Department of Labor Decision May Expand SOX Whistleblower Protection

A recent decision of the U.S. Department of Labor may expand whistleblower liability under the Sarbanes-Oxley Act (“Sarbanes-Oxley” or “SOX”) to private entities engaged in business with publicly-traded companies. Sarbanes-Oxley applies to companies listed on publicly-traded stock exchanges and, in section 806, protects employees who report certain wrongdoing to their superiors from retaliation. In Kalkunte v. DVI Financial Services, Inc., however, the Department of Labor’s Administrative Review Board affirmed an Administrative Law Judge’s decision holding that both DVI Financial Services (“DVI”), a publicly-traded company, and AP Services, LLC (“AP Services”), a privately-held company, retaliated against Sheila Kalkunte in violation of Sarbanes-Oxley.

The Complainant, Sheila Kalkunte, worked as an Assistant General Counsel for DVI. In June 2003, the Securities and Exchange Commission (“SEC”) began to examine the company’s disclosure statements. In August 2003, DVI hired AP Services to help it reorganization and secure funds from investment banks to continue operations. Under the agreement between DVI and AP Services, AP Services sent Mark Toney and a group of its employees to lead DVI’s restructuring efforts.

Also in August 2003, DVI’s Chief Financial Officer informed Kalkunte that the company reported inaccurate delinquency numbers to the SEC and that employees were shredding documents. Concerned about potential misconduct, Kalkunte reported the CFO’s concerns to DVI’s board of directors. The board subsequently retained outside counsel to investigate the alleged misconduct. The attorneys interviewed Kalkunte and Toney as part of the investigation. DVI later filed for bankruptcy and named Toney the interim Chief Executive Officer. Christine Clay, another AP Services employee, became Chief Administrative Officer.

After the bankruptcy filing, DVI eliminated a majority of its workforce, but retained its in-house legal staff. In fact, Kalkunte’s responsibilities increased. On September 10, 2003, Kalkunte sent an e-mail to a member of the board of directors and Toney to check the status of the investigation into the improprieties that she previously reported. Kalkunte did not receive a response to her inquiry. Toney and Clay discharged Kalkunte on September 18, 2003, without consulting DVI’s board of directors.

On December 15, 2003, Kalkunte filed a complaint with the Occupational Safety and Health Administration (“OSHA”), alleging that DVI and AP Services terminated her employment in retaliation for her whistleblower activity. (OSHA enforces whistleblower provisions of 17 federal statutes, including SOX.) On April 7, 2004, OSHA’s Regional Administrator determined that DVI and AP Services retaliated against Kalkunte. The companies challenged the determination.

On July 18, 2005, an Administrative Law Judge held that DVI and AP Services terminated Kalkunte’s employment in violation of Sarbanes-Oxley. The companies appealed the ALJ’s decision to the Administrative Review Board (“ARB”). The ARB affirmed the ALJ’s findings and held that although AP Services is a privately-held company, it too was liable under § 806 of Sarbanes-Oxley because it was an agent of DVI, a publicly-traded company.

In finding AP Services liable, the ARB applied a fact-intensive analysis, relying upon the extent of control AP Services’ representatives had over the general business and personnel matters of DVI. The ARB noted that AP Services paid the salaries of those employees who were placed at DVI, including Toney, DVI’s Chief Executive Officer. Toney had the authority to hire and fire DVI employees. He also supervised AP Services’ employees designated to the DVI service contract. Further, under Toney’s direction, DVI implemented a reduction-in-force and eventually eliminated Kalkunte’s position, notwithstanding her increased workload.

The Board noted that Sarbanes-Oxley imposes liability on “any officer, employee, contractor, subcontractor, or agent” of a publicly-held company for retaliating against an employee because of the employee’s whistleblower activity. Further, according to Sarbanes-Oxley regulations, “no company or company representative may discharge or in any other manner discriminate against any employee.” A company representative includes any officer, employee, contractor, subcontractor, or agent. Thus, the ARB reasoned, AP Services, a privately-held company, as an agent of DVI, was able to affect the employment of Kalkunte and, therefore, was subject to Sarbanes-Oxley’s whistleblower provisions.

The ARB also found that Kalkunte’s whistleblower complaint was a motivating factor in Toney’s decision to terminate her employment. According to the ARB, Toney offered ever-changing reasons for his decision to discharge Kalkunte. He initially explained that her position was eliminated as part of the reduction-in-force; then, he stated she was terminated for poor performance; finally, he claimed that outside counsel could do her work for lower costs. The ARB noted that Toney began to question Kalkunte’s value to DVI after she asked him about the status of her internal complaint. It also noted that Toney considered Kalkunte’s questioning an “irritant,” and concluded, “[W]hat to him was an irritant the law regards as protected activity.” Thus, the ARB held that DVI and AP Services discharged Kalkunte in retaliation for her whistleblower complaint and held both companies liable under § 806 of Sarbanes-Oxley. The ARB also noted that but for a procedural defect by Kalkunte, Toney could have been held personally liable under Sarbanes-Oxley.

Kalkunte was awarded backpay, damages for pain, suffering and mental anguish (the effects of her termination on her credit and humiliation) and reimbursement for costs, including reasonable attorney’s fees.

The Kalkunte decision demonstrates that privately-held companies are vulnerable to liability under Sarbanes-Oxley’s whistleblower provisions. While the ARB did not articulate a specific standard for finding “agency” liability, it relied upon facts particular to the case. In light of this decision, private companies should assess their business relationships with publicly-traded companies and consider the following;

  1. Whether specific relationships with public companies place them in the role of an “agent” or “representative” of the publicly-traded entity pursuant to Sarbanes-Oxley;
  2. Whether the relationship provides the employees of the private company with supervisory authority over employees of the public company, and, if so, whether the private company has controls to review any employment actions that its employees initiate vis-à-vis the employees of the publicly-traded company; and
  3. Whether the private company employees have been trained on their anti-retaliation obligations while they stand in the shoes of an agent or representative of the public company.

Jackson Lewis attorneys are available to answer your inquiries regarding this decision and to assist employers in corporate governance matters. The Corporate Governance and Internal Investigations Practice Group provides, among other things, counsel to management on Sarbanes-Oxley matters, including training on retaliation and related matters.