Risk Management

First Sarbox Whistle-blower Loses Case

A review board finds that the former CFO could not have "reasonably believed" that Cardinal Bancshares misled investors.
Stephen TaubJune 5, 2007

Five years after becoming the first person to win protection under the whistle-blower provision of the Sarbanes-Oxley Act, former Cardinal Bancshares CFO David Welch has lost his case. The Department of Labor’s Administrative Review Board ruled recently that it would not adopt an administrative law judge’s recommendation to reinstate Welch and award him back pay. The reason was that the judge erred legally, according to the board.

Welch claimed that he was fired from the bank holding company after he raised questions about the bank’s accounting policies and internal controls and later refused to certify its financial results. The bank argued that Welch was suspended and later fired solely because he refused to meet with an independent auditor and an attorney representing the company if his lawyer wasn’t present.

Welch’s allegations in large part seemed to hinge on certain loan recoveries that Welch had asserted were misclassified as “income.” Cardinal’s argued that because Welch had previously signed financial statements and Federal Reserve call reports without objecting to the entries, he could not have reasonably believed that the ledger entries were “improper.”

In a charge upheld by the administrative law judge’s ruling, Welch also contended that Cardinal’s external auditor, Larrowe & Co., didn’t communicate enough with him about financial matters that fell under Welch’s job description. Instead, Welch charged that the auditor went straight to Cardinal’s CEO, Ronald Leon Moore—and around Welch.

Welch also complained about the company’s internal controls. He contended that “too many individuals without financial expertise were making journal entries without the CFO’s review,” according to the administrative law judge, who concurred with Welch’s view.

But the appeals board countermanded Welch’s contentions on all those points, reasoning that some of his charges were not protected under Sarbanes-Oxley, as the administrative law judge had opined. “Welch’s concerns that Cardinal misclassified the loan recoveries and consequently misled investors do not constitute protected activity because Welch could not have reasonably believed that Cardinal misstated its financial condition,” according to the review board’s May 31 ruling. “Likewise, Welch’s complaints about access to [auditor] Larrowe & Co. and about Cardinal’s internal accounting controls are not SOX-protected activity because they do not relate to the federal securities laws. Therefore, since Welch has not demonstrated that he engaged in protected activity, an essential element of his case, we deny his complaint.”

The board applied the “reasonable belief” standard to Welch’s case in finding the judge in error. The standard requires the plaintiff to prove both that he actually believed that the SEC report overstated income and that a person with his expertise and knowledge would have reasonably believed that as well. The appeals judges ruled that even if Cardinal misclassified $195,000 in loan recoveries as year-to-date income as of the third quarter of 2001—which the administrative law judge contended—the company did in fact recover money it didn’t have before. “Therefore, an experienced CPA/CFO like Welch could not have reasonably believed that the third quarter SEC report presented potential investors with a misleading picture of Cardinal’s financial condition,” the review board found.