the objectives of the legislation.” 140 The law enforcement role of whistleblowers has become increasingly central as the budgets of regulatory agents shrink.141 Whistleblowing seems like a low cost form of law enforcement. Unlike government officials, whistleblowers are already insiders; they do not incur any information gathering costs to detect wrongdoing.142 Moreover, whistleblowers perform their public service free of charge. The only resource they demand of the government is an administrative or judicial remedy if their employer retaliates against them for their law enforcement activity. Whistleblower disclosures, however, sometimes impose costs on their employer. Internal whistleblowing can strain working relationships, resulting in lost productivity.143 External whistleblowers can disclose confidential information or inaccurate information that hurts the company’s business.144 Although employers can sometimes recoup such losses under a contractual claim against the employee for breach of loyalty or confidentiality, 145 most states protect employees who make erroneous disclosures based on good faith or a reasonable belief.146 Whistleblower protections and rewards alike tend to cover a broad range of employees, rather than making distinctions based on expertise or access to information. Federal statutes tend to cover either all employees working in certain sectors or all employees who make certain disclosures.147 Similarly, state whistleblower statutes and common law claims tend not to distinguish among employees, although those states requiring more than a good faith basis for whistleblowing sometimes take expertise into
139
O’Leary supra note 38 at 663. O’Leary supra note 38 at 663. 141 Thomas Egan, Comment: Wrongful Discharge and Federal Preemption: Nuclear Whistleblower Protection under State Law and Section 210 of the Energy Reorganization Act, 17 B.C. ENVTL. AFF. L. REV. 405, 405 (1990). 142 Id. at 406. 143 See Fisher et al supra note 7 at 133. 144 See discussion in supra note 82. See also Callahan and Dworkin, Buying Silence, supra note 36 at 176178; Fisher et al supra note 7 at 134 (noting the financial costs to the employer of whistleblowing). 145 See Callahan and Dworkin, Buying Silence, supra note 39 at 176-178. 146 See Callahan and Dworkin, The State of State Whistleblower Protection, supra note 17 at 120-122. 147 See discussion supra at note 40-41. 140
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account.148 As a result, voluntary whistleblower statutes have an over-inclusive quality, in that they cover employees who are not necessarily well-placed to recognize a violation of the law. This can produce disclosures that are both harmful to the employer and of questionable use to law enforcement. Anti-retaliation statutes necessarily struggle with a trade-off between breadth and precision. One might imagine that an airline mechanic would be much better suited to detect a safety violation than an employee scanning tickets at the ticket desk, but narrowing whistleblower protections to only airline mechanics would also sacrifice protection for the rare ticket checker who overhears an airline mechanic expressing grave doubts about the safety of an aircraft. Extending protection for the ticket checkers, however, also means protecting their good-faith but ill-informed safety disclosures and encouraging nuisance suits involving bad-faith and ill-informed safety disclosures. 149 Limiting whistleblower protections to only accurate disclosures, however, would create a chilling effect, since it is often unclear to the whistleblower ex ante whether her credible suspicions of wrongdoing are correct. As a result, the scope of whistleblower coverage cannot be altered without either sacrificing some valuable disclosures or producing some undesirable disclosures. However, the primary limitation of voluntary whistleblower statutes from a law enforcement perspective is that they produce too few whistleblowers. Because voluntary whistleblower statutes fail to reduce many of the social and professional risks of whistleblowing, many employees are reasonably deterred from bringing wrongdoing to light. Such employees can rationalize their behavior on the often accurate belief that others are aware of the wrongdoing and that others would do something if it were really a problem. 150 This is known as the “bystander effect” in social psychology, where groups fail to act in emergencies because individuals assume that others will intervene or that others are failing to act because the situation does not merit attention. 151 This phenomenon is especially prevalent in situations where those in a position of authority fail to respond to the problem.152
148
See e.g. Geary v. United States Steel Corp., 319 A.2d 174, 179 (PA 1974) (finding that the salesman plaintiff was not sufficiently expert to blow the whistle on the safety of employer’s product, even though it was withdrawn from the market subsequent to his disclosure). 149 See supra note 27 (discussing “good faith” and “reasonableness” standard). 150 See David Luban, Making Sense of Moral Meltdowns, LAWYERS’ ETHICS AND THE PURSUIT OF SOCIAL JUSTICE, 355, 366 (Susan Carle, Ed., 2005) (applying the bystander effect to the failure to blowing the whistle on Enron). 151 Some famous examples of the bystander effect include the murder of Kitty Genovese, where dozens of neighbors witnessed the murder and failed to call the police, and a psychology experiment by John Darley and Bibb Latane where subjects failed to act in staged emergencies where smoke filled the experiment room. Interestingly, the subjects responded to the emergency when they were in the experiment room alone. Id at 366 (citing John Darley and Bibb Latane, Bystander Intervention in Emergencies: Diffusion of Responsibility, 8 J. PERSONALITY AND SOC. PSYCHOL. 377 (1968). 152 Stanley Milgram’s experiments on authority, where subjects proved compliant in administering what they believed to be increasingly severe electric shocks to a person after being directed to do so by a man in a white lab coat, suggests that compliance is easier to induce than it seems. Id at 367-368.
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In the context of whistleblowing, the “bystander effect” means that when wrongdoing is disclosed at all, it is often too late to mitigate much of the harm. Dozens of WorldCom employees, for instance, purportedly knew about WorldCom’s fraud but said nothing. 153 Sherron Watkins, the celebrated Enron whistleblower,154 acknowledged that she witnessed questionable practices for years before finally raising them with Chairman Kenneth Lay in 2001, 155 after much of the damage at Enron was already done.156 C. Permitting Employers to Ignore Whistleblower Allegations Voluntary whistleblower legislation faces an additional law enforcement limitation with respect to internal whistleblowers – those who disclose wrongdoing to a supervisor or other official within the organization rather than making the disclosure outside the organization. Anti-retaliation remedies allow organizations to ignore internal whistleblowers, as long as they do not engage in formal retaliation. Organizational incentives to investigate whistleblower complaints only make the problem worse. i. Anti-Retaliation Remedies The structure of most whistleblower protections as anti-retaliation claims 157 privileges employee rights over law enforcement in some circumstances. Anti-retaliation claims typically require a showing of three elements: disclosure, retaliation, and causation. 158 Both internal and external disclosures are generally protected by whistleblower statutes.159 When an employee engages in external whistleblowing to a government agency, anti-retaliation laws function the way they were intended. The public interest is protected through the government agency, which can seek to remedy or punish the wrongdoing. The employee’s interests in retaining her job are protected through the anti-retaliation laws.
153
See Cherry supra note 40 at 1041 (citing the Wall St. Journal). For a discussion of Watkin’s whistleblowing activity see Cherry supra note 40 at 1036-1040. 155 Wendy Zellner, An Insider’s Tale of a Toxic Culture, BUSINESS WEEK, March 31, 2003 at16 (reviewing Sherron Watkins’ book). 156 Watkins’ August 2001 e-mail to Kenneth Lay concerned questionable transactions from 1999 and 2000. A copy of the e-mail is available at: http://www.itmweb.com/f012002.htm. 157 See discussion supra, Section I(a). 158 See e.g. Wells v. N. Carolina Dept. of Correction, 567 S.E.2d 803 (2002) (applying the North Carolina whistleblower statute); Patten v. Grant Joint Union High School District, 37 Cal. Rptr. 3d 113, 166 (Cal. Ct. App. 2005) (applying the California whistleblower statute) ; Heckmann v. City of Detroit, 705 N.W. 2d 689, 697 (Mich. App. 2005) (applying the Michigan whistleblower statute). These elements originate from the Title VII retaliation context. See e.g. White v. Burlington Northern, 364 F.3d 789, 796(6th Cir. 2004) (outlining these three elements in Title VII retaliation claims). 159 See Rutzel supra note 7 at 14-15 (noting that external whistleblowing to public authorities is always protected and that a majority of courts protect internal whistleblowing). 154
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When internal whistleblowing is involved, however, the trade-off between employee protection and law enforcement becomes apparent. When an employee discloses wrongdoing to a supervisor, the employer is unlikely to disclose the wrongdoing to a government agency. 160 The employer, then, is left to serve the law enforcement role. This gives employers the discretion to make cursory investigations or ignore whistleblower allegations entirely if to do so would save money. 161 These incentives are particularly acute when the cost of remedying the wrongdoing is high, the likelihood that the agency will discover the violation independently is low, or the penalties associated with the wrongdoing are low. Moreover, the threat of an anti-retaliation suit does not serve as a strong deterrent in this context. Anti-retaliation suits punish employers who retaliate but not those who simply ignore the wrongdoing. A claim brought by an employee who suffered no retaliation but whose employer failed to properly investigate the wrongdoing will be dismissed, for failure to prove the retaliation element. This encourages employers to invest in compliance programs aiming to reduce formal retaliation against whistleblowers but not in systems to detect and remedy wrongdoing. Of course, a whistleblower can force an employer to take her complaints seriously by threatening to disclose the wrongdoing to law enforcement. 162 However, employers can avoid or mitigate this risk by purporting to act on the information provided while doing little of substance, a fact which employees often have difficulty verifying. 163 Whistleblowers may also be reluctant to escalate the existing conflict with their employer generated by the initial disclosure. Having received a taste of the social penalties associated with whistleblowing, they may not want to further antagonize supervisors and coworkers. Particularly where the employer makes a half-hearted effort to remedy or punish the wrongdoing, the whistleblower may have a difficult time arguing for a more aggressive response without being perceived as vengeful or bitter. As a result, the law enforcement potential of internal whistleblowing is compromised. ii. Employer Incentives to Investigate Wrongdoing The Corporate Sentencing Guidelines and the Faragher decision were both intended to encourage employees to investigate employee complaints by reducing their liability for doing so.164 But as Michael Harper argues, these reforms actually serve to reduce an employer’s incentive to investigate.165 Faragher provides employers with an affirmative defense in harassment cases where the employer “exercised reasonable care to avoid harassment and to eliminate it 160
In some instances, however, organizations have a legal duty to disclose certain information to the public or to government agencies. Securities regulations, for example, require public companies to make disclosures. See discussion supra at Section III(A)(i). 161 See Rutzel supra note 7 at 35. 162 See Rutzel supra note 7 at 48. 163 See Rutzel supra note 7 at 35. 164 See discussion section I(c) supra. 165 Harper supra note 75 at 59.
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when it might occur.” 166 In the whistleblower context, a Faragher defense would offer employers two avenues for reducing their liability instead of one: they can limit liability either by refraining from retaliating against whistleblowers or by investigating whistleblower allegations. As the table below illustrates, a Faragher defense in the whistleblower context does not alter the employer’s incentives to investigate when the employer does not retaliate against the whistleblower. The defense would only serve to reduce the employer’s liability where it chooses to retaliate against the whistleblower. Retaliation Against Whistleblower No Retaliation Against Whistleblower
Employer Investigates With Faragher defense: Reduced liability Without Faragher defense: Liability No liability
Employer Fails to Investigate Liability No liability
This structure could even create perverse incentives. In cases of widespread or severe wrongdoing, where the public interest in law enforcement is high, the employer will find it cheaper to refrain from retaliating against the whistleblower than to fix the problem. By contrast, if the wrongdoing is relatively easy to investigate and fix, a Faragher defense would allow the employer to investigate the wrongdoing, but its liability to the employee for harassment would be reduced if it had taken reasonable precautions. iii. Whistleblower Rewards Of the various forms of voluntary whistleblower legislation, whistleblower rewards offer the greatest potential for motivating employers to investigate whistleblower disclosures. The False Claims Act presents an interesting illustration of this potential. The False Claims Act empowers any person to bring a qui tam action to expose government fraud and to share in the recovery should he prevail.167 It also contains an anti-retaliation provision that prevents employers from retaliating against employees for disclosing government fraud or bringing a qui tam claim. Callahan et al. noted the significant effect that extraordinarily large False Claims recoveries have had in encouraging employers to adopt effective internal whistleblower channels. 168 They fail to distinguish, however, between the effect of the qui tam provision and the anti-retaliation provision.169 While the anti-retaliation provision, like other whistleblower protections, serves to deter employers from retaliating against whistleblowers, it is the qui tam provisions that encourage employers to develop better internal reporting systems. The qui tam provisions do not depend on retaliation; they simply make the employer liable to employee-whistleblowers (or anyone else who discovers the fraud) for the underlying wrongdoing. In such circumstances, the best way for the company to reduce its litigation risk is to investigate whistleblower allegations 166
524 U.S. 775 at 805. 31 U.S.C. § 3730(b)(1) (1988). 168 Callahan et al supra note 63 at 190. See also note 54 (noting the size of whistleblower claims). 169 See discussion supra note 54. 167
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promptly and correct the fraud. If it fails to investigate the allegations, the fraud may become more widespread, making the employer liable to the whistleblower and the government for an even greater sum. Even as whistleblower rewards can effectively encourage organizations to investigate and correct wrongdoing, they still suffer from the agency problems discussed in Section II(A). Individual managers and employees may be deterred from conducting a sufficiently thorough investigation, fearing some of the accompanying social penalties of investigating wrongdoing. 170 Compelled whistleblowing, by contrast, does not suffer from this limitation. By placing individual liability on corporate actors for failing to act in response to wrongdoing, SOX addresses the agency problem. III. SARBANES OXLEY AS COMPELLED WHISTLEBLOWING LEGISLATION As Section II discussed, voluntary whistleblower provisions involve a number of built-in limitations. These limitations appeared to present an unavoidable set of tradeoffs,171 as mandatory whistleblower legislation was presumed too “draconian” to garner legislative support.172 Through SOX, however, Congress has demonstrated a willingness to impose whistleblower-like obligations on employees and agents of public companies. SOX thus raises the question of whether punitive approaches to whistleblowing are as draconian as they seem and whether, instead, they might address some of the problems voluntary whistleblowing faces. Employment law scholarship has largely ignored the implications of SOX’s corporate governance provisions for employment law.173 Rather, it has focused on the so-called “whistleblower provisions” of SOX, which protect corporate whistleblowers from retaliation. 174 Section 806 of the statute extends anti-retaliation protection to employees of public companies who engage in internal or external whistleblowing involving violations of securities law. 175 Section 806 is a significant development in employment law because it provides uniform protection to corporate whistleblowers that previously had to rely on a patchwork of federal and state remedies.176 Prior to SOX, corporate wrongdoing often fell outside of the scope of other federal and state whistleblower statutes. Moreover, state claims for wrongful discharge in violation of public policy were unavailable in jurisdictions that did not view corporate wrongdoing as a matter of public policy. 177
170
See discussion supra at Section II(a). For example, Stefan Rutzel argues that internal whistleblowers should not be provided with antiretaliation protection because of the reduced law enforcement benefit of internal whistleblowing. Supra note 7 at 47. 172 Kraakman supra note 7 at 58-59. 173 See discussion supra note 45. 174 See Baynes supra note 43; Cherry supra note 40 at 1085; Chiara & Orenstein, supra note 44. 175 Sarbanes-Oxley § 806(a). 176 See Cherry supra note 40 at 1042-1052. 177 Id at 1049. 171
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Like other whistleblower statutes, however, SOX requires whistleblowers to demonstrate that they have suffered retaliation for their disclosure. 178 Although the federal courts have not directly addressed the issue of what constitutes retaliation under SOX, they make use of the term “adverse employment action” in describing the retaliation element of the claim.179 Federal agency decisions also borrow heavily from Title VII jurisprudence in defining retaliation.180 Because the whistleblower provisions are retaliation-based, they likely suffer from the same structural limitations as other retaliation-based remedies discussed above. 181 SOX is unusual from an employment law perspective not for its anti-retaliation provisions but for its corporate governance provisions, which impose liability on various corporate actors for failing to act upon evidence of wrongdoing. Under SOX, attorneys representing public companies are required to report internally evidence of securities fraud and initiate an investigation.182 Executives must endorse their company’s financial statements, and are liable for omissions or false or misleading statements contained therein. 183 SOX also imposes additional disclosure-related obligations on the audit committee of the board of directors, forcing it to take a more active role in investigating allegations of wrongdoing.184 A. Forms of Compelled Whistleblowing As discussed in Section I, I use the term “compelled whistleblowing” to refer to imposing liability on an agent or employee of a corporation for failing to report, investigate, or correct the misfeasance of others within the organization. SOX includes three forms of compelled whistleblowing: 1) a duty to engage in internal whistleblowing; 2) imposing secondary liability on agents for the disclosures of the organization; and 3) a duty to investigate allegations of wrongdoing. Within the context of corporate law and securities regulation, compelled whistleblowing is an extension rather than a departure from previous law.185 Pre-SOX federal securities law places elaborate disclosure obligations on public corporations,186 although the duty applies at the organizational rather than the individual level. State corporate law imposes a duty of care on directors that requires them to monitor the corporation and develop proper reporting systems. 187 Finally, existing forms of 178
The statute provides that public companies may not “discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment.” SarbanesOxley § 806(a). 179 See Livingston v. Wyeth, 2006 U.S. Dist. LEXIS 52978 at 23 (M.D. N.Ca., July 28, 2006); Collins v. Beazer Homes USA, Inc., 334 F.Supp. 2d 1365, (N.D. Ga 2004). 180 See supra note 30. 181 See discussion supra section II. 182 See Sarbanes-Oxley § 307; 17 C.F.R. § 203(b), discussion infra Section III(B)(i). 183 See Sarbanes-Oxley §§ 302, 906., discussion infra Section III(B)(ii). 184 See Sarbanes-Oxley §§ 301, 207, 407, discussion infra Section III(B)(iii). 185 See section III infra. 186 See infra notes 193-195. 187 See discussion infra section III(A)(iii).
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gatekeeper liability hold auditors and other corporate agents liable for endorsing company statements that do not meet a certain financial or legal standard.188 The various forms of compelled whistleblowing essentially consist of linking the organization’s disclosure obligations to the fiduciary duties of various corporate actors. Below, I define the three types of compelled whistleblowing present in SOX and their relationship to corporate and securities law. i. Duty to Engage in Internal Whistleblowing In its simplest form, compelled whistleblowing requires an agent to disclose wrongdoing to a superior within the organization. A duty to engage in internal whistleblowing is not unprecedented in securities law. The 1995 Private Securities Litigation Reform Act required auditors to inform management and the board of directors or audit committee of any information uncovered in the course of an audit that indicates an illegal act has occurred.189 I describe mandatory internal whistleblowing as a form of compelled whistleblowing rather than as full-fledged “mandatory whistleblowing” because it is less coercive.190 Most references to mandatory whistleblowing as “draconian” tend to assume that external reporting would be required.191 Because internal whistleblowing presents a reduced risk that the whistleblower will publicly disclose confidential or false information,192 employers tend to favor internal whistleblowing. Internal whistleblowing is also generally perceived as less disloyal, and would therefore tend to subject employees to fewer social penalties. In the securities context, however, internal whistleblowing retains some law enforcement teeth because it can trigger a company’s public disclosure obligations. Federal securities law requires public companies to disclose all material information in its filings – information that would influence a reasonable investor. 193 This includes the discovery of fraud that significantly impairs the value of the company, and arguably even information that would make the company look bad and affect its stock price. 194 Securities law also requires companies to disclose any significant deficiencies in the company’s internal controls, 195 and any fraud “whether material or not” involving management or employees playing a significant role in the internal controls.196 Thus, 188
See Kraakman supra note 7 at 81-87 (discussing gatekeeper liability in the securities context). Larry Cata Backer supra note 93 at 390 (2004) (describing the PSLRA, 15 U.S.C. § 78j-1) 190 For the same reasons that attorneys strongly opposed the SEC’s “noisy withdrawal” proposal – which would have required external whistleblowing – but tolerate SOX’s internal whistleblowing mandate, internal whistleblowing is viewed as less risky for the employee. See discussion infra at Section I(D). 191 See e.g. Kraakman’s definition of “mandatory whistleblowing” supra note 7 at 58-59. 192 Callahan and Dworkin, Buying Silence, supra note 36 at 176-178; Fisher et al supra note 7 at 134 (noting the financial costs to the employer of whistleblowing). 193 See Simon supra note 82 at 22 (citing TSC Indus., Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976) and Basic, Inc. v. Levinson, 485 U.S. 224 (1988)). 194 Simon supra note 82 at 22. 195 Regulation S-K, Item 631; 17 C.F.R. § 240.13a-14a 196 Id. 189
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when a whistleblower discloses evidence of corporate fraud within the company, the company often must disclose the fraud in its public filings if the whistleblower’s allegations prove correct. ii. Secondary Liability for Organizational Disclosures Alternately, compelled whistleblowing can resemble a form of gatekeeper liability. Under this form of compelled whistleblowing, the employee incurs liability for endorsing false or misleading company disclosures. Compelled whistleblowing is distinguishable from gatekeeping when neither the third party nor the company can effectively opt out of the disclosure.197 Gatekeeper regimes typically confer a degree of choice on both the gatekeeper and the corporation by tying endorsement to the receipt of a benefit for a disclosure. A corporation hiring a law firm to issue an opinion letter for a questionable securities offering has three options if the firm expresses doubt about the transaction – it can include the letter; it can shop for another firm to provide the letter; 198 or it can choose not to proceed with the transaction. Similarly, a firm hired to evaluate a questionable transaction can avoid issuing a critical opinion letter by declining representation. Gatekeeper regimes come to resemble compelled whistleblowing when choice is removed from the corporation and the gatekeeper. First, gatekeeper endorsement becomes more coercive when it attaches to mandatory disclosures. While a company can avoid gatekeeper scrutiny on a questionable transaction by withdrawing the transaction, it cannot avoid gatekeeper scrutiny when endorsement is required for the company to file its annual reports. Compelled whistleblowing can also result from limiting a company’s ability to shop for permissive gatekeepers willing to bend the rules. For example, securities law requires companies to disclose when they fire their auditors and to include a letter from their former auditor explaining their agreement or disagreement with the statements in the filing. 199 Even where the company finds a more permissive gatekeeper, disclosure rules place the prior auditor in a whistleblowing role. Imposing secondary liability on employees for the disclosures of their employers is similar but not equivalent to mandatory whistleblowing. Mandatory whistleblower statutes place an absolute duty on certain agents to report evidence of a legal violation. A doctor who discovers evidence of child abuse must report it to state,200 and cannot avoid liability by persuading the parents to fix their parenting practices. By contrast, compelled whistleblowing leaves room for negotiation. An auditor who discovers defects in a company’s financial statements can seek revisions to the statement prior to its release, allowing the auditor to endorse the revised version. As Kraakman notes, refusing to
197
See discussion of gatekeeping, supra at Section I(d). See Kraakman supra note 7 at 63. 199 Regulation S-K Item 616. 200 See e.g. 119 Mass. General Law §51A. 198
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endorse a disclosure also does not provide complete information to regulators of a violation but signals to those who rely on the disclosures that something is awry.201 iii. Duty to Investigate Wrongdoing Compelled whistleblowing can also resemble a director’s duty of care under state corporate law. Corporate law imposes a duty of care on directors, holding them liable for making decisions without “exercis[ing] a good faith effort to be informed and to exercise appropriate judgment.”202 State courts have found a breach of a duty of care where a director of a closely held corporation failed to review the company’s financial reports and monitor the corporation, permitting the other directors to misappropriate corporate assets.203 Moreover, the Delaware Chancery Court has ruled that directors can be liable for failing to ensure that the company has proper internal information gathering and reporting systems.204 Similarly, a form of compelled whistleblowing can require agents to initiate investigations of allegations of wrongdoing. Although the initiation of an investigation is not “whistleblowing” as it is commonly understood, fact-gathering and investigation is often an essential component of whistleblower activity and subject to similar social penalties as whistleblowing. 205 In the securities context, a duty to investigate is equivalent to compelled whistleblowing because the results of an internal investigation may need to be included in the company’s public filings.206 The distinction between compelled whistleblowing and a duty of care can be blurry. Compelled whistleblower legislation is distinguishable from a duty of care in its specificity. Rather than generally requiring a fiduciary to monitor the corporation for wrongdoing, a compelled whistleblower statute will require a fiduciary to take specific action either to solicit internal disclosures or to investigate allegations of wrongdoing. A duty of care leaves room for a fiduciary to argue that inaction was reasonable under the circumstances and tolerates ignorance based on reasonable but faulty reporting mechanisms. By contrast, compelled whistleblower legislation attaches strict liability to inaction. B. Compelled Whistleblower Provisions in SOX SOX imposes compelled whistleblower duties on attorneys, executives and, to a lesser extent, audit committees of public companies. For attorneys, SOX imposes a duty to engage in internal whistleblowing and a duty to investigate evidence of securities fraud. Executives are subject to secondary liability for the accuracy of the company’s public filings. SOX also amplifies the audit committee’s duty to investigate. 201
Kraakman supra note 7 at 58. See In Re Caremark Inc., 698 A.2d 959, 968 (Del Ch. Ct. 1996). 203 See Baynes supra note 43 at 886 (describing Francis v. United Jersey Bank, 432 A.2d 814 (N.J. 1981). 204 In re Caremark, 698 A.2d 959 at 969. 205 See discussion supra at II(A). 206 See discussion supra section III(A)(i). 202
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i. Attorney Duty to Report and Investigate SOX requires attorneys to engage in internal whistleblowing and to investigate evidence of securities violations. SOX regulates attorneys through a series of new ethics rules enforced by the SEC. Section 307 of SOX directs the Securities and Exchange Commission (SEC) to issue rules of professional conduct for attorneys representing public companies.207 Unlike state ethical rules, failure to comply with SEC rules subjects attorneys to civil liability for securities fraud if they do not comply in good faith with the new rules.208 Under these rules, attorneys representing public companies who discover “evidence of a material violation of securities law or breach of fiduciary duty or other similar violation”209 have an ethical obligation to report it to the company’s chief legal officer. 210 If the chief legal officer fails to conduct an appropriate investigation, the attorney must disclose the evidence to the audit committee or board of directors. 211 Thus, not only does a lawyer have a legal obligation to blow the whistle once, she must renew her efforts if her first attempt was ineffective. The rules also impose a duty to investigate on the chief legal officer. Upon receiving evidence of a material violation, the chief legal officer is required to make an inquiry “into the evidence as he or she reasonably believes appropriate to determine whether the material violation described in the report has occurred.”212 A number of legal ethics scholars have argued that the final rules, mandating only internal whistleblowing and investigation, are too ambiguous 213 and too similar to existing rules to be useful. 214 However, an attorney’s duty to blow the whistle internally is both clarified and amplified in SOX. 215 Ethics rules prior to SOX required an attorney to “proceed as is reasonably necessary” if he “knows” of an ongoing or intended violation 207
The regulations cover attorneys representing public companies in an SEC “administrative hearing or in connection with any Commission investigation, inquiry, information request, or subpoena” and those who advise public companies in preparing public filings. 17 C.F.R. § 205.2(a). 208 Simon Lorne, supra note 87 at 65-66. 209 Sarbanes-Oxley § 307(1). 210 Section 307 requires attorneys to report “a material violation of securities law or breach of fiduciary duty or similar violation by the company or any agent thereof, to the chief legal counsel or the chief executive officer of the company or the equivalent thereof.” See also 17 C.F.R. § 203(b). 211 Sarbanes-Oxley § 307; 17 C.F.R. § 203(b). 212 17 C.F.R. § 203(b)(2). 213 See Chinaris supra note 82 at 369. Cf. Steinberg supra note 81 at 383 (noting that ambiguities are problematic in deciding when to act upon evidence of wrongdoing but can be addressed by seeking the independent advice of an outside lawyer). 214 Jenny E. Cieplak & Michael K. Hibey, The Sarbanes-Oxley Regulations and Model Rule 1.13: Redundant or Complementary, 17 GEO. J. LEGAL ETHICS 715, 718 (2004) (noting that “the rule corresponds to ethics rules adopted by "the vast majority of states," even though it is slightly broader than the Model Rule”); Fortney supra note 84 at 72 (finding that “experienced practitioners report that the ‘effects have been moderate’”). 215 Sarbanes-Oxley § 307. See also Chinaris supra note 82 at 367-371.
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of the law.216 Under SOX, an attorney’s ethical duty is triggered by “evidence” of a securities violation rather than actual knowledge of a violation. 217 Because the duty specifies that subordinate attorneys must disclose the evidence to the chief legal officer, it presents the officer with a clear course of action absent from the prior rules. The internal whistleblower rules also prevent senior attorneys from avoiding their investigatory duty by remaining willfully ignorant of corporate wrongdoing. These rules stand in contrast to the Model Rules of Professional Conduct, which create perverse incentives for a supervising attorney to remain ignorant of ethical issues confronting subordinate attorneys. The Model Rules generally make each attorney liable for her own ethical violations. 218 While a supervising attorney is required to make “reasonable efforts” to ensure that subordinate attorneys comply with ethical rules, she is only specifically liable for a subordinate’s ethical violations if the supervising attorney orders or ratifies the misconduct.219 If the supervising attorney’s advice turns out to be wrong, both the supervisor and the subordinate attorney will be liable if the ethical violation was clear.220 If the advice involved an “arguable question of professional duty,” then only the supervising attorney will be liable. 221 Either way, supervising attorneys have every incentive to discourage subordinates from approaching them about corporate wrongdoing because receiving such concerns only serves to increase their liability for any breach of ethical rules in their response to the wrongdoing.222 SOX corrects this perverse incentive by forcing subordinates to report the wrongdoing to a supervising attorney. While the idea that attorneys should report and investigate wrongdoing within an organization may seem self-evident, there is evidence that such inquiry was absent in the Enron case.223 In-house attorneys for Arthur Anderson, Enron’s auditors, appear to have tacitly approved destruction of Enron’s audit records despite mounting evidence suggesting Anderson was implicated in the wrongdoing.224 Similarly, when Enron hired its longtime outside counsel, Vinson and Elkins (“V&E”), to investigate whistleblower Sherron Watkins’ allegations of fraud, it conducted only a cursory investigation into the facts225 and concluded that additional investigation was not necessary.226 216
1983 ABA Model Rules of Professional Conduct rule 1.13 (revised in 2003). The 2003 revisions brought the ABA rule closer to the SOX rule. See Steinberg supra note 81 at 378. 217 Sarbanes-Oxley § 307. 218 ABA Model Rules of Professional Conduct Rule 5.2. 219 Model Rules of Professional Conduct Rule 5.1. 220 Model Rules of Professional Conduct Rule 5.1 & 5.2. 221 Model Rules of Professional Conduct Rule 5.2. 222 For example, Model Rule 3.4 prohibits a lawyer from destroying or counseling others to destroy or conceal a document having “potential evidentiary value.” The rules also require a lawyer to withdraw from representation if continued representation will make the lawyers complicit in a crime or fraud. See Model Rule 1.16. Both of these issues are raised in discovering evidence of wrongdoing by a client. 223 See Simon supra note 82 at 5-11. 224 See Simon supra note 82 at 9-11. 225 See Baynes supra note 43 at 879 (noting that the “investigation reported only limited cosmetic problems and no illegal activities.”). See also Simon supra note 82 at 5-8. 226 Vinson & Elkins, Memorandum Regarding Preliminary Investigation of Allegations of an Anonymous Employee, October 15, 2001, available at: http://fl1.findlaw.com/news.findlaw.com/hdocs/docs/enron/veenron101501ltr.pdf#search=%22vinson%20a nd%20elkins%20enron%22.
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The actions of both Anderson’s and V&E’s attorneys could be explained as an attempt to cover for their own negligence in failing to discover the fraud. They may also, however, be a function of a general organizational and social resistance to investigation, where the social costs of inquiry can be almost as steep as those of whistleblowing. Both Anderson and V&E may have been responding to an implied threat by Enron that they would lose their gatekeeper status if they asked too many questions. SOX does not necessarily provide complete protection from willful ignorance, as chief legal officers tasked with investigating evidence of misconduct can argue that their investigation qualified as “reasonable” and “appropriate” under the statute. 227 Nonetheless, the threat of prosecution for securities fraud for falling on the wrong side of reasonableness under the statute may force lawyers to be thorough. The attorney investigation requirement also imposes a baseline standard to thwart companies from reaping the benefits of gatekeeper shopping. Pre-SOX, companies like Enron could choose gatekeepers with a longstanding relationship with the company, knowing that they would be influenced by the prospect of future business and a desire to avoid implicating their own past decisions in any wrongdoing. While these influences remain after SOX, the prospect of individual liability serves to offset any tendency a lawyer might have had to allow patronage to affect his decisions about the scope and thoroughness of an investigation. Attorneys are well-positioned to initiate investigations into evidence of corporate fraud because of both their expertise and role in the disclosure process. Unlike managers, directors, or auditors, they are accustomed to navigating grey areas of fact and law to determine whether or not the alleged conduct is in fact illegal and whether the evidence supports the allegations. They are also well-positioned to determine whether the company is required to disclose the wrongdoing in its public filings. Finally, lawyers are subject to ethical rules regarding document retention 228 and legal rules regarding obstruction of justice. 229 Despite experience to the contrary from the Enron scandal, where attorneys appear to have tacitly approved the destruction of documents, 230 attorneys are expected to ensure that incriminating documents are retained. Legal ethics scholars tend to oppose SOX regulation of lawyers as a threat to lawyer-client confidentiality, though much of the criticism is directed at the “noisy withdrawal” rules that were later discarded. 231 The critique could equally be leveled against the internal whistleblowing and investigation rules because they might trigger the
227
17 C.F.R. § 203(b)(2). Model Rules of Professional Conduct Rule 3.4 (prohibiting lawyers from “alter[ing], destroy[ing], or conceal[ing] a document or other material having potential evidentiary value.” It also prohibits lawyers from counseling others to do so). 229 Sarbanes Oxley enhances criminal penalties for obstruction of justice – destroying, altering, or fabricating evidence. Sarbanes Oxley § 805. 230 See Simon supra note 82 at 9-11. 231 See discussion supra note 83. 228
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company’s disclosure obligations. 232 In his article on gatekeeping, Renier Kraakman notes that mandatory whistleblower rules are rare in part because they create “a powerful incentive to withhold information.”233 While concerns about confidentiality are perhaps well-founded in the context of individual representation, such concerns are less important in the context of organizational representation is different. The Model Rules of Professional Conduct reflect this distinction in a 2003 revision of the rules. Revised rule 1.13 clarifies that the lawyer’s duty of loyalty is to the organization itself and requires attorneys to report any wrongdoing “likely to result in substantial injury to the organization” to a higher authority within the organization.234 Where a client is a criminal defendant, disclosing the client’s wrongdoing would clearly hurt the client’s interests. But where the client is a public company, investigating wrongdoing and either remedying or reporting it depending on the company’s disclosure obligations advances the company’s interests by limiting its future liability. Imposing a duty to investigate allegations of fraud is also consistent with the existing compliance role that attorneys are often asked by clients to play. As William Simon argues, the bar’s “truculent response” to the new legal ethics rules represents a double standard allowing lawyers to “clin[g] to the prerogatives of ignorance and ambiguity” even as the law no longer allows their clients to do so.235 Kraakman’s argument that whistleblower obligations will lead to the withholding of information assumes that incentives within organizations are uniform. Admittedly, employees who have perpetrated a fraud will seek to conceal it from attorneys, but they would likely have done so prior to SOX. However, SOX could encourage those employees not complicit in the fraud to disclose information to the company’s attorneys if they know the company’s attorneys will treat the allegations seriously. Moreover, the executive certification requirements of SOX incentivize executives to provide attorneys with more, rather than less information, in order to ensure that the public filings are accurate and to reduce their personal liability.236 ii. Executive Certification Under SOX, the Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) must certify that company financial statements “fully comply” with securities law and “fairly presen[t], in all material respects, the financial condition and results of operations” of the company. 237 The CEO and CFO must also certify that they are “responsible for establishing internal controls” and “have designed the internal controls to ensure that material information” is made known to them.238
232
Larry C. Backer, argues that SOX turns the corporate organization into a panopticon, where attorneys and auditors are mobilized to scrutinize employees on behalf of the state. Supra note 93 at 341 (2004). 233 Kraakman supra note 7 at 60. 234 Model Rules of Professional Conduct Rule 1.13. 235 Simon supra note 82 at 30. 236 See discussion in section IIIB(ii), below. 237 Sarbanes-Oxley §§ 302, 906. 238 Sarbanes-Oxley § 302(a)(4).
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A CEO or CFO who knowingly certifies a financial statement that is false, misleading, or omits a material fact, is liable for up to $1,000,000 in fines and 10 years imprisonment. If the false certification is “willful,” an executive is liable for up to $5,000,000 in fines and 20 years in prison.239 Although the statute states that SEC filings by public companies containing financial statements “shall be accompanied” 240 by a certification from the CEO and CFO, it does not specifically provide for a penalty if the executive refuses to certify the statement. Prior to 2001, executives were required to sign off on their company’s financial statements and thus were liable for fraudulent statements contained therein. 241 Nevertheless, it was difficult to hold executives accountable absent the showing of an intent to defraud.242 The intent element for SOX liability – knowledge or willfulness – is similar to the scienter requirement for securities fraud.243 The key difference between pre- and post-SOX law, however, is the certification requirement relating to internal controls. Under prior law, an executive could argue that he had no knowledge of wrongdoing. Under SOX, if an executive argues that he lacks knowledge, the SEC can fall back on the executive’s certification of the company’s internal controls. If the internal controls prove inadequate, the SEC can hold the executive liable for certifying that they were satisfactory. If the internal controls were, instead, functioning properly, the SEC can use the executive’s certification of the adequacy of internal controls as evidence that the executive had actual knowledge of wrongdoing. Where the executive is liable both for the accuracy of the disclosure and for the adequacy of internal controls, the strategy of willful ignorance is no longer convenient. Executives must actively set up internal systems to ensure that their endorsement of the company’s financial statements is an informed one. The executive certification requirement under SOX resembles gatekeeping, in that it involves endorsement of a disclosure statement by a fiduciary of the company. However, it is considerably more coercive than a gatekeeper regime because the company cannot easily replace a gatekeeper with which it is dissatisfied. Firing a CEO or CFO who refuses to certify a public filing can be disruptive to the day to day operations of the company, would require the time-consuming process of hiring a new officer, and subjects the company to whistleblower liability under SOX’s anti-retaliation provisions.244 239
Sarbanes-Oxley §906. Id. 241 See David S. Ruder & Arek Sycz, The Securities and Exchange Commission’s Pre and Post-Enron Responses to Corporate Financial Fraud: An Analysis and Evaluation, 80 NOTRE DAME L. REV. 1103, 1106, 1140 (2005). 242 Securities fraud claims require the plaintiff to prove an intent to defraud on the part of the defendant. Securities Exchange Act of 1934, 17 C.F.R. 240.10b-5 (2003). 243 Id. 244 See Welch v. Cardinal Bankshares Corp., involving an executive who successfully prevailed on a SOX anti-retaliation claim against his employer for firing him after refusing to certify the company’s financial 240
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In addition, it is not clear how the company would proceed without certification. Public filings containing financial statements are mandatory and must be filed according to the schedule provided by SEC rules.245 The inclusion of an executive certification is also mandatory, and its absence at least sends a “red flag” to the SEC and the market, and may itself represent a violation of securities regulations.246 Similarly, the burden on the CEO and CFO is also considerably more coercive than a gatekeeper regime. In addition to the stiff criminal and civil penalties, SOX does not provide a clear exit strategy if the CEO or CFO is reluctant to certify the statement. Unlike an accounting company or law firm, CEOs and CFOs cannot safeguard both their liability and the organization’s reputation by encouraging the company to seek alternate representation. Unless the CEO or CFO resigns, declining to endorse a certification will force the company to proceed without it and signal to the market the flaw in the financial statements. Even a delay in certification can signal to the market that something is awry.247 The executive must insist on revisions to a flawed financial statement or signal the market of the flaw by refusing to endorse it. iii. Expanded Audit Committee Duties SOX imposes additional disclosure-related liability on the audit committee of the board of directors by designating it as a repository for internal whistleblowing and requiring it to develop procedures to manage the information it receives. Prior to SOX, the Private Securities Litigation Reform Act (“PSLRA”) had already made the audit committee a designated recipient of whistleblowing by auditors. Under the PSLRA, auditors are required to inform the audit committee or the board of directors of any illegal acts that have been detected.248 SOX serves to expand the audit committee’s role as recipient of internal whistleblowing.
statements. The opinion noted “Despite his refusal to sign the initial and third-quarter certifications, Welch acknowledge that prior to the enactment of the Sarbanes-Oxley Act he signed consolidated financial statements and reports of condition….Welch testified that he realized at the time that some of these reports were inaccurate, but did not report these problems because ‘at my age it’s difficult to change careers…Until Sarbanes-Oxley came along I didn’t feel like I had any legal standing to support my positions or to protect me.’” at Arb Case no. 04-054, ALJ Case No. 03-SOX-15, p13 (February 15 2005). 245 For examples of SEC filing deadlines see SEC website, Form 10Q, available at: http://www.sec.gov/answers/form10q.htm; Form 10K, available at: http://www.sec.gov/answers/form10k.htm. 246 Sarbanes Oxley § 302, providing that executive certification is “required.” 247 Empirical results on the signaling effect of the timing of executive certification is mixed. One study found that failure to certify had no effect on investors, and another found that opaque firms providing early certification provided positive information to the market. See Romano supra note 93 (citing Beverly Hirtle, Fed. Reserve Bank of N.Y., Staff Report No. 170, Stock Market Reaction to Financial Statement Certification by Bank Holding Company CEOs (2003), available at http://ssrn.com/abstract=425002; and Utpal Bhattacharya et al., Is CEO Certification of Earnings Numbers Value-Relevant? (Nov. 2002) (unpublished manuscript), available at http://ssrn.com/abstract=332621). 248 Backer supra note 93 at 390 (2004) (describing the PSLRA, 15 U.S.C. § 78j-1).
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Section 301 of SOX requires audit committees to establish company-wide procedures for dealing with any complaints regarding “accounting, internal accounting controls, or auditing matters.” 249 It also requires the audit committee to set up a confidential, anonymous process for employees to submit “concerns regarding questionable accounting or auditing matters.” 250 This provision gives voluntary whistleblowers a clear, direct path to the audit committee, though they need not make use of the audit committee reporting process to receive protection under SOX’s antiretaliation provisions. It also forces the audit committee to develop a process for receiving and investigating complaints. SOX also links the attorney’s duty to engage in internal whistleblowing with the role of the audit committee. If an attorney who blew the whistle to a chief legal officer concludes that the chief legal officer failed to “provide an appropriate response within a reasonable time,” then the attorney must report the evidence to the audit committee or another committee of the board consisting solely of independent directors.251 Under SOX, the audit committee is well-positioned to receive complaints of corporate wrongdoing. SOX requires members of the audit committee to be independent of the company, and thus unlikely to be complicit in any wrongdoing. 252 It also requires companies to disclose whether or not the audit committee includes a certified financial expert, increasing the company’s incentives to do so. 253 This makes the audit committee more likely to have the expertise required to identify serious allegations of corporate fraud. The audit committee is also well-positioned to receive complaints because of its role in the disclosure process. Under SOX, the audit committee is responsible for selecting and overseeing the outside auditors who evaluate the company’s financial statements.254 Its existing relationship with outside auditors makes reporting evidence of corporate wrongdoing to the auditors straightforward. Evidence of illegal acts may affect whether the auditor is able to issue an unqualified opinion letter in conjunction with the company’s public filing, and may trigger a duty to inform the SEC.255 The audit committee can also influence the content of a company’s public filings. In addition to overseeing the company’s auditors, the audit committee is responsible for “overseeing the accounting and financial reporting procedures”256 of the company. In response to evidence of wrongdoing supplied by a whistleblower, the committee could seek to revise the contents of the company’s public filings or issue a restatement. The
249
Sarbanes-Oxley § 301. Sarbanes-Oxley § 301(m)(4). 251 17 C.F.R. § 205.3(b)(3). If the company lacks a committee consisting of independent directors, then the attorney must report the violation to the entire board of directors. 252 Sarbanes-Oxley § 301. 253 Sarbanes-Oxley § 407. 254 Sarbanes-Oxley § 301, 202. 255 Backer supra note 93 at 389. 256 Sarbanes-Oxley § 205. 250
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committee could also seek to reform the company’s reporting or internal control mechanisms to better detect wrongdoing in the future. Not all scholars are convinced that the SOX reforms of the audit committee will improve the quality of internal reporting structures and public disclosures. Roberta Romano, for instance, notes that most empirical studies find that director independence does not improve corporate performance.257 This is consistent with the theory that the benefits of having outsiders serving on the board are offset against the informational costs of choosing decision-makers not privy to insider knowledge.258 Empirical studies have shown, however, that placing a director with financial expertise on the board of directors improves performance. 259 Thus, to the extent that the SOX disclosure rule results in a greater presence of financial experts on the board, it could be expected to improve the audit committee’s ability to handle complaints. Less clear, however, is the question of whether requiring the audit committee to receive and process internal whistleblower complaints will improve the accuracy of public filings. The audit committee will incur information costs in investigating whistleblower complaints. Unlike management, it may not be intimately familiar with the workings of the company.260 Furthermore, unlike auditors or attorneys, it may not be familiar with the financial or legal issues involved. Still, when it comes to internal whistleblowing, an examination of the complaint by high ranking, independent officials may be crucial. At the same time, a number of employment law scholars have complained about the absence of legitimate reporting mechanisms available for internal whistleblowers. Internal reporting structures are viewed as a form of window dressing in the whistleblower context because they tend to be controlled by managers who may have an interest in hiding the misconduct. 261 The audit committee may be sufficiently independent of management to address this particular concern. Thus the information costs of having independent directors may be justified in this particular instance. Miriam Cherry, however, argues that the SOX directive for audit committees to establish procedures for managing whistleblower complaints is not specific enough to be meaningful. Because the statute does not require the committee to establish specific
257
Romano supra note 93 at 1530-1532. See Jonathan R. Macey, A Pox on Both Your Houses: Enron, Sarbanes Oxley and the Debate Concerning the Relative Efficacy of Mandatory vs. Enabling Rules, 81 WASH. U. L. Q., 329, 341 (2003). See also Larry E. Ribstein, Market vs. Regulatory Responses to Corporate Fraud: A Critique of the Sarbanes-Oxley Act of 2002, 28 IOWA J. CORP. L., 1, 40-41 (2002). 259 See Romano supra note 93 at 1532. 260 Krawiec, supra note 63 at 513 (2003) (describing a study finding that OSHA violations were more common in organizations with internal compliance structures, theorizing that compliance structures are prevalent when managers seek to hide illegal activity); Rutzel, supra note 7 at 51; Estlund supra note 64 at 337-338. (noting “a distressing paucity of evidence about how well these internal enforcement systems actually perform and whether they succeed in protecting employee rights). 261 Krawiec, supra note 63 at 514. 258
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procedures, Cherry argues that the procedure could “conceivably” consist of simply “marking [complaints] with a large red check mark.”262 Her analysis, however, ignores the background legal duties of directors under state corporate law. Delaware corporate law already requires directors to establish reasonable reporting and information gathering mechanisms,263 and a process consisting only of placing a red check mark on complaints likely falls short of the reasonableness standard. Moreover, regardless of the procedures set forth by the committee, a director would breach his duty of care by failing to act upon actual knowledge of wrongdoing within the organization.264 Much of the traction in the SOX provisions regarding the audit committee is accomplished not through the requirement that auditors establish procedures to review complaints but by designating the audit committee as recipient of whistleblowing by employees and attorneys. The primary roadblock in Enron was that crucial information did not reach the audit committee to begin with. 265 While SOX perhaps could have accomplished more by specifying the type of procedures the audit committee should pursue, simply sending whistleblower disclosures to the audit committee at least serves the function of triggering the audit committee’s duty of care. This forces the audit committee to take a more active role in detecting and investigating fraud within the company. IV. THE BENEFITS OF COMPELLED WHISTLEBLOWING As discussed in Section II, voluntary whistleblower legislation faces a number of built-in limitations – it cannot remove the social penalties of whistleblowing, it does not produce enough disclosure, and finally, it does not require employers to make a thorough investigation into whistleblower disclosures. Compelled whistleblowing offers the potential to address these limitations. By placing whistleblowing obligations on high ranking officials, SOX could serve to lighten the workload of lower-ranking voluntary whistleblowers, who face greater risks in disclosing wrongdoing. This top-heavy approach to whistleblower liability could also alter the culture of disclosure within organizations, reducing the social penalties for compelled and voluntary whistleblowers alike. Finally, the interrelated duties to report and investigate will lead companies to more thoroughly investigate voluntary whistleblower disclosures. A. Allocating the Risks of Whistleblowing to Those Best Able to Bear Them
262
See Cherry supra note 40 at 1071. In re Caremark, 698 A.2d 959 at 969. 264 Delaware corporate law has held directors liable when they should have known about misuse of corporate assets. See supra note 203. Failing to act in the face of actual knowledge of wrongdoing would then represent an even stronger case of breach of duty of due care. 265 See Simon supra note 82 at 8. 263
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Given the high social and professional risks of elective whistleblowing, 266 one might imagine that compelled whistleblowing could only serve to hurt employees and subject them to unreasonable risks. Indeed, employment law commentators have tended to be suspicious of imposing disclosure obligations on employees. Stefan Rutzel argues that compelled whistleblowing raises First Amendment concerns, and is generally disfavored by courts as reminiscent of totalitarian regimes and McCarthyism. 267 He argues that individuals should be free to choose whether or not to blow the whistle because they will be forced to bear the “severe personal and social consequences” of whistleblowing.268 Commentators have reacted with similar suspicion to the SOX reporting requirements. Larry Cata Backer’s article, “Surveillance and Control: Privatizing and Nationalizing Corporate Monitoring after Sarbanes-Oxley,” argues that SOX contributes to a corporate governance system that operates like Jeremy Bentham’s Panoptican, where gatekeepers outside the organization and reporting mechanisms within the organization create an atmosphere of constant surveillance.269 His argument implies that employees will both have to bear unreasonable law enforcement duties, and be subject to unreasonable levels of scrutiny by others. However, there are a number of reasons to believe that the SOX reforms do not represent an erosion of employee rights. As Section III(c) noted, these additional responsibilities are not a radical departure from previous rules but an extension of an existing liability scheme. Moreover, these duties of inquiry and articulation do not fall on ordinary employees but on specialists or leaders whose primary duties include monitoring corporate compliance with securities law. Quite the opposite from Backer’s assertion that SOX conscripts all employees to serve a law enforcement role, SOX represents a division of labor that requires those at the top to bear the law enforcement burden. Moreover, assigning additional liability to top ranked corporate actors makes sense to the extent they are most likely to commit fraud. One study, for example, found that “90 percent of the financial reporting frauds were committed at the senior executive level.”270 Neither would SOX necessarily lead to widespread invasions of employee privacy or violations of client confidences. Inasmuch as SOX theoretically encourages attorneys, accountants, and executives to ferret out wrongdoing, the reforms primarily govern their responsibility to respond to wrongdoing once it has been brought to their attention.271
266
See discussion supra at II(a). See Rutzel supra note 7 at 43. 268 See Rutzel supra note 7 at 43. 269 Backer supra note 93 at 341. 270 Gina Gutzeit & Danny Li, Are We Safe from Financial Reporting Frauds? 23 AM. BANKR. INST. L. REV. 34, 34 (2004). 271 Executives are not required to assert that they scoured the company to assure that it has not violated securities law. They must assert that it does not misrepresent the financial condition of the company “based on the officer’s knowledge” and that they “have designed such internal controls to ensure that material information…is made known to such officers.” Sarbanes-Oxley § 302. 267
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One possible exception is Section 302(a)(4), which requires executives to certify that they “have designed such internal controls to ensure that material information…is made known” to them. 272 This disclosure rule creates a strong incentive for executives to scrutinize and reform the company’s internal controls, which tend to affect a wider segment of employees beyond those directly regulated by SOX. Even so, internal controls only affect those employees who handle financial matters and govern only the way they handle and record company transactions.273 The SOX structure of imposing whistleblower obligations on high-ranking corporate actors is analogous to the Calabresian theory of torts, which posits that tort liability should be allocated to the party that could have prevented the tort at least cost. 274 By turning attorneys, executives and directors into compelled whistleblowers, SOX essentially imposes the social penalties of whistleblowing onto employees who are best positioned to bear those penalties. If organizational wrongdoing is bound to be exposed eventually, it is preferable from an employee rights standpoint to mobilize high ranking officials to disclose and investigate wrongdoing, rather than to expect lower level employees to voluntarily place their job or psychological well-being at risk by blowing the whistle. As discussed in Section III, the institutional pressures to ignore and retaliate against whistleblowers within the company can be overwhelming. 275 Independent directors serving on the audit committee are perhaps most immune from retaliation because they are elected by shareholders.276 Outside attorneys are somewhat insulated from retaliation by the actors within the organization because they are not employees of the company. Although attorneys can feel pressure from their own employer to turn a blind eye to wrongdoing in order to retain a valuable client,277 outside firms are also concerned about maintaining their reputation and can look to other clients for business. The inside actors that SOX subjects to liability – in-house counsel, executives, and accountants – are also better placed than other employees to disclose wrongdoing. As specialists and leaders within the company, they have a degree of credibility and power that make other employees less likely to question their motives in reporting or investigating fraud. They are also more likely to be perceived as indispensable to the
272
Sarbanes-Oxley § 302(a)(4). Internal controls tend to take three forms: those designed to ensure accuracy (eg. cash registers with a price display for customers); those designed to prevent and frustrate misuse of assets (eg. using consecutively numbered cheques that must be signed by two people when the amount exceeds a certain amount); and those designed to detect misuse of assets (eg. mandatory two week holidays for employees holding key financial positions every year). DAVID R. HERWITZ & MATTHEW J. BARRETT, ACCOUNTING FOR LAWY ERS 160 (2001). 274 This is analogous to Calabresi’s “least cost avoider” theory in tort liability: that liability should be allocated to the party that could have prevented the tort at the least cost. See Union Oil Co. v. Oppen 501 F.2d 558, 570 (9th Cir. 1974)(citing GUIDO CALABRESI, THE COST OF ACCIDENTS, 69-73 (1970)). 275 Callahan and Dworkin, Who Blows the Whistle and Why supra note 41 at 165. 276 Macey argues that although boards are not captured by management, the real challenge is that they don’t have access to high quality information. Supra note 258 at 341-342. 277 See discussion of Vinson and Elkins’ relationship with Enron section III(B)(i). 273
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organization and therefore less vulnerable to retaliation.278 Moreover, where the fraud is perpetrated by a middle- or high-level employee, these actors are often the only individuals with enough political capital in the organization to take them on.279 The compelled whistleblower rules also tend to protect junior lawyers from taking all the blame for the ethical breaches of a firm or a department. The prior ethical rules created incentives for senior attorneys to discourage junior attorneys from asking them about difficult ethics issues – such as how to respond to evidence of corporate fraud.280 The internal whistleblower obligation forces senior attorneys to address such questions, rather than leaving a junior attorney to struggle with them in isolation. The chief legal officer’s duty to investigate also relieves a burden from junior attorneys who might conclude that an investigation is warranted but do not have sufficient influence among managers to initiate one. B. Reducing the Social Penalties of Whistleblowing Compelled whistleblowing may serve to reduce the social costs of whistleblowing by taking the choice away from the whistleblower. If co-workers and supervisors perceive a whistleblowing attorney as simply doing her job rather than choosing to disrupt the organization, they may impute more benign motives to the whistleblower and lower the likelihood of retaliation. Co-workers are more likely to identify with an employee who takes action because failing to do so exposes her to liability than one who blows the whistle for espoused moral reasons.281 Compelled whistleblowing is also less likely to be stigmatized. Voluntary whistleblowing suffers from a selection effect, where employees with limited political capital in the organization or those whose jobs are already at risk are disproportionately likely to blow the whistle. 282 Because compelled whistleblowing obligations apply uniformly to all employees occupying a certain position within the organization, the
278
See Rutzel supra note 7 at 40. At the same time, in-house attorneys occasionally have difficulty sustaining whistleblower claims because of their duty of confidentiality. See General Dynamics Corp. v. Superior Court, 876 P.2d 487, 490 (1994). The Department of Labor has not yet been presented with any SOX whistleblower claims involving in-house attorneys. It seems likely, however, that they would be afforded whistleblower protection under SOX. In-house attorneys would be covered under Section 806 as “employees” of public companies. The Model Rules of Professional Conduct Rule 1.6(b)(6) allow attorneys to violate their duty of confidentiality where required to “comply with other law or a court order,” so a disclosure of fraud to the SEC would not be barred under the model rules. 279 See Joyce Rothschild & Terance D. Miethe, Whistleblower Disclosures and Management Retaliation, 26 WORK AND OCCUPATIONS 107, 122 (1999) (discussing empirical study showing that whistleblowers in supervisory positions were less likely to suffer from retaliation than non-supervisors). 280 See supra note 222. 281 Courts are also more sympathetic to whistleblowers who act to avoid civil or criminal liability. Compare Tamey v. Atlantic Richfield Co. 610 P.2d 1330 (Cal. 1980) (protecting whistleblower for refusing to participate in anti-trust activity that could have subjected him to criminal liability) to Pierce v. Ortho Parmaceutical Corp., 417 A.2d 505 (N.J. 1980) (refusing to protect a whistleblower who argued that following employer’s instructions would have violated the hypocratic oath). 282 See discussion supra Section II(A).
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company would not suffer from the same selection effect. 283 Since SOX imposes whistleblower duties only on high-ranking employees, it could even conceivably serve to reverse some of the stigma of voluntary whistleblowing. A number of commentators assume that the compelled whistleblower provisions of SOX can only serve to weaken the organizational clout of the fiduciaries involved. Corporate law scholars argue that executive certification will make CFOs and CEOs more risk averse284 and reduce their access to information within the firm.285 Legal ethics scholars fear that SOX regulation of lawyers will impinge on lawyer-client confidentiality. 286 Indeed, employment law scholars tend to oppose mandatory whistleblowing because of the burden it imposes on the whistleblower.287 On the contrary, there are a number of reasons to believe that compelled whistleblower obligations make employees more powerful. Just as Title VII allowed employees who supported integrated workplaces to insist that their company use nondiscriminatory hiring practices, so too does compelled whistleblowing make it easier for attorneys, executives and directors to disclose and investigate fraud. CEOs and CFOs can reasonably insist that financial statements be subject to additional review or that a flaw in the company’s internal controls be included in the disclosure statements. Executive certification liability allows them to resist pressure to simply trust their subordinates and sign off on statements that they have not read.288 Similarly, when the audit committee is provided with whistleblower disclosures from employees and attorneys, they no longer have to depend solely on managers to supply truthful information and can insist on a thorough investigation. SOX also changes the power dynamics between lawyers and clients. Because of the duty to investigate evidence of wrongdoing, lawyers no longer have the option of ignoring corporate misfeasance to curry favor with their management contacts. The internal whistleblowing requirement also ensures that the higher-ranking lawyers who make the judgment calls about what is included in the company’s public filings know about evidence that may need to be disclosed. The social dynamic under SOX is analogous to game theory, according to which, as Thomas Schelling argued, actors could increase their bargaining power through precommitment strategies.289 For example, a union representative will have a much easier 283
Bainbridge and Johnson note that the signaling effect of attorney whistleblowing could be altered by SOX, where if such reporting up became sufficiently common it would tend to be perceived as a “routine procedure” rather than challenging managers’ ethical judgment. Supra note 82 at 319. 284 Ribstein supra note 258 at 37. 285 Larry E. Ribstein, Sarbox: The Road to Nirvana, 2004 MICH. ST. L. REV., 279, 286 (2004)(arguing that executive certification will inhibit information flows). 286 See discussion supra section I(D). 287 See Rutzel supra note 7 at 43. 288 Indeed, the SEC proposed an executive certification requirement in 2002 to “reinforce the responsibility of CEOs and CFOs regarding periodic reports and to promote their more active and direct involvement.” Ruder supra note 241 at 1140 289 THOMAS SCHELLING, THE STRATEGY OF CONFLICT 29 (1989).
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time forcing certain terms on management if the union had already voted to strike if certain demands weren’t met. The union representative can then honestly assert that he cannot compromise on the issue because his hands are tied. In this context, compelled whistleblowers find that their legal liabilities surprisingly make them more powerful. Indeed, a small empirical study conducted by Susan Fortney, found that SOX gave corporate counsel more leverage in negotiating with clients on compliance issues.290 C. Improving the Efficacy of Voluntary Whistleblowing Compelled whistleblowing could prove to be a useful complement to voluntary whistleblowing. Not only could it potentially reduce the stigma of voluntary whistleblowing, it also places liability on individuals within the organization for failing to respond properly to a whistleblower’s disclosures. In this respect, SOX gives internal whistleblowing a viral quality. If an elective whistleblower brings evidence of corporate fraud to the attention of auditors, attorneys, executives or the audit committee, she triggers a duty to disclose the problem to someone else or to fix the problem.291 The duties may also compel them to alter the company’s public filings to reflect the new information. The SEC, through its enforcement actions, has explicitly encouraged serious internal investigations and public disclosure of fraud by imposing harsher penalties on companies that fail to do so. 292 To the extent that SOX forces both individuals within the company and the organization as a whole to investigate internal whistleblower allegations, it increases the law enforcement effect of internal whistleblowing. Moreover, SOX alters the calculus of self-preservation when an internal whistleblower reports wrongdoing to a supervisor or other official within the company. While it may have been professionally prudent to conveniently ignore evidence of wrongdoing prior to the enactment of SOX, inaction triggers civil and potentially criminal liability under SOX. The harsh penalties it imposes for obstruction of justice and for altering and destroying documents293 serve to make all employees much more reluctant to participate in a cover up. D. Producing More Timely and Consistent Disclosures 290
Fortney supra note 84 at 75. If employees make disclosures to in-house or outside counsel, such disclosures trigger the attorney’s whistleblower obligations. See discussion infra at III(c). Disclosures to directors or the audit committee triggers their duty of due care. See Simon supra note 82 at 19. Reporting to a CEO or CFO also triggers their certification liability if they fail to report the fraud to the audit committee. See Sarbanes-Oxley § 302(a)(5)(b). 292 In 2002, the SEC increased its enforcement actions substantially, especially in pursuing criminal and civil penalties for individual wrongdoers. See Ruder supra note 241 at 1106. The SEC imposes harsher penalties if the company had inadequate reporting methods, failed to investigate wrongdoing promptly and thoroughly, and failed to disclose the wrongdoing to the regulators and the public. Gibson, Dunn & Crutcher, L.L.P, “Real Time” Enforcement: Recent Trends in Enforcement Actions, Glasser Legalworks Annual Conference on SEC Disclosure, Accounting, and Enforcement (May 15-16 2003), available at http://media.gibsondunn.com/fstore/documents/pubs/Sec_Lit-Real-Time_Enforcement.pdf. 293 Sarbanes-Oxley § 205. 291
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Compelled whistleblowing is both more reliable and timely than voluntary whistleblowing. Imposing liabilities on fiduciaries forces them to internalize the costs of inaction, giving them an incentive to act every time they witness wrongdoing. While voluntary whistleblowing suffers from a collective action problem, compelled whistleblowing works through individual incentives. Compelled whistleblowing is also more likely to be timely, as the speed with which a fiduciary responds to evidence of wrongdoing can reflect on the reasonableness of her response. Some scholars, however, argue that the corporate governance provisions of SOX will create a chilling effect on information flows within the organization.294 These critics assume that organizations are persistently resistant to transparency and accountability. But as William Simon notes, the trend in corporate structures has been towards internal transparency and accountability and away from personal loyalties and departmental rivalries.295 It is also significant that SOX imposes whistleblower obligations on key actors within the organization. These actors have the power to alter the company’s reporting structures and to influence the organizational culture to provide more accountability. When employees know that the executives and directors running the company insist on thorough investigations and do not tolerate corporate misfeasance, the organization becomes less vulnerable to managers seeking to misuse corporate assets and keep employees quiet. For the same reasons, compelled whistleblower legislation may also increase the volume of voluntary whistleblowing. Knowing that the organization will thoroughly investigate whistleblower allegations, employees are more likely to come forward with information of misconduct. To the extent compelled whistleblower legislation reduces the stigma of whistleblowing, it will also make the choice to blow the whistle easier. Indeed, because SOX tends to increase executives’ liability for corporate misfeasance that the executive did not detect but should have known about, it would tend to create incentives to reward, rather than punish whistleblowers. CONCLUSION This paper attempted to challenge the long-held assumption that punitive approaches to whistleblowing are bad policy. Rather, it argued that imposing disclosurerelated liability on individual employees and agents of companies could serve as a useful supplement to voluntary whistleblower legislation. Compelled whistleblowing tends to advance employee rights by imposing the social penalties of whistleblowing on those employees best able to bear them. Disclosure-related liabilities may even make employees more, rather than less, powerful, by giving them a legal justification to demand compliance with securities rules or thorough investigations into corporate fraud. 294
Ribstein, Sarbox: The Road to Nirvana, supra note 285 at 286 (2004)(arguing that executive certification will inhibit information flows). See also discussion section III(B)(i). 295 Simon supra note 82 at 22-24.
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Unlike anti-retaliation legislation, compelled whistleblowing forces organizations to treat voluntary whistleblower disclosures seriously by placing liability on individuals for failing to act in response to evidence of wrongdoing. As William Simon observes, SOX forms part of a larger legal and cultural trend towards holding individuals responsible for inaction and complicity in organizational wrongdoing. 296 As a result, compelled whistleblowing may become an increasingly acceptable means of overcoming collective action problems and assuring accountability in the workplace.
296
See Simon supra note 82 at 22-30.
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