Sarbanes-Oxley Act of 2002 (“SOX”) is a federal law. Congress passed it on July 30, 2002, in response to a number of major corporate and accounting scandals. SOX, among other things, created whistleblower protection for any employee who reports that a publicly-traded company subject to SEC regulations has engaged in any of a number of fraudulent activities.
Although introduced with great fanfare, the Ninth Circuit Court of Appeals just recently issued its first opinion analyzing the substantive requirements necessary to establish a claim under the Act’s whistleblower-protection provisions. In Van Arsdale v. International Game Technology, decided on August 13, 2009, the Court held whistleblowers must show only that they called attention to what they believed was fraud to sue their employers for wrongful termination under SOX.
International Game Technology (“IGT”) is a publicly-traded, Nevada-based company specializing in computerized gaming machines and similar products. The company hired Shawn and Lena Van Arsdale in January 2001 to work as in-house intellectual property (“IP”) attorneys.
In September 2002, IGT promoted Shawn to Director of Strategic Development. He generally was responsible for overseeing IGT’s IP litigation. IGT promoted Lena in 2003 to Director of IP Procurement, making her responsible for the transactional side of IGT’s IP division. Her job included managing IGT’s patents, trademarks, and copyrights. After their promotions, both Shawn and Lena reported directly to IGT’s General Counsel, Sara Beth Brown.
In September 2001, IGT began merger negotiations with Anchor Gaming (“Anchor”). Bally Gaming (“Bally”), one of Anchor’s competitors, began advertising a new “Monte Carlo” slot machine featuring a “bonus wheel” before Anchor’s merger with IGT. Two high-level Anchor employees asserted that the Monte Carlo machine infringed on a particular patent Anchor owned known as the “wheel” patent. The wheel patent was a valuable part of Anchor’s holdings and its validity could have affected the merger.
As part of his department’s due diligence in connection with the proposed IGT-Anchor merger, Shawn arranged to purchase a Monte Carlo machine in Chicago. He sent it to IGT’s outside patent litigation counsel so counsel could assess the machine’s effect on Anchor’s patent. Shawn met with outside counsel to discuss the possibility the wheel patent could be redrafted. After IGT’s inner circle discussed the issue, the company decided to proceed with the merger.
In August 2003, well after Anchor and IGT merged, the U.S. Patent and Trademark Office issued IGT a new patent. Anticipating litigation with Bally, IGT’s counsel during its pre-litigation investigation discovered that an Australian version of the Monte Carlo machine could invalidate IGT’s patent. As a result, the benefits of the IGT-Anchor merger may have been overvalued.
Shawn raised this issue internally, suggesting that Anchor may not have disclosed the potentially flawed patent to IGT. But management at IGT changed after the Anchor merger. The new CEO hired David Johnson, Anchor’s former General Counsel. Shawn and Lena raised the patent issue with Johnson. A few months later, IGT fired both of them for alleged performance problems.
Lower Court Proceedings
The Van Arsdales sued IGT in the Nevada federal district court. The complaint alleged violations of SOX’s whistleblower protection provisions and various other state-law claims. IGT moved for summary judgment, which the district court granted. The Van Arsdales then appealed to the Ninth Circuit Court of Appeals.
Elements of a SOX Claim
The Court of Appeals noted the case was one of first impression for the circuit. The Court examined the statute’s text and Department of Labor regulations. The regulations set forth four required elements of a SOX whistleblower claim: (1) the employee engaged in a protected activity or conduct; (2) the named person knew or suspected, actually or constructively, the employee engaged in the protected activity; (3) the employee suffered an unfavorable personnel action; and (4) the protected activity was a contributing factor in the unfavorable action.
To constitute protected activity, an employee’s communications must “definitively and specifically” relate to one of the listed categories of fraud or securities violations under the Act. An employee must also have (1) a subjective belief the conduct being reported violated a listed law, and (2) this belief must be objectively reasonable.
The Court concluded the Van Arsdales’ conversations about the patent issue definitively and specifically related to shareholder fraud, even though they never used the word “fraud” or referred to SOX. The Court explained an employee need not cite a code section he believes was violated to trigger the protections of the Act.
To have an objectively reasonable belief there has been shareholder fraud, the complaining employee’s understanding must at least approximate the basic elements of a securities fraud claim: (1) a material misrepresentation or omission of fact, (2) the employer’s knowledge of the misrepresentation or omission, (3) a connection with the purchase or sale of a security, (4) the employee’s on the misrepresentation or omission, and (5) economic loss.
The Court concluded the Van Arsdales’ fraud theory was valid. The wheel patent was an important asset Anchor brought to the merger with IGT. Given the potential effect of the Australian machine on the patent, the replacement of IGT’s management with former Anchor officials, and their alleged financial motives favoring nondisclosure, it was objectively reasonable for Shawn and Lena to suspect that the non-disclosure of the Australian patent prior to the merger could have been deliberate.
The Court pointed out it was not critical to the Van Arsdales’ claim that they prove that Anchor officials actually engaged in fraud in connection with the merger. The Van Arsdales needed to show only that they reasonably believed there might have been fraud and were fired for raising questions about it.
The Court also concluded the Van Arsdales had a subjective belief the conduct they were reporting violated a listed law because there was no evidence the Arsdales’ various complaints were made in bad faith and IGT did not suggest otherwise.
Other Elements of the Claim
With respect to the decision-maker’s knowledge, the Court concluded the Van Arsdales engaged in protected activity during the meeting with the new General Counsel, and other meetings with former management. IGT did not dispute that the Van Arsdales’ termination of employed satisfied the “unfavorable personnel action” element of their whistleblower claim.
The final element of a prima facie case under the Act is that the circumstances were sufficient to raise the inference the protected activity was a contributing factor in the unfavorable action. The primary evidence on this issue was the proximity in time of the Van Arsdales’ terminations to the meeting with the new General Counsel. In addition to the timing, Shawn’s seemingly positive record at IGT, and the lack of specific evidence in the record supporting claims about his performance, a reasonable fact finder could find Shawn’s protected activity contributed to his termination. Like Shawn, Lena was promoted shortly after joining IGT in 2001, and the record was bereft of specific evidence that she was performing her job inadequately. The Court held a fact finder could reasonably determine this asserted reason was a pretext for unlawful retaliation.
Because the Court concluded the Van Arsdales made out a prima facie showing of retaliatory termination in violation of the Act, IGT could not obtain summary judgment unless it showed by clear and convincing evidence it would have terminated the Van Arsdales even absent any protected activity. IGT did not argue it could satisfy this requirement on appeal, so the Court reversed the district court’s granting of summary judgment to IGT.
Although the elements of a whistleblower retaliation claim in violation of SOX are similar to other retaliation claims, the Van Arsdale analysis is significant for the relatively easy road it lays for plaintiffs to plead a prima facie case to avoid summary judgment. Employers should therefore include SOX whistleblower claims within the list of protected activities in their EEO and anti-retaliation policies and procedures and consult with outside counsel when faced with an employee complaint of fraud.