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Many companies think the whistle-blower provisions of Sarbanes-Oxley will spark nuisance suits by disgruntled employees. The truth is far more complex.
Alix Stuart, CFO Magazine
October 1, 2003
When Matthew Whitley was laid off from his job last March as a finance manager at The Coca-Cola Co., along with about 1,000 other employees, he didn't take it lying down. Two months later, Whitley approached his former employer seeking a whopping settlement—$44.4 million—on the grounds that he had been fired in retaliation for raising concerns about accounting fraud. When Coke balked, Whitley turned for relief to a new ally: the Sarbanes-Oxley Act of 2002. He filed for whistle-blower protection under the act's Section 806 provisions, and initiated federal and state lawsuits that charged seven Coke executives, including CFO Gary Fayard, with crimes ranging from racketeering to mail and wire fraud.
"This disgruntled former employee has made a number of allegations accompanied by an ultimatum: that the company pay him almost $45 million or he would go to the media," said Coke in a May statement announcing the claims. Since then, a Georgia state court judge has dismissed most of the charges, including those related to racketeering and breaches of fiduciary responsibility. While Coke may still have to defend itself against claims related to wrongful termination, "we are confident we will prevail once the facts are presented in a court of law," said Coke in a statement.
One of Whitley's allegations, however, has already had some effect. His contention that Coke falsified a marketing test of Frozen Coke at Burger King restaurants in Virginia led the company to make a public apology and an offer to pay Burger King $21 million. In July, the Department of Justice (DoJ) announced it was launching a criminal investigation of the alleged fraud.
CFOs may be forgiven for fearing that cases like Whitley's are a harbinger of things to come—that, thanks to the protections afforded by Sarbanes-Oxley, irate workers will accuse their employers of financial wrongdoing in order to wring large settlements from them. Indeed, on August 27, a federal judge refused to dismiss a whistle-blower lawsuit accusing TXU Corp., an energy company, of earnings manipulation; unless the case is settled, it will become the second suit filed under Section 806 to reach a federal court (the first involved JDS Uniphase Corp.).
But it remains to be seen whether Sarbanes-Oxley will have a significant impact on whistle-blower litigation. Although the number of such filings has increased, most will probably be dismissed as lacking merit. And even with the new protections of Section 806, would-be whistle-blowers still face a painful cost-benefit decision: whether a lawsuit with uncertain chances of success is worth the professional and personal sacrifices that will assuredly be required.
A Reasonable Belief
In theory, disgruntled ex-employees have always been able to accuse their ex-employers of misdeeds in order to claim wrongful termination. But until the passage of Sarbanes-Oxley, most public-company employees had little to gain financially if the company denied the charges and refused to settle. Since the mid-1980s, the federal government has protected whistle-blowers whose work affects public welfare, including, for example, federal employees, government contractors, power-plant operators, and airline staff. But people who spoke out about financial fraud had no legal protection except for a handful of state laws—and then, often, only if the matter affected the general public.
Today, the law says that an employee needs only "a reasonable belief" that his or her employer is violating a securities law or is in any other way imperiling shareholder value to qualify for government protection from retaliation. "Retaliation" encompasses everything from firing to verbal threats and missed promotions. Within 90 days of experiencing retaliation, an employee can file for protection, which means anything from reinstatement with back pay to a full federal court trial with the potential of compensation for pain and suffering. These protections apply even if the employee is wrong about his or her accusations.
"The employee could be wrong, but if they have a reasonable belief there's been a violation and the company retaliates against them in any way, it triggers the whistle-blower protection in Section 806 and leaves the company wide open," says Neil Aronson, a partner with Mintz Levin Cohn Ferris Glovsky and Popeo in Boston.
A separate section of the law puts managers who allow retaliation against a whistle-blower at risk of jail time or fines. That, in turn, exacerbates the enormous public-relations risk to the company. Add to that the praise heaped on whistle-blowers like Enron's Sherron Watkins and WorldCom's Cynthia Cooper, and what does an angry employee have to lose?
Plenty, it turns out. Most people who have publicly accused their companies of securities fraud say Sarbanes-Oxley does little to mitigate the high personal price of coming forward.
"It's the exception that a whistle-blower is looking to get even, because it's very painful to break ranks with [your company], even if [you] have strong legal rights," says Thomas Devine, an attorney who has counseled more than 2,000 whistle-blowers protected by other federal statutes through the Government Accountability Project, a nonprofit group based in Washington, D.C. Even with legal protection, once whistle-blowers go public, their reputations are called into question and their future career prospects hampered, all for the dubious goal of reinstatement to a work environment in which they are considered troublemakers.
Even if a case does go all the way to a federal court, whistle-blowers would probably have to change industries if they ever want to work again, says Devine, since they will be considered "wild cards" regardless of the outcome. And despite the attention given Watkins et al., most whistle-blowers are rebuffed, not supported, by the federal government. Since Sarbanes-Oxley was passed, about 131 public-company employees have reported violations of whistle-blower protections to the Occupational Safety and Health Administration (OSHA) of the Department of Labor (DoL). (The agency was directed to oversee these violations because it has handled the industry-specific whistle-blower statutes.) Most of these investigations—83 percent of the 60 completed so far—have been dismissed or withdrawn.
True, the percentage of cases upheld may increase, since about one-third of claims have been thrown out for technical reasons—for instance, because the company is private or the alleged retaliation began before passage of the law. But in general, says John Spear, OSHA's head of investigative services, 75 percent of cases brought each year under other whistle-blower statutes are found to lack merit.
Even when the claims of fraud and retaliation are justified, it's unclear what the whistle-blower will gain. Attorneys can name wildly different figures depending on whether the underlying assumption is that the whistle-blower will never work again, will work but won't be promoted, or will have to retrain for a new profession. No one yet knows what civil juries or federal-court judges will accept.
Final Straw at Coke
From that perspective, Matthew Whitley represents all the reasons whistle-blowers are more to be pitied than feared. As he tells it, losing his $140,000-a-year job was the final straw in what had been a long personal battle against earnings management.
In his 11 years at Coke, 9 of them as an internal auditor, the 37-year-old Whitley claims he caught various attempts to minimize current expenses, using such techniques as stretching out capitalization periods or booking payments to bottlers as assets. Under previous CEO Robert Goizueta, he says, such concerns were heard and addressed. Since Goizueta's death in late 1997, though, Whitley says he has seen a progressive deterioration in accounting controls and an increasing reluctance to fully correct problems.
For example, Whitley led an internal investigation in 2001 that found vice president John Fisher had used fraudulent marketing schemes to sell Frozen Coke products and equipment to Burger King. Since the scheme violated Coke's code of conduct, among other problems, Whitley recommended the executive be fired. Instead, Coke's audit committee, which includes Warren Buffett, simply demanded that Fisher forfeit half of his 2000 bonus and 2001 stock-option award. Fisher was later promoted to a senior vice president post, while Burger King was allegedly never informed of the incident.
When outsider Steve Heyer (he had been COO of Turner Broadcasting) was promoted to COO in December 2002, Whitley saw hope for more systemic changes. On December 30, Whitley sent an E-mail to Heyer outlining some of his concerns about recent incidents. Heyer mailed back an invitation to provide more details, and a month later Whitley sent Heyer an E-mail with a nine-page memo attached, listing many of the violations of Coke's code of conduct he had helped investigate and the subsequent light punishments that generally resulted.
Heyer, who through a spokesperson claims he received but never opened the twice-sent attachment, never responded, according to the complaints Whitley filed in May. Nor did any word come from CFO Fayard, with whom Heyer had indicated he would share the memo. But in mid-February 2003, Whitley received the worst performance review of his career, according to his complaint, after a history of above-average marks and positive comments about his integrity. On March 26, he was laid off as part of a companywide reorganization.
When Heyer stopped responding to Whitley's ongoing attempts to follow up by E-mail, Whitley sent a copy of the memo to Coke's general counsel, Deval Patrick, in mid-March, offering to meet with him. Whitley says he continued to press for a meeting after his layoff, but finally gave up in order to file for whistle-blower protection within the 90-day window.
"I didn't want to go public, but I didn't know what choice I had because no one would listen to me," says Whitley. The proposed $44.4 million settlement "was intended to get Coke's attention," he says, adding that he never expected Coke to pay that amount.
Coke has not responded so far to any of the specific allegations, but the company denies that it fired Whitley in response to the claims he raised, and downplays the claims themselves. "As we have investigated all of the allegations raised by Mr. Whitley, we have found nothing material that requires a restatement of our financial statements, or we would be doing that right now," said Heyer in July's second-quarter conference call.
Still, while the issues might not be material to Coke at a corporate level, it's hard to say Whitley was just grousing. In response to his lawsuit, Coke conducted an internal investigation and subsequently agreed to pay Burger King $21 million as recompense for the marketing frauds, after firing Fisher in April for a further (and unrelated) violation of the corporate conduct code. The company announced in June that it was writing down $9 million due to overvalued assets in its Fountain division, and said it would continue to investigate financial arrangements with its suppliers. In August, Coke announced that Tom Moore, Fountain president and a named defendant in Whitley's suit, was stepping down.
Whose story—Whitley's or Coke's—is the real thing could be decided by a civil-court jury or the DoJ, which is investigating the alleged Frozen Coke fraud. But Whitley isn't pinning his hopes solely on Section 806 and OSHA. Why? "In many ways, Sarbanes-Oxley is toothless," says Marc Garber, Whitley's attorney, "because the [DoL] has no subpoena power and no authority to interview employees without a company representative present." That makes it difficult to gather the evidence necessary to win a case.
Thus, while OSHA is still investigating Whitley's case, Garber, a former federal prosecutor, is also relying on broader state and federal lawsuits. The latter offer the opportunity for fuller investigation, he explains, and the potential for a larger settlement.
Hanging on at Duke
Other whistle-blowers who have endured OSHA investigations agree that the protections aren't as strong as they might seem. "People ask me, do I think Sarbanes-Oxley will cause more people to come forward? I don't think so, not if they know their careers will be forever altered," says Barron Stone, an 18-year employee of Duke Energy Corp.'s finance department.
Stone's efforts to blow the whistle at Duke started in early 1999, when he told the American Institute of Certified Public Accountants, the South Carolina Board of Certified Public Accountants, and the Securities and Exchange Commission that Duke was intentionally understating revenues for its regulated energy division to avoid having its rates lowered. Stone says he waited in vain for regulators to catch the problems on their own, and finally, in July 2001, he decided to step forward. He put in an anonymous call to the company's ethics hotline and met with the head of the Public Service Commission of South Carolina (PSCSC).
As a result of the call and the meeting, both Duke and the PSCSC launched investigations into the accounting disputes, which to varying degrees vindicated Stone's claims that earnings had been understated. In November 2002, Duke agreed to pay the states of North Carolina and South Carolina $25 million to be applied toward rate reductions in connection with the charges.
Stone went public with his story last August because he believed that Duke officials had apprised senior finance staff of his call to the ethics line and had dropped hints to his colleagues as well (see "Talk, or Walk?" October 2002). Since then, Stone has also revealed that he tipped off the SEC about some other efforts to manipulate earnings in Duke's unregulated businesses.
Through it all, incredibly, Stone has hung on to his job (and even received an 8 percent raise)—but not to his career prospects, he says. Once a senior forecast analyst, Stone says he was essentially demoted to an undefined role in February 2002, and passed over for a new position that August after a history of frequent promotions and increasing responsibilities. He has been assigned to execute entry-level projects, and has been moved to an office far away from the rest of his unit. While he is technically a manager, he has no employees to manage—and has been told he will not get any. "They have been very calculated and very precise in trying to wear me down," he says. "They would never promote me again. They probably never will if I stay here 30 years."
For that reason, Stone and his attorney, Gerry Bos, sought whistle-blower protection under Sarbanes-Oxley in November 2002. But the DoL dismissed the case in March 2003, in part because the alleged retaliation started before the law went into effect, and in part because of insufficient evidence.
Stone and Bos contend that the dismissal was based on OSHA's deficiencies, not theirs. For instance, Stone says that for lack of subpoena power, OSHA investigator Dale Boyd "told me point-blank, 'I can talk to the controllers and the vice presidents, et cetera, but if they lie to me, I accept whatever they tell me.'" Boyd was also of little help in building Stone's case, the accounting manager says, eschewing much of the critical information he had previously provided to regulators. "He was very unclear about what he wanted, how he wanted it, and the ramifications of what had happened," says Stone. "I spent inordinate amounts of time getting him what he said he needed, and then he didn't use most of it."
Duke, for its part, sees the dismissal as the final chapter in the case. "Obviously, the [DoL] has looked at this case and found no wrongdoing on Duke's part," says spokesperson Randy Wheeless. Duke has contended all along that Stone's manager didn't know that Stone was a whistle-blower when he transferred him. The company maintains the transfer was part of a larger reorganization. "From our perspective, it's pretty much settled," says Wheeless. Stone notes that there is still a complaint pending in federal court in Charlotte filed on his behalf.
Waiting for OSHA
Anyone waiting to be rescued by OSHA is liable to be waiting for Godot," charges Devine of the Government Accountability Project. He says that given OSHA's track record handling other whistle-blower cases, "it's a black hole...cases languish indefinitely."
Although Sarbanes-Oxley gave OSHA new responsibilities, the agency received no additional resources to go along with them. It did bring in representatives from the SEC and DoJ to speak with its investigators, says OSHA's Spear, and "familiarize them with issues related to Sarbanes-Oxley." In any case, connecting the dots between a red flag raised and a subsequent act of retaliation—particularly if it doesn't involve a layoff or a salary cut—is always difficult.
Moreover, the remedies OSHA can offer are weak. None of its initial findings are binding, so it must broker a voluntary settlement between employee and employer. Even then, at best an employee can hope to be reemployed at the same seniority level—potentially in another division—with back wages plus interest for lost time, along with litigation costs, expert-witness fees, and attorneys' fees. OSHA has no power to order accounting procedures reformed, numbers restated, or other employees fired. "We focus on making the complainant whole, not on changing the work environment," says Spear.
A whistle-blower's allegations of fraud, in general, fall to more-powerful agencies, like the DoJ and the SEC. But those agencies also offer little in the way of subsequent reward, protection, or even information about the case. "The SEC is kind of a one-way street," says Stone, who had provided documents to the SEC's regional Atlanta office. So far he has not been deposed by the SEC, which is reportedly investigating Duke.
Others complain that investigations go nowhere. Roy Olofson, a former vice president of finance at Global Crossing who made allegations of accounting fraud, was interviewed only once—by the U.S. Attorney's office in winter 2002, according to his attorney, Paul Murphy. "After that, we saw no follow-up," says Murphy. The investigation has since been dropped, despite a $1 billion earnings restatement related to Olofson's concerns in late 2002.
Some whistle-blowers say they can't get heard at all. "I'm starting to feel like the wallflower at the dance," says Lynn Brewer, who worked in various divisions of Enron from 1998 to 2000. She has been trying to share her Enron documents and experiences with the DoJ and various members of Congress since the day the company filed for bankruptcy in December 2001 and nullified her confidentiality agreement with Enron. "At that point, I was getting desperate to get my story out there, because I was getting concerned about my own culpability," she says.
Yet getting government officials even to return her phone calls has been a challenge. For instance, she says she E-mailed and phoned Sen. Byron Dorgan (D—N.Dak.), but never heard back, nor has she heard from anyone from the SEC or the DoJ. Now on the lecture circuit for organizations such as The Conference Board and the Association of Certified Fraud Examiners, Brewer says she gets 15 to 20 E-mails or phone calls per month from people who feel trapped by illegal activity at their companies. "My official answer is to send them to OSHA," she says, "but I also give them the name of a good lawyer." In the long run, of course, there's hope that Sarbanes-Oxley may have the desired effects on whistle-blowing. "A case could be made that there will be fewer claims in the future," says OSHA's Spear, "because the act puts more mechanisms in place for companies to hear from whistle-blowers early. Plus, there's a criminal penalty attached to [retaliation], which tends to get people's attention."
But reporting ethics violations is still perilous. While Coke, for example, now has a link on its Website for employees who want to report issues regarding accounting, controls, auditing, or other matters, all comments are forwarded to senior management rather than to the board or a third party. And while the site's FAQs section assures employees that they can "report suspected violations of the [conduct] code without fear of reprisal or retaliation," few are likely to do so after Whitley's experience.
Meanwhile, whistle-blowers still have to find their next job. Olofson is now consulting as he looks for permanent employment. "While this cloud is hanging over him, it's very difficult for him to find work that would make sense for him otherwise," says Murphy, his attorney. "His career path has been dramatically impacted by coming forward with his concerns."
And after sending out about 150 résumés, networking with about 50 people, and working with six recruiters, Whitley has had one interview in three months. For anyone else, that could be chalked up to the state of the economy. But Whitley has no doubt what has blown an ill wind on his job prospects: blowing the whistle at Coke.
Alix Nyberg is a staff writer at CFO.
How to Respond to Whistle-Blowers
Many companies are scrambling to establish toll-free hotlines and Web-based mechanisms that allow audit-committee members to hear directly from employees, suppliers, and customers who want to voice concerns about accounting or internal controls. According to the Sarbanes-Oxley Act of 2002 and Securities and Exchange Commission rules, such systems must allow for anonymity and be in place by a company's first annual meeting after January 15, 2004, or by October 31, 2004, whichever comes first.
But CFOs may do well to become better listeners. Most whistle-blowers say they never would have gone public with their concerns about the financial statements if senior management had been more attentive to them. And opening up the lines of communication doesn't necessarily mean opening Pandora's box.
Only about 5 percent of anonymous employee complaints received at United Technologies Corp. (UTC) each year relate to possible financial wrongdoing, says Patrick Gnazzo, the vice president in charge of investigating such claims. (UTC employees can report abuse anonymously through the company's Dialog program, which uses printed and online forms, or its ombudsman office, which fields phone calls.) Neither that percentage, nor the absolute volume, has changed much in the 17 years the office has been in existence, he says, not even after Sarbanes-Oxley. "If you're all trying to do the right thing in the first place, what's the fear of hearing from people?" asks Gnazzo.
The big question, of course, is how to separate the wheat from the chaff when confronted with an allegation. In fact, attorneys say the threshold for launching an investigation is pretty low. "If it violates the laws of nature, you don't have any obligation to investigate," says Jeff Stone, an attorney with McDermott, Will and Emery in Chicago. "But if it could be true, the prudent and wise thing to do would be to conduct an investigation." Indeed, at UTC, Gnazzo will check out accounting-related complaints even when the financial exposure is extremely low, or even zero. "If you take care of the $120 cases, you take care of the larger issues at the same time," he says.
Once a complaint is received, companies need to make every effort to protect a whistle-blower's anonymity, attorneys say. That task is considerably easier at big companies like UTC, where internal audits are routine. At smaller companies, they say, the best option may be to question senior-level managers in confidence before broadening the inquiry to rank-and-file workers.
Companies should also keep track of complaints, since OSHA's 90-day statute of limitations starts when the alleged retaliation occurs, not when the concerns are raised. "This means every time you let someone go or reduce compensation or turn them aside for a promotion, the audit committee has to ask the question: Has this person in any way questioned our audit practices?" says Neil Aronson, a partner at Mintz Levin Cohn Ferris Glovsky and Popeo. "Theoretically, you could disagree now with the CFO, and then bring a claim when the CFO demotes you two years later."
So is it ever OK to fire someone who has previously raised concerns? Of course, say attorneys. "If it turns out the person has maliciously spread false information about the company, you'd have good grounds to consider terminating that relationship," says Stone.
Neither of these attorneys, however, advocates rewarding employees who report allegations that turn out to be true. Says Aronson: "What you're asking them to do is their job, and you don't want to create a bounty system that might further skew incentives." —A.N.
Telling on Yourself
Almost from the day he joined medical-equipment maker Vital Signs Inc. in late 2001, Joseph Bourgart had suspicions about the Totowa, New Jersey based company's accounting choices. As a result, he approached CEO Terry Wall, audit-committee members, and the general counsel as many as 30 times between January and November 2002 about what he considered to be inflated valuations for inventory and an investment in China, as well as understated values for expenses such as supplier rebates and taxes, among other issues.
Bourgart was summarily demoted and then forced to resign in January. Since then, the $175 million firm has taken charges of about 40 cents per share to correct many of those concerns. So why hasn't he been protected by whistle-blower statutes? Bourgart was CFO at the time, and as such certified the financial statements he was challenging.
Bourgart filed a civil lawsuit in New Jersey state court in May. His attorney, Jon Green, of Green Lucas Savitz and Marose LLC, insists that his client was bullied into signing the statements by Wall, who is also chairman, founder, and majority stockholder, but later realized the error of his ways. Wall, meanwhile, claims Bourgart had conceded that the accounting was appropriate after an audit-committee review last summer and furthermore "voiced no objection" to any part of the 10-K in December. Vital Signs has moved to dismiss the case, and has threatened to countersue. Under Section 906 of Sarbanes-Oxley, Bourgart could face fines of up to $1 million or 10 years in jail for "knowingly" signing erroneous statements. Meanwhile, Green says he has eschewed the law's whistle-blower statutes, "because we felt they didn't provide adequate protection." Instead, Bourgart is making his case under the long-standing New Jersey Conscientious Employee Protection Act, a whistle-blower-protection law with higher damage payouts.
Other attorneys say that, hypothetically, such a case isn't impossible for a CFO to win. "The question is really whether he exhausted his responsibilities of due diligence before he signed, and took action on anything that didn't pass the smell test," says Jeff Lerer, an attorney with Foley Hoag in Boston. Provided Bourgart can show why he couldn't have known the truth at the time of the filing, he's probably off the hook, Lerer speculates, at least for criminal penalties. —A.N.
Blowing the Whistle: Six Recent Cases
|James Bingham, former assistant treasurer;|
|In 2000, Bingham alleged that Xerox fired him for drawing management's attention to accounting and financial-reporting errors. He assisted the SEC in a civil case that Xerox later settled by paying a $10 million fine and restating four years' worth of financials. The company also covered nearly $20 million fines against executives charged with fraud.||Wrongful-dismissal suit pending.|
|Nina Aversano, former president of North America sales to service providers;|
|Aversano filed suit against Lucent in December 2000, alleging that the company's then-CEO fired her after she called his sales targets unreachable and told him he was misleading investors with aggressive forecasts.||Suit was settled in January.|
|Tax attorney Robert Schmidt and tax manager Thomas Walsh;|
|The pair claim that Levi Strauss fired them in December 2002 after they refused to withhold financial informatino from auditor KPMG. They brought suit in April 2003, accusing Levi of filing false financial statements since 1997. They have also called for whistle-blower protection.||Levi countersued in May, alleging that the pair stole company documents and accusing them of defemation.|
|William J. Murray, a former senior vice president of capital management;|
|Murray filed suit in April under Section 806 of Sarbanes-Oxley. He alleges that Dallas-based energy company TXU fired him for questioning what he saw as unorthodox accounting and arguing that the company did not have the required 180 days to review the claim before Murray took it to federal court. A federal judge in Dallas denied the request.||Trial date expected soon.|
|Anthony Gonzalez, chairman of Colonial's local advisory board;|
|Gonzalez approached the president and the CEO of Colonial after he learned they had started a side business together that competed with the company. When the pair continued the business despite his warning, Gonzalez spoke with the CEO and CFO of Colonial's parent company in Alabama. He alleges he was fired the following day.||Gonzalez filed suit under Sarbanes-Oxley in July|
|David Welch, former CFO;|
|In court in August, Welch's attorney invoked the Sarbanes-Oxley whistle-blower provision, arguing that Cardinal fired his client for raising concerns about accounting and refusing to certify the company's financial reports. According to Cardinal, Welch was fired after he was asked to discuss his allegations with the company's lawyer and one of its external auditors but refused to talk without his own lawyer present.||Decision pending.|
|Chart compiled by Kate O'Sullivan|