Securities Law | Expert Legal Commentary

April 21, 2009

Day v. Staples: The “Reasonable Belief” Required for SOX Whistleblower Protection

Day v. Staples

By Josh Lawler of Zuber Lawler & Del Duca and Joel Ginsberg

Day v. Staples: The “Reasonable Belief” Required for SOX Whistleblower Protection

In Day v. Staples, 555 F.3d 42 (1st Cir. 2009), the Court of Appeals for the First Circuit ruled that the “reasonable belief” requirement for whistleblower protection under the Sarbanes-Oxley Act of 2002 (“SOX”) includes both “objective” and “subjective” reasonableness. In this case of first impression before the First Circuit, the court agreed with the Fourth Circuit’s interpretation of SOX whistleblower protection requirements and denied the protection to an aggrieved employee whose allegations failed to meet the basic elements of a securities fraud claim. The court’s ruling also suggests that employers who take seriously and investigate their employee’s claims may have a viable defense in whistleblower protection cases.

Background of the case

Kevin M. Day worked for Staples, Inc., as a Reverse Logistics Analyst. Shortly after he began his employment, he started complaining to his superiors about various inefficient billing and collection practices at Staples. Day felt that these practices manipulated accounting data in a way that negatively impacted shareholders.

Day was allowed to air his concerns in meetings with management and the company undertook an internal investigation into Day’s concerns. Ultimately, the company determined that no shareholder fraud was taking place, and management explained to Day the business rationales for the practices. Nevertheless, Day continued to complain. Ultimately, he was fired for his inflexible and disruptive conduct.

Day took his complaint to OSHA, claiming that he had been fired unlawfully in violation of SOX provisions. The OSHA investigator concluded that Day’s claim lacked merit and amounted to little more than a disagreement with management about internal procedures. Day then filed suit in federal court; the district court granted summary judgment in favor of Staples after determining that Day’s belief that he had uncovered fraud at the company was “not reasonable.” Day filed this appeal.

Background of SOX whistleblower protection

Section 1514A(a)(1) of the Sarbanes-Oxley Act of 2002 prohibits retaliation against any employee who “provide[s] information… regarding any conduct which the employee reasonably believes constitutes a violation” of the pertinent laws listed in that section. This provision was adopted in the wake of the Enron and WorldCom accounting scandals and it was designed to combat a perceived corporate code of silence at many publicly-traded companies that hampered investigations into wrongdoing.

The First Circuit noted that the “plain language” of the whistleblower provision protects employees from retaliation only where the employee voices concern about any one of three specific types of illegal conduct: 1) violations of specified federal criminal fraud statutes;2) violations of any SEC rule or regulation; 3) violations of any federal law provision relating to fraud against shareholders. Day v. Staples, 555 F.3d 45, 54-55 (1st Cir. 2009). In order to receive SOX protection, an employee must show that his communications specifically related to one of the laws listed in section 1514A(a)(1), falling into one of these categories. 555 F.3d at 55.

Day’s claim lacked objective reasonableness

The First Circuit focused specifically on the requirement that an aggrieved employee’s communications be based on a “reasonable belief” of unlawful conduct, stating that the term “reasonable belief” “has both a subjective and objective component.” 555 F.3d at 54. The Court easily found that Day met the subjective component, as he brought his complaints in good faith. Id.

However, the Court determined that Day’s allegations lacked objective reasonableness. Day argued that his complaints went to the third type of illegal conduct – shareholder fraud. The Court stated that, to be protected, an employee does have to refer to specific statutes or legal standards, “but he must have an objectively reasonable belief that the company intentionally misrepresented or omitted certain facts to investors, which were material and which risked loss.” Id. at 56. Based on this measure, the court easily found that “Day’s assertions do not meet the basic components of fraud or securities fraud.” Id.

Analyzing each of Day’s complaints, the Court found that they were essentially “allegations that the company’s practices did not maximize shareholder profits.” Id. But the Court explained that complaints about corporate inefficiency, poor internal practices, “needless loss of revenue,” billing discrepancies, and the like, without more, do not constitute fraud. Id.

Moreover, the fact that the company took Day’s complaint seriously, heard him, investigated his allegations, and gave Day an explanation for the practices played a major role in the Court’s analysis. The Court wrote that “Day’s beliefs were not initially reasonable as beliefs in shareholder fraud and they became less reasonable as he was given explanations.” Id. at 58.

Conclusion

The First Circuit’s decision in Day v. Staples, is in line with the trend of federal cases strictly construing and therefore limiting the potentially broad scope of Sarbanes-Oxley. Day holds that in order to obtain whistleblower protection, an employee has to do more than merely voice complaints about internal operations that do not materially impact shareholders – he has to sufficiently allege a threshold case of fraud.

Moreover, Day encourages employers to take employee complaints and concerns seriously and investigate and respond to them appropriately. If employees continue to raise issues, the employers’ response likely creates a viable defense under the whistleblower provisions.

About the Authors

Joel Ginsberg is Deputy General Counsel at Guidance Software, an industry leader in digital investigative solutions.

Image Credit: ©iStockphoto.com/NickyBlade

View a PDF of the judicial opinion

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Josh Lawler
Joel Ginsberg

Companies Mentioned

Staples, Inc.

Also See:

Amgen Inc. v. Connecticut Retirement Plans & Trust Funds: Supreme Court Sides with Investors in Securities Fraud Class Action

Gabelli v. SEC: Unanimous Supreme Court Rejects Extending Statute of Limitations in SEC Enforcement Actions

In re Rigel Pharmaceuticals, Inc.: Ninth Circuit Increases Difficulty for Investors to Sue Drug Companies Based on Clinical Trial Results

Mastick v. TD Ameritrade, Inc.: Court Upholds Use of California Arbitration Act in Contracts Governed by California Law

Lawson et al. v. FMR LLC: Sarbanes-Oxley’s Whistleblower Protection Is Limited to Employees of Publicly Traded Companies

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Companies Mentioned

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The Public Employees’ Retirement System of Mississippi

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CIBC World Markets Corp.

Citigroup Inc.

Barclays Capital Inc.

Citigroup Global Markets, Inc.

TD Securities (USA), Inc.

BMO Nesbitt Burns Corp. n.k.a. Harris Nesbitt Burns Corp.

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W. R. Huff Asset Management Co., LLC

Guardian Capital Management

ABN AMRO Bank N.V.

Vesta Insurance Group, Inc.

Free Enterprise Fund

Banc of America, N.A.

Torchmark Corp.

Beckstead and Watts, LLP

Barclays Bank PLC

KPMG Peat Marwick, LLP

Deloitte & Touche LLP

Public Company Accounting Oversight Board

BNY Capital Markets, Inc.

Florida State Board of Administration

Credit Suisse Securities (USA) LLC

Credit Lyonnais Securities (USA) Inc.

The Cleaners & Caulkers Local 1 Pension Fund

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Ameriprise Financial, Inc. f.k.a. American Express Financial Corp.

Deutsche Bank AG

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The Royal Bank of Scotland plc

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Harris Nesbitt Corp.

Consolidated Management Group, LLC

The Bank of Nova Scotia

Asset Management Holding AG

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