Sarbanes-Oxley Whistleblower Need Not Prove Securities Fraud
In Donaldson v. Severn Savings Bank, Judge Bredar held that there is no independent materiality element to establish protected whistleblowing under Section 806 of the Sarbanes-Oxley Act. This decision is consistent with a recent trend in DOL and federal court precedent declining to require SOX whistleblower to prove that they disclosed actual securities fraud.
Vanessa L. Donaldson brought a SOX whistleblower action against her former employer Severn Savings Bank claiming she was unlawfully terminated after she reported to her supervisor her suspicions about an inaccurate bank report. In particular, Donaldson alleged that she informed her supervisor that the commercial/retail manager for Donaldson’s branch falsified the retail production report for the third quarter of 2013 in a scheme to collect unearned bonus pay.
Severn contended that Donaldson failed to allege she engaged in protected activity because she failed “to allege any facts whatsoever that would indicate any material misrepresentations (or omissions) were reported to Severn’s shareholders” and therefore lacked an objectively reasonable belief that she was disclosing shareholder fraud. Judge Bredar rejected Severn’s narrow construction of SOX:
Severn’s argument seems to be premised upon the notion that Donaldson’s complaint must include an objectively reasonable belief as to the existence of the elements of a Rule 10b-5 private cause of action, including the elements of reliance, economic loss, and loss causation. (Id. 7-11.) As earlier noted, however, the complaint, in the Court’s view, focuses upon Donaldson’s belief that one of the three types of criminal fraud had occurred. The elements of a Rule 10b-5 cause of action are, thus, irrelevant to an assessment of the adequacy of Donaldson’s complaint.
An objectively reasonable belief as to any of these kinds of criminal fraud must necessarily be based upon facts known to Donaldson that would permit a reasonable inference that Zachry had engaged in either wire fraud, bank fraud, or securities fraud against Severn. The elements of those crimes, therefore, are relevant to this determination. As the Supreme Court has noted, sections 1343 (wire fraud) and 1344 (bank fraud) were modeled upon section 1341 (mail fraud) and have as their common element a scheme or artifice to defraud by false or fraudulent pretenses, representations, or promises. Neder v. United States, 527 U.S. 1, 20-21 (1999). Likewise, section 1348 (securities fraud) was modeled on the mail and wire fraud statutes, United States v. Mahaffy, No. 05-CR-613, 2006 U.S. Dist. LEXIS 53577, at *33-34 (E.D.N.Y. Aug. 2, 2006), vacated and remanded on other grounds, 693 F.3d 113 (2d Cir. 2012), and includes an element of a scheme or artifice to obtain something of value by false or fraudulent pretenses, representations, or promises.
. . . Severn has attempted to argue that the unknown amount of unearned bonuses should be compared to Severn’s total assets, which it then includes in its briefing papers. (See Def.’s Mot. Dismiss Supp. Mem. 9 n.4.) . . . In any event, the federal criminal fraud statutes do not incorporate the common-law fraud elements of justifiable reliance and damages. Neder, 527 U.S. at 24-25. The statutes prohibit the scheme to defraud, not a completed fraud. Id. at 25. Thus, the amount of loss sustained, if any, by Severn is of no moment. . . . Materiality of falsehood, on the other hand, was a common-law element of actionable fraud at the time these fraud statutes were enacted and is an incorporated element of the mail fraud, wire fraud, and bank fraud statutes. Neder, 527 U.S. at 25. . . . But § 1514A carries no independent materiality element. Welch, 536 F.3d 276. Consequently, Donaldson’s objective belief need not be about a material matter, as Severn has argued. Rather, her objective belief must be based on facts permitting an inference that Zachry’s allegedly false representation was material to Severn’s course of conduct. Materiality is defined as having “`a natural tendency to influence, or [is] capable of influencing, the decision of the decisionmaking body to which it was addressed.'” Neder, 527 U.S. at 16 (alteration in original).
Donaldson has adequately alleged that Zachry’s falsehood in the retail production report was intended to affect Severn’s decision as to how much Zachry’s bonus should be. If the retail production figures were improperly inflated, then inferentially, Zachry’s bonus, based on the production figures, would have been likewise improperly inflated. In addition, Donaldson alleges that the amount of Selby’s bonus would also have been influenced by the retail production report. Thus, materiality has been properly alleged. As a result, it may be inferred from Donaldson’s complaint that she had an objectively reasonable belief that Zachry and, perhaps, Selby were engaged in a scheme to defraud Severn . . . .
Donaldson is consistent with the DOL’s ARB decision in Sylvester v. Parexel holding that a SOX complainant need not allege shareholder fraud to receive SOX’s protection. SOX was enacted to address “corporate fraud generally,” and so a reasonable belief that a violation of “any rule or regulation of the Securities and Exchange Commission” could lead to fraud is protected, even if the violation itself is not fraudulent. Sylvester v. Parexel International LLC, ARB No. 07-123, at *19 (May 25, 2011). Federal courts have adopted the Sylvester standard for assessing SOX protected conduct. See Rhinehimer v. U.S. Bancorp Investments, Inc., No. 13-6641 (6th Cir. May 28, 2015); Nielsen v. AECOM Tech. Corp., 762 F.3d 214, 220-21 (2d Cir. 2014) (granting Skidmore deference to Sylvester); Wiest v. Lynch, 710 F.3d 121 (3d Cir. 2013) (according Chevron deference to Sylvester); Stewart v. Doral Fin. Corp., 997 F. Supp. 2d 129, 135-36 (D.P.R. 2014) (adopting the Sylvester standard); Leshinsky v. Telvent GIT, S.A., 942 F. Supp. 2d 432, 443 (S.D.N.Y. 2013).
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