Welch v. Cardinal Bankshares Corp., DOL ALJ, No. 2003-SOX-15 (Jan. 28, 2004)

In the first completed trial on the merits under the whistleblower provision of the Sarbanes-Oxley Act, the Department of Labor last week ruled against the company and ordered it to reinstate its Chief Financial Officer, with whom it had had a series of disagreements regarding financial reporting practices.  Welch v. Cardinal Bankshares Corp., DOL ALJ, No. 2003-SOX-15 (Jan. 28, 2004). 

The decision provides insights on the difficulties public companies will face when endeavoring to satisfy their financial reporting obligations while also managing tense personnel relations with high-placed finance officers who allege wrongdoing. 

The Sarbanes-Oxley Act makes it illegal to retaliate against an employee for providing information or making a complaint regarding activity that he “reasonably believes” to be a violation of the securities laws.  Complainant David Welch had served as CFO of Cardinal Bankshares, a Virginia bank holding company; in that position, he repeatedly expressed concern with the company’s financial reporting practices and took a number of steps that the judge in the case determined to be protected activity under Sarbanes-Oxley: 

• He refused to certify the company financial reports for the third-quarter of 2001, explaining in a September 2002 memorandum to the CEO that improper accounting on two entries had caused the quarterly earnings to be overstated by nearly 14 percent.  The company’s outside auditors later reached the same conclusion regarding the entries, and reclassified them in the year-end report.  Based partly on this restatement, the ALJ concluded that the CFO had indeed “reasonably believed” that the entries in the earlier report ran afoul of the securities laws. 
  
  
• In explaining why he would not certify the company’s third-quarter 2001 financials and a second-quarter 2002 financial report as well, the CFO complained that he had been cut out of communications between the company and its outside auditors who had prepared the reports.  This denial of access made it impossible for him to develop the confidence in the financial reports necessary to discharge his responsibilities as CFO, he maintained.  The ALJ found this complaint regarding “access to Respondent’s external auditors” to be Sarbanes-Oxley protected activity.
  
  
• In the memorandum to the CEO, the complainant charged that the company had deficient internal controls because personnel outside the finance department routinely made journal entries without the CFO’s knowledge or approval.  (A number of these entries later proved to be erroneous.)  When the company’s Audit Committee subsequently instructed the CEO to investigate this allegation, the ALJ concluded, it validated the CFO’s concerns. 

After Welch voiced these and other concerns with the company, the Audit Committee directed an investigation into his allegations, as well as an examination of concerns that had been expressed with Welch’s own performance as CFO.  The inquiry – which relied, in part, on the outside auditors whom Welch had charged with improper conduct – identified numerous instances of what the company considered to be deficient performance by its CFO:  State bank examiners had found fifteen errors in a report Welch certified; Welch had failed to take responsibility for training and procedures to ensure proper financial accounting and compliance with Sarbanes-Oxley; he had refused to work with the company’s Data Processing Manager to implement new accounting software.  Welch also conceded filing with the Federal Reserve reports that contained some of the same errors that later caused him to refuse to certify quarterly financial statements; he said he had failed to speak up earlier because, before enactment of Sarbanes-Oxley, he feared the loss of his job.  “The Company had a CFO that had surfaced issues,” its in-house attorney said, “but not in the proper way or in a timely fashion . . .  Cardinal could not continue in a dysfunctional relationship with its CFO.” 

As tensions mounted between Welch and the company, he was asked to present his allegations of financial improprieties to the audit committee; when he declined to attend without his personal lawyer present, he was terminated. 

The Labor Department’s Occupational Safety and Health Administration (“OSHA”) investigated Welch’s complaint and found it to be without cause.  Welch appealed to the ALJ, who held a two-day trial in which the CEO and several members of the Board of Directors testified.

In determining whether, for purposes of Sarbanes-Oxley, “protected activity” had been a “contributing factor” in Welch’s termination, the ALJ adopted a generous standard of causation that has been applied under another whistleblower statute:  a “contributing factor” exists when activity “tends to affect in any way” the outcome of the decision, he stated.  Welch’s complaints had clearly precipitated rising tensions with the CEO and the Board, the ALJ concluded, and the former CFO’s failure to meet without his attorney present served as a mere “pretext” for retaliation.  The judge also emphasized the close proximity in time between Welch’s complaints and his termination, which he deemed further evidence that the termination was retaliatory. 

The ALJ recognized that the company could still prevail with “clear and convincing” evidence that it would have terminated the CFO even in the absence of his complaints, but ruled that such a showing had not been made. 

As a remedy, the judge ordered Welch’s reinstatement as CFO, as well as payment of back pay, attorney’s fees, and expert witness costs.  The decision is appealable to the Department of Labor’s Administrative Review Board and, ultimately, to the federal courts. 

The Welch case demonstrates some of the challenges the Sarbanes-Oxley whistleblower provision presents to employers, and to the Department of Labor.  Corporate officers must proceed with care as they attempt simultaneously to ensure that financial statements are accurate, to respond to internal complaints, and to address job performance problems by personnel in finance and accounting functions.  Employees who handle sensitive financial information will – like employees in any other function – occasionally have job performance problems that must be addressed.  Frequently, these problems may emerge at the same time as, and may even be directly related to, criticisms the employees have made regarding corporate financial and accounting practices.  For employers in these circumstances, it will be important to address these performance problems in a way that is independent from responding to any criticisms or complaints regarding internal corporate practices.  Investigators and administrative law judges at the Labor Department, meanwhile, will need to handle cases in a way that is sensitive both to the rights of “whistleblowers,” and to the need of companies - and their shareholders - to have responsible, capable personnel handling accounting and finance matters. 

With its combined expertise in labor and employment matters and securities law, Gibson, Dunn & Crutcher is uniquely positioned to represent employers who have received potential Sarbanes-Oxley whistleblower complaints.  The firm has handled numerous whistleblower cases before the Department of Labor, and has considerable experience representing corporations, and their audit committees, in connection with allegations raised by potential Sarbanes-Oxley whistleblowers.  In handling these matters, we are mindful of the importance of seriously examining the whistleblower allegations while also providing a thorough representation to our client, be it the company or the audit committee.  To that end, we are able to bring to bear the expertise of our nationally-respected Securities Litigation practice group to ensure that implications under the securities laws -- as well as the employment-related aspects -- are fully appreciated and addressed.  For more information on our Labor and Employment practice, please contact practice group Co-Chairs Nancy McClelland at 213-229-7000, or Eugene Scalia at 202-955-8500.  To learn more about the Firm’s Securities Litigation group, please contact practice group Chair Wayne W. Smith at 949-451-3800.

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