Risk & Compliance

Cardinal Refuses to Reinstate CFO

In the first Sarbox whistleblower case to go to trial, Cardinal Bankshares blocks CFO from reinstatement until a final order comes through.
Marie LeoneJune 28, 2006

In a widely watched whistleblower case, Cardinal Bankshares yesterday decided once again to refuse a Department of Labor judge’s recommended order to reinstate the bank’s former CFO, David Welch, the company’s outside attorney Laura Effel told CFO.com. Instead, the bank holding company plans to wait and see whether the DoL or Welch brings an action against the company in U.S. District Court, she noted.

On June 9, the DoL’s Administrative Review Board denied the bank’s request to delay the reinstatement order. The bank previously appealed a 2004 “recommended decision and order” by DoL Administrative Law Judge Stephen Purcell to reinstate Welch as CFO and award him back pay.

Welch was fired from Cardinal in October 2002 for refusing to speak with the bank’s audit committee without his personal attorney present. Welch’s lawyer, Bruce Shine, said the finance chief believed that the bank was preparing to fire him for disclosing improper accounting practices during internal meetings. Thus, Welch refused to meet with the audit committee without legal representation, Shine added.

Welch is said to be the first person to go to trial under the whistleblower protection provision of the Sarbanes-Oxley Act of 2002.

The court battle, which will be four years old in October, “is the closest thing to a divorce case I’ve seen” as an employment attorney, said Shine, a principal with Shine and Mason. Effel, an employment litigator with LeClair, Ryan, Flippin, and Densmore, also notes that the case has dragged on for an unusually long time.

Effel argues that the original “recommendation” by Judge Purcell to reinstate Welch is not a final order as defined by the department. The judge also recommended that Cardinal should award him back pay, possibly future pay, special damages, attorney fees, expenses, and interest on back wages.

For an order to be final, one of a number of things must happen, Effel said. For example, the Secretary of Labor could confirm the review board’s recommended order. Another way for the order to become final would be if the respondent, in this case, Cardinal, decides not to appeal the order, which would make it final after a certain waiting period.

Meanwhile, the bank has spent at least $400,000 on the case, Cardinal CEO Leon Moore told shareholders recently. Further, the tiny community bank, which recorded $450 million in assets and a net income of $2.2 million for 2005, will separately shell out about $125,000 in Sarbanes-Oxley compliance costs this year, estimates Moore.

Nevertheless, Cardinal’s board and shareholders support the bank’s defense strategy, Moore said in an interview. “Nobody — shareholders or directors — [is] suggesting that we settle,” asserts Moore. He says that the case has ramifications for other public companies, since a win by Welch would “set a precedent” allowing employees to make accusations and refuse to meet with the audit committee unless accompanied by a lawyer. Both America’s Community Bankers Association and the Virginia Independent Bankers Association filed amicus briefs with the DoL supporting Cardinal’s position.

Moore pointed out that in 2003, the Securities and Exchange Commission asked for documents related to the Welch’s claims that year and have never come back to the bank with any comments. Bank regulators, including the Virginia State Corporation Commission and the Federal Deposit Insurance Corporation, have also given Cardinal a clean bill of health three times since Welch made his allegations, the CEO noted.

For his part, Welch testified that he refused to certify Cardinal’s third quarter 2002 financial statements because of improper journal entries amounting to $195,000. As a result of the improper accounting, Cardinal showed a decrease in taxable income for 2001, a decrease in expense in 2002, and an increase in net income for 2002, according to Welch’s testimony.

Welch also testified that the 2001 entries were material and should be restated because “the third quarter’s income statements and balance sheets [for 2001] would appear in the following year in the third quarter of 2002 as comparative statements,” which are relied upon by investors. The error convinced Welch, according to his testimony, that the overstated income made Cardinal appear to performing better than it really was.

In addition, he noted that the incorrect journal entries were made by the bank’s internal auditor. That was problematic, the ex-CFO asserted, because “the internal auditor should not be making journal entries to the general ledger when she’s going to be responsible for possibly auditing those same numbers.”

Moore said that when the accounting discrepancies were brought to his attention, he turned the investigation over to the audit committee, which hired its own investigator. “I did not participate [in the internal investigation] at all,” said Moore.

In September 2002, the audit committee hired Cardinal’s auditor, Larrowe and Company, to help with the internal investigation. The accountant at the firm that audited Cardinal’s financial statements was not involved with the probe.

Welch, a certified public accountant who also holds an MBA, has not held a permanent job since being fired from Cardinal. Currently Welch prepares online accounting courses for Liberty University. Before joining Cardinal as CFO, he served as a staff accountant at Larrowe and Company; a controller for Wellmont Health Systems; a cost accountant and financial analyst for Quebecor Printing; and an adjunct professor at both Tusculum College and Northeast State Community College.

Asked why he thinks Welch has not been able to find permanent work since being fired, Shine said that he believes the marketplace perceives the former finance executive as “damaged goods.”

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