VideoIf the saga of David Welch is any example, corporate employees who witness or suspect financial wrongdoing may want to think twice before speaking up. In 2002 Welch became the first person to seek whistle-blower protection under Section 806 of the Sarbanes-Oxley Act. In the ensuing five years his case has gone largely nowhere, and he now appears to be one appeal short of losing altogether.
He's far from alone. Of nearly 1,000 complaints filed under the whistle-blower provisions of Sarbox, not one has survived company appeals to result in an unequivocal win for the complainant. Many have been settled at some stage of the process (see the chart at the end of this article), but the lesson so far seems to be that if companies continue to fight they will ultimately prevail.
Welch served as CFO of Cardinal Bancshares, a bank holding company based in Floyd, Va. In 2002 he raised an alarm regarding $195,000 in loan recoveries that he believed had been misclassified as income. Welch refused to certify the company's financial statements and was suspended and then fired. The company has always maintained that the firing had nothing to do with Welch's questions about accounting practices but stemmed from his refusal to meet with an independent auditor and a company attorney unless his own attorney could be present.
In 2004, an administrative law judge recommended that Welch be reinstated and awarded back pay. The judge agreed with Welch that the company's external auditor, Larrowe & Co., had not properly communicated with him about matters that fell within his purview (Welch had contended that the auditor did an end run around him and went straight to CEO Ronald Leon Moore) and that the company's internal controls allowed people without financial expertise to make journal entries without Welch's review.
The judge also disagreed with the company when it argued that, because Welch had previously signed financial statements and Federal Reserve call reports without objecting to entries he later labeled as questionable, he could not have reasonably believed them to be improper.
In May, the Department of Labor's Administrative Review Board rejected the judge's findings. It argued that Welch's complaints about the company's auditor and the company's own internal controls did not qualify as "[Sarbox]-protected activity." Nor, the ARB argued, did his complaint about the handling of loan recoveries qualify as a legitimate Sarbox complaint, because Welch "could not have reasonably believed that Cardinal misstated its financial condition" as a result.
All of which raises the logical question, If those aren't Sarbox-protected activities, what are? "The ARB is restricting what is 'protected activity' [to a degree] far greater than what the act had intended," says D. Bruce Shine, Welch's attorney and a partner in Shine & Mason of Kingsport, Tenn. Shine admits that some early Sarbox whistle-blower cases were "junk and never should have been filed," but says Welch's concerns were valid given his background as a CPA and CFO and the fact that he brought in a forensic CPA to review the matter.
Welch plans to appeal to the Fourth Circuit Court of Appeals. Based on the resolution of previous Sarbox whistle-blower actions, his odds of prevailing seem to be literally 1,000 to 1. — Stephen Taub
Marching to Different Drummers
A report by the New York Federal Reserve on hedge funds set off alarm bells recently when the bank seemed to suggest that funds were stockpiling too many eggs in one basket.
Headlines based on the paper, by Federal Reserve economist Tobias Adrian, warned that hedge funds have concentrated risk in too few places, prompting fears that an economic blip could lead to a devastating domino effect.
But a careful reading of the report indicates otherwise. While Adrian did find that hedge-fund returns are closely correlated, that is not because funds are following similar investment strategies but because volatilities across a spectrum of investments are currently quite similar.
"Just because returns are correlated does not mean that the investments are," says Peter Morici, a professor at the University of Maryland. Rather, he says, "it's an indication that the markets are working efficiently and that competition is keeping returns within a [tight] range."
Ironically, the recent collapse of hedge fund Amaranth Investors offers proof of the overall health of the industry, according to Ed Easterling, founder of Crestmont Research, which follows the hedge-fund industry. That Amaranth's loss of more than $3 billion in natural-gas investments did not hasten a downfall in other funds indicates that "hedge-fund managers tend to stick to what they are good at," says Easterling, and collectively spread risk across many industries and investment options.
But Morici, for one, argues that closely correlated returns and a reliance on individual investing strengths still say little about the overall nature of the unregulated hedge-fund industry. "From what we know about hedge funds, we should still be skeptical," he says. Reports of an impending domino effect may have been mistaken, but the resulting sigh of relief will likely be brief as many observers resume holding their breath. — Joseph McCafferty
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