DOL Board Liberally Interprets the Sarbanes-Oxley Act in a Ruling Impacting Both Private and Public Employers

Volume 5, Issue 11
August 9, 2006

In Klopfenstein v. PCC Flow Technologies Holdings, Inc., ARB No. 04-419 (ARB May 31, 2006), the Administrative Review Board ("Board") of the United States Department of Labor ("DOL") reviewed the whistleblower claims of an executive under the Sarbanes-Oxley Act of 2002 ("SOX"). SOX prohibits employers and individuals from retaliating against employees for providing information related to alleged violations of 18 U.S.C. § 1341 (mail fraud), § 1343 (wire, radio, TV fraud), § 1344 (bank fraud), or § 1348 (securities fraud), or any rule or regulation of the Securities and Exchange Commission or other federal laws relating to fraud against shareholders. The Board liberally applied the statute and its ruling is important to both private and public employers.

Keith Klopfenstein was Vice President of Strategic Operations for Flow Products, Inc. ("Flow"), a private division of PCC Flow Technologies Holdings, LP ("Holdings"). Holdings is a non-public, wholly-owned subsidiary of Precision Castparts Corp. ("PCC"), a public company with a class of securities registered under the Securities and Exchange Act ("SEC"). Klopfenstein noticed discrepancies in Flow's inventory balances; while he did not consider the discrepancies to be fraudulent, he believed they would cause a material overstatement of assets if not corrected. Klopfenstein assigned his subordinate to investigate; the subordinate reported the issue to the Finance Department and others, and Klopfenstein began regularly noting the need for reconciliation in weekly inventory reports he prepared for Holdings' weekly managers' meetings. As the Company worked to reconcile the imbalances, an employee of PCC learned of shipping procedure violations which ultimately led to Klopfenstein's termination.

Klopfenstein alleged against Holdings and Flow's Vice President of Finance, Allen Parrott, that he was discharged in retaliation for reporting the inventory issue. The administrative law judge dismissed the case finding that Holdings, a private company, and Parrott were not subject to SOX. The judge also found that Klopfenstein failed to prove that he was terminated "because of" his protected activity. Klopfenstein appealed to the Board which reversed. In remanding the case to the judge for further proceedings, the Board considered three important issues:

1. Who can be a defendant in a SOX claim?

While the Board did not rule on whether a non-public subsidiary of a public parent corporation could be covered under SOX, it did hold that the private company, Holdings, and Flow Executive, Parrott, could be proper defendants if they were acting as agents for the public company PCC. The Board explained that an agency relationship could exist given the overlap between officers for PCC and Holdings and the involvement of PCC officers and employees in Holdings' investigation and Klopfenstein's discharge.

2. What is protected activity under SOX?

The Board did not decide whether Klopfenstein's report constituted protected activity in light of his admission that he did not believe the inventory discrepancy was fraudulent. The Board noted, however, that "SOX protection applies to the provision of information regarding not just fraud, but also 'violation of any rule or regulation'" of the SEC. Moreover, in response to the defendants' arguments that Klopfenstein never properly reported the issue, the Board stated: "A complainant need not express a concern in every possible way or at every possible time in order to receive protections, so along as the complainant's actual communications 'provide information, cause information to be provided, or otherwise assist in an investigation.'"

3. How does the employee prove that the discharge was caused by the protected activity?

The judge indicated that Klopfenstein had to prove that he was terminated "because of" his protected activity. The Board, however, ruled that the correct standard of proof is much lower, and only requires Klopfenstein to prove "whether protected activity was a contributing factor," which is "any factor which alone or in combination with other factors, tend to affect the outcome of a decision."

The Board's holding in Klopfenstein reminds employers that private companies and its employees may be subjected to SOX liability if sufficient evidence exists to show that the private company or its employees were acting as agents for the public company. Additionally, the ruling makes clear that the DOL will liberally apply the statute to protect as much conduct as possible and make it easier for an employee to prove that the protected conduct resulted in adverse action. Therefore, the decision gives all employers, both private and public, yet another reason to be extremely cautious with employee reports of improper conduct, policy violations, or irregularities.

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