Sarbanes-Oxley and Whistle-blower Protections

Sarbanes-Oxley and Whistle-blower Protections

By Phil Kleckner and Craig Jackson

Editor’s Note: Part 1 of a series.

One can only wonder how much damage would have been avoided if Enron employee Sherron Watkins had blown the whistle sooner.

Discussion about the Sarbanes-Oxley Act has largely focused on corporate governance and accounting independence issues for publicly traded companies, and overlooked the implications for companies whose employees “blow the whistle.” In fact, Sarbanes-Oxley has increased the protection provided to whistle-blowers in three major areas:

Publicly held companies are now required to have a venue in place to receive the reports of anonymous whistle-blowers. Section 302 of Sarbanes-Oxley states: “Each audit committee shall establish procedures for the confidential, anonymous submission by employees of the issuer of concerns regarding questionable accounting or auditing matters.”
After receiving a report, any investigation conducted must comply with section 806 of the act, which states that “no publicly traded company, or any officer, employee, contractor, subcontractor, or agent of such company may discharge, demote, suspend, threaten, harass, or in any other manner discriminate against an employee in the terms and conditions of employment because of any lawful act done by the employee.” What exactly can be considered a threat? What constitutes harassment? How do you know the identity of an anonymous whistle-blower?
Sarbanes-Oxley provisions have made it clear that retaliation against whistle-blowers will not be tolerated. A new section, 1513(e), has been added to Title 18 of the U.S. Code. It is now a criminal offense to retaliate against whistle-blowers, carrying penalties from a large fine to 10 years in prison.

Current company policies may no longer be sufficient to meet the requirements of section 806 of the act, which dictates the course of action a company will be permitted to take to address allegations of internal fraud. Before Sarbanes-Oxley, an investigation undertaken by a company to look into allegations of internal fraud could have uncovered the identity of the whistle-blower. Now, an allegation by the whistle-blower that she was “harassed or discriminated” against could have a serious impact on the company.

If an audit committee were to receive an anonymous letter regarding employee fraud, it would seem logical to provide this information to the company’s internal auditors. Unfortunately, because internal auditors may be close to day-to-day operations, it is conceivable that the identity of the whistle-blower would be discovered by the internal auditors during the investigation, which could lead to a claim of harassment or discrimination. Similarly, if the audit committee were to give the information to internal counsel, there is a good chance the whistle-blower’s identity could be discovered.

Section 806 of Sarbanes-Oxley has made it difficult for companies to handle fraud investigations internally. Companies will most likely retain outside special counsel in order to maintain independence during investigations. Outside special counsel has no motivation to seek out the identity of the whistle-blower. They are merely concerned with ascertaining any truthfulness behind the allegations found in the anonymous letter.

The retention of outside counsel may not totally solve the problem. Most fraud involves the unlawful depletion of company assets. Therefore, the investigation will need the services of someone with financial expertise. Because section 806 could disqualify an internal audit, a company would be likely to retain its external auditors to perform forensic work. However, the Enron case demonstrated that the external auditor can become so entwined with the leaders that it loses its independence long before the company’s final crash. Section 201 of Sarbanes-Oxley makes it clear that public accountants who audit a company’s financial statements are advocates of the company, and cannot perform independent forensic work.

Forensic accountants are specialists that take traditional accounting one step further and ask the question, Why? Unlike traditional auditors and tax accountants, forensic accountants specialize in areas such as fraud examination, business consulting, business valuation, bankruptcy, and a number of others. Forensic accountants are interested in providing tangible services, not compliance services.

The Sarbanes-Oxley Act, while only imposing regulation on public companies, has presented some unique questions for non–publicly held companies. For example, according to Sarbanes-Oxley, a company’s auditor is prohibited from providing forensic services to a client because of independence issues. However, if the auditor’s client is not a publicly held company, no independence issue exists. It will be interesting to see a court’s reaction to this question. Private companies would be wise to avoid jeopardizing themselves by raising this issue.

The Sarbanes-Oxley Act’s improved whistle-blower protections will go a long way toward ensuring that future frauds will not occur. Companies will have to develop measures to investigate whistle-blower reports that will investigate the accuracy of the claim, and avoid any action that can be considered harassment, discrimination, or threatening, while maintaining the anonymity of the whistle-blower. The new penalties for violating any of the above should be incentive enough to ensure compliance. Furthermore, by forcing companies to retain expertise from sources other than external auditors, books and records will be more scrutinized than ever.

Phil Kleckner, CFE, CPA/ABV, is the director in charge of the business crimes group, and Craig Jackson, MA, is an associate, both at RosenfarbWinters, LLC, in Roseland, N.J.