Sarbanes-Oxley Whistleblower Protections Cover Employees of Mutual Fund Firms

Last week, Massachusetts federal district court judge, Douglas P. Woodlock ruled that whistleblower protections of the Corporate and Criminal Fraud Accountability Act of 2002 (“Sarbanes-Oxley”) apply to employees of private firms that operate and advise mutual funds (“Mutual Fund Firms”). According to an attorney for one of the plaintiffs, this was the first time the Sarbanes-Oxley whistleblower provisions were applied to mutual fund firms.

 Background

Woodlock’s memorandum and order addressed motions to dismiss in two separate cases. In the first case, plaintiff, Jackie Hosang Lawson sued FMR LLC, FMR Corp. and Fidelity Brokerage Services. In the second case, Jonathan M. Zang sued Fidelity Management & Research Company, FMR Co., Inc., and FMR LLC.  The defendants are referred to hereafter as “Fidelity.”

According to the decision, Lawson worked at Fidelity for more than a decade, most recently as Senior Director of Finance. Lawson claimed that she had questioned the firm’s financial methodology. For example, she believed that internet expenses were not properly allocated and that 12b-1 fees (fees paid out of the fund assets to support sales of fund shares) were being improperly retained by the firm. She allegedly reached out to various management personnel and also contacted OSHA. In response, Fidelity allegedly retaliated by lowering her performance evaluations, reducing her bonus, subjecting her to verbal abuse and ultimately making it impossible for her to continue working there.

Zang, according to the decision, worked for Fidelity for approximately eight years, most recently as a mutual fund portfolio manager. Zang allegedly objected to what he saw as inaccurate disclosure of portfolio manager compensation. Zang contended that in response, Fidelity retaliated by giving him poor performance ratings and ultimately firing him without severance.

 Whistleblower Protection under Sarbanes-Oxley

Sarbanes-Oxley protects certain employees who blow the whistle on publicly held companies. Under the law, whistle-blowing includes helping to investigate conduct the employee reasonably believes violates federal laws designed to protect shareholders. Whistle-blowing also includes assisting in a legal proceeding related to a violation of such a federal law.

Sarbanes-Oxley forbids retaliation against covered employees. The language provides that no publicly held company:

 “or any officer, employee, contractor, subcontractor, or agent of such company, may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment” when that employee blows the whistle.

Dispute Concerning Which Employees are Covered

Fidelity argued that the Sarbanes-Oxley whistleblower protections only apply to “an employee of a publicly traded company.”  Lawson and Zang worked for the Fidelity entities, all of which are private companies. Although the mutual funds themselves are publicly held, Larson and Zang were not employees of the funds themselves. Indeed, the funds have no employees whatsoever. Instead, the funds (with the guidance of the board of trustees) “hire” a variety of contractors to perform services, including money management. Therefore, in Fidelity’s view, the whistleblower claims should be dismissed.

In contrast, the plaintiffs supported a more expansive reading of the statute, claiming that the law prevents retaliation against employees of “any officer, employee, contractor, subcontractor, or agent of” a publicly traded company. “Lawson and Zang argue that the statute encompasses not only employees of public companies but also employees of private companies, particularlythose that act as investment advisers to public investment companies.”

 The Ruling

In the memorandum and order, the judge denied Fidelity’s motions to dismiss the Sarbanes-Oxley claims, but granted the motions to dismiss the state law wrongful discharge claims. He seemed to reject both the narrow and expansive reading, finding “that both of the opposing interpretations suggest somewhat awkward applications to various business relationships.”

Woodlock  first determined that the provisions covered “employees of any related entity of a public company.” Then, he went on to interpret the law to apply to Lawson and Zang.  He wrote that:

“For the goals of SOX to be met, contractors and subcontractors, when performing tasks essential to insuring that no fraud is committed against shareholders, must not be permitted to retaliate against whistleblowers. These concerns are especially strong for mutual funds, which have no employees and implement the funds’ management through contractual arrangements with investment advisers. If Section 806 only protected employees of public companies, then any reporting of fraud involving a mutual fund’s shareholders would go unprotected, for the very simple reason that no “employee” exists for this particular type of public company.”

In arriving at the decision, the judge distinguished related decisions, such as a decision by the New York Federal District Court, Brady v. Calyon Sec. (USA) Inc., 406, F. Supp. 2d 307 (S.D.N.Y. 2005). In that case, the court decided that the whistleblower provisions of Sarbanes-Oxley “did not cover an employee of a privately held broker-dealer that allegedly acted as an “agent and/or underwriter” for public companies.”