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First Circuit Rules That SOX Whistleblower Protections Do Not Apply to Employees of a Contractor or Subcontractor of a Public Company

Posted in Sarbanes-Oxley Act, Whistleblower Issues

In a February 3, 2012 Opinion, the First Circuit Court of Appeals reversed a Massachusetts federal court decision and held that, while the whistleblower protections of the Sarbanes-Oxley Act apply to employees of "public companies" (i.e., a company with registered securities or one that files reports under Section 15(d) of the Exchange Act), they do not apply to an employee of a contractor or subcontractor of such a public company.

Both plaintiffs. Jackie Hosang Lawson and Jonathan Zang, were employees of private companies that were contractors providing advising or management services to the Fidelity family of mutual funds (investment companies which were public companies, but not parties in either suit). 

Mr. Zang was employed by Fidelity Management & Research Co. and later by FMR Co., Inc., which was formed as a subsidiary of Fidelity Management & Research Co. (collectively, the Fidelity Management companies, which served as investment advisers or sub-advisers to certain of the Fidelity mutual funds).    Mr. Zang alleged that he was terminated by the Fidelity Management companies in July 2005 in retaliation for raising concerns about inaccuracies in a draft revised registration statement for certain Fidelity funds, which he thought violated several federal securities laws. After pursuing a claim against his former employers before the Occupational Health & Safety Administration ("OSHA"), Mr. Zang ultimately filed a Complaint in federal court in May 2008.

Ms. Lawson, a former employee of Fidelity Brokerage Services, LLC, a private subsidiary of FMR Corp., which was succeeded by FMR LLC (which collectively operate under the trade name Fidelity Investments), alleged she was constructively discharged in September 2007 in retaliation for raising concerns relating to cost accounting methodologies. She too, filed claims with OSHA and ultimately filed a Complaint in federal court in March 2008. 

Both Complaints allege that defendants wrongfully retaliated against plaintiffs by terminating them in violation of the SOX whistleblower provisions, 18 U.S.C. § 1514A. Both complaints also contained a state law claim for wrongful discharge.

The defendants moved to dismiss the complaint in each case. In a March 31, 2010 Memorandum and Order (also available at Lawson v. FMR LLC, 724 F. Supp. 2d 141 (D. Mass. 2010)), Judge Douglas Woodlock concluded that the whistleblower protection provision within SOX section 806 extended its coverage beyond "employees" of "public" companies (as those terms are defined in the section) to encompass also the employees of private companies that are contractors or subcontractors to those public companies. The Judge dismissed the state law claims.

Upon defendants’ motion, Judge Woodlock entered a Memorandum and Order on July 28, 2010 certifying the following question for appellate review:

Does the whistleblower protection afforded by Section 806(a) of the Sarbanes-Oxley Act, 18 U.S.C. § 1514A, apply to an employee of a contractor or subcontractor of a public company, when that employee reports activity which he or she reasonably believes may constitute a violation of 18 U.S.C. §§ 1341, 1343, 1344, or 1348; any rule or regulation of the Securities and Exchange Commission; or any provision of Federal law and such a violation would relate to fraud against shareholders of the public company?

The First Circuit began with an analysis of the relevant SOX provision, which states:

Whistleblower protection for employees of publicly traded companies. – No company with a class of securities registered under section 12 of the Securities Exchange Act of 1934 (15 U.S.C. 78l), or that is required to file reports under section 15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78o(d)), or any officer, employee, contractor, subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee …

The Court noted that the parties agreed that "this provision extends whistleblower protection to employees of ‘public companies’ – that is, those with a class of securities registered under section 12 of the 1934 Act or those that file reports with the SEC pursuant to section 15(d) of the 1934 Act." The defendants argued that the statute provides that no public company (including an officer, employee, contractor, subcontractor, or agent of that company) may discriminate against an employee of such public company for engaging in protected whistleblowing activity. The plaintiffs argued that a covered "employee" includes both the employees of public companies and those who are the employees of those public companies’ contractors, subcontractors, or agents.

The First Circuit agreed with defendants that "only the employees of the defined public companies are covered by these whistleblower provisions; the clause ‘officer, employee, contractor, subcontractor, or agent of such company’ goes to who is prohibited from retaliating or discriminating, not to who is a covered employee." The Court based this upon principles of statutory interpretation and a review of the legislative history of the Sarbanes-Oxley Act. The Court also determined that, although the SEC and the Department of Labor submitted amicus briefs supporting plaintiffs’ position, their arguments were not entitled to deference.

The Court concluded its decision by stating that "[i]f we are wrong and Congress intended the term ‘employee’ … to have a broader meaning than the one we have arrived at, it can amend the statute." Otherwise, the Court, stated it was "bound by what Congress has written."

Jim Hamilton provides a thoughtful analysis of the Court’s Opinion in his World of Securities Regulation Blog (here).