Sarbanes-Oxley Act Whistle-blower Provisions: Practical Concerns

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The comprehensive protection afforded whistleblowers in the Sarbanes-Oxley Act (SOX) creates significant liability for companies covered under the law.

Section 806 of Sarbanes affords direct protection against retaliation to whistleblowers employed in publicly held companies. Privately held companies are indirectly covered by the Act for three reasons, according to Marc Steinberg and Seth Kaufman writing for the Journal of Corporation Law of University of Iowa College of Law.

"First," Steinberg and Kaufman write, “many privately held companies act as contractors, subcontractors or other agents of publicly held companies, and thus are covered by this part of SOX. Second, the criminal penalties apply to both publicly and privately held companies. Third, state courts may well look to SOX in their interpretation of similar state laws.”

Section 302 of the Sarbanes-Oxley Act assigns responsibility for developing procedures for whistle-blower compliance to the audit committee. Section 302 of Sarbanes-Oxley states: “Each audit committee shall establish procedures for the confidential anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters.”

To meet the anonymity requirement, many audit committees have established “hotlines” for personnel to use when they believe a fraud has been committed. According to Steinberg and Kaufman, SEC Enforcement Director Stephen Cutler has “urged companies to appoint a permanent ombudsman or business practices officer” to receive complaints. Complaint procedures should be easy to understand and copies of the procedures should be made available to all employees. Preserving confidentiality decreases the chances of a retaliation claim.

Preserving the anonymity of the whistle-blower can prove to be difficult if the complaint reaches the investigation stage, particularly if the investigation is conducted by the company's internal auditors, according to Phil Kleckner and Craig Jackson, of RosenfarbWinters, writing in Accounting Today. Moreover, Section 201 of Sarbanes makes it clear that the external auditor of a public company may not perform investigations due to independence issues. Forensic accountants or Certified Fraud Examiners, who specialize in investigating fraud, and are employed by other firms, may conduct investigations according to Kleckner and Jackson. It is not clear if privately held companies may use their external auditors for investigation, but Kleckner and Jackson say that companies would be wise to avoid the risk.

Dealing with incompetent employees who happen to be whistle-blowers involves legal risk for companies. Adverse action under Section 806 of SOX extends beyond dismissal, to demoting, harassment and other forms of discrimination. Whistle-blower complaints of job retaliation by an employer must be lodged with the OSHA of the U.S. Department of Labor within 90 days of the alleged violation. Since OSHA will not conduct an investigation if the employer establishes that it would have taken the same adverse action regardless of the employee's whistle-blowing, employers should prepare policies to document their position. Company policies regarding documentation of disciplinary action or investigations can be the “clear and convincing evidence” that SOX requires to respond to the complaint, according to Steinberg and Kaufman.

Companies should conduct training in SOX requirements for employees, contractors and subcontractors, say Steinberg and Kaufman. Managers should be trained in handling complaints. Steinberg and Kaufman suggest that companies document the training and ask “contractors and subcontractors to sign a document that acknowledges that they attended the training session.”

Although only 15 percent of Sarbanes-Oxley whistleblower complaints have been found to have merit according to Richard Fairfax of the Department of Labor and reported by USA Today, that number is comparable to cases the Department hears under other whistle-blower laws. Whistle-blowers who win their cases are entitled to back pay and attorneys' fees as well as their old jobs, “quite a lot of benefit” according to Fairfax. In practice, however, whistle-blowers often settle with their former companies and go on to less rewarding positions, USA Today reported.

Whistleblowers protected from job retaliation under Sarbanes-Oxley and other federal statutes received some tax relief recently from the America's Jobs Creation Act of 2004. Individuals with legal fees and court costs arising from a discrimination suit may now deduct the costs directly from income on the front of the tax return according to the IRS. Taxpayers do not need to itemize. Thus legal fees will be taxed only once, as income to the attorney.

The deduction only covers costs paid after October 22, 2004 and cannot exceed the amount includible in income for the year on account of a judgment or settlement resulting from the discrimination claim. Generally, employees who incur legal expenses related to doing or keeping a job deduct these expenses on Schedule A as a miscellaneous itemized deduction.

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