SOX and whistleblowing.

• Author: Dworkin, Terry Morehead
• Position: Sarbanes-Oxley Act of 2002

The language of the Sarbanes-Oxley Act ("SOX") leaves no doubt that Congress intended whistleblowing to be an integral part of its enforcement mechanisms. The Act attempts to encourage and protect whistleblowers in a variety of ways, including providing for anonymous whistleblowing, establishing criminal penalties for retaliation against whistleblowers, and clearly defining whistleblowing channels. Unfortunately, these provisions give the illusion of protection for whistleblowers without effectively providing it. There is increasing evidence that virtually no whistleblower who has suffered retaliation and pursued remedies under SOX has been successful. Additionally, social science research and studies of whistleblowing laws indicate that SOX is unlikely to increase reports.

This Article compares the SOX whistleblowing provisions with other state and federal whistleblowing statutes, discusses the shortcomings of the SOX provisions, and explains why SOX needs to be revised in order to help ensure the integrity of the markets. Recommended revisions include significantly rewarding whistleblowers that come forward with novel and relevant information. Experience with the False Claims Act and equivalent state statutes show such incentive legislation to be the only truly effective legislative model. The Article goes on to discuss various ways to create an incentive reward fund. While some of the current law as well as some of the suggested revisions potentially put SOX in conflict with privacy and whistleblowing laws of European countries, the conflicts can be eliminated through judicious use of exemptions and/or through judicial interpretation.

TABLE OF CONTENTS INTRODUCTION I. WHISTLEBLOWING UNDER SOX A. Comparative Coverage B. Retaliation II. THE INADEQUACIES OF SOX WHISTLEBLOWING A. Inadequate Protection for Whistleblowers B. Failure in Spurring Whistleblowing 1. Protective Whistleblower Legislative Model 2. Incentive Legislation III. EFFECTIVE SOX WHISTLEBLOWING A. The Foreign Reach of Sarbanes Oxley B. Exemptions CONCLUSION INTRODUCTION

The Sarbanes-Oxley Act of 2002 ("SOX") (1) represents a reification by the Unites States Congress of the importance of whistleblowing in the control, detection, and deterrence of wrongdoing. It followed the dramatic growth of whistleblowing laws in the 1980s and 1990s, (2) along with a growing hostility and distrust of big business and government. However, it was the wrongdoing, scandals, and resultant publicity, and the anger brought on by the leaders of failed corporations such as Enron and WorldCom that were the particular impetus for the law. (3) Whistleblowers were important in bringing the wrongdoing to light (4) and in testifying before Congress in hearings about the law. (5) Today they play a crucial role in SOX enforcement.

SOX has been controversial since its enactment (6) and has been challenged on a variety of grounds including charges that it is unconstitutional (7) and too costly, especially for small business (8) and foreign companies. (9) It has also been blamed in part for reduced foreign listings on the New York Stock Exchange. (10) In response to these and other complaints, many commentators and legislators have proposed amendments to SOX. (11) In addition, because SOX is relatively new and litigation is evolving, there are still many unanswered questions about its effectiveness, scope, and application that create something of a moving target for reformers. (12) One important question is whether SOX will be effective in getting observers of wrongdoing to report it. Another is whether the whistleblower enforcement mechanisms will run afoul of laws in other countries.

The first Part of this Article contains a comparative discussion of whistleblowing under the provisions of SOX. The following Part discusses why, from a social science research and practical perspective SOX is not proving effective in protecting whistleblowers. The third Part analyzes the likely ineffectiveness of SOX to spur whistleblowing and the incentive legislation that would better achieve this. The fourth Part discusses the extraterritorial reach of the whistleblowing sections of SOX and proposals for exemptions. The final Part proposes reforms of the whistleblowing sections to better achieve the intended goals of SOX.

1. WHISTLEBLOWING UNDER SOX

   1. Comparative Coverage

      There are three whistleblower sections to SOX. The most important, Section 806, states that a covered company cannot "discharge, demote, suspend, threaten, harass, or in any other manner discriminate" against a whistleblower who reports covered information to someone within the organization who "has the authority to investigate, discover, or terminate misconduct." (13) In specifying to whom the whistleblowing report should be made, SOX is like most of the U.S. state and federal whistleblowing statutes. (14) It also comports with the commonly understood definition of whistleblowing as "the disclosure by organization members (former or current) of illegal, immoral, or illegitimate practices under the control of their employers to persons or organizations that may be able to effect action." (15) Additionally, like virtually every whistleblower statute, domestic or foreign, whistleblowers are not required to be correct in order to be protected. (16) They must merely reasonably believe that the information concerns a covered violation. (17)

      Section 806 is unusual in specifying internal whistleblowing as an appropriate channel. Most state and federal statutes designate only an external recipient. (18) In this regard, SOX follows common whistleblower practice since internal reporting is the most common type of initial whistleblowing. (19) Benefits of internal whistleblowing include facilitating the prompt investigation and correction of wrongful conduct and minimizing the organizational costs of whistleblowing by permitting employers to rectify misconduct confidentially, with little disruption to the employer-employee relationship. Internal whistleblowing also enables the correction of misunderstanding, which reduces the likelihood that the organization and its employees will unfairly suffer harm. However, it may also allow for cover-ups, as happened in some of the recent scandals.

      Another distinctive section of SOX is the requirement of a channel for anonymous whistleblowing. This provision is unique among whistleblower statutes. (20) Section 301 of SOX requires audit committees of covered companies to establish whistleblowing procedures whereby employees can anonymously submit issues of concern regarding questionable accounting or auditing matters. (21) Further, it requires the committees to have procedures for retaining and treating the reports. Most commonly, the organizational response to this requirement has been to contract with an independent hotline company to receive the reports. (22)

      A person who reports the suspected fraud externally must give the information to a federal regulatory or law enforcement agency, or to any member or committee of Congress in order to be protected. As in virtually all whistleblowing statutes, (23) SOX does not protect whistleblowers who go to the media. (24) While studies of media whistleblowers indicate that these whistleblowers are as responsible as other whistleblowers and have good reasons to resort to the media, domestic and foreign legislators seem not to trust them or to encourage this kind of reporting. (25)

   2. Retaliation

      If the whistleblower suffers retaliation for reporting, [section] 806(a) gives the employee the right to bring a civil suit. Before that can happen, the employee must first file a complaint with the Secretary of Labor, who then refers it to the Occupational Safety and Health Administration for investigation. An administrative law judge of the Department of Labor hears the evidence resulting from the investigation and renders a decision. (26) The case will not go forward if the employer can show by clear and convincing evidence that it would have taken the action in the absence of the whistleblowing. (27) Congress established a time limit of 180 days within which the Secretary of Labor should render a decision based on this process. (28)

      If there is no decision in 180 days, then the employee may bring a civil suit for de novo review in the district court. (29) This creates the potential for conflicting decisions and duplicative litigation

      because the whistleblower can file a lawsuit in the district court while the administrative proceeding is still pending. (30) At least one court distinguished between this theoretical concern and the case before it because under the circumstances of the current case it did not lead to "an absurd result." (31) This was particularly true because the district courts can conduct a de novo review. (32)

      SOX, in defining retaliation as encompassing discharging, demoting, suspending, threatening, harassing, "or in any other manner discriminat[ing]" against the whistleblower, statutorily encompasses a broader definition of prohibited retaliation than most state whistleblower laws. (33)

      The definition of covered employees is similarly broad. It includes current and former employees and applicants. (34) Most whistleblower statutes do not cover applicants. (35) The coverage applies not only to publicly traded companies (36) but also to contractors, subcontractors and agents of those companies. (37) This means, for example, that if an accountant for Arthur Anderson suffered retaliation for reporting fraud at Enron (as was alleged), the accountant could file a SOX complaint. The law is sufficiently vague that it may also cover U.S. citizens working for a foreign-listed publicly traded company overseas or for a private foreign subsidiary of a covered U.S. company, or a foreign employee working for a foreign subsidiary. (38) If this is the case, SOX may run afoul of European privacy law and the whistleblowing statutes of other...