First Circuit Dismisses SOX Whistleblower Claims Against Staples, Inc.

Holding:

In a judgment of first impression for the circuit, the U.S. Court of Appeals for the First Circuit ruled that an employee’s (Kevin Day , or "Day") disagreement with management about internal tracking systems that are not reported to shareholders is not actionable. In so stating, the First Circuit laid down the rule that an employee’s accusations against a company’s alleged inefficient processes are not protected by the whistleblower provisions of the Sarbanes-Oxley Act of 2002 (“SOX”). In this case, Day filed SOX claims against his former employer Staples, Inc. ( “Staples”), alleging that he was terminated for reporting fraudulent practices in its accounting and other internal processes. The U.S. District Court for the District of Massachusetts issued summary judgment to Staples, stating that Day’s belief about fraud in the internal processes of Staples was not reasonable. On appeal, the First Circuit affirmed, holding that a company's management may legitimately decide that certain practices are more efficient than others.

Detailed Summary:

Plaintiff-appellant Day sued his former employer Staples alleging he was fired for reporting fraud, in violation of SOX’s federal whistleblower protection provision and of state law.

Day’s complaint did not assert any specific violations of securities laws; rather, it stated that he believed certain Staples practices resulted in the “manipulat[ion] [of] accounting data in an unlawful manner that had negative financial ramifications for Staples,” which “defrauded Staples’ shareholders” and violated the Staples Code of Ethics. Opinion, p. 2. The U.S. District Court for the District of Massachusetts granted summary judgment in favor of Staples. Id., citing Day v. Staples, Inc., 573 F. Supp. 2d 336 (D. Mass. 2008). Day then filed this appeal.

Day’s supervisors described many instances of serious dissatisfaction with Day’s job performance independent of his complaints about potentially fraudulent business practices at Staples. These concerns about poor performance began approximately three weeks after Day began working at Staples—one month before Day voiced concerns about possible fraud in one of the department’s practices to his supervisors—and continued until his employment terminated.

Day first filed a complaint with the Occupational Safety and Health Administration (“OSHA”) on September 26, 2005, alleging retaliatory termination in violation of the SOX whistleblower protection provision, 18 U.S.C. § 1514A.

On November 23, 2005, the OSHA investigator concluded Day’s claim lacked merit because Day’s concerns appeared to be a “disagreement with management” about internal procedures and were not the “protected activity of alleging intentional deceit of shareholders or violations of [Securities and Exchange Commission (“SEC”)] rules or regulations.” Id., p. 15.

Thereafter, Day filed his federal court complaint on April 11, 2006, alleging SOX and state-law claims. On February 7, 2008, the district court granted Staples’s motion for summary judgment on all counts and denied Day’s cross-motion for summary judgment. The district court held that Day’s SOX claim failed as a matter of law because his belief that Staples was engaged in accounting fraud was not reasonable. The district court reasoned that although “[Day’s] concerns were stated with adequate particularity, Plaintiff’s belief that he had uncovered fraud was not reasonable.” Id., pp. 15-16, citing Day, 573 F. Supp. 2d at 346. It based its decision in part on a determination that “Day lack[ed] the knowledge, training and experience to harbor a reasonable belief of fraud.” Id.

In resolving Day’s appeal, the First Circuit examined the whistleblower provisions of the SOX, stating that SOX protects “whistleblower” employees of publicly-traded companies by prohibiting employers from retaliating against employees because they provided information about specified potentially unlawful conduct. Id., citing 18 U.S.C. § 1514A; Welch v. Chao, 536 F.3d 269, 275 (4th Cir. 2008).

In this appeal, the First Circuit focused on whether Day had an objectively reasonable belief that the conduct constituted securities fraud or shareholder fraud. The plain language of SOX does not provide protection for any type of information provided by an employee but restricts the employee’s protection to information only about certain types of conduct.

On the basis of such analysis, the First Circuit found that Day’s assertions did not meet the basic components of fraud or of securities fraud. Specifically, a disagreement with management about internal tracking systems which are not reported to shareholders is not actionable.

Further, the First Circuit held that several of Day’s complaints amounted to allegations that the company’s practices did not maximize shareholder profits. Day’s belief was not itself an objectively reasonable belief that shareholders have been or are likely to be defrauded. A company may legitimately decide for a number of reasons that maximizing short-term profits through certain practices is not its goal, particularly if the practices lead to consumer unhappiness. Further, a company’s management may legitimately decide that certain practices are more efficient than others. A complaint about corporate efficiency is also not within the intended protection of SOX.

Further, “merely stating in conclusory fashion that a company’s books are out of compliance with GAAP would not in itself demonstrate liability under section 10(b) or Rule 10b-5.” Id., p. 24, citing In re Cabletron Sys., Inc., 311 F.3d 11, 34 (First Cir. 2002). Even when a company’s accounting method is in violation of GAAP, “some techniques . . . might prove to be entirely legitimate, depending on the specific facts.” Id. , citing Cabletron at 34-35. Claims that there has been accounting fraud thus require evidence beyond a belief in a mere accounting irregularity, and not even an accounting irregularity can be reasonably alleged here. Id., citing Novak v. Kasaks, 216 F.3d 300, 309 (2d Cir. 2000).

On the basis of the foregoing, the First Circuit affirmed the district court’s grant of summary judgment to Staples.

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