Auditors Can Be Whistleblowers: A Guest Post On Recent Developments In Whistleblower Case Law
It’s rare but it does happen. Employees of the largest audit firms do occasionally step up and blow the whistle on potentially illegal and/or unethical activities at their firm or its clients.
The Guardian writes about the whistleblower now formally charged in Luxemburg for leaking PwC’s copies of tax letter ruling documents:
A 28-year-old former PricewaterhouseCoopers auditor charged with theft and violating trade secrets in Luxembourg in the wake of the LuxLeaks tax avoidance scandal has revealed his identity and claimed he acted out of conviction, in an interview with the French newspaper Libération.
Antoine Deltour, who joined PwC from business school in 2008, resigned two years later. “Normally auditors are a bit like regulators. It is a useful profession, we verify the accounts of companies,” he told the newspaper. “But I wasn’t feeling at home in that environment (at PwC). Bit by bit I discovered how extreme the system was in reality – it was a massive tax optimisation practice. I didn’t want to be part of that.”
The most interesting thing about Deltour’s admissions is that he believes he is not alone.
Deltour, who said he had not passed information to the ICIJ, told Libération: “From the beginning, I acted out of conviction, for my ideas, not to appear in the media.”
He added that he was part of “a broader movement” — a reference to the fact that the Guardian and other media working with the ICIJ had this month published more revelations and further confidential tax rulings secured by Ernst & Young, KPMG and Deloitte.
It will be interesting to see if PwC and the other large firms can squelch this “movement” with threats and legal action or whether the cat is already out of the bag. If professionals in the US, UK or Australia become willing to act “out of conviction” and expose activities that their firms cover up on behalf of clients or that contravene public policy and the public good, we may witness a sea change return to the concept of the auditor’s “public duty” rather than the typical “pleaser” personality that is highly risk-averse, prone to group think, and fears a black mark on his or her permanent record above all.
Jason Zuckerman is a Principal at Zuckerman Law and represents whistleblowers nationwide in actions brought under federal whistleblower protection and rewards statutes. Prior to founding his firm, he served as Senior Legal Advisor to the Special Counsel at the U.S. Office of Special Counsel, the federal agency charged with protecting whistleblowers in the federal government, and served on the Whistleblower Protection Advisory Committee, which makes recommendations to the Secretary of Labor to improve OSHA’s administration of federal whistleblower protections. Zuckerman has written extensively about federal whistleblower rights and his advice is cited in Financial Statement Fraud: Prevention and Detection.
He’s written a guest post about several recent developments should be of interest to internal and external auditors and compliance professionals, whether they work for a public company or a professional services provider.
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Outing a whistleblower
Section 301 of the Sarbanes-Oxley Act of 2002 (SOx) requires companies to offer employees an option to report questionable auditing or accounting matters anonymously. Even prior to the enactment of SOx, companies tried to maintain the confidentiality of a whistleblower when investigating a whistleblower’s internal disclosures. Has the company violated the whistleblower protection provision of SOx if it reveals the whistleblower’s identity without taking any personnel action against the whistleblower?
A federal court of appeals answered that question in the affirmative in Halliburton v. Admin. Review Bd, holding that “outing” a whistleblower is a prohibited adverse action under SOx.
While working as Director of Technical Accounting Research and Training in the Finance and Accounting department at Halliburton, Anthony Menendez disclosed to his supervisor his concern that practices involving revenue recognition did not conform with GAAP. Menendez’s supervisor initially responded by telling Menendez that he is not a “team player” and should try harder to work with colleagues to resolve accounting issues.
Unable to persuade Halliburton management to take corrective action, Menendez filed a confidential disclosure with the SEC, and sent a memo to Halliburton’s Board of Directors raising the same issues that he had disclosed to the SEC. A few days after Menendez sent the memo to the Board, the SEC contacted Halliburton’s General Counsel (GC) to notify Halliburton that the SEC was investigating the company’s accounting practices and instruct Halliburton to preserve relevant records. Having seen Menendez’s memo to the Board, the GC surmised that Menendez was the source of the SEC inquiry. The GC then sent an email to Menendez’s colleagues instructing them to retain certain documents because “the SEC has opened an inquiry into the allegations of Mr. Menendez.”
Subsequent to the GC outing Menendez as a whistleblower, Menendez’s colleagues began treating him differently, refusing to work and associate with him. Menendez described the day on which he saw the GC’s email outing him as a whistleblower as one of the worst in his life. The court recognized that outing a whistleblower might dissuade a reasonable employee from whistleblowing:
It is inevitable that such a disclosure would result in ostracism, and, unsurprisingly, that is exactly what happened to Menendez following the disclosure. Furthermore, when it is the boss that identifies one of his employees as the whistleblower who has brought an official investigation upon the department, as happened here, the boss could be read as sending a warning, granting his implied imprimatur on differential treatment of the employee, or otherwise expressing a sort of discontent from on high . . . In an environment where insufficient collaboration constitutes deficient performance, the employer’s disclosure of the whistleblower’s identity and thus targeted creation of an environment in which the whistleblower is ostracized is not merely a matter of social concern, but is, in effect, a potential deprivation of opportunities for future advancement.
This decision underscores the broad scope of retaliatory actions that can give rise to a SOx retaliation claim, including discharging, demoting, suspending, threatening, harassing or otherwise discriminating against an employee who engages in protected whistleblowing. Although Halliburton did not terminate Menendez’s employment or take actions that directly affected his pay, he can recover damages under SOx for emotional distress and reputational harm.
Several recent court cases are encouraging for whistleblowers
Fortunately, the Halliburton decision is one of several recent positive developments in judicial and administrative interpretations of the SOx whistleblower protection provision.
In March 2014, the Supreme Court held in Lawson v. FMR that employees of contractors of public companies, including employees of accounting and audit firms, can bring SOx whistleblower retaliation claims. Lawson relies heavily on the legislative history of SOx, including the role of outside auditors and accountants in enabling accounting fraud at Enron:
“Congress plainly recognized that outside professionals — accountants, law firms, contractors, agents, and the like — were complicit in, if not integral to, the shareholder fraud and subsequent cover-up (Enron) officers … perpetrated.” . . . Indeed, the Senate Report demonstrates that Congress was as focused on the role of Enron’s outside contractors in facilitating the fraud as it was on the actions of Enron’s own officers. See, e.g., S. Rep., at 3 (fraud “occurred with extensive participation and structuring advice from Arthur Andersen … which was simultaneously serving as both consultant and independent auditor for Enron” (internal quotation marks and brackets omitted)); id., at 4 (“professionals from accounting firms, law firms and business consulting firms, who were paid millions to advise Enron on these practices, assured others that Enron was a solid investment”) . . . Also clear from the legislative record is Congress’ understanding that outside professionals bear significant responsibility for reporting fraud by the public companies with whom they contract, and that fear of retaliation was the primary deterrent to such reporting by the employees of Enron’s contractors. Congressional investigators discovered ample evidence of contractors demoting or discharging employees they have engaged who jeopardized the contractor’s business relationship with Enron by objecting to Enron’s financial practices. See, e.g., . . . .Yost, Andersen Whistleblower Was Removed, Associated Press (Apr. 3, 2002) (Congressional investigation reveals that Andersen removed one of its partners from its Enron team after Enron officials expressed unhappiness with the partner’s questioning of certain accounting practices) . . . .
In the same vein, two of the four examples of whistleblower retaliation recounted in the Senate Report involved outside professionals retaliated against by their own employers. S. Rep., at 5 (on Andersen and UBS Paine-Webber employees); see also id., at 4-5 (Andersen employees who “attempted to report or ‘blow the whistle’ on (Enron’s) fraud … were discouraged at nearly every turn“). Emphasizing the importance of outside professionals as “gatekeepers who detect and deter fraud,” the Senate Report concludes: “Congress must reconsider the incentive system that has been set up that encourages accountants and lawyers who come across fraud in their work to remain silent.” Id., at 20-21. Lawson, 134 S. Ct. at 1169-70 (emphasis added).
Audit firms are under competitive pressure to retain (and please) clients. Robust whistleblower protection for employees of audit firms is essential to ensure that those employees can disclose questionable or unlawful accounting or auditing practices regarding clients, or even their own firms, without fear of reprisal.
In March 2014, a California jury awarded $6M to Catherine Zulfer, a former accounting executive at Playboy Enterprises Inc. who alleged that her employment was terminated in retaliation for refusing the CFO’s instruction to set aside $1 million for discretionary executive bonuses that had not been approved by the board of directors. Most of the bonuses would have been paid to the CEO and CFO. Zulfer warned Playboy’s General Counsel that the bonus accrual could violate SEC rules prohibiting the circumvention of internal accounting controls. Following Zulfer’s internal whistleblowing, the CFO retaliated against her by excluding her from meetings, forcing her to take on additional duties, and eventually terminating her employment.
This is the highest jury verdict ever obtained under SOx and it will likely spur SOx whistleblowers to try their claims before juries, rather than before administrative law judges at the Department of Labor.
Section 806 of SOx protects employees of publicly-traded companies and employees of contractors and subcontractors of publicly-traded companies against retaliation for providing information about securities fraud, shareholder fraud, bank fraud, a violation of any SEC rule or regulation, mail fraud, or wire fraud. A prevailing whistleblower can obtain reinstatement or front pay in lieu thereof, lost wages and benefits and special damages, which includes emotional distress, reputational harm and other non-economic harm resulting from retaliation.
In 2013 and 2014, several federal courts of appeals adopted or deferred to a decision of the DOL’s Administrative Review Board in Sylvester v. Parexel broadly construing SOx protected whistleblowing. This is a very significant development in that it will be more difficult for employers to obtain summary dismissal of SOx claims prior to trial by attacking the whistleblower’s reasonable belief or the lack of specificity in the whistleblower’s disclosure. In particular, courts adopting Sylvester will apply the following principles to determine whether a SOx complaint engaged in protected conduct:
- The whistleblower need not show that he or she disclosed an actual violation of an SEC rule or actual shareholder fraud, but instead need only show that he or she reasonably believes that the conduct complained of constitutes a violation of one of the laws comprising the categories of protected conduct under Section 806.
- An employee need not wait until the illegal conduct occurs to make a protected disclosure, so long as the employee “reasonably believes that the violation is likely to happen.”
- A complainant need not allege shareholder fraud in order to be protected under SOx. It is sufficient for an employee to form a reasonable belief that a violation of “any rule or regulation of the Securities and Exchange Commission” could lead to fraud, even if the violation itself is not fraudulent. For example, SOX protects a disclosure about deficient or inadequate internal controls over financial reporting, even though there is no allegation that fraud has actually taken place.
- The reasonable belief standard requires an examination of the reasonableness of a complainant’s beliefs, but not whether the complainant actually communicated the reasonableness of those beliefs to management or the authorities.
- A SOx complainant has engaged in protected activity if he or she simply has an objectively reasonable belief that a violation of the laws in Section 806 has occurred – the complainant does not need not establish the various elements of criminal fraud.
This broad interpretation of the scope of SOx protected whistleblowing is consistent with the prophylactic or preventative purpose of Section 806, i.e., to protect all good faith and reasonable reporting of fraud, and to encourage early reporting (before shareholders are harmed).
The Ethics Resource Center’s National Business Ethics Survey for 2013 found that “more than one in five workers who reported misconduct said they experienced retaliation in return.” Internal and external auditors and accountants working for public companies are best positioned to detect and report accounting fraud, but also face significant disincentives to come forward, including the retaliation and alienation that Menendez and Zulfer encountered when they blew the whistle on questionable accounting practices.
For several years after the enactment of SOX, courts created loopholes in Section 806 of SOx that rendered it a fairly weak remedy to combat whistleblower retaliation. Recent developments in administrative and judicial decisions interpreting Section 806 of SOx suggest that it can be a potent remedy to hold companies accountable for retaliation.
