The Fourth Circuit Rejects ReInstatement for First Sox Whistleblower
August 12, 2008 | Leave a Comment
The first claimant to win a Sox Whistleblower case suffered another setback in a federal appeals court last week. The 4th U.S. Circuit Court of Appeals refused to reinstate David Welch to his job, ruling that he failed to explain how his employer’s alleged shoddy accounting practices could be considered a violation of federal law. Welch was dismissed as chief financial officer of Cardinal Bankshares Corp. in 2002 after reporting what he said were misclassifications in financial reports that essentially overstated the bank’s earnings by $195,000. Cardinal is the holding company for a bank in southwestern Virginia.
In the case, styled Welch v. Chao, Judge Diana Gribbon Motz wrote that a SOX whistleblower doesn’t have to cite code sections to make out a claim, but he has to identify the specific conduct he “reasonably believes” is illegal. Judge Motz wrote that communications about misclassifications in financial statements could form the basis of a SOX whistleblower claim, but that Welch’s SOX claim failed because his citation of accounting treatises and later-passed laws and regulations could not show how the bank’s accounting practices reasonably could have been perceived as a violation of federal securities laws.
J-SOX
April 12, 2008 | Leave a Comment
Japan recently enacted the Financial Instruments Exchange Law which includes a regulation entitled Management Assessment and Audit of Internal Control over Financial Reporting (”ICFR”). ICFR requires management to provide an assessment of its internal control over its financial reporting. The regulation also requires that the registrant obtain an auditor’s opinion on management’s assessment. The regulation, commonly referred to as “J-SOX” named after Sarbanes-Oxley, is applicable to companies that are publicly registered on Japanese stock exchanges and is effective for registrants’ fiscal years beginning on or after April 1, 2008.
The new law is complex and confusing. ICFR will impact the 3,800 companies listed on Japanese stock exchanges and will also affect the subsidiaries of the listed companies, even if they operate in other parts of the world.
The implementation guidance (published by the FSA) recommending a risk-based, top-down approach to J-SOX implementation twhcih means that that the parent company will begin by evaluating entity level controls (e.g., overall control environment, oversight by the board of directors, etc.) and will work down to specific processes and financial statement accounts.
The Section 1 guidance, which covers the basic framework for internal control, requires a control framework that includes the common COSO elements of:
- Control Environment
- Risk Assessment
- Control Activities
- Information and Communication
- Monitoring
In addition to those five COSO elements, J-SOX also incorporates “Response to IT” as it relates to ICFR as a new component. The Section 2 guidance covers management assessment and reporting of ICFR and includes the following five areas:
- Definition of Financial Reporting
- Scoping of Management Assessment
- Structure for Internal Control Assessment Method and Use of Specialists
- Evaluation of Company Level Controls
- Process Level Controls – Assessment of Operating Effectiveness
The Section 3 guidance covers the audit of ICFR and includes the following four areas:
- The meaning of auditor’s “Indirect Reporting”
- Sample size for testing operating effectiveness
- Use of the work of internal audit and/or others
- Reporting on material weaknesses and other reportable conditions.
Japan’s electronic data regulations and their potential interplay with J-SOX will be the subject of a later post.
Criminal Exposure of Sarbanes-Oxley
April 4, 2008 | Leave a Comment
Section 1107 of SOX imposes several criminal penalties. The penalties include a fine and/or imprisonment for up to 10 years. Section 1107 does NOT create a private cause of action. See In Re Compact Disc Minimum Advertised Antitrust Litigation, MDL No. 1361 (D.Me.Oct. 2, 2006).
Section 1107 provides that:
“whoever knowingly, with the intent to retaliate, takes any action harmful to any person including interference with the lawful employment or livelihood of any person, for providing to a law enforcement officer any truthful information relating to the commission or possible commission of any Federal offense.”
This section of SOX is not limited to publicly traded employers. It appears to apply broadly to both individuals and corporations. The Section prohibits retaliation against persons who provide to a law enforcement officer “any truthful information” relating to the commission or possible commission of “any Federal offense.” Thus the information is not limited to matters involving corporate fraud or accounting abuses but can involve “any Federal crime“.
Section 1107 could create “land mines” for employers. For example, a report to a law enforcement official that a co-worker or supervisor engaged in any of the following activities would appear to be protected under this Section: (1) willfully creating dangerous working conditions in violation of OSHA laws; (2) violating one of the multitude of environmental laws; (3) copying or using software with out permission; (4) storing and/or transmitting indecent material via a company computer; or (5) the destruction of documents in response to notice of a governmental investigation.
Another concern for employers should be the risk of defending both a civil proceeding and a criminal proceeding under the Act, with a potential early communication to OSHA being the employer’s first required statement on the matter. The substantial resources required to defend against both proceedings simultaneously could result be a drain on the employer’s assets.
The final concern resulting from Section 1107 is the location of its codification at 18 U.S.C. § 1513(e). This section is specifically listed within the definition “racketeering activity” under the Racketeer Influenced and Corrupt Organizations Act (“RICO”). The result of this is that Section 1107 will likely be a basis for asserting civil RICO claims in a whistleblower case.